Today I want to analyze the claimed position of human rationality in the debate over welfare spending. There is a set of loaded language about people rationally responding to incentives. I want to untangle this debate and analyze the claims. First I want to set up the debate and then explore the complexities from an economics perspective.
I think that many people generally care for the welfare of the poor; Many people have a kind of bleeding heart attitude. So often the debate even among people who oppose welfare is over optimal outcomes for the poor. This leads us to a question: what policies best help people? People here can raise objections that welfare is harmful to others.
A bleeding heart fiscal conservative might say something like, “I have never seen a man spend carefully money that he didn’t earn”. In this case the argument they are advancing is simple, working for some money instead of it being given to you will be the best thing for you. People who received welfare waste these resources; those who worked and earned the same quantity of money made better use of these resources. These are things you can in theory measure. I think that people do care about people wasting away and want to prevent policies that lead to self destructive behaviors. So it is plausible that you can want to defund welfare and still care about people.
The opposition to this claim is that welfare does not cause poor behavior. Giving someone money as opposed to having them work for it does not change their behavior, other than maybe working less. There is some cost to society, but people argue that this is just the cost we pay as society. Still the issue here is that giving people welfare is not harmful to people, but benefits them.
The issue in the debate is how people will respond to this welfare and what is best for the poorest among us. This leaves the question down to whether or not it causes self destructive behavior. The rhetoric used in this debate asserts the conservative position here is on the side of economics and rationality. “I mean it is just economic rationality that people will spend money better if they work for it”, this is something that sounds reasonable for the conservative to say. A liberal might even retort, “People are not economically rational!”
So the rhetoric here reduces the question of welfare causing harmful behavior to a question of economic rationality. Conservatives are on the side of economic rationality and liberals are opposed to this. So it might be asked: Do people respond to the incentives of the system and act rationally?
What I find interesting about these claims to economic rationality is that they are entirely ass-backwards. The conservative position here is not arguing for economic rationality. If you pay close attention it requires that people act entirely irrationally. The liberal position here is closer to one of arguing for economic rationality.
Let us consider this parallel debate on solutions for global poverty. In Poor Economics, a book about global poverty by two Nobel prize winning economists Banerjee and Duflo. As a side note they won the Nobel prize for economics dealing with global poverty and the research in this book; Very good read and I would highly recommend it. They discuss the debate on whether subsidizing bed nets is effective in stopping malaria.
If people do not take advantage of cheap preventive technologies to improve their health, could it be precisely because the cheap technologies are cheap?
This is not as implausible as it might seem. Plain vanilla economic rationality dictates that the cost, once paid or “sunk,” should not have any effect on usage, but there are many who claim that as is often the case, economic rationality gets it wrong. In fact, there is a “psychological sunk cost” effect—people are more likely to make use of something they have paid a lot for. In addition, people may judge quality by price: Things may be judged to be valueless precisely because they are cheap.
So this introduction to the policy debate sets us up with a conflict. It is not a matter of just helping people, but whether people will value and properly use the opportunity to help them. On one side of the debate, people assert that people are irrational and biased by sunk cost; This implies they will not value and take advantage of things which are given to them as free AID. If they had to pay for them, then they would realize that they are useful and thus gain the benefits of what they have.
On the other hand, if people are subject to a sunk cost effect, for example, these subsidies can backfire—usage will be low because the price is so low. In The White Man’s Burden, William Easterly seems to suggest that this is what is going on. He points to examples of subsidized bed nets being used as wedding veils. Others talk about toilets being used as flower pots or, more graphically, condoms being used as balloons.
So this argument here is that we can’t give aid to the poor because they will not respond rationally to the benefits we give them. If people did behave rationally then they would take full advantage of what you give them. If you have a bed net, no matter the source, it rationally protects you just as good no matter how hard you worked to obtain it. Giving the poor welfare, charity, or aid should have no impact on the perceived benefit and thus the optimal usage of the resources.
If Easterly is right and aid leads people to waste what they would otherwise put to good use, this is evidence that people are not rational. We are all human and have biased psychologies. This doesn’t mean we act rational or irrational. We have various degrees of behavior depending on the task. These issues are not a given that say people will value what they work for more than what they don’t work for.
Now the issue that Banerjee and Dufloo take with the position that people receiving aid will behave irrationally is that they have evidence against this conclusion.
Several studies that have tested whether people use things less because they got them for free found no evidence of such behavior. Recall Cohen and Dupas’s TAMTAM experiments, which found that people are much more likely to buy bed nets when they are very cheap or free. Do these subsidized bed nets actually get used? To figure this out, a few weeks after the initial experiment, TAMTAM sent field officers to the homes of people who had purchased nets at the various subsidized prices. They found that between 60 percent and 70 percent of women who had acquired a net were indeed using it. In another experiment, over time usage went up to about 90 percent.
The case that they lay out is that actually higher prices for bed nets are more of a burden than a psychological incentive to use the bed net more because of the sunk cost. It is also strongly in doubt here if there is any evidence that the global poor value the bed net anymore because they worked and paid for it. This illuminates that the debate here is indeed over whether people are rational, but the evidence supporting the effectiveness of aid to the global poor is evidence that defends the economic rationality of the global poor.
We can draw parallels from this debate to our other debate over the effectiveness of welfare policies. The claims that people don’t value what they don’t work for is contrary to basic notions of economic rationality. The conservative position here is actually the one arguing against economic rationality and responding to incentives.
This is not to say that conservatives are wrong, the sunken cost fallacy is definitely pervasive in human psychology. There is something to people valuing things they work for more. I tend to think the conservative analysis has a lot of merit. Still the conservative critique of welfare is arguing for economic irrationality. Human psychology and behavior is an empirical issue. I have only addressed how this debate can not be taken for granted. In certain circumstances such as over bed nets for the poor, I presented a case that aid helps the poor. There may also be other side debates about morality, structure, or the extent of our welfare programs. This is a matter of other debates.