Illiquidity does not seem to lower the quality of decision-making

by on March 12, 2016 at 3:08 am in Economics, Uncategorized | Permalink

There is a new AER piece by Leandro S. Carvalho, Stephan Meier, and Stephanie W. Wang, here is the abstract:

We study the effect of financial resources on decision-making. Low-income US households are randomly assigned to receive an online survey before or after payday. The survey collects measures of cognitive function and administers risk and intertemporal choice tasks. The study design generates variation in cash, checking and savings balances, and expenditures. Before-payday participants behave as if they are more present-biased when making intertemporal choices about monetary rewards but not when making intertemporal choices about nonmonetary real-effort tasks. Nor do we find before-after differences in risk-taking, the quality of decision-making, the performance in cognitive function tasks, or in heuristic judgments.

I would describe that one as a victory for Gary Becker…

Here are ungated versions.

1 Ray Lopez March 12, 2016 at 8:38 am

Translate into English please? My 15 second read (trying to be first) is that poor people on payday don’t make ‘give it to me now’ decisions about non-money issues, but do for money issues?

2 anon March 12, 2016 at 9:06 am

Ray, even as an economist, I had to read the intro to get the point, the abstract is not as accessible … see this bit:

“The poor often behave differently from the non-poor. For example, they are more likely to make use of expensive payday loans and check-cashing services, to play lotteries, and to repeatedly borrow at high interest rates. The debate about the reasons for such differences has a long and contentious history in the social sciences. The two opposing views are that the poor rationally adapt and make optimal decisions for their economic environment or that a “culture of poverty” shapes their preferences and makes them more prone to mistakes.”

This paper suggests that the poor are reacting to financial constraints in a rational way (not enough cash, liquidity temporarily can make it “rational” to react to an inflow of money). Their results do not suggest that the poor are short-sighted (or have other preferences that make them behave differently than the non-poor) or that they are under so much stress that they can’t make sound decisions in general. The big question is whether the temporary “poverty” around paydays which is the focus of this study generalizes to persistent poverty. It probably does not fully but this is a cleverly designed study.

3 Ray Lopez March 12, 2016 at 9:30 am

Thanks but it still makes no sense. So the study is saying that playing the lottery on payday or buying whiskey instead of milk is rational, not ‘culture of poverty’?

4 BC March 12, 2016 at 11:30 am

The study is saying that playing the lottery is not *caused* by (the financial stresses of) poverty. Poverty may impose liquidity constraints but does not seem to *cause* one to make different (non-liquidity-related) decisions, impair cognitive function, take different risks, etc. In other words, a poor lottery player is just as likely to play the lottery right after receiving his paycheck, when his financial stresses are lower, than right before. The stress of running out of cash in and of itself does not seem to impair his decision making.

5 anon March 12, 2016 at 11:36 am

Ray, you would have been disappointed if you had participated in the survey experiment no lottery tickets or whiskey involved …

“In the monetary intertemporal choice task … participants were asked to allocate an experimental budget of $500 into two payments with pre- specified dates, the second of which included interest. Participants had to make 12 of these choices in which the experimental interest rate varied (0%, 0.5%, 1%, or 3%), as did the mailing date of the first payment (either today or four weeks from now) and the time delay between the two payments (four weeks or eight weeks). Approximately one percent of the participants were randomly selected to be paid based on one of their 12 choices.”

Present bias here is wanting the money much sooner (today versus a four weeks for the early payment makes a big difference in whether choose early or delayed payment). They find that the pre-payday (poor) group is more likely to choose the very immediate reward is than the post-payday group; however, this seems to tied up with a need for money … not a persistent trait. They are also look at a real effort task which did not involve money:

“also were asked to make intertemporal choices regarding real effort … participants had to choose between completing a shorter survey within 5 days or a longer (30-minute) survey within 35 days. They were asked to make five such choices, with the length of the earlier survey gradually increasing (from 15 to 18, 21, 24, and 27 minutes). Five similar choices followed, in which the deadlines were shifted from 5 to 90 days (shorter) and 35 to 120 days (longer). Approximately one percent of the participants were randomly selected to have one of their 10
choices implemented (i.e., “implementation surveys” were sent to those selected participants).”

Here they find no differences in present bias in pre and post payday groups. The experiments are a bit contrived but IRL it is very hard to sort out causal factors, so this adds to the discussion of what drives apparently bad decisions of the poor. Also note that liquidity constraints (a temporary lack of money) are much “easier” and less intrusive to solve (give people better access to credit/smooth out payments) than teaching patience. Of course, paydays are regular, easy to predict, so I’m not sure if we are really talking about liquidity constraints the way standard econ models imagine. Also the authors find present bias (problems in self control) in both their “poor” and “non poor” groups … so more liquidity might create more (and broader) problems.

6 Ray Lopez March 12, 2016 at 1:23 pm

OK, thanks. It seems your interpretation is not consistent with the others upstream, but maybe it’s like the three wise blind men with the elephant, each is feeling a different part of the animal. And this seems obvious: “They find that the pre-payday (poor) group is more likely to choose the very immediate reward is than the post-payday group; however, this seems to tied up with a need for money … not a persistent trait ” – so poor people need money fast, but if they don’t need money they don’t act so poor? Whatever. I doubt this social science paper is reproducible. I think the TC reference to Gary Becker is something along the lines of between giving a poor person cash or free cheese, or free legal aid, it’s best to give them cash since the poor folk know best and will not, contrary to conventional wisdom, play the lottery and/or buy whiskey with it.

Shorter synopsis: for the poor, increased liquidity does not mean buying more whiskey!

7 Owen March 12, 2016 at 8:45 am

(“randomly assigned to receive an online survey”)

Oh it was a ‘random’ survey process, so the results must be really scientific and can be generalized to a very large population.

The responses were not at all a random sample of the population being studied. Plus the responses were self-reported data (unverifiable). And online-surveys are the gold standard of survey research.

Facts are unimportant. Important thing is that the authors got a “Study” published with their names on it.

8 Nathan W March 12, 2016 at 9:16 am

And to think that all of these shortcomings are highlighted directly in the abstract. If only all research were so forthright … that alone might be good cause to publish this particular paper.

9 Owen March 12, 2016 at 9:31 am

Nonsense

10 Owen March 12, 2016 at 9:52 am

…that is the abstract is nonsense, and self-incriminating as noted.

With all the recent attention on the Replication Crisis in scientific studies, one might suppose there would be more caution by researchers and those who publicize research.

11 Nathan W March 12, 2016 at 10:04 am

Some things are for practical purposes not easily (or at all) replicable. This should not stop us from getting some hints at what’s going on.

In many studies, the incriminating parts are hidden in the footnotes or appendices. Putting them in the abstract should be considered good practice, in my opinion. It primes the reader to take the results with a grain of salt, which is intellectually honest.

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