Nudging on Donations

Mostly Economics points to the new working paper by Dean Karlan and John List that suggests an innovative way for charities to signal their credibility nudge donors into increasing their donations. Karlan and List write,

We develop a simple theory which formally describes how charities can resolve the information asymmetry problems faced by small donors by working with large donors to generate quality signals. To test the model, we conducted two large-scale natural field experiments. In the first experiment, a charity focusing on poverty reduction solicited donations from prior donors and either announced a matching grant from the Bill and Melinda Gates Foundation, or made no mention of a match. In the second field experiment, the same charity sent direct mail solicitations to individuals who had not previously donated to the charity, and tested whether naming the Bill and Melinda Gates Foundation as the matching donor was more effective than not identifying the name of the matching donor. The first experiment demonstrates that the matching grant condition generates more and larger donations relative to no match. The second experiment shows that providing a credible quality signal by identifying the matching donor generates even more and larger donations than not naming the matching donor. Importantly, the treatment effects persist long after the matching period, and the quality signal is quite heterogeneous - the Gates’ effect is much larger for prospective donors who had a record of giving to 'poverty-oriented' charities. These two pieces of evidence support our model of quality signals as a key mechanism through which matching gifts inspire donors to give.

In this context, I have blogged earlier about studies by the same duo and others about how matching contributions and its magnitude can provide signals that can increase the amounts of donations made by prospective donors. Quality signals are powerful mechanisms to "crowd-in" funds from donors.

But there is nothing surprising about this finding since this underlying premise underpins much of modern financial markets. If Warren Buffet invests in a particular stock or fund, the chances are that it will attract a herd of investors! In fact, hedge funds raise private capital by playing up the credibility of their prior investors and using that to encourage prospective investors. Start-up firms which have atleast one big angel investor will find it much easier to raise additional capital.

This also has important longer-term lessons for the aid and philanthropy businesses. The powerful impact of credible lead donors, like Bill and Melinda Gates, should be leveraged to multiply the amounts of money that can be raised. For example, the Gates Foundation could work with a series of smaller non-government organizations (NGOs) within sectors where the Foundation is already active, provide small seed capital, and then encourage those NGOs to leverage it to solicit additional funds from other donors. I am sure this model is already being used by the larger foundations and their donees, though the share of their funds routed through such partnerships may be small.  

In fact, this is what multilateral agencies like the World Bank and the UNICEF have been doing for years. They provide the first tranche or seed funding for new initiatives and projects,, which is then leveraged to raise additional capital, both from private sector and other non-government agencies. The presence of the Bank or UNICEF provides the necessary reassurance to these lenders and donors that necessary due diligence has been done and the project is worthy of support and their investments and donations are less likely to go down the drain.

Therefore, is it time that the larger and more reputed private donor agencies leverage their brand name and reputational value to help smaller organizations raise more capital and thereby multiply the amount of money that can be mobilized to serve the same causes espoused by the larger donor?

The last-mile challenge in banking for the poor

It has always been thought that lack of access to formal bank accounts prevented poor people from saving more and once accounts were opened they would be able to more optimally manage their finances. But now that we have made some progress, albeit tiny (only 5.5% of 650,000 Indian villages have bank branches and half the adults in the country do not have access to bank accounts), with access through the campaign for total financial inclusion (TFI), have the desired outcomes been achieved for those people?

Surprisingly, it does appear that having a bank account does not automatically translate into its use, much less efficient management of personal finances. Livemint points to a study by Skoch Development Foundation which found that only 11% of 25.1 million no-frills accounts opened between April 2007 and May 2009 are operational mostly because of the high costs.

India Development Blog points to an IFMR study of the impact of TFI campaign in Gulbarga District of Karnataka (claimed to have achieved 100% financial inclusion), which found that 36% of sample households remained without access to formal and semi-formal savings mechanisms and more importantly, access to bank accounts did not translate into bank account usage. It was found that the accounts were used mostly to manage NREGS payments or SHG transactions. Critical to the lesser than expected account usage is the high transaction costs, especially by way of travel costs.

I am inclined to believe that even if access to formal banking systems, by way of opening a bank account, is increased, actual usage is likely to remain low unless bridge the last mile gap and take banking to the door-step of the people, especially in rural areas. The recent decision by the Reserve Bank of India to approve the deployment of mobile bank business correspondents, equipped with electronic terminals, to transact at the sub-branch level is certain to increase the quality of access. This will ensure that, unlike now, rural account holders are more likely to actively transact using their accounts.   

In this context, mobile phones have the potential to revolutionize banking and increase utilization dramatically. Mobile phones-based technologies offer the attraction of directly placing the bank account in the hands of the customer, thereby lowering transaction costs and increasing the likelihood of account usage. It may therefore be tempting to get carried away by this possibility, coupled with a campaign to increase financial literacy, and assume that it will ensure account usage.

However, dovetailing NREGS and other government cash transfers through TFI accounts, extensive use of business correspondents and mobile phone-bassed technologies, and financial literacy, while necessary are not sufficient conditions to ensure optimal account usage.In fact, unless complemented with other initiatives, mere increase in access to banking accounts, could be counter-productive. It could just as easily enable access to debt and other less than desirable financial products, whose extensive adoption could be detrimental to the interests of the poor people.

Behavioural science teaches us that even with access to their accounts and adequate financial literacy, human beings are cognitively constrained. This in turn means that despite firm commitment to save or spend on certain things, people tend to renege and fall short on achievement. People discount the value of later rewards by a factor that increases with the length of the delay. They are therefore tempted to spend on immediate needs as opposed to save for important long-term requirements. Further, drawing from theories of "mental accounting", it has also been found that people tend to save optimally when they they know what they are saving for.  

It is therefore necessary that the bank accounts are structured to address these cognitive biases. This assumes importance since we need to bear in mind that the ultimate objective is not to merely enable access to bank account, but to enable poor people with systems to more effectively manage their scarce finances. What can be done to ensure that poor people save more, optimize on their interest returns, manage their long-term needs like health care, children's education and pensions, make more effective purchase decisions, and so on? In simple terms, how do we ensure that people not only manage their finances effectively, but also overcome their cognitive urges which are often determental to their interests?

I have written about several examples of how innovative financial products can overcome such cognitive biases and increase the likelihood of optimal outcomes for poor people with management of their finances. In fact, bank savings accounts and financial products, with subtle commitment features, have the potential to dramatically increase not only usage but also effective usage of bank accounts. I have bloggged earlier about Save More Tomorrow, default pension savings, lottery savings products, products to increase fertilizer consumption, multi-tier accounts (also here), and budgeting family expenditures. See also this and this.

In this context, there is a big window of opportunity. Bill and Melinda Gates Foundation have just pledged $500 million to helping poor people learn to save money. They propose to fund research and project interventions in this area to emulate the examples like the hugely successful mobile banking for the poor — via cellphone in Kenya and Bangladesh and smart card in Mexico. Spurred on by the low domestic savings rate, this area has been the focus of considerable interest in the US too. It is appropriate that some part of this be leveraged into experimenting with financial products and structured accounts that help overcome cognitive biases.

It needs to be borne in mind that TFI and optimal utilization of bank accounts by the poor needs to go beyond mere door-step acceess to bank accounts.

Framing the inequality debate

Widening inequality is arguably one of the most important socio-economic challenges facing societies, rich and poor, across the world. Unfortunately, despite the steep widening of inequality in recent years, it has not generated the anticipated level of social outrage.

