
Economists Discover the Poor Behave Differently From the Rich - jmacd
http://www.businessweek.com/articles/2013-11-07/economists-discover-the-poor-behave-differently-from-the-rich#r=rss
======
jonnathanson
Apropos of nothing: that is the weirdest stock photo I've seen in months, the
caption underneath it is asinine, and the guy on the left sort of looks like
Matt Damon.

Apropos of the article: the headline is really making hay out of a tangential
point. Sure, the "poor vs. rich" angle gets more clicks and inbound links. But
the real point -- which is a huge one, as far as the field of economics is
concerned -- is that the "rational (and by implication, homogeneously
rational) actor" presumption is under fire. It's been under fire before
because people have been shown, time and again, to behave economically
irrationally. But this time it's under fire because people have been shown to
react heterogeneously to the same stimuli and incentives. (Not really touched
upon in the article, but also worth mentioning: a third major critique in
recent years has been the revelation that classical economics was highly
skewed by the idiosyncrasies of the Western cultures in which it was
cultivated and codified. It turns out that not everyone around the world
behaves like 19th-20th Century Austrians, Britons, or Americans.)

All of this is huge, I repeat, because pretty much _every_ foundational theory
in classical economics is predicated on homogeneity and rationality. Every
single one. The entire field. Even a preponderance of modern economics is
undergirded by flawed assumptions borrowed from classical models.

I, for one, am really excited by the modernist, behaviorist, relativist,
empiricist and frequentist challenges to classical economics. This is sort of
like seeing a paradigm shift in a highly influential field of study play out
in something resembling real time. Economics has always been based on
statistics -- even highly sophisticated statistics -- but the inputs, so to
speak, have been pretty unsophisticated. These challenges will help drag
economics into the 21st century.

~~~
anigbrowl
_people have been shown, time and again, to behave economically irrationally_

Likewise, choices that appear irrational may turn out to be entirely sensible
but for the exclusion of relevant factors. Having been quite poor in the past
I can certainly distinguish between irrational choices of the 'oh fuck it, let
tomorrow take care of itself' variety and rational ones of the 'this is
inefficient, but satisfies constraints' type.

As an example of the latter, consider riding the bus. In many places you can
get a monthly pass at a substantial discount to paying multiple fares every
day. But for someone who is un- or under-employed, the expected value of
purchasing the monthly pass is quite different from that of someone with a
predictable commute; if that person makes the wrong guess about how often s/he
will travel over the month, it can result in a significant opportunity cost.

Then there's the even simpler case of the person who can't accumulate enough
cash at a time to buy the monthly pass, but who won't be able to get paid at
the end of the week without taking the bus to work each day. Absent credit
facilities, paying bus far on a day-by-day basis can be perfectly rational
when viewed in the individual's overall economic context. Unfortunately,
economics textbooks don't devote much attention to multiple inelastic
constraints.

~~~
yummyfajitas
_irrational choices of the 'oh fuck it, let tomorrow take care of itself'_

Having a high discount rate is not irrational. Multiple discount rates are,
but a single high discount rate is perfectly rational.

~~~
anigbrowl
It depends. There have certainly been times where I've deferred some necessary
purchase in favor of a frivolous one, eg choosing to pay a bill late so I
could go out with friends and have beers. Now that's not so bad if you know
you're going to be able to pay the bill next week, and arguably there's some
psychological benefit in being social and and consuming some alcohol to de-
stress, not to mention the signaling value of apparent economic liquidity.

But if you discount the future too liberally, then pretty much anything can be
spun as a rational choice, eg drug addiction, being a hobo, taking up crime or
whatever. I smoked fairly heavily for about 20 years, which I'm sur is going
to have some negative impact on my future lifespan/quality of life, if the way
I felt by the time I quit is anything to go by. For all that I liked smoking
at times, it was basically a symptom of nictotine addiction and I can't say my
life was improved by having been a smoker. This is certainly one case where I
discounted the future too heavily.

~~~
xixi77
I think you are confusing irrationality with ex-post regret. It is to be
expected that people would come to regret many choices that were rational at
the time they were made.

