Earmarking, mental accounting, commitment, present bias, time inconsistency, heterogeneity of time preferences – what are they talking about, how do they fit together?
The academic discussions and papers of behavioral economists usually focus on one or two of these concepts at a time, don’t bother to give clear definitions and fail to tie them together in a coherent picture. That’s not a failing, just an inconvenience for those of us who are not familiar with the labels and concepts they are working with. However, at least one recent paper compensates with the very breadth of the research design and results it reports – Pascaline Dupas and Jonathan Robinson on “Why Don’t the Poor Save More? Evidence from Health Savings Experiments” in Kenya (I have quoted below from the July 18, 2011 version but this is the slightly revised version now on Dupas’s Stanford University webpage). A careful reading of this paper yields deep insights into the various factors influencing a person’s propensity or reluctance to save.
Here I share a layman’s summary of those insights in layman’s language. My focus is not on the health-promoting purposes of the savings (I will return to that in Theme Six) but on what Dupas and Robinson (and others) seem to be learning about the psychology of saving. Their findings do not address the impact of what microfinance providers have been offering the poor so much as what they could offer the poor in the near future.
Some people find it hard to save – at all – because money in the hand right now is worth more to them than money squirreled away for future use. Call it impatience or lack of self-control or present bias, if you will, but remember, this may or may not be a personality trait. This may also, or instead, represent a realistic pessimism about the prospects for successfully accumulating a large enough sum to buy something relatively expensive. Why not use the money I’ve got right now to buy something I can afford now? Who knows what money will be in my hands even a few days from now?
Why this pessimism?
Having a safe place to save money is a huge issue for the poor. Safe from the threat of theft and fire, to be sure, but also from the threat of relatives and friends and one’s self. The respondents in western Kenya were much more concerned with the latter type of threat, what they called “unplanned expenditures” – transfers to friends/relatives and purchase of “temptation goods.” D & R use the elegant phrase “taxed by social networks” in referring to the pressure of frequent requests for money in the context of culture that tells the wannabe saver that s/he ought to respond with whatever money is readily available.
The wannabe saver understands the benefit of putting some money aside, out of sight and out of reach, so that it is not so readily available when a brother stops by with yet another “crucial” need or when the urge grows for some comfort from one of those “temptation goods” that, after all, cost only a few shillings. But what are the options? I don’t want it so far out of reach that I can’t use the money when I need it, whether it be for an emergency expense (like a trip to the hospital) or a planned expense (like a bag of fertilizer at planting time). “Under the mattress” is maybe a little too readily available and subject to losses from fire and theft. Deposited in a bank is maybe not available enough, and besides, it is costly to get there and a major hassle to deal with forms, fees, armed guards at the door and rude tellers.
Then there is the not-so-little problem of remembering to set a bit of money aside regularly.
Earmarking, social commitment and reminders can save the wannabe saver. These are key elements that explain the wide popularity of ROSCAs (and ASCAs, but D & R did not study these). ROSCAs meet regularly (two or three times a month in western Kenya) and members hold each other accountable for bringing the agreed amount to the meeting. Moreover, there is credit involved, because all but the last member in the rotation to receive the pot (at the last meeting of the “cycle” of, on average, 17 meetings) goes home with the anticipated amount of money before having paid in that full amount to the ROSCA pot.
An Experiment with Low-Tech Saving Devices
To explore further the strengths and weaknesses of earmarking and commitment, D & R offered the members of 113 ROSCAs a variety of opportunities to save even more (for health purposes, because of the prominence of health problems in the lives of the ROSCA members) through a combination of encouragement and a few simple, new “technologies.” They randomly assigned the ROSCAs to one of five groups. For all five, at ROSCA meetings, individuals were encouraged to set a target to save for purchase of health products or for emergency treatment (most chose to target their extra savings for mosquito nets or water purification products or payment for unexpected health care).
One of the five groups got only the encouragement and served as a control for the introduction of saving devices to the other four groups. Here are the savings devices offered, one for each of the four treatment groups:
Safe Box: a metal box with deposit slit, locked with a padlock, the key provided to participant, and a passbook to record deposits and know the total money inside without opening the box. Each recipient was asked to write what health product s/he was saving for, and its cost, on the front of the passbook.
Lock Box: an identical box and passbook, but not given the key. Instead, the key was kept by the program officer, so that respondents could not open the box on their own. The cell phone number of the program officer was written on the passbook, and participants were instructed to call the program officer once they had reached their saving goal. The program officer would then meet the participant and open the lock box at the shop where the product could be purchased.
Health Pot: involves the ROSCA as a group; participants were told that if a subset of the ROSCA members could agree on a health product that they would all want to acquire, those members could agree to an additional contribution earmarked for the health product, to be made at each meeting on top of the regular contribution. The size of the health contribution would depend on the health product chosen and the number of people participating in the health-pot scheme. To ensure that the health pot would be used to acquire the chosen product, ROSCAs were encouraged to purchase the health product on behalf of the pot recipient or to accompany the pot recipient to the shop where the product was to be purchased, instead of letting the recipient walk away from the meeting with the pot in cash.
Health Savings Account (HSA): also took advantage of the ROSCA structure, but this treatment did not require agreement across members. Each participant was encouraged to make regular deposits into an individual HSA managed by the ROSCA treasurer. The treasurer was given a ledger book in which to record deposits, withdrawals and balances for each member’s account. The funds deposited into the HSAs were earmarked for health care expenses – ROSCA treasurers were encouraged to not allow withdrawals unless the participant needed money to pay for clinic fees or medications. The money saved in HSAs by ROSCA members was usually kept by the treasurer of the ROSCA, or deposited in a bank account if the ROSCA owned one.