In a recent article in the NYT, Ian Ayres and Aaron Edlinn, had called for a Brandeis tax, as a tax directly on inequality. The Brandeis Ratio is the average income of the richest one percent of household to the average median household income. This ratio has risen alarmingly from 12.5 in 1980 to 36 by 2006. The Brandeis tax be an automatic extra tax on the income of the top 1 percent of earners — a tax that would limit the after-tax incomes of this club to 36 times the median household income. It would therefore be an inequality capping tax.

In a series of posts in Freakonomics, they take their argument one step ahead and advocate that the debate on income inequality be framed in terms of "medians". They write,

"Framing income inequality in terms of "medians" is also part of a larger goal of making the median household incomes more salient... Part of our goal is to change the way politicians speak about income equality. Framing the income of the wealthy in relation to the median income will help us all keep in mind the relative success of the middle class.

It might even be useful to describe other things in terms of medians. A new Cadillac Escalade will run you 1.4 medians. A year’s tuition at Yale Law School is about .88 medians. We might even restructure government salaries so that they automatically adjust with the median... To raise the prominence of the median measure, government could standardize a "mi" symbol."

Behavioural psychologists have long pointed to the power of framing in re-orienting the human mind. In the instant case, absolute income numbers are not very effective in signalling about the degree of inequality. However, when the same is framed in terms of "mi", the extent of inequality becomes cognitively striking.

Similar framing can be an effective strategy in the various conservation (water, electricity etc) and environmental awareness campaigns. Water closets could be rated based on the number of buckets of water used. Air conditioners can be rated by describing their energy consumption as a multiple of that of a fan. In all these cases, the message is framed in a language that is readily graspable and therefore cognitively salient.

In this context, economist Robert Frank has constructed a Toil Index to more evocatively highlight the middle-class squeeze. It represents the number of monthly hours of work required to rent a house in an area served by a school of average quality. And it has just shot up vertically since the last decade.

The influence of Prospect Theory mapped

Mostly Economics points to a fantastic graphic that maps the spectacular growth in "scholarly influence" of Prospect Theory, which examines decision making in conditions of uncertainty and risk, as measured by Journal citations and references in different fields. Daniel Kahneman and Amos Tversky published their landmark paper on Prospect Theory in 1979.



This visualization is also an example of the power of graphically illustrating concepts like growth in influence of ideas and trends.

Thinking beyond stage one with incentives

Last week I blogged about the possibility of perverse incentives being generated in teachers by off-school hours remedial education. The larger purpose of the post was to highlight how specific policies can have unanticipated secondary or emergent consequences which could even end up subverting the desired objective.

In this context, Uri Gneezy, Stephan Meier, and Pedro Rey-Biel have an excellent paper which looks at the similar consequences caused by incentives in public policy. They write,

When explicit incentives seek to change behavior in areas like education, contributions to public goods, and forming habits, a potential conflict arises between the direct extrinsic effect of the incentives and how these incentives can crowd out intrinsic motivations in the short run and the long run... In the emerging literature on the use of incentives for lifestyle changes, large enough incentives clearly work in the short run and even in the middle run, but in the longer run the desired change in habits can again disappear...

A considerable and growing body of evidence suggests that the effects of incentives depend on how they are designed, the form in which they are given (especially monetary or nonmonetary), how they interact with intrinsic motivations and social motivations, and what happens after they are withdrawn... we believe that the discussion should not be whether incentives negatively affect contributions to public goods, but when incentives do and do not work.

They discuss the different dynamics of extrinsic incentives and its impact on intrinsic motivation - "bribes" reduce intrinsic motivation; "pay enough or don't pay at all"; when incentives are so high, people choke under pressure; clarity in incentive message - "read these books" rather than "read books"; incentives can break social norms of trust and weaken pro-social behaviour or reduce image motivation; motivation is crowded out after incentives are removed; differing impact of incentives on students, teachers and parents, etc.

In the context of extrinsic incentives crowding out intrinsic motivation and pro-social behaviour, it may be interesting to explore whether this effect would be same at all initial levels of motivation. Intuitively, it would appear that such crowding out becomes pronounced in case of individuals with higher initial levels of motivation. Alternatively, in case of individuals with lower motivation levels, extrinsic incentives may not have much adverse effect. In such people, they neither enjoy their activity nor do they place as much a premium on their image vis-a-vis others.

Does it mean that extrinsic incentives may be more effective or have less adverse long-term consequences in many developing countries among cutting edge public functionaries who are largely characterized by low levels of self-esteem and motivation?

A few thoughts on remedial education

Arguably one of the biggest failures of school education in India is its one-size-fits-all approach wherein teachers cover the prescribed subject syllabus on a single-track mode for the entire class. This approach overlooks the differential learning abilities within a group of children. Under the circumstances, certain children fall behind and this lag gets carried forward to the next class and so on (since there is a system of automatic passing in all primary classes).

In order to address this problem, remedial education aimed at the laggards, has emerged as the favored solution. However, there is considerable ambiguity about how this remedial education should be administered. One area of debate is about when this remedial instruction should be imparted. Should it be integrated into the regular classroom instruction and imparted along with regular teaching during the classroom hours itself? Or should it be done outside the regular classroom hours?

There are merits and demerits with both approaches. This post will skip this issue. However, there is an important behavioural dimension to the latter approach that is often overlooked in such debates. If the remedial instruction is shifted to off-school hours, then it may do little to change the status quo or the incentives of the regular teachers.

The deficient model of pedagogy will persist. More damagingly, it may crowd-out any remaining motivation to get all the children in the class to achieve the grade-specific learning competency during the regular classroom hours. Reassured that the laggard student would be brought upto speed through off-school hours remedial instruction, the teacher may be further emboldened (or feel less guilty) to continue with the prevailing inefficient mode of instruction. So will the off-school hours remedial instruction model end up exacerbating the problem of single-track teaching?

What would be the effect of the possibility of off-school hours remedial education on students? Logically, some would loath the possibility of having to sit through more hours of classroom instruction and therefore be encouraged to learn during the regular classes. Some others would let their attention down during the regular class hours in the firm reassurance that there would always be the off-school hours classes to fall back on. Which of these two effects would dominate?

A more appropriate solution, one that takes into account the aforementioned failings, is to have a mix of both approaches. To the extent possible the remediation should be integrated into the regular classroom instruction. However, those extremely deficient students could be remediated through off-school hours instruction.

Update 1 (8/4/2012)

Esther Duflo, Pascaline Dupas, and Michael Kremer have evidence that appears to, among other things, also support my aforementioned thesis, from this study of additional contract teacher assignment to certain schools. They find great benefits from a complementary strategy that involves decentralized hiring of contract teachers, and School-Based Management training programs. They write,

"We examine a program that enabled Parent-Teacher Associations (PTAs) in Kenya to hire novice teachers on short-term contracts, reducing class sizes in grade one from 82 to 44 on average. PTA teachers earned approximately one-quarter as much as teachers operating under central government civil-service institutions but were absent one day per week less and their students learned more. In the weak institutional environment we study, civil-service teachers responded to the program along two margins: first, they reduced their effort in response to the drop in the pupil-teacher ratio, and second, they influenced PTA committees to hire their relatives. Both effects reduced the educational impact of the program. A governance program that empowered parents within PTAs mitigated both effects. Better performing contract teachers are more likely to transition into civil-service positions and we estimate large potential dynamic benefits of contract teacher programs on the teacher workforce."

