OPINION: How to Stamp Out Poverty? Behavioral Economics

(The Philadelphia Inquirer/TNS) —

Albert Einstein is credited as defining insanity as doing the same thing over and over again and expecting a different outcome. While this statement is used for a variety of situations, perhaps it is nowhere better applied than when characterizing this country’s numerous attempts to eradicate poverty.

In 1964, President Lyndon Johnson declared war on poverty. At the time, 14.7 percent of Americans were living below the poverty level, according to the U.S. Census. Fast forward to 2013, and 14.5 percent of our citizens were poor.

Jason Zweig of Money Magazine says there are many reasons for the lack of progress in this ongoing battle. In a Wall Street Journal article, he shows how most antipoverty programs have not considered how people actually act.

The hodgepodge of national, state and local incentives and programs designed to address this issue assume people will minimize risk and maximize activities that achieve short- and long-term financial well-being. This approach – the foundation for which can be found in 18th-century Enlightenment thinking – serves as the basis for classical economics, as well as for policy on taxes, savings and social welfare programs.

Unfortunately, we know all too well that people do not always act rationally. If they did, they would optimize the amount of money they put in tax-free savings and take full advantage of compound interest.

Using the same logic, people would not buy lottery tickets because the probability of “winning big,” so to speak, is infinitesimal. Yet, buy them we do. People with the lowest per-capita income are the most likely to buy lottery tickets.

We also know that those who take out payday loans are paying phenomenally high interest rates. Yet such loans remain popular.

We know that companies charge exorbitantly high interest rates to those who borrow on their pending tax return, but every tax season a large number of people do just that.

Behavioral economics is a relatively new field. It documents the many ways in which human minds fall short of perfect rationality. Working with psychologists, behavioral economists develop incentive-based policies based on what we know about ourselves as humans.

For instance, Lutheran Social Services developed a program, partially underwritten with a grant from the Calvin K. Kazanjian Economics Foundation, to help people who were falling behind on their mortgage and other payments. Realizing that people like to gamble, families who made payments on time became eligible for occasional drawings worth several thousand dollars. The results have been phenomenal, as the program has increased the financial well-being of participants.

Behavioral economists at Yale, Harvard, Columbia and the Massachusetts Institute of Technology, as well as several large state universities, have set up experiments using random groups to help people save. It is human nature to procrastinate, especially when it comes to retirement savings. With this in mind, behavioral economists designed experiments where two groups were told about the benefits of starting a tax-free savings account. One group was told they need not begin to save for five months. The control group was asked to start saving immediately.

Within three years, the group that was offered the deferred savings plan increased their savings substantially more than the group that was told to begin saving immediately. Most in the latter group procrastinated; some never saved at all. Interestingly, the rate of increase in savings was more pronounced among those with low income as compared with middle-income families.

It is human nature to want to be part of the crowd. That is true in this country as well as others. In India, borrowers in “repayment groups” convened weekly to pay off a portion of their debt. They were three times less likely to default on their next loan, according to Zweig. In this country, a similar program is being introduced by some banks, credit unions and financial-counseling organizations.

Many other experiments are underway. They all share one common denominator: Behavioral economists figuring out human tendencies and then designing savings and debt-repayment plans, and other strategies that appeal to our natural instincts. This approach seems to work with people in a number of countries and with a variety of income levels, but it is most effective with those in the low-income bracket.

Behavioral economics may be a way to address the seemingly irretraceable problem of poverty and poor money management. The alternative is the proliferation of programs that exacerbate, rather than alleviate, the problem. We should give some of the ideas of behavioral economists a try, because with few exceptions, doing what we have been doing over and over again simply isn’t working.

_ _ _

Michael A. MacDowell is president emeritus of Misericordia University in Dallas, Pa., and managing director of the Calvin K. Kazanjian Economics Foundation.

To Read The Full Story

Are you already a subscriber?
Click to log in!