Scarcity: Why Having Too Little Means So Much (14 page)

The
confusion about the value of things comes about because we do not make trade-offs—perhaps do not even know how to make these trade-offs—when we have abundance. To look at this directly, we asked subjects to imagine the following scenario:

You purchase a season ticket package
for your favorite sports team. The package includes tickets to a set schedule of eight games. Although a single ticket for each game costs $30, your season ticket package costs only $160, or $20 for each ticket. You like the set of games included in the ticket package, so you decide to buy it.

Now imagine that the season is almost over, and you only have one game left to see. In fact, this game has a lot of buzz around it, and tickets are currently selling for $75 around town. You are about to go to the game. Imagine how you feel about the cost of attending the game.

Subjects were asked to rate how much each of the two following statements captures their feelings about the cost of attending the game:

I feel like this costs me $75, the current worth of the ticket and the price I could have gotten had I chosen to sell.

I feel like this costs me $20, the price I paid for the ticket.

What’s the right answer here? Economists view $75 as the real cost: if you skip the game, you can sell the ticket and get $75. (This doesn’t even include the time trade-off.) Economists call this the opportunity cost—the trade-off of what else you could have spent the money on. Well-off people get this wrong. They are much more likely to say $20. Many of them would even choose a third option:
$0 because the ticket is already paid for
. You can see why it feels this way to the well off. When you have slack, arguably $0 (or $20
because that’s something you can anchor on) feels “right.” With slack, you are not giving up anything to go—selling that ticket really wouldn’t buy you anything you wouldn’t already buy.

In contrast, the poor have a clear idea of what they could do with $75. As a result, we find that the poor are much more likely to report that it feels as if the ticket costs them $75. Once again, they appear much closer to the economic ideal.

Every year many economists from around the world gather in one place to present research. (Sound like fun? Tickets are still available.) In 2005, two economists,
Paul Ferraro and Laura Taylor
, decided to turn the tables. They presented a question similar to the one above to more than two hundred professional economists. The responses were (somewhat predictably) far from the economic ideal. As the economist Alex Tabarrok blogged, “
I have a hard time believing that this is possible
but 78 percent of the economists gave the wrong answer! This is not a hard question. There is no trick. Opportunity cost is central to economics, the people asked were among the best economists in the world, a large majority of them have taught intro econ and yet the correct answer was the least popular.”

Is it so surprising that the world’s leading economists do not think about things this way? After all, they are well paid and have plenty of slack in their budgets. Not accustomed to facing minor trade-offs, why should they be prone to calculate minor opportunity costs? Measured against economics textbooks, these economists gave the wrong answer. But measured against everyday human behavior, they gave the right answer. Many well-off people—including these economists—do not think about trade-offs for modest amounts.

One could interpret our results as suggesting that being poor makes people better at economics than professional economists. One may also be tempted to conclude that economists would be better at economics if they were paid less, but at least one of the authors disagrees with this conclusion.

Behavioral economics was born from the empirical observation that people violate several basic predictions of economics. They do
not consider opportunity costs. Their willingness to pay for items is too easily moved. But economics is meant to follow the logic of scarcity. It is fitting then that its predictions are truer for those who actually have the scarcity mindset.

We are, of course, not proposing that the poor are always more rational. What they have is a specific skill: they are better at making ends meet today. They make a dollar go further. They become experts in the value of money. This expertise can make them appear more rational, less prone to inconsistencies, in some contexts. But this local expertise also becomes a hindrance. Along with the focus that brings expertise comes tunneling. And with tunneling comes a slew of negative consequences.

There is nothing in the prospect
of a sharp, unceasing battle for the bare necessities of life, to encourage looking ahead, everything to discourage the effort.

—
JACOB RIIS,
HOW THE OTHER HALF LIVES

A recent report by the Center for Responsible Lending featured the story of Sandra Harris:

Once a student in the Head Start child development program
for low-income families, Sandra had come to serve on the board that administers Head Start in New Hanover County. She was honored as 2003 Employee of the Year for her work at the University of North Carolina, Wilmington (UNC-W), and Wilmington residents knew her as a radio personality on WMNX. But all was not well for Sandra underneath the surface. Her husband had lost his job as an executive chef. The couple, who had always been a month ahead on their rent and bills, found themselves in a cash crunch. Their car insurance was due, and Sandra simply could not pay the bill.

Then Sandra came across a solution: a payday loan. The idea was simple. She’d get cash now and pay it back along with a fee when her paycheck arrived in a couple of weeks. Exactly what she needed.
She took the loan and paid her insurance bill on time. And on her next payday, Sandra was ready to pay off the small loan and the $50 fee.

“You know, you can renew,” the payday clerk told her, and the thought of her unpaid light bill flashed into her head. Sandra thought, “You’re right. I do need it.”

Sandra had started a chain. Next month was no easier than this one. Money was even tighter, and because of the fees, the amount she owed was even bigger. In the coming months, she kept rolling over the loans—taking a new loan to pay off the previous one. On some months she would even roll over the fees.