The governance program involved giving the parents in the PTA committee School-Based Management (SBM) training how to  interview and select job applicants, monitor and assess teachers’ effort and performance, and perform a formal review of the contract teacher’s performance to decide whether to renew her contract.They write about how empowering parents mitigates the negative effects among civil service teachers,

First, in schools with SBM training, civil-service teachers were more likely to be present in class and teaching; second, in those schools, relatives of civil-service teachers were less likely to be hired as contract teachers; third, those relatives who were hired anyway performed as well as non-relatives (which could comefrom better selection of the remaining relatives, or stronger incentives).

However, on contract teachers, I have reservations about their political acceptability and consequent scalability.

Decline of capitalism and availability bias

Availability bias refers to human cognitive failure to grasp historical perspectives and draw flawed inferences from immediate and salient events. The graphic below captures this problem in the context of debate questioning the value of capitalism as an economic system. As I have blogged earlier, this trend prevails in many areas of modern public life.



I am not holding a brief for capitalism. Capitalism is surely flawed and like any system of allocating scarce resources, need to be constantly learning from successes and failures, adapting and evolving. The more important point that deserves serious debate is that the events of the past few years have raised several questions about some of the characteristic features of American capitalism. Capitalism needs to learn from these experiences and adapt if it is to retain its credibility.

In fact, the ardent free market capitalists and neo-liberals too suffer from availability bias when they abstract from the limited experience of the two decades of Great Moderation to oppose any role for government to remedy market failures, including by imposition of higher taxes.

Appropriate to this debate, John Kay has an excellent op-ed in FT in the contenxt of the Occupy Wall Street protests that capitalism "should be replaced by something nicer". He is spot on in this assessment,

"Perhaps the "something nicer" which should replace capitalism is a more nuanced – and more accurate – account of capitalism itself."

The psychology of poverty

Conventional wisdom on poverty has been that poor remain poor because of low incomes and their certain lifestyle and behavioural traits - lack of cleanliness, limited self-control, wasteful expenditures, idling away time etc. While incomes are not within their control, it has been argued that the poor could be encouraged to change certain behavioural traits that could increase the likelihood of their overcoming or atleast mitigating poverty.

This post is a summary of considerable research that appears to point to a significant role of behavioural psychology in determining the behaviour of the poor.

1. I had blogged earlier about the bee-sting theory of Charles Karelis.

When we're poor our economic worldview is shaped by deprivation, and we see the world around us not in terms of goods to be consumed but as problems to be alleviated. This is where the bee stings come in: A person with one bee sting is highly motivated to get it treated. But a person with multiple bee stings does not have much incentive to get one sting treated, because the others will still throb. The more of a painful or undesirable thing one has (i.e. the poorer one is) the less likely one is to do anything about any one problem. Poverty is less a matter of having few goods than having lots of problems. Poverty and wealth, by this logic, don't just fall along a continuum the way hot and cold or short and tall do. They are instead fundamentally different experiences, each working on the human psyche in its own way.

Karelis argues that poverty introduces a diminishing marginal utility to putting in effort, "One doesn't have enough money to pay rent or car insurance or credit card bills or day care or sometimes even food. Even if one works hard enough to pay off half of those costs, some fairly imposing ones still remain, which creates a large disincentive to bestir oneself to work at all."

2. Conventional wisdom would have it that people exercise their free willpower to resolve conflicts among competing choices and demands on their scarce resources (be it money, time, space, attention, affections etc) and make decisions in a rational manner and in their best interests. In other words, these decisions are thought to be under the control of the respective individuals.

A recent New Republic article points to the pioneering work of researchers from Case Western Reserve University, Roy Baumeister, Ellen Bratslavsky, Mark Muraven, and Dianne Tice, who found that an individual’s capacity for exerting willpower was finite. Their experiments found that self-control was depletable - exerting willpower in one area makes us less able to exert it in other areas subsequently in the immediate future.

They had food-deprived subjects sit at a table with two types of food on it: cookies and chocolates; and radishes. Some of the subjects were instructed to eat radishes and resist the sweets, and afterwards all were put to work on unsolvable geometric puzzles. Resisting the sweets, independent of mood, made participants give up more than twice as quickly on the geometric puzzles. Resisting temptation, the researchers found, seemed to have "produced a 'psychic cost'".

In another experiment, participants were asked to remember a number – the number was randomly selected to either be a short two digit number or a seven digit number – and then to walk down a hallway to another room for an interview. As a seeming afterthought, they were told there is a snack cart in the hallway and to help themselves to one of the snacks. The snack choice was either fruit salad or chocolate cake. The subjects asked to remember the two-digit number selected the fruit salad in equal proportions to the chocolate cake. The subjects tasked with remembering the longer seven digit number overwhelmingly chose the chocolate cake. The authors attribute this to depletable self-centrol - when attention is focused elsewhere, such as on retaining a long number, there is less of this resource available to guide the decision over snack choice.

In another experiment in rural Rajasthan by Dean Spears, people were, in random order, offered to purchase a well-known brand of soap at a highly discounted price and they were also asked to squeeze a mildly resistant handgrip for as long as possible (handgrips are common way to measure cognitive control, with the duration determined by mental will power). He found that if the hand grip came before the offer of discounted soap, both poor and rich respondents squeezed the grip for an average of two minutes. But if the decision to purchase soap was taken before the hand grip exercise, the rich respondents still held the handgrip for an average of two minutes, while the poor gripped for a full 40 seconds less. He found that by making economic decision making more difficult for the poor, poverty depletes cognitive control.

These results have been corroborated in more than 100 experiments, where researchers have found that exerting self-control on an initial task impaired self-control on subsequent tasks - consumers became more susceptible to tempting products; chronic dieters overate; people were more likely to lie for monetary gain; and so on. In addition to self-control decisions, these researchers have expanded the theory to cover tradeoff decisions - like choosing between more money and more leisure time. They have found that tradeoff decisions require the same conflict resolution as self-control decisions and appears to similarly deplete our ability to muster willpower for future decisions.

In all these cases, willpower can be understood as the capacity to resolve conflicts among choices as rationally as possible, and to make the best decision in light of one’s personal goals. And, in all of them, willpower seems to be a depletable resource. The Development Impact blog writes,

"The conditions of poverty exact a heavy toll on cognitive resources through the everyday challenges of scarcity. The repeated trade-offs confronting the poor in daily decision making – i.e. "should I purchase a bit more food or a bit more fertilizer?" – occupy cognitive resources that would instead lay fallow for the wealthy when confronted with the same decision. The rich can afford both a bit more food and a bit more fertilizer, no decision is necessary...

My impulsive desire may prefer the consumption good in front of me, but my cognitive control can resist that impulse and select the alternative investment good if it hasn’t already been depleted through recent repeated usage. If my control resource has been depleted through earlier use, then the conditions of poverty can induce behavior that in turn prolongs poverty... because cognitive control is a depletable resource, the higher frequency of difficult economic decisions confronting the poor takes a toll on subsequent decisions."

Dean Spears did field experiments in India and analysed the American Time Use Survey and found that poverty is responsible for lower performance and control.

3. The theory of declining temptations says that the fraction of the marginal dollar that is spent on temptation goods decreases with overall consumption. Sendhil Mullainathan and Abhijith Banerjee argue that "declining temptations can help to explain a large range of phenomena, from poverty traps to credit and investment behavior". They argue that this "has a number of striking implications for the investment, savings, borrowing and risk-taking behavior of the poor".