Not everything we do is rational, but all the things you mentioned can -- and
imo should, absent evidence to the contrary -- be treated as rational choice.

~~~
anigbrowl
Oh come on, you've never done anything that you _knew_ was a bad idea before
you did it?

------
yetanotherphd
For people who are saying "how could economists be so stupid" here is some
background:

First, economics as a field has somewhat fallen into a trap where people are
overly focused on models that are analytically tractable. This leads them to
use unrealistic models that can be solved with infinite horizons, rather than
realistic models with finite horizons.

Second, there is always a limit to how realistic your model can be, so unless
there is a strong reason to think that heterogeneity is important in your
model, you probably won't include it. In this case it may not have been
completely obvious that heterogeneity was really important in analyzing the
effects of stimulus.

Finally, most people with economics degrees are about as privileged as people
with the same degree level in other fields. So being privileged really cannot
explain disagreements between economists and other educated people.

------
diminoten
Well yeah, people are different, this is blatantly obvious. But gravity isn't
9.81m/s^2 either[0]. And the speed of light isn't "c" (299,792,458 m/s) or
even constant at all[1].

But these "wrong" facts are useful when creating predictive models of our
universe. That's all this is - a "wrong" fact used to help simplify a model.
Turns out the representative agent might be an oversimplification, but so are
G (9.81 m/s^2) and c (299,792,458 m/s), depending on what you're doing.

In a "science" (science is a methodology and lies a spectrum, and is not a
dogma, so let's try to keep some perspective) where you don't really have a
"lab", all you can do is create predictive models that fit your observational
data.

Technology of the past 10 years brings more data, and lets economics move away
from the representative agent of the past 100 years. Good. Let's do that, but
let's not forget whose shoulders we sit on - no one mocks the orbital model of
the atom, or Newtonian laws of physics, even though both models are outdated
[2][3].

    
    
        [0] - http://curious.astro.cornell.edu/question.php?number=465      
        [1] - http://arxiv.org/abs/astro-ph/0305457    
        [2] - http://spiff.rit.edu/classes/phys314/lectures/bohrprob/bohrprob.html    
        [3] - http://en.wikipedia.org/wiki/Classical_mechanics#Limits_of_validity

------
guelo
> For example, Olivier Blanchard, now chief economist of the IMF, wrote in
> 1990 that when a government tightens its belt to reduce deficits, households
> might start spending, relieved that the problem is being handled and there
> won’t be an even bigger readjustment in the future.

It is astounding to think that changing your personal spending based on what
happens in DC is supposed to be the "rational" behavior. These are not
economists, they are radical political ideologues dressed in pretend academic
clothing.

~~~
yetanotherphd
The idea is that people will anticipate that because the government is
reducing deficits now, it will have less fiscal problems in the future, and
therefore the individual will be less likely to be affected by higher taxes in
the future or a greater fiscal crisis in the future.

The individual doesn't have to deduce this themself. The information could
come second or third hand through a variety of channels.

------
LukeWalsh
Articles like this just go to show how little acceptance there still is for
behavioral economics data in mainstream policy making.

Just a few years ago data from lab experiments was not widely accepted because
people were unsure if it was relevant to how people act in the real world.
Countless times the effectiveness of lab experiments has been proven.

I am looking forward to the day when people finally accept that traditional
economic models are not perfect (duh!) and that people are not perfect,
rational, decision making robots.

------
dschiptsov
Oh, god, they finally discovered that people live possessed by emotions, are
ignorant, and that the model of a rational agent optimizing its payoff is just
disconnected from reality nonsense?)

There are huge cultural differences also. Russians are spending enormous
amount of money on their mistresses using easy bank credit they barely able to
pay back, while Cambodians are buying Lexus cars while living in wooden
shacks, etc.

While so-called poor people (read _proles_ \- ignorant working class with very
restricted, repetitive behavior) are much more prone to the peer and the
bandwagon effects and much more concerned about "equality" and conformity, no
oversimplified economic model could capture a complex and volatile behavior
even of a primitive drunk.

My guess is that so-called "behavioral economics" and "behavior finance" are
attempts to make more realistic and useful models, together with an important
notion that the whole system is extremely dynamic, volatile and constantly
changing/evolving. Equilibriums are moving.

------
Aloha
How could they not know this?

"The challenges the world faced in 2010—low home values, credit hard to get,
central banks unable or unlikely to lower interest rates further—“were
nonexistent in representative-agent models,” says Christopher Carroll, who
teaches at Johns Hopkins. At the ECB’s Frankfurt conference, Carroll presented
a paper that bolstered Krusell and Smith’s model with microeconomic data. For
Carroll, people differ in one crucial way. “The marginal propensity to
consume,” according to the paper, “is substantially larger for low-wealth than
for high-wealth households.” Rich people behave like the hyperrational agent.
They plan for the future. They save during a stimulus, thinking about the
taxes to come. And they can borrow during a fiscal contraction.

