For a very long time, governments all over the world try to cope with poverty. Over the past 50 years, $2.3 trillion have been spent on aid, but poverty is still an important issue. Hence, the upcoming question is: What are initiators of these programs missing? What could help to improve existing programs?
In 2011, Dean Karlan and Jacob Appel published the book More than Good Intentions – How a New Economics is Helping to Solve Global Poverty in which they discuss the problem of efficient development aid by combining insights from behavioural economics with field research in developing countries. They say, in order to really decrease poverty around the globe it is necessary to fully understand the complexity of poverty. Poverty is based on systematic errors and its roots lie e.g. in the way populations and societies interact. However, not only the entity matters but also individual decisions. The economically widely used approach to analyse efficiency based on cost and value reaches its limits when it comes to poverty. To fully understand poverty, aid programs need to take human irrationality into account and adopt resulting behavioural insights in order to improve the well-being of the poor. Subsequently, to find out whether aid programs can work one needs to ask What is the root causing the problem? Other than considering poverty in all its dimensions it is also necessary to thoroughly evaluate existing programs to understand why some programs work better than others – preferably with field experiments: Does the aid program actually solve the problem? How much better off is the world because of this program? A good tool to find out about a program’s effect is the Randomized Control Trial (RCT), which uses large scale before- and after-evaluations of living situations by randomly splitting people into groups and therewith generates an objective, unbiased image of the impact an aid program has. Using this tool, they present ideas that are proven to be effective in development by applying behavioural economics and some of these ideas are applied nudges.
But what exactly are nudges? Nudges are a concept developed by Thaler and Sunstein that, properly used, can help people to make better choices and improve their living conditions. People tend to behave predictably irrational as they have characteristics and qualities that lead to decisions ill though trough such as planning fallacy, inertia, overconfidence, rule of thumps, loss aversion, availability bias and representativeness. By applying nudges, these inefficiently considered economic decisions can be improved and better welfare enhancing outcomes can be achieved. Nudges can tackle health related issues such as obesity and smoking, enhance donation behaviour, improve savings, and many more. Nudges shall make people consider their choices more sensibly but without restricting their freedom. Putting fruits and vegetables at eye level is a nudge; banning junk food however isn’t. And exactly this idea is used by Karlan and Appel in order to find out whether saving schemes tailored to human behaviour can help the poor in developing countries to stop borrowing and start saving.
How is saving different for the poor in developing countries? Procrastination, inertia, hyperbolic discounting and other psychological biases make saving hard. For the poor saving is even harder: saving does not slake thirst, stave off hunger, or prevent illness. Saving requires abstinence and patience. For the poor, today’s needs are essential for survival, they cannot save on necessities such as food. Additionally, they face barriers to save like account-opening fees, withdrawal fees, high interest rates, corruption or minimum balance requirements.
Having this in mind, can the idea of nudging help to overcome the vicious circle of poverty? The idea behind a nudge is to give right incentives to overcome behavioural biases. Hence, in theory nudges can be used to tackle components of human behaviour that lead to poverty or make poverty persist. To test whether this statement holds, Karlan, Ashraf and Yin undertook an experimental “action research” in the Philippines. Their aim was to find out how the design of a savings product influences the type of clients attracted to the product and the impact the product has on financial savings. Will people opening an account share some characteristics? Do they lack of self-control or do they have difficulties keeping money in the household because of external effects? And can a new type of savings account cause an increase in the total financial savings? They used a RCT to find out whether a self-control product could really work and therefore designed a SEED (Save, Earn, Enjoy Deposit) savings account. The SEED savings account is constructed as a nudge: it is a voluntary option providing incentives and mechanisms that directly address the inability to save. The nudge within the SEED account is a commitment feature that locks away savings until a set goal is reached. Therewith, it becomes impossible to give in on temptations or short-sighted wishes and needs. Clients can opt for restricted withdrawals until a specified date or until an amount of money set as goal is reached. After conducting the RCT and their action research, Karlan et al. found that actually more than a quarter of the participants wanted the savings account with the commitment feature. Overall, the SEED account had a strong positive impact on savings. People who opened an SEED account increased their savings after six months by 192%, which equals an average increase of 690 pesos. After twelve months their savings increased by 337%. And due to the fact that the study used a randomized control design, the results certainly indicate that the increase in savings is caused by the design of the products concept.
Overall, existing programs already being necessary and helpful could improve their approach in including the findings concerning nudges. In More than Good Intentions, Karlan and Appel have shown that using simple nudges as commitment tools in saving-products can successfully raise total savings. Thus, targeted and specialized products can be a great supplementing tool to address issues in the developing world. It is not necessarily needed to spent more money on development aid, but rather to put poverty and developing aid in an individual context. It is important to consider the human side of poverty. This might be more time consuming in the short view, but in the long run a case-to-case approach of aid programs can save money, make the poor better off and thus increase overall welfare.
- Ashraf, N., Karlan, D. and Yin, W. (2006) ‘Tying Odysseus to the mast: Evidence from a commitment savings product in the Philippines’, The Quarterly Journal of Economics, 121(2), pp. 635–672. doi: 10.1162/qjec.2006.121.2.635.
- Karlan, D.S. and Appel, J. (2011) More than good intentions: How a new economics is helping to solve global poverty. New York: Penguin Group (USA).
- Karlan, D., McConnell, M., Mullainathan, S., & Zinman, J. (2010). Getting to the Top of Mind: How Reminders Increase Saving. NBER Working Paper No. 16205.
- Thaler, R.H. and Sunstein, C.R. (2009) Nudge: Improving decisions about health, wealth, and happiness. New York: Penguin Group (USA).
- World Bank; International Monetary Fund (2016). Global Monitoring Report 2015/2016: Development Goals in an Era of Demographic Change. Washington, DC: World Bank.