They advocate using these insights to design commitments savings products (that both force savings and limit withdrawals) for poor people. Nava Ashraf, Dean S. Karlan, and Wesley Yin designed commitment savings products for a Philippine bank and found that those who opened the account increased savings by 192% and 337% over 6 and 12 months respectively relative to the control group.

4. Lack of control

Psychologist Martin Seligman has propounded the concept of "learned helplessness", as a "condition of a human person or an animal in which it has learned to behave helplessly, even when the opportunity is restored for it to help itself by avoiding an unpleasant or harmful circumstance to which it has been subjected". It follows that clinical depression and related mental illnesses may result from a perceived absence of control over the outcome of a situation.

Accordingly, when we don't feel we have some level of control over our lives we get depressed. And when we feel we have no control for a long time we stop trying to improve a terrible situation because we don't think it's possible anymore. Eric Barker writes about the story of taming elephants - after being leashed by a chain and realizing that they cannot break-free, elephants stop trying to get free even if the chain is replaced with a rope. Such feeling of lack of control, arising from factors like unfair workplaces, bad bosses, and unemployment, have been found to lead to poor health. It is therefore natural for a poor person, who faces a series of continuous struggles on even the most mundane and basic of things, to feel that things are mostly out of his control and accordingly feel depressed and unproductuive.

5. Decision fatigue

I have blogged earlier about a study by Shai Danzigera, Jonathan Levavb and Liora Avnaim-Pessoa of the changes in the nature of decision-making by eight experienced parole judges in Israel during a court session. They found that the prisoners appearing for parole were "anywhere between two and six times as likely to be released if they are one of the first three prisoners considered versus the last three prisoners considered".

The larger message sought to be highlighted by this experiment is that human beings are vulnerable to decision fatigue - the ability to discriminate and make objective decisions get depleted as the session or day (or even life?) progresses. Jon Tierney sums it up nicely,

"No matter how rational and high-minded you try to be, you can’t make decision after decision without paying a biological price. It’s different from ordinary physical fatigue — you’re not consciously aware of being tired — but you’re low on mental energy. The more choices you make throughout the day, the harder each one becomes for your brain, and eventually it looks for shortcuts, usually in either of two very different ways. One shortcut is to become reckless: to act impulsively instead of expending the energy to first think through the consequences... The other shortcut is the ultimate energy saver: do nothing. Instead of agonizing over decisions, avoid any choice. Ducking a decision often creates bigger problems in the long run, but for the moment, it eases the mental strain. You start to resist any change, any potentially risky move — like releasing a prisoner who might commit a crime. So the fatigued judge on a parole board takes the easy way out, and the prisoner keeps doing time."

This analysis is similar to the arguement above that people have a finite store of mental energy, which enables them to exert self-control. Therefore, once they indulge in activities that require utilization of this self-control (like decision making), their reservoir of mental energy is depleted, and they are likely to show less mental commitment in subsequent activities. This phenomenon manifests itself in people making irrational and often impulsive choices and decisions when their mental energy level gets depleted.

Extending this analysis to poor people could help throw light on some of the elements that characterize people living in poverty. Experiencing scarcity in everything (time, money, space, jobs, physical strength etc), more than any others, poor people have to constantly make decisions involving trade-offs. This depletes their pool of mental energy faster, leaving them to either act impulsively or not act at all. The popular caricatures of poor people with different manifestations of these attributes can atleast partially be attributed to decision fatigue and depleting mental energy.

Tierney offers a neat summary of all these new behavioural psychology theories of poverty,

"This sort of decision fatigue is a major — and hitherto ignored — factor in trapping people in poverty. Because their financial situation forces them to make so many trade-offs, they have less willpower to devote to school, work and other activities that might get them into the middle class. It’s hard to know exactly how important this factor is, but there’s no doubt that willpower is a special problem for poor people. Study after study has shown that low self-control correlates with low income as well as with a host of other problems, including poor achievement in school, divorce, crime, alcoholism and poor health."

Analyzing India's Cricket Debacle - A Black Swan Event?

I have been thinking of posting this all through India's disastrous recent cricket tour of England. It was Chris Dillow's excellent post about cognitive biases in football that finally got me around to writing it.

The dismal performance of India's cricketers has been variously attributed to IPL, England emergence as the successor to the great West Indian and Australian teams of the past forty years, India's "club-side" like bowling attack and the inability of its batsmen to cope with the swinging ball, and so on.

Without going into the merits of each of these, if we view this performance in its true perspective - the sheer magnitude of the defeat, the recent relative performances of both teams, and an individual assessment of the players from both sides who played in the series - none of the aforementioned explanations appear convincing.

Consider these. India's 4-0 defeat, apart from being its worst ever against England in 15 series there, was also its worst test loss margin ever. In fact, even the great West Indies, with all its great bowlers and batsmen, or Australia of the last two decades, could not inflict a test defeat of such magnitude, even in series with more tests. Undoubtedly much weaker Indian teams, both in batting and bowling, have performed more creditably against far better teams than the current English team, even in conditions atleast as adverse as that in the recent series. A logical performance-based explanation would lead us someway down the conclusion that the current English team is among best ever cricket team or conversely this Indian team is among the worst ever team assembled by the country!

In the build-up to the series, both teams had equally impressive recent test records. If anything, India's performance was superior, both in terms of the fact that its successes were for a longer period of time and was against slightly better opposition. The No 1 test ranking was a just reflection of India's superiority. Apart from its big success in Australia last winter, England's recent victories have been against the lesser teams (nothing in Pakistan, Sri Lanka, India, and South Africa).

Interestingly, it needs to be borne in mind that the same set of English bowlers have played in all the last three test series between the two countries, two of which were in England, and two of which were won by India and one was drawn. James Anderson (in four) and Stuart Broad (in two) led the English bowling attack on these tours. This brings us to the English bowlers themselves. While Anderson is arguably one of the finest exponents of swing bowling in friendly conditions today, his place among the greats of swing bowling is questionable. Stuart Broad's place was itself under threat, though it can be argued that his best years may be ahead. Take out the performance of the last one year, and the averages speak for themselves.

Man to man, given the fact that Graeme Swann was hardly a factor in the first three tests, the South African attack of Dale Steyn and Morne Morkel, against whom the same Indian batting line-up fared with great distinction less than a year back, is far superior. In terms of every imaginable measure of a bowler's art, Dale Steyn is far superior to James Anderson. Morne Morkel is similarly superior to Stuart Broad. Although England's third seamer, Chris Tremlett or Tim Bresnan or Steve Finn, is superior to South Africa's, the added presence of Jacques Kallis evens up things on this front. So, if South Africa's bowlers are superior to the English bowlers, there is something amiss about attributing the extraordinary English performance to the excellence of their bowlers.

I have three explanations for the triumphalism of English cricket writers,

1. Statistical coincidence - As Chris Dillow writes, events occasionally turn out such that one team enjoys the rare confluence of all fortunate factors, while the other team suffers the exact opposite. England had all its players playing at the peak of their form and free from injuries (and given their otherwise normal averages, it cannot be denied that England enjoyed one of the rare runs of all players being in great form), conditions favorable to its bowlers, its batsmen facing a weak and demoralized bowling attack, and so on. India had exactly the opposite - the injury toll, even with IPL workload, and the near complete batting failure, being inexplicable.