Each of the four devices offered a designated, secure place to save, providing physical distance (not ready to hand) and mental accounting (intended for a specific purpose) that help a person resist temptation and social pressure (“unplanned expenditures”). To these features, the Lock Box, Health Pot and HSA add earmarking for a health purpose (to purchase a health product in the cases of the Lock Box and the Health Pot and for emergency health expenses in the case of the HSA). Earmarking (in contrast to simple mental accounting in the case of the Safe Box) reduces liquidity, because it involves a commitment to the person(s) holding the literal or figurative key to the box or pot or HSA.
Note that even for the individual devices (Safe Box, Lock Box and HSA), the offer was made in the presence of other members of the ROSCA and each participant’s decision to take up the offer was public (just as the decision to participate in the Health Pot had to be public by nature).
D & R conducted a baseline and then two follow-up surveys at approximately six and twelve months after experimental treatments were offered.
Overall take-up was very high for all four devices. At the 12-month mark, just over two-thirds of those offered the device had some cash in their box at the time of the (unannounced) survey or had participated in a Health Pot. Take-up of the HSAs was even higher: 97% had created one within 12 months.
Comparing the devices in terms of their impact on investment in preventive health products, D & R estimate that simply having access to a safe storage place for money (the Safe Box) accounts for an average additional 175 Ksh (about $2.50) spent on preventive health products since the baseline. Earmarking (the Lock Box) accounts only for an additional 50 Ksh spent on these products, which implies that the liquidity cost of earmarking depresses savings to spend on the same health products by 125 Ksh on average, compared to the storage technology without earmarking (the Safe Box). Finally, social commitment and credit (the Health Pot) have the largest impact, accounting for an average increase of 282 Ksh in spending on health products.
D & R found similar results for devices that allow use of savings to pay for emergency health care (the Safe Box and the HSA). Both devices reduced the frequency of not having enough money to afford full treatment, but only the HSA reduced the frequency to a statistically significant degree compared to the control. Earmarking savings (the HSA compared to the Safe Box) appeared to be much more valuable for the purpose of emergency health care (a first-order concern to many households) than for purchasing preventive health products. No surprise there.
Lasting Impacts and Spillover Effects
While their primary data are from follow-up surveys conducted after 6 and 12 months with 771 individuals, D & R also assessed longer-run effects with follow-up surveys conducted about three years later with a random subsample. Because the key to the Lock Box was handed over to the owner after six or twelve months, the three-year results for the two boxes were combined. Usage was still substantial: 39% of people were still saving in their box, and for those, the average amount of cash found in the box at the time of the survey was above 700 Ksh (about $10). Most of the people (83%) still saving in their box reported saving towards a specific goal. The majority of them maintained at least one health-related goal (63%), but people often reported saving towards a multiplicity of goals, including for their business, or schools fees. D & R found strong evidence of lasting impacts in the two other treatment groups as well: 48% were still participating in the Health Pot and 53% in the Health Savings Account. Of those still saving in an HSA, 73% had made a withdrawal, and the majority of withdrawals were for health emergencies.
D & R also found evidence of spillover effects at the 3-year follow-up: out of 18 ROSCAs in the control group, 2 had adopted the Health Pot scheme and 4 had adopted the HSA scheme. Adoption of these schemes in the Safe Box and Lock Box group was lower, with only one or two ROSCAs adopting these schemes.
Here is D & R’s abstract of the paper:
The two main barriers that keep people from saving on their own appear to be transfers to others and unplanned expenditures on luxury items. Providing people with a designated safe place to keep money was sufficient to overcome these barriers for the majority of individuals, through a mental accounting effect. Adding an earmarking feature reduced savings for the average individual due to the associated liquidity cost and did not help present-biased people save more. For such individuals, stronger incentives to start and continue making deposits are necessary to overcome self-control problems.
And from D & R’s conclusion to their paper:
This paper suggests that existing informal mechanisms in rural Kenya are insufficient – introducing a technology as basic as a simple box with a lock and key allows the average individual to substantially increase her investment in preventative health and to reduce her household’s vulnerability to health shocks. We present evidence that the mechanism through which this simple safe box enables savings is through a mental accounting purpose. The money put into the box was seen by respondents as “for savings” and was therefore less likely to be spent on luxuries or given away to others. Usage of the box remained high for (at least) 33 months after it was introduced.
Such a simple technology is not valuable for everybody, however. In particular, mental accounting appears insufficient to enable individuals with present-biased preferences to save more. An individual commitment savings account or lockbox is not effective either, however. While present-biased people may realize the need to commit money to savings and be interested in a commitment device, actually putting money into the lockbox itself requires an act of self-control. In our study, we find that present-biased individuals enthusiastically accepted the Lock Box, but failed to save much in it. In contrast, the enthusiasm that led them to sign up for the Health Pot tied their hands not only to spend the money a certain way, but also to continue to save on a regular basis (i.e., at each ROSCA meeting). This strong social commitment feature is the only one that enabled present-biased individuals in our sample to overcome their barriers to savings.
What I find most intriguing about this wonderful study is that the “technologies” are simple yet effective and can be diffused and maintained outside the formal financial system. Why were these technologies not already in use? D & R asked and found that, for the most part, the ROSCA members (relatively sophisticated members of the communities but still often very poor) simply had not thought of them – encouragement for those of us who still believe that outsiders can offer something of real value to local people, if presented appropriately. Properly interpreted, the study results provide a wealth of implications and guidance for both formal financial service providers and non-formal savings group promoters who seek to innovate in ways that dovetail with the needs and preferences of wannabe savers in poor communities.