Poverty and Savings Behavior

Introduction

• Credit markets do not function smoothly for the poor
• New products like micro-credit help address this issue
• This lecture focuses on poor savings and the challenges of escaping the poverty trap

Motive for Savings: Intertemporal Consumption Smoothing

• Individuals save to smooth consumption over their lifetime
• Income is earned in one period, and not in another
• Utility is concave, meaning the marginal utility of consumption declines as consumption increases
• If an individual is fully patient (β = 1), they treat current and future consumption equally
• If an individual is less patient (β < 1), they prefer consuming today rather than tomorrow
• Aim is to smooth out consumption to maximize overall utility

Motive for Savings: Self-Insurance

• People need to insure against unexpected income shocks
• Concave utility functions are standard
• Insufficient insurance products mean precautionary savings are needed

Motive for Savings: Self-Insurance

• Poverty leads to greater risks in daily life, so greater needs for insurance
• Individuals with limited access to insurance markets save to handle risks
• The amount saved relies on the individual's patience

Behavioral Biases

• The prefrontal cortex, although recent in evolutionary terms, controls our deliberative processes.
• This region interacts with older brain regions to regulate emotions and survival.
• Individuals may exhibit time inconsistency, favoring immediate gratification over future needs.
• Individuals with time-inconsistent preferences (impatient now, but patient in the future) have trouble saving.

Commitment - Tying Odysseus to the Mast

• People pay for ways to commit to certain goals
• People use gym memberships to commit to exercise. This is more expensive than pay-per-visit gyms.
• There may be reasons why poor individuals struggle to make decisions

Evidence from Philippines

• A study partners with a Filipino rural bank.
• A survey on time inconsistency preferences was conducted on 1,777 existing or former clients
• A new savings account (SEED) was offered to some clients
• The account restricted access but didn't compensate for this.
• The interest rate remains unchanged in the SEED Account.
• Other clients have different types of savings accounts offered and tracked
• The results are then tracked monthly and bi-monthly.

SEED Design - Withdrawal

• Individuals set time-based, and money-based goals from their SEED accounts.
• Customers may choose a date
• Or a particular amount of funds.
• Decisions are non-changeable once made.

SEED Design - Deposits

• Participants may choose a locked box.
• The box allows easy deposit without going to the bank
• Limits money access through a locked box
• An alternate form of deposits is provided via automatic transfer from an existing account.

SEED Design - How To Identify Who Has Commitment Problem?

• Researchers evaluated how time inconsistency impacted saving behavior
• By use of hypothetical scenarios.

SEED Design - Results

• Time inconsistent people are more likely to sign up for the SEED savings product
• The SEED savings effect is mostly seen in women
• The results are largely robust

SEED Design - Results

• Commitment approach has positive savings effect when compared to standard accounts and marketing efforts
• Results are also influenced by outlying behavior of the individuals

SEED Design - Results

• Researchers examined binary outcome variables to counter the effect of outlier bias.
• Savings increase is substantial in the test group.
• Magnitude of the increase was normalized by initial savings
• Commitment influences the individuals and their savings

SEED Design - Results

• The treatments had a lasting effect on commitment to savings.
• Results are positive and significant.
• Marketing efforts didn't influence results.

SEED Design - Results

• The difference between commitment and marketing group treatment isn't significant.
• There is not much difference in conclusions whether compared with OLS.
• Results are largely driven by outlying behaviour.

SEED Design - Results

• Researchers measured total balances six months and 12 months later.
• This examined whether the overall positive savings response was a short-term or lasting result
• Using binary indicators measure the probability of savings behaviour.

SEED Design - Results

• Improvements in savings amount stem from new savings accumulation and not from a shifting of assets.

• Results examined whether savings behaviour from the commitment account influenced savings in other regular accounts.

SEED Design - Results

• Results demonstrated the commitment approach positively impacted savings behaviour

SEED Design - Conclusion

• Savings need patience, forgoing immediate gratification
• Individuals exhibit time inconsistency due to this conflict.
• People are more prone to save when faced with commitments.
• Individual preferences can be difficult to measure and recover.

SEED Design - Conclusion

• Positive savings increase are not always welfare-enhancing.
• Loss of funds liquidity may cause individual harm.

Recommended Readings

• Books on poor economics
• Studies on commitment devices for savings