And once, the coincidence of factors align in such comprehensive manner, and one team starts to suffer, it is more likely that its confidence will deplete just as fast as that of the other will rise. A self-fulfilling spiral is triggered off. A statistical outlier will then get mistaken for something else.

2. We live in the present - The stellar performance of the same English bowlers, who not far back were whacked by all and sundry in the cricket World Cup (admittedly there is difference between test and one-dayers, but not so much as to merit such differential - Morkel and Steyn hardly suffered such consistent punishment even in one-dayers), raises the issue of how we should assess modern day cricketers.

The amount of cricket modern cricketers play means that their careers are more likely to be short and spliced with injury or fatigue interruptions. In the circumstances, there is a strong case for assessing players based on their current form. Given the competition and standards, even lesser mortals (say, Time Bresnan or Chris Tremlett) playing cricket today are likely to have a streak of great form for some period of time. Then law of averages catch up and they fall back to their mean career trajectory. Only the great players, and there appear to be only a handful of true greats playing now, can sustain their high-level performance for years.

3. Availability Bias - The 3-1 victory over Australia in 2009-10 was easily the greatest cricketing achievement for England in nearly four decades, if not more. It was preceded and succeeded by consistent performances by the team, albeit, as aforementioned, against the weaker teams. The whitewash of the World No 1 Indian team on top of all this naturally reinforces the positive feeling about the team and therefore the impression of an all-conquering team.

In fact, this is classic availability bias, wherein the immediate recollections of the team's performance gets disproportionate importance in the overall assessment of the team. The immediacy of the string of these successes, amplified manifold by modern media coverage, gave rise to the impression of an all-conquering team.

None of this is to denigrate the English achievement nor condone the pathetic performance of India. It is only to fill in a sense of perspective to the emotion charged reporting that dominated the richly deserved triumph of the British team.

Incentivizing savings habit among the poor

The government of India have initiated a Total Financial Inclusion (TFI) program to ease formal institutional credit constraints and expand their ability to manage their finances more optimally. However, while the policies under implementation may achieve success with the former, the later remains a much more formidable challenge.



The prevailing set of policies, revolving around the TFI program and door-step banking through business correspondents, will deliver a savings bank account to every citizen. It is also being suggested that the Aadhaar number and Aadhaar-linked savings bank bank accounts could provide the ideal platform to implement the proposed cash transfer schemes to deliver subsidies. All these will still not address the ultimate objective of getting people to optimally utilize their savings bank account to manage their finances efficiently. The challenge will be all the more bigger in promotion of savings among those poor who are more acutely present-biased (or have greater self-control problems).



Promotion of savings habit among the poor has been an area of interesting research in recent years, driven mostly by trends and developments in behavioural economics. Economists like Sendhil Mullainathan have expanded on Richard Thaler's mental accounting framework to explain how people's subliminal predisposition to categorize and evaluate savings and spending decisions can be invoked to nudge people into managing their finances more optimally.



I had blogged earlier about the merits of a system which divides income into separate, end-use based mental accounts.

"It helps people manage their finances more effectively in two ways. One, people are inclined to save if they are aware of what they are saving for. For example, a "car account" is a strong nudge to get people to save for purchasing a car. Two, separation of expenditure heads with pre-defined allocations help in effective management of expenditures."

Based on the mental accounting framework, I have also blogged about the merits of use-directed multi-tier accounts to nudge people into saving for specific purposes.



In this context, the most recent research paper (pdf here) on incentivizing savings among the poor come from an experiment among the rotating savings and credit associations (ROSCAs) of Kenya by Pascaline Dupas and Jonathan Robinson. They provided members of 113 ROSCAs in Kenya with different household and ROSCA savings instruments (like individual lock and key boxes and ROSCA health pot) to save for health and other contingencies and found that it could "substantially increase investment in preventative health, reduce vulnerability to health shocks, and help people meet their savings goals".



They also found that providing people with a designated safe place to keep money was sufficient to overcome the common barriers to savings - transfers to other people and "unplanned expenditures" on temptation goods - through a mental accounting effect ("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").



The find strong evidence that use-directed commitment savings products can be effective in promoting savings even among the more present-biased individuals. The ROSCA health pot was a commitment savings approach wherein a sub-group in a ROSCA could agree on a health product and provide additional contribution (over and above their ROSCA contribution), which could be redeemed each month to purchase the particular health product for one member at a time. They write about the present-biased members of the ROSCA,

"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."

They point to an earlier study by the same authors from the same area in Kenya which found that providing simple bank accounts to wmone who run small vending businesses had substantial savings impact only on about 40% of them. They write,

"Since the bank accounts did not provide any form of earmarking or a strong commitment feature, their primary function was likely to provide a designated place to save. The present study suggests that more sophisticated devices that include stronger commitment features might be better suited for some of those individuals who did not use the simple savings account. For others, it appears that a less sophisticated but more easily accessible device such as a Safe Box would be better suited to save small sums on a regular basis."

The "framing effect" and monetary policy

In its quarterly monetary policy review, the Reserve Bank of India (RBI) has raised its benchmark repo rate (the rate at which it lends money to commercial banks) by 50 basis points to 8%, its 11th successive increase since October 2009.

In the accompanying statement, the RBI expressed heightened concerns at inflationary expectations getting unleashed. It argued that inflation was a far bigger concern than any slowdown in economic growth. In simple terms, as the RBI Governor's press statement indicates, the main thrust of the interest rate decision was to "moderate inflation and anchor inflation expectations".

Given this "inflation targeting" based paradigm in central bank communication, the rate hike has expectedly raised concerns about its adverse impact on economic growth. It is argued that the increased cost of borrowing would discourage investments and slow down growth. Further, they also claim that since the inflation is driven by supply-side causes, monetary policy actions will have little impact on the final outcomes. This view is based on the valid assumption of an inflation-growth trade-off.

However, a different, "over-heating economy" paradigm based central bank communication could give a different spin to this interest rate decision. It is common knowledge, and the RBI statement reiterates this, that inflation in India is caused by supply constraints. The growth on the supply-side of the economy is simply unable to keep pace with demand growth. These constraints include infrastructure bottlenecks, slow growth in manufacturing production capacity and agriculture production etc.

In the circumstances, there are only two options - ease supply-side constraints and/or slow down demand growth. Since the former is a medium to long-term challenge, the only alternative is to cool-down the economic growth. In this context, the objective of the RBI's rate hike decision becomes one of deliberately cooling down an over-heating economy. The interest rate hike has the desired contractionary effect on the economy. In this monetary policy communication paradigm, lowering growth, and not inflation, is the direct objective. If this is the objective, then the inflation-growth trade-off loses its relevance, with the balance tipping decisively in one direction.

This debate is a classic case of what behavioural economists call "framing effect". Substantively, both "inflation targeting" and "cooling the overheating economy" based monetary policy decisions amount to the same. However, when framed in terms of the former, concerns about growth come to the fore, forcing governments into criticising the central bank. In contrast, when framed in terms of the latter, where slowing down growth is the explicit objective, the criticism of the central bank is likely to be more muted.

Mental fatigue and decision-making

One of the less understood and least discussed areas of public policy is the influence of psychological and behavioural motivations in determining the actions and decisions of human beings. Conventional wisdom on this has relied on the assumption that human beings are rational and respond to incentives (rewards and punishments) and regulations (rules). But this approach overlooks the critical influence of cognitive biases on human behaviour.

