16.6 David Laibson and the Pull of Instant Gratification
Keynes called the consumption function a “fundamental psychological law.” Yet, as we have seen, psychology has not played much of a role in the subsequent study of consumption. Most economists assume that consumers are rational maximizers of utility who are always evaluating their opportunities and plans in order to obtain the highest lifetime satisfaction. This model of human behavior was the basis for all the work on consumption theory from Irving Fisher to Robert Hall.
More recently, economists have started to return to psychology. They have suggested that consumption decisions are not made by the ultrarational Homo economicus but by real human beings whose behavior can be far from rational. This new subfield infusing psychology into economics is called behavioral economics. The most prominent behavioral economist studying consumption is Harvard professor David Laibson.
Laibson notes that many consumers judge themselves to be imperfect decisionmakers. In one survey of the American public, 76 percent said they were not saving enough for retirement. In another survey of the baby-boom generation, respondents were asked the percentage of income that they save and the percentage that they thought they should save. The saving shortfall averaged 11 percentage points.
According to Laibson, the insufficiency of saving is related to another phenomenon: the pull of instant gratification. Consider the following two questions:
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Question 1: |
Would you prefer (A) a candy today or (B) two candies tomorrow? |
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Question 2: |
Would you prefer (A) a candy in 100 days or (B) two candies in 101 days? |
Many people confronted with such choices will answer A to the first question and B to the second. In a sense, they are more patient in the long run than they are in the short run.
This raises the possibility that consumers’ preferences may be time-inconsistent: they may alter their decisions simply because time passes. A person confronting question 2 may choose B and wait the extra day for the extra candy. But after 100 days pass, he finds himself in a new short run, confronting question 1. The pull of instant gratification may induce him to change his mind.
We see this kind of behavior in many situations in life. A person on a diet may have a second helping at dinner, while promising himself that he will eat less tomorrow. A person may smoke one more cigarette, while promising himself that this is the last one. And a consumer may splurge at the shopping mall, while promising himself that tomorrow he will cut back his spending and start saving more for retirement. But when tomorrow arrives, the promises are in the past, and a new self takes control of the decisionmaking, with its own desire for instant gratification.
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The possibility that consumers may deviate from conventional rationality and exhibit time-inconsistent behavior is potentially important for designing public policies, as the following case study discusses.7
CASE STUDY
How to Get People to Save More
Many economists believe that it would be desirable for Americans to increase the fraction of their income that they save. There are several reasons for this conclusion. From a microeconomic perspective, greater saving would mean that people would be better prepared for retirement; this goal is especially important because Social Security, the public program that provides retirement income, is projected to run into financial difficulties in the years ahead as the population ages. From a macroeconomic perspective, greater saving would increase the supply of loanable funds available to finance investment; the Solow growth model shows that increased capital accumulation leads to higher income. From an open-economy perspective, greater saving would mean that less domestic investment would be financed by capital flows from abroad; a smaller capital inflow pushes the trade balance from deficit toward surplus. Finally, the fact that many Americans say that they are not saving enough may be sufficient reason to think that increased saving should be a national goal.
The difficult issue is how to get Americans to save more. The burgeoning field of behavioral economics offers some answers.
One approach is to make saving the path of least resistance. For example, consider 401(k) plans, the tax-advantaged retirement savings accounts available to many workers through their employers. In most firms, participation in the plan is an option that workers can choose by filling out a simple form. In some firms, however, workers are automatically enrolled in the plan but can opt out by filling out a simple form. Studies have shown that workers are far more likely to participate in the second case than in the first. If workers were rational maximizers, as is so often assumed in economic theory, they would choose the optimal amount of retirement saving, regardless of whether they had to choose to enroll or were enrolled automatically. In fact, workers’ behavior appears to exhibit substantial inertia. Policymakers who want to increase saving can take advantage of this inertia by making automatic enrollment in these savings plans more common.
A second approach to increasing saving is to give people the opportunity to control their desires for instant gratification. One intriguing possibility is the “Save More Tomorrow” program proposed by economist Richard Thaler. The essence of this program is that people commit in advance to putting a portion of their future salary increases into a retirement savings account. When a worker signs up, he makes no sacrifice of lower consumption today but, instead, commits to reducing consumption growth in the future. When this plan was implemented in several firms, it had a large impact. A high proportion (78 percent) of those offered the plan joined. In addition, of those enrolled, the vast majority (80 percent) stayed with the program through at least the fourth annual pay raise. The average saving rates for those in the program increased from 3.5 percent to 13.6 percent over the course of 40 months.
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How successful would more widespread applications of these ideas be in increasing the U.S. national saving rate? It is impossible to say for sure. But given the importance of saving to both personal and national economic prosperity, many economists believe these proposals are worth a try.8 