Can behavioural economics help us understand and fight poverty?

Dawid-Willem Pienaar

There is much debate in the development world about the degree to which governments, NGOs and aid agencies should intervene in the lives of the poor. The thinking can be divided into two broad ideological groups. The first group, taking roughly the neoclassical economics view, assumes that poor people (like everyone else) are highly rational beings with coherent beliefs who make good choices that are in their own best interests, subject to constraints; and that there is therefore little justification for meaningful interventions into their lives or decision-making. The second group, by contrast, support interventions because situational and psychological constraints can lead the poor to making bad decisions.

Behavioural development economics charts a course somewhere between these two extremes – suggesting that poor people are for the most part just as rational as everyone else, but that their unique situation causes psychological biases and weaknesses to have a more detrimental effect on their lives.[i] Behavioural economists do not see people living in poverty as irrational beings that are in constant need of guidance. Instead, they look for specific cases where mental biases lead to sub-optimal choices, and aim to show how seemingly small tweaks can substantially increase the success of policies.

Applying behavioural economics to poverty analysis: an example

People tend to be “time-inconsistent” or “present biased”. This means that when making decisions, people tend to put much greater weight on their immediate happiness than on what would make them happy in future; i.e. we tend to procrastinate and succumb to short-term temptations. For example, although you don’t want to go the gym right now, you’d like, (and even expect!), to go the gym in future. But when the future becomes the present, you may again decide that it would be best if you put off going for the gym…just for a bit – creating a vicious cycle of gym avoidance. This cycle can often only be broken through the use of ’commitment devices‘ (e.g. telling a friend you’ll meet them at the gym the next morning).

As innocuous as this effect may seem, it can have a substantial impact on those living in poverty, particularly in relation to their borrowing and savings behaviour. For example, a recent study suggests that succumbing to temptation, say by buying cigarettes, is much more damaging to the poor than to the middle class who can afford to “waste” some of their income and still be able to save.[ii] This can help explain why the poor often save very little and (seemingly irrationally) rely on formal or informal rolling short term credit despite excessively high interest rates. The same level of self-control problems, that have small effects on middle class consumers, can trap lower-income consumers in poverty.

Research also suggests that people are less resistant to temptation and more prone to errors when they are subject to mental strain. One study finds that even trivial tasks such as being asked to remember a 7 digit number makes people succumb to simple temptation (choosing chocolate cake rather than fruit salad) more easily than they would otherwise.[iii] The tremendous emotional, mental and physical strain associated with a life of poverty might therefore make the poor not only more sensitive to the impact of seemingly frivolous expenditure, but more prone to it than their higher-income counterparts. And temptation goods have indeed been shown to form a much larger part of poor households’ spending.[iv]

As a way of overcoming this potentially self-destructive behaviour, the poor often seek out ways to commit to actions that don’t seem optimal without an understanding of self-control problems. This includes preferring illiquid savings accounts (often with very low interest rates), or taking part in informal peer-to-peer savings groups like Rotating Savings and Credit Associations (ROSCAs) as ways of constraining spending and committing to saving.[v]

How has behavioural economics affected policy?

Behavioural research has also shown that people respond to the way that information and choices are presented. For example, people often do not deviate from default options. Retirement savings increase significantly when employees’ default option is to automatically contribute a proportion of their salaries to retirement savings each month, even when very little effort is required to avoid this option. Similar results are found for vaccination and organ donation in developed countries. A much larger proportion of people are vaccinated in school or listed as donors when they are automatically included in these schemes unless they decide to opt out.[vi] Policies like these, that don’t limit choices but present options in a way that subtly suggests an appropriate course of action, are often called ‘nudges’; and are gaining popularity in the developed world. The UK government’s ‘nudge unit‘, which incorporates behavioural insights into government policies and communications, has been so successful that it now also advises other governments.[vii]

Such nudges can have a substantial positive impact on groups, like the poor, that are particularly susceptible to specific behavioural biases. By influencing these groups to make economics decisions that have positive direct impacts, nudges can improve the overall welfare of society. What makes nudges particularly popular is that they don’t restrict personal choice. The option to choose alternatives still exists, it just requires (minimal) extra effort. Since behavioural biases affect people to differing degrees, nudges avoid forcing the same options on everyone.

In fact, nudges can often be designed to target only groups exhibiting specific behaviour (and in doing so also increase the cost-effectiveness of policies) as the following example illustrates. Many countries controversially provide large subsidies on fertilizers. A recent study suggests that some (but not all) farmers underestimate their future self-control problems and continually delay buying fertilizer – which incurs costs today but increases future crop yields – in the belief that they will buy it later.[viii] A randomised control trial in Kenya showed that a once-off discount in the price of fertiliser can get some farmers to start buying fertilizer earlier (the discount is temporary, so procrastination is not an option). More importantly, many of the new buyers started permanently using fertilizer even after the price was returned to its normal higher level. The once-off decrease in price thus seems to only affect the long-term behaviour of farmers with self-control problems. This kind of intervention, therefore, avoids the potential distortion created by long-term fertilizer subsidies which often lead to the overuse of fertilizers (with negative fiscal and environmental implications). Accounting for present-bias thus helped to design a policy that is as effective as traditional policies in this area, but that avoids many of the costs and distortions linked to more traditional policies.

Reasons for caution and the way forward

Behavioural theory, however, is no policy-making silver bullet.[ix] Policymakers are also subject to psychological biases and may not always interpret the lessons of behavioural theory correctly. Additionally, studies have shown that correct decisions are more likely when the stakes are higher, and people clearly have higher stakes in their own lives than policymakers do.

What is clear, however, is that where interventions do take place, it will often be possible to make them more effective by considering behavioural factors. Evidence so far suggests that the minutiae of policy design and implementation matter greatly, and that the success of policy interventions depend on the extent to which they enable individuals to access and correctly evaluate information to make good decisions.

The discipline is still in its infancy and has a long way to go before it is fully integrated into mainstream economics. Many ground-breaking results have only been proven in very specific lab or field settings, and often several different biases can explain the same non-rational behaviour.

However, neoclassical economists have for too long downplayed the impact of seemingly ‘irrational’, but very real and consistent, behaviour when suggesting policies. In politically divisive topics such as poverty eradication, it is encouraging that economists are increasingly investigating how people actually think and behave; rather than how we would like them to.