An excellent post in Economix draws attention to the critical role of extraneous, human behaviour-related factors in deciding outcomes in public administration. It points to a recent paper by Shai Danzigera, Jonathan Levavb and Liora Avnaim-Pessoa who analysed the changes in the nature of decision-making by eight experienced parole judges in Israel during a court session.

They examined more than 1,000 rulings made by them in 2009 found that the probability of favorable decisions declined dramatically as the session progressed. They write,

"Are judicial rulings based solely on laws and facts? Legal formalism holds that judges apply legal reasons to the facts of a case in a rational, mechanical, and deliberative manner. In contrast, legal realists argue that the rational application of legal reasons does not sufficiently explain the decisions of judges and that psychological, political, and social factors influence judicial rulings. We test the common caricature of realism that justice is “what the judge ate for breakfast” in sequential parole decisions made by experienced judges. We record the judges’ two daily food breaks, which result in segmenting the deliberations of the day into three distinct “decision sessions.” We find that the percentage of favorable rulings drops gradually from ≈65% to nearly zero within each decision session and returns abruptly to ≈65% after a break. Our findings suggest that judicial rulings can be swayed by extraneous variables that should have no bearing on legal decisions."

A Guardian report quotes one of the authors, Jonathan Levav,

"You are anywhere between two and six times as likely to be released if you're one of the first three prisoners considered versus the last three prisoners considered."

This finding resonates with studies elsewhere and in other areas. Behavioural economists like Dan Ariely have found that making successive decisions depletes a limited mental facility. As people get tired, they look for shortcuts, and one of the easiest shortcuts is to uphold the status quo – in this case, denying parole. As the Economix report writes about its implications elsewhere,

"This suggests that college admissions committees are more likely to accept the first applicants they consider after a lunch break. Or that quality-control officers may be more likely to ignore possible flaws in products as a long day drags toward its close."

As the Economix post argues, while food and rest are imperfect solutions to overcome mental fatigue related problems, checklists may be more effective in addressing them. In fact, Prof Levab points to the extensive use of checklists by professionals like pilots as an acknowledgement of the reality of mental fatigue.

Update 1 (7/6/2011)

The idea of depletable self-control - that an individual’s capacity for exerting willpower was finite (or exerting willpower in one area makes us less able to exert it in other areas) has been gaining currency in recent years. In 1998, researchers at Case Western Reserve University published some of the young movement’s first returns. Roy Baumeister, Ellen Bratslavsky, Mark Muraven, and Dianne Tice set up a simple experiment. They had food-deprived subjects sit at a table with two types of food on it: cookies and chocolates; and radishes. Some of the subjects were instructed to eat radishes and resist the sweets, and afterwards all were put to work on unsolvable geometric puzzles. Resisting the sweets, independent of mood, made participants give up more than twice as quickly on the geometric puzzles. Resisting temptation, the researchers found, seemed to have "produced a 'psychic cost'".

Over the intervening 13 years, these results have been corroborated in more than 100 experiments. Researchers have found that exerting self-control on an initial task impaired self-control on subsequent tasks - consumers became more susceptible to tempting products; chronic dieters overate; people were more likely to lie for monetary gain; and so on.

In addition to self-control decisions, researchers have found the same problem with tradeoff decisions - where w resolve conflicts among choices as rationally as possible. Any decision that requires tradeoffs - like choosing between more money and more leisure time - require the same conflict resolution as self-control decisions and seems to deplete our ability to muster willpower for future decisions.

Princeton economist Dan Spears has found that such self-control and trade-off decisions are more pervasive for poor people, with the result that they make a large number of sub-optimal subsequent decisions. For example, if you have enough money, deciding whether to buy the soap only requires considering whether you want it, not what you might have to give up to get it. However, many of the tradeoff decisions that the poor have to make every day are onerous and depressing - whether to pay rent or buy food; to buy medicine or winter clothes; to pay for school materials or loan money to a relative - are weighty, and just thinking about them seems to exact a mental cost.

Mullainathan and Banerjee too found that given their scarce incomes, the same self-control or trade-off decision problem is more consequential for the poor than the rich. These findings bring in a new dimension to poverty - "poverty doesn’t simply reduce freedom by constraining an individual’s choices, but that it may actually alter the nature of freedom by reducing an individual’s willpower".

Empowering consumers using behavioural insights

The Behavioural Insights Team located in the British Cabinet Office has released its latest strategy document (pdf here). It argues for the use of insights from behavioural psychology to empower consumers and help them make more informed and effective choices. It is hoped that this will in turn encourage competitive businesses, improve overall economic efficiency and thereby long term economic growth. As the report says, "A better deal for consumers and the economy means a better deal all round."

Its earlier report which advocated the use of insights from behavioural economics to address health care issues is discussed here. Its two-fold objectives are defined as

"1. To put consumers in charge so that they are better able to get the best deals for themselves individually and collectively as well as looking at ways to empower the most vulnerable who may not otherwise benefit from these exciting developments.
2. To contribute to our broader growth agenda, supporting a strong private sector recovery and helping to raise underlying long-term growth rates."

The strategies and initiatives proposed include,

"1. A radical new programme of work – 'mydata' – which will enable consumers to access, control and use data currently held about them by businesses;
2. A range of new ways of ensuring that consumers are given richer, more relevant information about the goods and services they buy (including clearer information on Credit Card Statements);
3. A drive to encourage collective purchasing and collaborative consumption, which enable people to come together to buy or use goods;
4. The development of a self-regulatory quality mark for web and comparison sites, and the publication by Government of complaints and performance data held about businesses"

The Better Choices : Better Deals program seeks to put power into the hands of consumers so that they can choose optimally between suppliers and in the process incentivize businesses to be more efficient and innovative. In order to achieve this, it seeks to leverage three recent trends,

"1. The increasing role of new technologies, in particular internet and mobile phone applications, that have opened up new channels for consumers to find, compare, and purchase goods and services.
2. The use of data, drawn from customers’ own transaction histories, that have allowed businesses to understand their customers better, allowing them to make more tailored recommendations.
3. The development of new ways for different consumers to collaborate across the economy – for example whether by sharing cars or bicycles, or giving feedback about a GP practice, a local tradesman or a multinational corporation."

The centerpiece of the campaign is the "mydata" program undertaken by the government in partnership with consumer groups and leading businesses to give consumers more control and access to their personal transactions data in a way that is portable and safe. This will enable them to "take advantage of the growing number of applications which can use this data to find them a better deal, or tell them interesting things about their spending habits".

The Better Choices : Better Deals campaign also proposes to go beyond the conventional regulations driven approach to protect and benefit consumers. This would include working in partnership with businesses and voluntary associations to build norms of social responsibility and consumer satisfaction. The program will appeal to businesses to reduce their carbon footprint, improve skills and create jobs, support the local community, and improve the quality and well-being of their consumers.

On changing human behaviour

Changing human behaviour, so as to get people to act in a manner that increases the likelihood of achieving certain social or environmental goals, is one of the most challenging areas of public policy. Standard approaches involving regulation and incentives (taxes, rewards, and penalties), while effective to certain extent, are increasingly becoming blunt instruments, especially on the more universal of social and civic problems.

In this context, Richard Thaler and Cass Sunstein's path-breaking book, Nudge offers several interesting insights into how human beings can be subtly nudged into performing specific tasks. And a series of small nudges could go a long way towards meeting important public policy goals.

An excellent summary of these techniques comes from Oliver Payne with his 19 ways to "ask" for sustainable change in human behaviour. He has three presentations (Summary, Part I, Part II, and Part III, this, this) form an excellent resource.