After a round of rollovers, the first lender demanded full payment of the loan. Sandra could not pay it off, so she went to another payday lender, Urgent Money Service, and took out a loan to pay back the first lender. She kept getting in deeper. Within six months, Sandra was paying rollover fees on six different payday loans. In June 2003, Sandra and her husband were close to being evicted from the apartment they had lived in for six years. Sandra wrote, “Basically, we ended up having to use one loan to pay off another loan, and ended up paying $495 to $600 per month in fees, never paying the loans down.”

This went on for at least six months. This money did not support a lavish lifestyle, Sandra said. “People think you’re living above your means,” she said. But she was paying bills, not buying clothes. Sandra was working diligently to manage her family’s bills during a tough financial time. …

Sandra bounced checks. Her car was repossessed. She increased her tax exemptions so she’d have more money to pay her bills and ended up owing thousands of dollars in back taxes. She finally broke and spent a shift at the radio station wiping tears away between segments.

“It takes a lot for me to cry,” she said.

The
data suggest that Sandra’s story is fairly typical. In 2006, there were
more than 23,000 payday lender branches
in the United States, which was
more than all the McDonald’s
(12,000)
and Starbucks
(almost 9,000) locations combined. Sandra’s practice of rolling over and accumulating fees is also common. Three-quarters of all payday loan volume comes from rollovers, ultimately accounting for
$3.5 billion in fees each year
.

Why do those strapped for cash take on such extreme loans that they cannot afford to pay back? Why do they allow themselves even to start down such a slippery slope? Such questions typically lead to debates about the importance of personal responsibility or about how unscrupulous businesses prey on low-income individuals; they fuel discussions about the myopia of the poor and the need for financial education. Consumer advocates bemoan the payday loan industry as predatory and push to ban these loans. Others point out that when you’re in real need, a loan, however expensive, can be better than no loan. We raise this example not because we want to enter this debate. We raise it because it provides an important window on scarcity.

The problem is more than just with payday loans. The cash-strapped borrow in many ways, not just through payday loans. They “borrow” by paying their bills late. About one of every six families in the lowest income quintile (the bottom 20 percent) pays at least one bill late in any given year. At the extreme end of this are “reconnect” fees. One study found that
18 percent of the poorest families
have had their phone disconnected and 10 percent have had a utility shut off within a twelve-month period. Paying $40 to have your phone service reconnected after failing to pay the bill in time is similar to paying a $40 fee for a loan to avoid the disconnection in the first place. A 1997 study estimated that
nearly 5 percent of the annual income of the poor
was spent on reconnections and servicing and late fees, a number that we suspect has risen dramatically since then. Sandra Harris also “borrowed,” first by reducing her tax withholdings and then by falling behind on her tax payments. The poor
around the world borrow, often from
informal moneylenders who charge rates every bit as extreme
as the payday lender (and sometimes more). And yet poor borrowers pay these rates, not once but continuously, setting in motion the same slippery slope of rolled-over debt.

This phenomenon is not unique to the poor. Busy people borrow time, often at similarly high rates. To make room for a project due soon, the busy borrow by putting off other work. And just like a payday loan, the bill comes due: the work that was postponed must now get done. And there is often a “fee” for borrowing time as well: putting off work can increase the time it takes to do it. Mailing your tax returns via certified mail would have taken minutes, but on the last day, there’s a line around the block at the post office. Because of an impending deadline, you put off typing up your handwritten notes from an interview. Later, you must decipher those notes, which takes longer than it would have when the interview was fresh in your mind. And just like the payday borrowers, the busy also roll over their debts. Something you were going to do today now needs to be put off because of something you postponed till today from yesterday. How many tasks are delayed time and time again before they finally get done? And for similar reasons—the next chance you get to do it, you find yourself with no more time than you had before.

Borrowing goes hand in hand with scarcity.

Why do we borrow when we face situations of scarcity? We borrow because we tunnel. And when we borrow, we dig ourselves deeper in the future. Scarcity today creates more scarcity tomorrow.

Take Sandra’s example. That initial bill she could not pay created scarcity. She then tunneled on making ends meet that month. Within that tunnel, the payday loan proved eminently attractive. Its benefits
fell inside that tunnel: it helped her make it through the month. The costs of the loan—the repayment and the fees—all fell outside this tunnel. The loan seemed to offer a solution to the problem she was fixated on.

Our own qualitative fieldwork supports the view that tunneling makes the payday loan particularly attractive. Ask a borrower at the time of borrowing, “How do you plan to pay it back?” and you usually get cursory answers such as “Well, I get paid in a week.” Probe a bit—“But don’t you have other expenses?”—and you encounter exasperation, as if you just don’t get it. “Don’t you understand? I’ve got to make my rent payment
this
month!” The subtext being “I’m focusing on what needs to get done now!” Next month’s budgeting is an abstraction, something to turn to later. Like all the worthy goals that do not matter when you’re speeding to the hospital, the long-term economics of the payday loan do not matter at that moment. This is why payday loans are so attractive—people turn to them when they are tunneling on putting out a fire. And their best feature is that the loans put out this fire, quickly and effectively. Their worst feature—that the fire will return in the future, possibly enlarged—is obscured.

