The Curse of Hyperbolic Discounting

I think it is fair to say that the left-wingers over at Balloon Juice are not very happy with me, which is understandable…but(!) hopefully this will help close some of the gap between what they imagine my ideology is, and where I actually stand!

A commenter named ‘Brick Oven Bill’ had this to say about poverty:

Benjamin Franklin teaches us:
“The best way to help the poor is to make them uncomfortable in their poverty.”
My very own recent field experiments teach us that you can buy cream puffs with food stamps. And we have also determined that one cream puff equates to four pounds of potatoes.

This was indeed a very popular notion back in the 18th century. One that Thomas Malthus shares:

When the wages of labour are hardly sufficient to maintain two children, a man marries and has five or six. He of course finds himself miserably distressed. He accuses the insufficiency of the price of labor to maintain a family. He accuses the parish for their tardy and sparing fulfillment of their obligation to assist him. He accuses the avarice of rich, who suffer him to want what they can so well spare. He accuses the partial and unjust institutions of society, which have awarded him an inadequate share of the produce of the earth. He accuses perhaps the dispensation of Providence, which have assigned to him a place in society so beset with unavoidable distress and dependence. In searching for objects of accusation, he never adverts to the quarter from which all his misfortunes originate. The last person that he would think of accusing is himself, on whom, in fact, the whole of the blame lies.

Malthus goes on the draw a rather unhappy conclusion:

If he can not support his children, they must starve; and if he marry in the face of a fair probability that he shall not be able to support his children, he is guilty of all the evils which he thus brings upon himself, his wife, and his offspring.

The thought here, of course, is the same as Benjamin Franklin’s; the most effective deterrent not being able to support yourself or others is to watch their (and your) deaths. However, in his writings, Malthus was identifying a problem with hyperbolic discounting. What this means is that the effects of delay are highly exaggerated in near term. More plainly, hyperbolic discounting generates short-sightedness, and “weakness of will”.

Someone who heavily discounts the future will spend money for immediate gratification, even if he resolves to save money for the long run. There is a very high correlation between poverty and hyperbolic discounting. Because this is true, many of the left simply deny that the fact that it exists, or worse — even if they acquiesce to the fact that poor people tend to heavily discount the future, they claim that we need better education, more information, etc., to battle the problem. The traditional hard-line right wing (not Hayek, yes Rothbard) is Mathus’ and Franklin’s prescription; let them suffer.

Why these strategies are wrong is that they both exaggerate the problem. Education is the perfect example of something that people who heavily discount the future will not tolerate. The whole problem with extreme hyperbolic discounting is that it makes people unwilling to tolerate short-term deprivation in order to receive exponential long-term benefits. The right’s preferred solution does the exact same thing. Making alcoholics ineligible for liver transplants, or not paying for cigarette smokers’ chemotherapy so that they have to suffer financially isn’t going to deter anyone, because the punishment is so far off that it is effectively discounted to zero. There is no use in kicking people after they’re down, in the same way that it is unconstructive to repeatedly tell people how badly they are screwing up..

So how do we, as a wealthy society, deal with this very real problem, which keeps generations of people trapped in poverty, unable to build any semblance of wealth? Well, we have to design programs that change the incentive structure in a way that places immediate gratification contingent upon achieving a long-term goal. We could also use a tax code that encouraged savings, and not consumption…and relying on consumption taxes instead of income taxes can go a long way in deterring this type of behavior. Unfortunately, most solutions to this problem tend to be overtly paternalistic (which is why the left prefers price controls to simple cash transfers)…however, I think you would find that people would be more than happy to be patronized in order to build wealth and a better life for their children.

4 thoughts on “The Curse of Hyperbolic Discounting

  1. The problem with trying to encourage savings through the tax code is that all interest earning savings is necessarily someone else’s debt, so if a lot of savings is created that means banks create more incentives to go into debt/more aggressively market all the ways you should go into debt. We do not want a tax code that encourages more savings generally — quite the opposite. But it may be possible to change the tax code to encourage more saving *by the poor*. So for example, leave it as an income tax, but the first $1,000 in interest income does not count as income (maybe even match the first $100?) Get people to do some saving, don’t reward millionaires for buying lots of mortgage backed securities.

    I agree with the general idea of putting the incentives up front, though — a tax on cigarettes will do more to discourage smoking that providing universal health insurance will do to encourage it, for example.

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