1. Simply Ask - eg. when asked nothing in a food Que, only 40% of students took a serving of fruit, but when specifically asked whether they will have fruit, nearly 70% took fruit; voters who were asked a few days before voting whether they will vote were more likely to turn up and vote etc. The "exposure effect" increases the likelihood of the desired outcome.

2. Ask using the right words - eg. carbon offsets are more acceptable than carbon tax; user charges are easier to push through than taxes (framing of the issue); nudge to prevent people from stealing wood from Arizona's Petrified Forest National Park ("Many past visitors have removed petrified wood from the Park changing the natural state of the Park" Vs "Please don't remove the petrified wood from the Park in order to preserve...", the latter was more effective) (reinforcement of social norms); describe carrots as "X-ray vision carrots" (to pre-schoolers) or soup as "Rich Vegetable medley Soup" increases uptake considerably (selective perception) etc.

3. Ask using the right images - eg. the dual image of a littered environment being changed to a clean one reinforces social norms and is more effective in driving home the message on littering than just a littered environment image (it ends up reinforcing the damaging message that many people do litter).

4. Ask using the right authority - eg. Don't Mess With Texas campaign (which did not work with fines) reduced roadside littering by over 70% over 5 years through a campaign with sporting and country-music heroes imploring people to not litter. Ads avoided the negatives of shame and guilt in favor of the positives of pride and group identity (reinforcement of social norms).

5. Ask using the right fake authority - eg. An office tea and coffee "honour box" (into which people dropped the charges) was more effective at boosting honesty and collecting money when a pair of eyes (Big Brother Eyes) was displayed beside it (authority effect - sensitivity to our actions being observed by others); smiley and frowny faces about your driving speed on electronic signboards in South Lanarkshire Council roads (instead of numerical speed information) was more effective at reducing speeds (social approval - smile, you're on camera!); smiley and frowny faces to represent electricity usage on consumers' electricity bills by South California Edison electricity utility's OPower Home Energy Reporting System etc.

6. Ask in the right order - eg. listing disadvantages followed by advantages of carbon tax was found to be more effective in getting public approval than the other way round (framing and anchoring effects)

7. Ask at the right time - eg. traffic light synchronization program in Texas which informed drivers (through digital signboards) about their optimal traffic speeds lowered delays by 25% (self-serving bias)

8. Ask with the right incentive - eg. RecycleBank has a program in many US and UK cities that weighs the amount you re-cycle and converts it into points which can either be redeemed for shopping coupons at local stores or brand outlets (partnership with eBay and Marks & Spencers) or informs them the equivalent numbers of trees saved and oil barrels conserved.

9. Add options - eg. using decoys to help people make choices between various options (by say, adding an additional qualification to the item we want people to purchase or not purchase); keep a non-recyclables (or trash) bin beside the recyclables so as to ensure more effective sorting (framing effect); also small hole for recyclables bin and a larger hole for non-recyclables bin etc

10. Take away options - eg. default options in computer programs nudges data entry operators away from making mistakes; mandatory fields and server clock times too reduces the probability of errors in data capturing.

11. Ask, but have a default option - eg. have a default menu option in school restaurant or conferences which is vegetarian (or healthy food) and provide non-vegetarian (or junk food) when asked (dramatically increases uptake) (framing effect); California's Ready Return tax filling form is pre-filled with last year's data was widely welcomed by assessees etc.

12. Ask a completely different question - eg. Piano staircase and calorie counters on steps (Goodnight Hostel in Lisbon) encouraged people to use stairs over the escalators (framing effect); Bottle Bank Arcade bins placed at strategic locations in Swedish cities that asks people to deposit used bottles and cans.

13. Let the feedback ask the question - eg. Ambient Orb device nudges people to optimize their electricity usage. Cognitively salient information helps people overcome inertia.

14. Don't Ask, Tell - eg. Inform tax payers that evasion is the exception and most people pay or put cards in the toilet to inform guests that most other guests re-use their towels. In both these cases, there is a reinforcement of a social norm.

15. Ask nothing, other than simply to measure - eg. Drivers become more mileage conscious with merely owning a car (say, a hybrid car) whose USP is mileage.

16. Don't ask anything - other than they go public - eg. grading restaurants in Los Angeles (reinforce social norms); Wattson household energy monitor whose data is displayed on the owner's Facebook page (Social norms - peer pressure) etc

17. Ask for a commitment - in the future - eg. shower timer to control water flow (temporal discounting or time inconsistent preferences); commitment contracts on exercising and eating habits on StickK.com etc

18. Ask Kinetically - eg. automatic light and AC on and off when key is inserted or taken off the slot in hotel rooms; square peg, compared to round peg, to hold lavatory paper (each tug is met with a resistance, which encourages people to optimize on their toilet paper usage) etc.

19. Make the question irrelevant - eg. smaller plates to reduce over-eating (selective perception); moving the clock backwards and forwards to make more optimal use of sunlight.

As can be seen from all these, loss-aversion, framing, and social norms are the commonest cognitive biases that can be targeted to formulate policies. People draw different conclusions and act differently based on how the information/data is presented - people are context dependent. People are much more averse to losses than to similarly sized gains - pain of loss is twice the pleasure of gain! People prefer to follow the herd and their actions to reinforce the social norms.

Beating inflation by downsizing packages!

As input costs rise and inflationary pressures take hold, in order to keep sale prices unchanged, consumer products businesses have sought to subtly reduce quantities in their standard packages. The high unemployment rates and weak demand in the US means that businesses cannot afford to pass on price increases to consumers. A NYT article writes,

"As an expected increase in the cost of raw materials looms for late summer, consumers are beginning to encounter shrinking food packages... companies in recent months have tried to camouflage price increases by selling their products in tiny and tinier packages. So far, the changes are most visible at the grocery store, where shoppers are paying the same amount, but getting less...

In every economic downturn in the last few decades, companies have reduced the size of some products, disguising price increases and avoiding comparisons on same-size packages, before and after an increase. Each time, the marketing campaigns are coy; this time, the smaller versions are 'greener' (packages good for the environment) or more 'portable' (little carry bags for the takeout lifestyle) or 'healthier' (fewer calories)."

The size of the packages, atleast the width and height, are kept the same. Or marketers design a new shape and size altogether, complicating any effort to comparison shop. Businesses seek to capitalize on the fact that consumers are generally more sensitive to changes in prices than to changes in quantity. In any case, a very small number of shoppers take the trouble of reading quantity labels on packages while making their purchases.

See this fascinating advertisement (via Economix) by Blue Bell Ice Creams that it has not been trying to reduce the size of its packets!

Ricardian equivalence in insurance

Ricardian equivalence refers to the argument that consumers internalize the government's borrowings by cutting back on their spending (or increasing their savings) in anticipation of higher taxes in future. Conservative economists have invoked this to argue that government deficit spending cannot stimulate aggregate demand.

The NYT has an article raising the issues concerning insurance industry in the aftermath of the Japanese earthquake and tsunami,

"Moody’s said ratings for all of the major reinsurers were stable, and many reinsurance analysts said they saw one bright spot in the disaster: prices for reinsurance have been declining for several years, and while the earthquake will hurt the results of companies for one quarter, it might spur new demand and higher prices.

Reinsurance contracts are often renewed in April, and Keefe, Bruyette & Woods issued a report on Tuesday suggesting that losses from the earthquakes in Japan and, recently, New Zealand would lead to firmer prices on California earthquake and Florida hurricane insurance."