Poor people are what economists call “borrowing constrained.” They tend to
have more needs than are being met, so when money arrives, they spend it. When
the government stops spending and credit is hard to come by, the mythical
everyman, like the rich person, continues to spend. But most real people don’t
have access to credit, and they hunker down. Carroll’s findings have been
confirmed by other academics in the last two years who looked at Italian and
U.S. data."

I remember what poor was - I always knew where my paycheck went well before I
got it.

~~~
xixi77
I have not seen the Carroll paper, but actually all the description in the
article fully applies to the original Krussel and Smith paper, which I know
very well.

One problem here is that actually, heterogeneity does not really matter much
for the aggregate! In other words, the model may be more realistic, but the
aggregate behavior -- such as consumption and economic growth -- tends to be
relatively unaffected by inequality. This happens because of two things: (1)
the poor people, exactly because they are poor, do not consume enough to
create a meaningful economy-wide impact, and (2) people really hate being
poor, and save more during good times so that they don't get hit with the
constraints in bad times. The second one can be to some extent accounted for
by allowing a sizable fraction of people to be somewhat irrational, and by
getting rid of the "infinitely lived" consumers; the first would stay though.
I am curious about what is exactly done in the Carroll paper to make it
matter.

------
ilaksh
Economics is not a science. Its a series of attempts to rationalize
inequality. The IMF is a criminal organization. Austerity is both
international and class warfare.

~~~
anigbrowl
Economics most certainly is a science. You're addressing a failure of
macroeconomics, which I agree is quite deficient in many ways. Microeconomics
works fantastically well in most cases.

 _The IMF is a criminal organization._

Never ascribe to malice what can be adequately explained by stupidity.

~~~
jafaku
> Never ascribe to malice what can be adequately explained by stupidity.

Do you seriously think you can just copy paste a phrase that sounded about
right in certain context and reuse it everywhere?

~~~
anigbrowl
I've found it extremely useful advice to live by. It's easy to ascribe wicked
motives towards one's antagonists, but doing so leads down a rabbit hole of
magical thinking because you really don't know what motivates them in most
cases. All sorts of ill-effects can result from people who sincerely believe
they're doing the right thing but who have failed to fully appreciate the
consequences of their actions. It's more productive to address the undesirable
outcomes of a policy than it is to demonize the policy makers, unless you have
abundant evidence of ill-will.

~~~
Digit-Al
> All sorts of ill-effects can result from people who sincerely believe
> they're doing the right thing but who have failed to fully appreciate the
> consequences of their actions.

Or to put it another way: The road to Hell is paved with good intentions.

------
krallja
How depressingly obvious.

~~~
anigbrowl
The other sad thing about macro is a lack of consideration about the cash
constraints facing poor consumers.

For example, suppose there's some 20% off offer available on a regular
household expense. The rational thing to do is buy in bulk so you can take
advantage of the offer, but if you're poor that option isn't necessarily
available, because buying in the requisite quantity to receive the discount
means going without some other necessity - eg there's no point in buying lots
of diapers when they're on sale if it means there's no money left over for
baby food.* Of course couponing allows for fairly flexible strategies and with
time the savings can add up, allowing for some greater flexibility; but the
underlying fact is that the more money you have, the easier it is to take
advantage of discounts that save you money. Inability to access economies of
scale is a brutal fact of life at the bottom of the economic pyramid that
manifest almost every time one needs to buy food.

* It's just an example, don't get hung up on what exact level of public assistance is available to people with babies in an attempt to negate the point.

~~~
unclebucknasty
This is absolutely true and is a part of the general cash flow problem that
the poor face. Never having surplus (or even being at a defecit) after
attempting to meet their basic needs month-over-month serves to keep them from
moving ahead.

For instance, it is very difficult to reduce debt, invest, obtain an
education, or otherwise "get ahead". All income is instead spent on day-to-day
subsistence, so they continue to receive a lower share of the economy, while
paying down little principal and paying maximum interest.

It's another overlooked element: it's not just about income and wealth. It's
about cash flow. It's just somehow odd that if a person earned the same income
over his lifetime, but received a sizeable advance on some portion, it could
dramatically alter the quality of his life.

------
mritun
This is just mind boggling. This article is another piece that shows that
economists are behaving like evil... pure evil!

Leave aside experiments on humans and animals, these guys are basically
experimenting with families and entire nations just for fun of gathering more
"data" for theories they can confirm or deny by just asking people in the
streets.

Kind of makes me help understand why Indian politicians were such staunchly
opposed to recommendations of IMF and their group of economists all along.
Those rich idiots don't know how 99% of the world functions.

