Understanding Life in Poverty

Milla Nyyssölä

Behavioural economics, an approach combining the insights of psychology and economics, is coming to the fore in development economics. It is especially relevant in the search for new and more effective ways to reduce poverty.

On 1-2 September 2011, UNU-WIDER hosted a major conference in Helsinki, Finland on the topic involving some 60 researchers and practitioners. The aim was to take stock, identify policy messages, and uncover promising areas for further research. The conference included a wide range of presentations with a focus on improving our understanding of how people cope with poverty. Theories need to take this on board, and in doing so may change the policies necessary to reduce poverty. Bangladesh, China, Ethiopia, Ghana, India, Mexico, Pakistan, Tanzania, and other developing countries were discussed, over the 2-day conference.

The conference was jointly organised by Markus Jäntti of Stockholm University, Ravi Kanbur, a UNU-WIDER board member, of Cornell University and Jukka Pirttilä of University of Tampere. The conference took place under UNU-WIDER’s project on ‘New Approaches to Measuring Poverty and Vulnerability’, which is directed by Jäntti and Pirttilä.

Poverty and behavioural economics

Behavioural economics is challenging some of the traditional assumptions that economists make regarding individual and household behaviour. For example windfall gains are often spent differently from income that is earned from hard work. Critically, the decision-making context has a role in shaping people’s preferences. Concepts of fairness as well as social and community values affect individual behaviour, not just the prospect of material gain. Karla Hoff (World Bank) discussed psychological mechanisms that make preferences susceptible to social influences and presented evidence on how social factors determine people’s preferences. The parallel sessions included much discussion on the factors impacting the preferences and attitudes of the people across a wide range of countries and circumstances.

People living in poor countries often set their aspirations too low and achieve less, because they have more pessimistic beliefs about how their efforts can influence outcomes. In contrast, the well-off live in circumstances that reinforce their self-efficacy; they benchmark themselves relative to a wide set of successful people, and this further motivates high levels of effort.

Field experiments and empirical evidence show that poor people often make choices that are inconsistent with their long-run welfare. Highlights from the conference included Sendhil Mullainathan (Harvard University) who discussed the cognitive consequences of scarcity. The poor are good in ‘packing’, making the most of their limited budget today, and worse in ‘planning’, cognitive reflection for the future. Stressful trade-offs and the need to meet today’s needs take time and energy away from planning and self-control.

Dean Yang and Dan Silverman (both University of Michigan), Xavier Giné (World Bank), and Jessica Goldberg (University of Maryland) investigated the difficulty that the poor have in committing to their plans. Their experimental evidence showed that the poor face considerable social pressure and they exhibit a clear bias towards present consumption.

Uncertainty and welfare

Uncertainty, welfare, and their measurement were among the key themes of the conference. The main findings show that self-reported happiness and economic growth exhibit a positive relationship in the contexts in which the poor live, but in richer contexts other factors increasingly influence self-reported life satisfaction. Traumas and losses were shown to have an impact on risk behaviour and welfare. Capturing these in welfare measures is vital, and new ways were proposed for measuring individual utility in these situations. Moreover, experimental approaches presented at the conference added to the literature that now exists on the inefficiencies that arise within households that relate to risk-behaviour and trust—all having a gender dimension. Those inefficiencies contribute to keeping people trapped in poverty.

Since the poor have such a concern for immediate survival, this needs to be incorporated in measuring welfare. Progress is being made. Conchita D’Ambrosio (University of Bocconi) proposes a new measure for economic insecurity that places more weight on recent events and losses.

Better help for the poor

Sessions included evidence from new field experiments, new theories, and new interpretations of the econometric evidence. This broadens current understanding of the behaviour of the poor and will help in the design of more effective programmes for poverty reduction, incorporating ideas such as ‘mental taxing’ and ‘framing’ which feature in the policy prescriptions from behavioural economics.

Dean Karlan (Yale University) discussed reminder mechanisms in saving; he demonstrated that reminding about specific future expenditures increases poor people’s saving rates despite their meagre resources. Nava Ashraf (Harvard University) presented evidence from a field experiment where a scheme providing social recognition, in the form of stars posted on a thermometer displaying female condom sales, incentivized poor hairdressers towards promoting these family planning methods to their customers more cost-effectively than monetary rewards.

Stimulating and developing entrepreneurship is vital for poverty reduction, and behavioural economics provides insights into training micro-entrepreneurs as well as building their human and financial capital. Papers from Xavier Giné and Ghazala Mansuri (both World Bank), and Bertil Tungodden, Lars Ivar Oppedal Berge and Kjetil Bjorvatn (all Norwegian School of Economics and Business Administration) presented experimental and other empirical evidence on individual decision-making and ways to overcome barriers to entrepreneurship.

To better help the poor and get more focus on understanding poverty in development programmes we need the insights now becoming available from behavioural economics. Initiatives to influence behaviour complement other actions including measures to create and strengthen household assets, improve educational outcomes, and reduce gender discrimination.

The present literature is still small, but vibrant and growing, and one of the aims of the UNU-WIDER conference was to stimulate further thought and action. The conference constituted one more step in bringing more evidence into the design and implementation of development initiatives that can deliver true gains for the poor.

About the author

Milla Nyyssölä is a UNU-WIDER research assistant, and a PhD student in economics at
Aalto University, Helsinki.

WIDER Angle newsletter
September 2011
ISSN 1238-9544