Of course, none of this is unique to payday loans or to money. Think about putting off answering an e-mail. When we take on this time debt, we focus on the benefits: “Right now I need to get other things done.” We do not spend much time asking ourselves, “How will I make time for this later?” It is not that we are blind to the costs; they just do not get much attention.

There is an important implicit assumption here about what we tunnel on. Sandra is short of cash today and still expects to be short of cash next month. The perpetually busy are busy this week and next. Those who experience scarcity experience it not only now but typically also later. Yet people tunnel on their immediate scarcity; knowing you will be hungry next month does not capture your attention the same way that being hungry today does. The bill that is due now generates threatening notices; the bill in two months’
time is nowhere to be seen. Even if you were to think carefully about tomorrow’s scarcity, you’d really only “know” it in the abstract; you wouldn’t
feel
it, and thus it wouldn’t capture your mind in the same way. One reason for this is the bandwidth tax. The present presses automatically on you. The future does not. To attend to the future requires bandwidth, which scarcity taxes. When scarcity taxes our bandwidth, we become even more focused on the here and now. We need cognitive resources to gauge future needs, and we need executive control to resist present temptations. As it taxes our bandwidth, scarcity focuses us on the present, and leads us to borrow.

We have already seen data that support this assumption. Recall the deadline study from
chapter 1
in which one group of students had three weeks to finish an assignment while a second group faced a deadline every week. We attributed the second group’s boost in performance to the focus dividend. But, of course, the first group also faced a deadline, one that was three weeks away rather than one week. This tells us that the three-week deadline was not as pressing. In fact, initially, each one-week deadline may not have felt very pressing either. But we can guess what happened. The deadline only mattered once it got close. Until then, it was an abstraction; it failed to evoke the scarcity mindset. But that mindset arose three times for those who had one-week deadlines and only once for those who had three weeks. All this, incidentally, should be familiar. It is why we experience a rush of productivity shortly before a deadline that was always there.

Tunneling this way creates a bias toward borrowing. Because only the most immediate scarcity enters the tunnel,
loans are particularly attractive
.

Of course, taking a loan need not be a bad choice. When you really do have more time next week, putting off things is eminently sensible. Borrowing to pay rent if you are facing eviction can be sensible if you have a paycheck coming soon. When resources today—time or money—can truly provide greater benefit than they would in the future, a loan is a good idea. When we tunnel, though, we borrow
above and beyond what is dictated by this cost-benefit calculus. When faced with scarcity, we borrow when it makes sense in the long run and when it does not.

This explanation for borrowing is different from the usual ones. To explain why the poor borrow excessively, we do not need to appeal to a lack of financial education, the avarice of predatory lenders, or an oversized tendency for self-indulgence. To explain why the busy put off things and fall behind, we do not need to appeal to weak self-control, deficient understanding, or a lack of time-management skills. Instead, borrowing is a simple consequence of tunneling. To test this idea, we resort to one of our favorite tools: creating artificial scarcity in the lab.

This time we turn to
Family Feud
, an American TV game show that our colleague Anuj Shah was curiously familiar with (not what you’d expect from a time-pressed Princeton PhD student, which he was at the time). Contestants on
Family Feud
are asked to name items that belong to categories like “Things Barbie could auction off if she needed money fast.” Prior to the show, a hundred random Americans are presented with these categories, and they give their favorite answers. Contestants must then guess the most common answers, earning more points for those that are more popular. The answer “Barbie’s dream car” earns 35 points because 35 out of the 100 people gave that as an answer. (“Ken,” Barbie’s friend, earns 21 points.) Many quiz shows ask trivia questions that require esoteric knowledge, leaving the audience wondering whether the contestants read almanacs for fun. The questions in
Family Feud
, by contrast, are accessible and engrossing because there is no correct answer, only popular ones. It democratizes truth—you could call it the first postmodern game show.

Shah realized that
Family Feud
contestants experience scarcity:
they must respond under time pressure, with very limited time to think. Regular trivia questions require that you
recall
an answer—either you know it or you don’t. On
Family Feud,
the questions require a different, more creative approach. When asked, “Name something Barbie would sell,” you sort through various candidate responses. You might think of things associated with Barbie and see if any of them might be sold. You could also think of things people typically sell and see if Barbie owns any of those. Each path leads to different answers, from “Ken” to “car.” These answers are mere guesses: the potential popularity of each must then be contemplated. Time pressure means fewer paths can be followed, and less time can be devoted to gauging each answer’s potential. Unlike busy people who measure scarcity in days or hours,
Family Feud
contestants measure it in seconds. Instead of deciding which project to work on first, they must quickly decide how to come up with the most popular answers.