~~~
code_duck
They're not evil, merely really, really bad at their jobs. They seem to
believe they're doing the right thing.

------
known
How Poverty Taxes the Brain

[http://m.theatlanticcities.com/jobs-and-
economy/2013/08/how-...](http://m.theatlanticcities.com/jobs-and-
economy/2013/08/how-poverty-taxes-brain/6716/)

------
AnthonyMouse
> Attempts to divine—or calculate—how fiscal decisions affect the economy rest
> on the “marginal propensity to consume,” the likelihood that if you put a
> dollar in someone’s hand, he will spend rather than save it.

Why are economists always so hung up on the concept of saving vs. spending, as
though one is inherently better than the other?

Spending is good because it stimulates the economy -- if 1000 instances of Joe
buy some new clothes then the clothing retailers can hire some new sales
staff. Investing is good because it stimulates the economy -- if 1000
instances of Joe buy a share of stock then the availability of capital to
create new small businesses increases and new small businesses create jobs.

It isn't about spending vs. saving, it's about whether the money goes to
something productive or efficient or it goes to something harmful or
inefficient. If a rich person gets more money and invests in small businesses,
that's good. If a rich person gets more money and uses it to hoard precious
metals, that's bad. If a poor person gets more money and uses it to buy books
and go to college, that's good. If a poor person gets more money and uses it
to buy cigarettes or to secure credit to buy an inefficient luxury SUV, that's
bad.

It's not about saving vs. consumption. Unless someone is just stuffing cash
into a mattress (which _is_ bad and also stupid), "saving" is just consumption
of investments, which is consumption by proxy when the invested-in entity
spends the money. The question is whether the thing ultimately consumed is
more beneficial than the alternative -- which is a question I can certainly
see why economists like to avoid, because you practically can't answer it in
the aggregate.

Here's a great example. The hypothesis is that rich people spend differently
than poor people because they're rich, right? The fact that they have money
allows them to act rationally because they can afford to make long-term
investments. So, if the hypothesis is correct, lottery winners should behave
like rich people, because their newfound wealth allows them to plan for the
long term and stop making short term decisions just to keep food on the table.
Reality? A majority of lottery winners go on to declare bankruptcy.

Because it's not about rich vs. poor. It's about what types of economic
activity produce beneficial results. But economists and governments are
preposterously bad at predicting what those things will be.

Which means I'm going to be back in here beating the drum on the basic income.
It provides the poor with a baseline level of consumption which they can
choose of their own free will. The problem with need-based programs is that
the government is deciding what people need, and they're terrible at it -- and
then they create an enormous marginal tax rate on the poor by withdrawing the
benefits from anyone who dares to live the life of luxury that exists just
above the poverty line.

Let the people themselves decide what they need. People in the aggregate are
smarter than legislators.

~~~
nhaehnle
The question you lead with may answer itself once you clearly distinguish
between "saving" and "investing" \-- you muddle those terms up quite a bit in
your comment.

Saving decisions by households primarily mean less spending, hence less
demand, hence less incentive to invest in the first place. This is a plain
common sense first order effect.

That there may be a _second order_ effect via interest rates is somewhat
plausible, but it just boggles the mind how many people seem to believe that
this second order effect would ever trump the first order effect of savings
decisions. And I think this is explained by the simple fact that people do not
correctly distinguish between savings decisions and investment decisions,
where I mean investment not in the sense of "buy some shares/funds", but in
the sense of "create new means of production".

Just like it has been said that physics is understood through the search of
the correct sign, it seems that economics is understood through the search of
proper definitions of what we mean by "saving" and "investment".

~~~
AnthonyMouse
> That there may be a second order effect via interest rates is somewhat
> plausible, but it just boggles the mind how many people seem to believe that
> this second order effect would ever trump the first order effect of savings
> decisions.