This is classic rational expectations (or cognitive biases) operating from both ends of the market. Property owners, atleast in earthquake prone and coastal areas, swayed by the availability bias generated by events in Japan, will be more inclined to insure their assets in a more comprehensive manner. Similarly, insurers would increase the actuarial risks associated with such events and price their premiums upwards.

Assuming that the actual risks remain the same (taken on a historic scale), the insurer can therefore hope to claim higher profits in future (though this is partly reduced the higher premiums that re-insurers are themselves likely to charge). To this extent, insurers will be able to recover a large portion of the current payouts from these higher future premiums. This begs the accounting question about what is the real long-term impact of such earthquakes on the insurance industry.

The Groupon effect - using social networks to address collective action problems

In recent months, the electronic coupon company, Groupon, has revolutionized the way the internet can be harnessed to minimize search and co-ordination costs (the collective action problem) in retailing. Its electronic discount coupons get activated (discount sales happen) only if a certain number of fellow citizens agree to buy the same thing on the same day. The retailer makes up his loss due to lower price with larger number of customers, who not only bring in larger immediate sales but more importantly brings in future patronage.

Groupon subscribers receive notifications of one deal a day, tailored to their location and profile. The local business gets customers, and Groupon takes a share of the coupon proceeds. The average Groupon deal offers 50 to 90 percent off retail goods and services, from restaurant certificates to skydiving lessons. Once the tipping point in registrations is reached, all buyers are locked in, and their investment becomes irrevocable. If the point is not reached, the deal is automatically aborted.

Groupon's spectacular success (it has been described the fastest growing internet company ever and has already crossed 50 million subscribers) since its founding in 2008 by Andrew Mason has naturally generated considerable commercial interest. Attempts by all the major web-service providers, including Yahoo and Google, to take-over Groupon have been rebuffed. The company recently raised a record $950 million from big investors and is considering a $15 bn IPO soon.

For its part, Groupon harnesses the power of psychology to attract customers and retailers. It seeks to leverage the inherent attractiveness of a shopping plan where customers are forced to wait for sometime to find out whether they can win the deal. The one-deal a day strategy also means that the attention bandwidth of customers can be more easily captured.

This psychological attraction of getting deep discounts also means that Groupon like websites are likely to become extremely popular in price-snesitive markets like India. In order to overcome the challenge posed by the limited reach of computers and internet, it may be more effective to use the now ubiquituous mobile phones to deliver such shopping deals in these countries. Further, mobile phones offers the possibility of much greater interactivity, potential for behavioural nudges, and the achievement of more overall efficient outcomes.

A recent article in NYT, in the context of the recent wave of street protests that have swept Middle East and North Africa, speculates on the possibility of solving the collective action problem with street protests. It writes, "Even if we all watch television coverage of demonstrations together and express our enthusiasm for the movement online, we have no guarantee our neighbors will take the physical risk of going out in the streets until they actually do so".

Technology will make it much easier for frustrated societies to express their collective anger. However, I am inclined to believe that translating this collective angst into tangible action on the field will remain beyond the reach of technology (apart from increasing the likelihood of participation) and as much a challenge as ever.

Update 1 (20/4/2011)

Excellent infographic on the rise of Groupon.

Update 2 (5/5/2011)

Felix Salmon identifies the USP of Groupon - the idea that coupons only become activated once a certain minimum number of people have signed up for them. He writes,

"This is essentially a guarantee for the merchant that the needle will be moved, that their effort won’t be wasted. With traditional advertising or even with old-fashioned coupons, a merchant never has any guarantee that they will be noticed or make any difference. But with a Groupon, you know that hundreds of people will be so enticed by your offer that they’re willing to pay real money to access it. That kind of guaranteed engagement is hugely valuable, and more or less unprecedented in the world of marketing and advertising."

Update 3 (5/11/2011)

Groupon debuted in the equity markets 31% higher than its offer price in its first trading day, bringing the online coupon-seller’s valuation to more than $16bn and reflecting a surge of excitement for one of the fastest-growing and most controversial companies to list in recent years. Shares in the company were set at $20 late on Thursday, then jumped as high as $31.14 in the first few minutes of trading before closing at $26.11. Groupon raised $700m in its highly anticipated initial public offering, in a deal which valued the company at $12.6bn, higher than the anticipated cap of $11bn but below the $20bn the company had sought earlier this year.

The company’s co-founders, who own about a third of the company’s shares, became billionaires. Andrew Mason, chief executive, has a stake worth about $1.2bn. Groupon’s buyers included many funds that intended to “flip” the shares to take advantage of their first-day jump. By the close, 49m shares had changed hands, nearly the entire float, making it the second most traded US stock on the day.

The third batting power play and game theory!

One of the interesting debates on the sidelines of the Cricket World Cup relates to the timing of when batting team captains should use their third power play (PP) of five overs. The third PP, to be availed at the request of the batting team, imposes a restriction that the fielding team can have only three fielders outside the thirty yard circle.

The dilemma for batting captains is to use it earlier, say in the 30-40 over period, or preserve it for the slog overs. Apart from the argument that since the ball is changed in the 34 th over (and since a harder ball is easier to hit), it may be effective to take PP early, there has not been much analysis of the issue. However, a simple balance sheet of the costs and benefits of both alternatives to each side reveals that the choice is not as hard as it appears.

The benefits for the batting side are several and significant

1. With or without field restrictions, slog overs are a form of PP in themselves, atleast from the mental frame of the batsmen. It may therefore be more effective to take an early PP and get more runs earlier than otherwise would have been the case. The batting team effectively gets two PPs! The batting team can also carry the momentum on to the slog overs - the bowling side will have to mentally recover after the PP.

2. The bowling side is forced to call on its best bowlers much earlier than they would have preferred. Typically, the best bowlers have three spells - opening burst, slog overs, and a containing or wicket searching spell in the middle. If the PP is taken in the slog overs, it coincides with the bowlers final planned spell. However, an early PP, especially if the bowler has already completed his middle spell, can wreck the best laid plans of the bowling captain. Forced into dividing their ten overs into four spells, the best bowlers will have less overs for the slog.

3. Even without field restrictions, slog overs generally yield more runs. The incremental benefit, in terms of runs scored, with PP restrictions are not likely to be substantial. However, in the earlier overs, without field restrictions, batting sides are likely to score only modestly (3-4 runs an over in an average scoring match and 5-6 runs an over in a high scoring one). The incremental benefit of early PP is therefore significant.

4. Finally, the harder the ball, the easier is it to strike. Since the ball is replaced in the 34 th over, it is surely more sensible to opt for an early PP.

The negative side of the equation for the batting side is the risk of losing wickets in the PP and being left with limited fire-power to take advantage of the slog overs. However, this is more a question of the batsman's judgement of the PP situation, an issue of mental orientation. An element of representativeness bias in the batsman's mind anchors the third PP to slog overs.

It needs to be borne in mind that batting PP are not slog overs. In slog overs, batsmen throw caution to the winds safely in the knowledge that the end of the innings is near. But early PPs are followed by more overs. The risks being taken need to be weighed accordingly.

Consider this 2X2 matrix of the two alternatives - early and slog overs PP - from the perspective of the batting and bowling sides.



As can be seen, the early PP is the dominant strategy for the batting side - for the batting side, its benefits are singificant while for the bowling side, the costs are just as high!