Traditional economic growth models rest on the concept of rational economic actors making the most personally profitable transaction. Of course, no one is perfectly rational. These models merely represent and describe a perceived reality. In real life, external or intangible factors often lead to decision-making biases and non-rational behavior. Behavioral economics demonstrate that even the most fundamental microeconomic models do not accurately reflect the situations faced by the extreme poor.
These situations often demand overwhelming decisions, from rationing the family’s food, to finding money for rent. Distraction, anxiety, and fatigue are more likely when the basic necessities of life are variable and uncertain. The mental and physiological effects of poverty can create a vicious cycle. Even a minor “cognitive tax” can impede one’s ability to make a rational decision that might mitigate poverty, whether that is making low-risk, long-term investments or seeking preventative medical care. Obviously, this phenomenon complicates aid projects designed to serve society’s poorest members.
Consider a financial inclusion program aimed at the “bottom of the pyramid.” Beneficiaries may feel uncomfortable when brought into the unfamiliar environment of a bank to discuss opening an account. Additionally, beneficiaries must read unfamiliar legal language to decide what type of account they need. These discomforts are forms of cognitive taxes. People in such situations are also more likely to consider advertising or packaging when making their decisions, without fully understanding the consequences. Factors like the physical accessibility of finance centers, the emotional connection with workers, and the simplicity of the preferable actions may matter much more to an individual than perceived profitability.
In most instances the people designing such a financial awareness program are middle-to-upper class and exempt from the same financial decisions, since operating a bank account is often assumed for them, rather than being a question to consider. My point here is not that policymakers are ignorant of the challenges facing the poor, or that the poor are focusing on the wrong aspects of decision-making. Rather, aid projects are more likely to succeed when the program design acknowledges that beneficiaries often have other things on their mind than the future profits of possible financial investments.
In many ways, these minute economic decisions reflect the context of economic structure. The informal sector contributes about 55% of Sub-Saharan Africa’s GDP and about 80% of the labor force. Since many developing countries lack strong formal institutions, people often rely on social norms of the informal sector as the basis for their economic activity. So it follows that if those norms promote cooperative and collective behavior, higher levels of trust will emerge. Studies have shown that higher rates of trust and reciprocity within a society are associated with a higher rate of economic growth. Additional research into how policymakers can encourage those cooperative social preferences might open new opportunities for economic growth.
But conjecture into the attitudes of the poor is simply not a sound foundation for aid policy. The development field’s emerging norms of “data-driven decisions” should include the quantifiable influences of poverty on economic behavior. Recent behavioral experiments have adopted this approach. For example, they have explored the influence of poverty on the propensity to cooperate in social dilemmas; trust and reciprocity; norms of fairness and altruism; and risk and time preferences. As a next step, research should explore how these intangible social norms translate into tangible economic activities.
Here, too, there is opportunity for collaboration and trust-building through transparency. Data-sharing relationships between behavioral economists and policymakers could lead to smarter, more efficient program designs that lift more people out of poverty.
Laura Holzenkamp is a Sophomore majoring in Economics and International Relations & Global Studies.
Image source: http://schwadroncartoons.com/
These situations often demand overwhelming decisions, from rationing the family’s food, to finding money for rent. Distraction, anxiety, and fatigue are more likely when the basic necessities of life are variable and uncertain. The mental and physiological effects of poverty can create a vicious cycle. Even a minor “cognitive tax” can impede one’s ability to make a rational decision that might mitigate poverty, whether that is making low-risk, long-term investments or seeking preventative medical care. Obviously, this phenomenon complicates aid projects designed to serve society’s poorest members.
Consider a financial inclusion program aimed at the “bottom of the pyramid.” Beneficiaries may feel uncomfortable when brought into the unfamiliar environment of a bank to discuss opening an account. Additionally, beneficiaries must read unfamiliar legal language to decide what type of account they need. These discomforts are forms of cognitive taxes. People in such situations are also more likely to consider advertising or packaging when making their decisions, without fully understanding the consequences. Factors like the physical accessibility of finance centers, the emotional connection with workers, and the simplicity of the preferable actions may matter much more to an individual than perceived profitability.
In most instances the people designing such a financial awareness program are middle-to-upper class and exempt from the same financial decisions, since operating a bank account is often assumed for them, rather than being a question to consider. My point here is not that policymakers are ignorant of the challenges facing the poor, or that the poor are focusing on the wrong aspects of decision-making. Rather, aid projects are more likely to succeed when the program design acknowledges that beneficiaries often have other things on their mind than the future profits of possible financial investments.
In many ways, these minute economic decisions reflect the context of economic structure. The informal sector contributes about 55% of Sub-Saharan Africa’s GDP and about 80% of the labor force. Since many developing countries lack strong formal institutions, people often rely on social norms of the informal sector as the basis for their economic activity. So it follows that if those norms promote cooperative and collective behavior, higher levels of trust will emerge. Studies have shown that higher rates of trust and reciprocity within a society are associated with a higher rate of economic growth. Additional research into how policymakers can encourage those cooperative social preferences might open new opportunities for economic growth.
But conjecture into the attitudes of the poor is simply not a sound foundation for aid policy. The development field’s emerging norms of “data-driven decisions” should include the quantifiable influences of poverty on economic behavior. Recent behavioral experiments have adopted this approach. For example, they have explored the influence of poverty on the propensity to cooperate in social dilemmas; trust and reciprocity; norms of fairness and altruism; and risk and time preferences. As a next step, research should explore how these intangible social norms translate into tangible economic activities.
Here, too, there is opportunity for collaboration and trust-building through transparency. Data-sharing relationships between behavioral economists and policymakers could lead to smarter, more efficient program designs that lift more people out of poverty.
Laura Holzenkamp is a Sophomore majoring in Economics and International Relations & Global Studies.
Image source: http://schwadroncartoons.com/
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