How can the poor save more using commitment devices ?

One of the most common problem among poor is their ability to save in each possible stage for contingency. The presence of temptations and present bias often derail them from this goal. Thus sticking to a course of action has an important significance in the presence of immediate pressures in this era. In standard model of savings, there is no room for such pressure and people can estimate money worth saving in the future, considering all shocks and external factors. Thus they can implement this without a hassle. But for many marginalized groups, implementing such plans are much easier said than done.

Therefore recently, behavioral economists have started comprehending devices people may use to deal with such temptations. Discount rates form a part of inter-temporal preferences that differ with horizon.  Since people have high discount rates for short horizons (short term impatience) and a very low one for distant horizons (long term patience) it leads to Present bias or Hyperbolic discounting (Ainslie1992, Strotz 1956, Laibson 1997).  Individuals partly (not fully) recognize their inter temporal inconsistency.

There are some commitment devices that are actively choosen by individuals. Wertenbroch (1998) argues that in order to avoid temptation, people are able to forego quantity discounts on good they would be tempted to consume, for eg. Cookies and buy small quantities of the tempting foods. Apart from this the Gym membership( Paying for whole year in advance) and New year resolutions are used as commitment devices by many people, but not everyone have the patience, planning and deliberate action taking and fail to follow through the course of plan. Another direct evidence of commitment devices include using deadlines as a self-control device (Ariely and Wertenbroch, 2002). Students who chose their own deadline for submitting three different papers faired relatively better than those who were given a big deadline at the end as these students chose evenly spaced deadlines for all papers giving them the incentive to complete everything in a timely manner.

Savings in developing countries can be easily linked with this perspective. It provides an alternative view on micro credit institutions such as ROSCA – Rotating savings and credit association (Gugerty 2003). There are regularly held meetings and a pre-specific amount is contributed by the members at each meeting. Sometimes meetings also be tied to seasonal cash flow cycles in rural communities. The collective fund is then given to one individual at a time, thus each individual get their turn and get back their contributed funds. They are attractive because members often do not pay any interest and in case someone defaults, the risk to the members is reduced as the rotation is time limited, generally no more than six months. One of the main reason for their popularity is that they serve as a commitment device in many ways. There is a social pressure from other members to help everyone commit to their desired savings level since savings is made a public act (Ardener, Shirley and Burman 1995). As some ROSCA participants say, ‘’you can’t save alone’’. Also the self-control problem is solved as the individuals either get nothing or the full amount at once, allowing individuals to save up larger amounts than they normally would and making large and important purchases rather than temptation for other purchases and immediate demands when they would be putting money aside each month and saving at home where family and relatives may demand access to savings. Also since the poor unconditionally value liquidity, it also helps them during liquidity shocks as otherwise they would dip into real savings to address certain problems. Thus it acts as a simplified and transparent system well suited to communities with low levels of literacy. Other related micro credit institutions include ASCAs and Grameen bank.

Another ‘commitment device’ for saving is illustrated by Ashraf, Karlan and Yin (2004).  He talks about the growing popularity of ‘SEED’ accounts at a bank in Philippines, where money can be withdrawn by individuals only once a pre specified goal is achieved or at a specific date and not at will. It is surprising to note that more than 30 % of the individuals chose this account over regular savings account as it helped the clients to substantially increase their savings rate.

Effective policy implementation to promote savings plays a key role here. Since the normal financial institutions in many developing countries fail to provide credit to credit worthy borrowers and are often not robust enough to provide such innovation in this dimension and a monopolistic financial institution may only use the commitment devices and temptations of the poor rather as a leverage for their own self interests and profit maximization, therefore the government, donor organizations and NGO’s should step in and promote educational programs regarding small scale investments and financial management with a least invasive price tag in order to inculcate saving habits in each possible state to cope with shocks and eliminate self control problems (present bias and intention action divide) among poor.

 

References

Ainslie G., 1992. Picoeconomics. Cambridge: Cambridge University Press.

Strotz, R. (1956). “Myopia and Inconsistency in Dynamic Utility Maximization.” Review of Economic Studies, 23, pp. 165-180.

Laibson D., 1997 Golden Eggs and Hyperbolic Discounting. Quarterly Journal of Economics. 62, 443-478.

Wartenbroch, K., 1998, “Consumption self-control by rationing purchase quantities of virtue and vice,” Marketing Science, 17, pp. 317-337.

S. Mullainathan (2005) “Development economics through the lens of psychology”.

Ariely, D., and Klaus Wertenbroch, 2002, “Procrastination, Deadlines and Performance: Self-Control by Precommitment,” Psychological Science, 13, pp. 219-224.

Gugerty, Mary Kay, 2001, “You Can’t Saving Alone: Testing Theories of Rotating Savings and Credit Organizations,” mimeo, Harvard University.

Ardener, Shirley, and Sandra Burman, eds., 1995. Money-Go-Rounds: The Importance of Rotating Savings and Credit Associations for Women. Washington DC: Berg Publishers.

Asharf, N., Dean Karlan and Wesley Yin, 2004, “Tying Odysseus to the Mast: Evidence from a Commitment Savings Product,” mimeo, Princeton University. http://www.wws.princeton.edu/~dkarlan/downloads/SEED.pdf

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