This is just what I'm talking about. Dismissing the economic benefits of
increased investment as "second order effects" when what really matters is
whether the recipients of the money make more economically productive
decisions than would the consumers in the alternative.

Take the obvious example. On the one hand you can invest money in a local
small business which would otherwise not have had an investor and will use the
money to hire more local employees who will go on to pay local taxes (allowing
lower tax rates or more local services) and consume further local goods and
services. On the other hand, you can go to Walmart and buy some knickknacks
from China, which will do very little for the local economy as the primary
result will be to stimulate the economy in China. It seems exceedingly obvious
that the investment _can be_ better for the local or national economy than the
consumption. On the other hand, you can easily imagine some investment choice
that would be less beneficial than some consumption choice -- because what
matters is not the distinction between savings or investment and consumption,
it is the economic benefit to the local economy of the ultimate use of the
money.

> investment not in the sense of "buy some shares/funds", but in the sense of
> "create new means of production".

That distinction is certainly important, but that's exactly what I'm talking
about. If you buy some shares, now the person who sold them has the money. So
what does that person do with it? Perhaps they immediately turn around and buy
some shares in something else. Now that seller has the money, and so on until
somebody does something with it other than buying shares. So what is that? It
could be something useful, like some economically productive type of
consumption, or increasing the means of production. It could be something
stupid, like hoarding gold or sticking it in a mattress or buying a prime
piece of real estate and then not using it for anything. But these are the
same decisions that the original party faced, and there is no reason to expect
that the seller(s) of the shares will be any better or worse at finding a
productive use of the money than the original party would have been.

Let's even go ahead and concede that on average savings are less economically
productive than spending for some reason. You still have the same problem,
because averages are not instances. There remain many instances of saving or
investment that are more economically productive than many instances of
spending, and preferring the latter to the former is conceding an enormous
amount of economic inefficiency.

~~~
nhaehnle
In many cases there is no recipient of the money because we're talking about
the bottom 80% in terms of wealth who typically just end up leaving the money
in some form of savings account or paying down some debt.

That is probably a wise decision for that individual, but it's not going to
boost the economy.

Your obvious example may be obvious to you, but it is _not_ a typical example
of savings decisions. That was my point: You have to distinguish clearly
between savings decisions and investment decisions. Also, typical cases and
averages are what matters when you look at the macroeconomy, and that's what
you were talking about in your first comment to which I replied.

~~~
AnthonyMouse
> In many cases there is no recipient of the money because we're talking about
> the bottom 80% in terms of wealth who typically just end up leaving the
> money in some form of savings account or paying down some debt.

How do you mean there is no recipient? In that case the recipient is the
lender or the bank, which allows them to lend the money to someone else.

You might also be surprised how good for the economy paying down debts can be
in the long term. The person who paid the debt is not paying interest on it
anymore, and has now improved their credit worthiness, which reduces the
interest they pay on all of their remaining debts. The interest not paid can
be spent or used to pay further debts (virtuous cycle). Or in the future the
borrower can leverage the increased credit worthiness into more borrowing at
lower monthly payments, allowing increased future spending.

This is really one of those situations where politics and reality collide.
Having the middle class pay down their debts is great for the economy in the
long-term. But it may not do anything much _today_ , which is what politicians
care about when they're running to reelection. Hence we have a bunch of
backward-facing policies that prioritize spending over saving when they are
both important to economic growth and the choices between one and the other
would be more efficiently made by the people.

~~~
nhaehnle
When you pay down bank debt, the money just disappears, hence no recipient.

Similarly, if you save money at your bank, your bank doesn't actually get more
money. At best, you're shifting it from a checking account to a savings
account.

------
known
To alleviate
[http://en.wikipedia.org/wiki/Global_poverty](http://en.wikipedia.org/wiki/Global_poverty)
every
[https://en.m.wikipedia.org/wiki/Third_world](https://en.m.wikipedia.org/wiki/Third_world)
nation Currency should be pegged to
[https://en.m.wikipedia.org/wiki/Opec](https://en.m.wikipedia.org/wiki/Opec)
Oil for 4 years due to
[https://en.m.wikipedia.org/wiki/Triffin_dilemma](https://en.m.wikipedia.org/wiki/Triffin_dilemma)

------
antihero
It took them this long to figure this out? Do these academics actually know
any poor people?

------
72deluxe
Yes! They spend less (as they have less to spend!) :-)

