Why Having Too Little Leads to Bad Decisions
Financial stress leads to a downward spiral of bad decision-making.
Posted Sep 26, 2013
If I’d only done this instead of that, I’d be in better financial shape today. How many times have you found yourself thinking that thought?
While hindsight is always 20-20, a growing body of research is illuminating a surprising factor in poor decision-making: feeling that you don’t have enough.
The scarcity can be not enough money, not enough time, or not enough turns in a game like Angry Birds.
How Poverty Impedes Cognitive Function
Let’s look first at money. A research team led by Harvard economist Sendhil Mullainathan asked shoppers at a New Jersey Mall (whose annual incomes ranged from $20,000 to $70,000) to imagine that their car required a repair costing $300. They were free to pay for the repair now, take out a loan to cover the cost of the repair, or simply ignore it. Then the shoppers were given a series of tasks to complete that measured various aspects of intelligence, such as logical thinking and problem solving. The researchers found that performance on the cognitive tasks was the same regardless of income level. But when the cost of the repair was increased to $3,000, a very different picture emerged: The cognitive performance of those at the upper end of the income distribution was unaffected by the increase. But those at the lower end suffered a 40% decline! The authors interpreted this to mean that scarcity impaired people’s ability to think clearly. The threat—even an imagined threat—of a large bill made it difficult for poor people to focus on the cognitive tasks at hand.
Do people behave like this in “the real world”? The answer appears to be yes. Mullainathan and colleagues provided sugar cane farmers in India with psychological tests before their harvest and after the harvest. The farmers performed better on the tests after the harvest, when their financial coffers were flush. The results of these two studies were reported in the August 30 issue of Science. The abstract can be found here.
Does Poverty Lead to Bad Decision-Making, or Is It the Other Way Around?
One objection you might have about the studies I just described is that perhaps poor people are just more emotionally over-reactive. You may go even so far as to argue that that is why they are poor—they can’t handle stress and pressure.
This is where laboratory experiments come in handy. Using college students from the University of Chicago, Princeton, and Harvard, Mullainathan and colleagues studied the impact of a number of different types of scarcity on decision-making. Participants were randomly assigned to various scarcity conditions so the researchers were not studying performance differences between rich and poor. Instead, they were studying what happens to people of similar backgrounds when they are placed in conditions of plenty or scarcity.
Across a number of studies, participants played games such as Wheel of Fortune, Angry Birds, or Family Feud. They were randomly assigned “budgets” of a number of chances given to play the game. These budgets could contain many chances (“rich”) or few (“poor”). The budgets were distributed in “paychecks” across multiple rounds of the game. “Poor” participants received smaller “paychecks” than “rich” participants. On each round, they could earn rewards. If they completed a round without using up their “paychecks," the unspent units were carried forward to the next game.
Now here’s the most important part: Some participants were allowed to borrow chances when they ran out, but they had to pay a cost to do so. This is analogous to using a credit card when you run out of money before your next paycheck.
The first question is whether these differences in resource allocation affected cognitive performance. To answer this, participants were tested on a variety of cognitive and attention tasks after they had completed the games. “Poor” participants performed significantly worse on the cognitive tasks than did the “rich” participants.
The next question is whether people make better or worse financial decisions under conditions of scarcity. The studies returned the same pattern of results regardless of which game was played: “Poor” participants borrowed more than did “rich” participants, and accumulated greater debt as the game progressed. Because they were paying interest on their borrowing, their “paychecks” shrunk over the course of the game. They also borrowed heavily regardless of whether the interest rate was high or low. In fact, “poor” participants fared better when they did not have the option to borrow. “Rich” participants, on the other hand, performed equivalently whether they had the option to borrow or not, they borrowed less, and they tempered their decisions to borrow based on the interest rate they would be charged.
The final question is how well participants performed in the games. Given that “rich” participants had more chances to win, it is no surprise that they did better than “poor” participants. But the affect of scarcity was more insidious than that. In the Family Feud game, some participants were allowed to see previews of questions that would be used in the next round. “Poor” participants did not take advantage of the previews; they performed the same whether they were given the “heads up” or not. “Rich” participants, on the other hand, made use of the hint, and their performance improved. The researchers concluded that “poor” participants were so focused on the demands of the current game that they did not consider what was going to happen in the very near future. Instead, scarcity led “poor” people to neglect future rounds and borrow away from them. The results of this work were reported in the November 2, 2012 issue of Science; the abstract can be found here.
The Bottom Line
Mullainathan and Princeton psychologist Eldar Shafir summarize these and many other studies in their new book Why Having Too Little Means So Much (2013, Times Books). The takeaway message of the book is this: Scarcity of time, food, opportunity, or even friendship, can create a narrowed mindset in anyone. No one is immune.
I am a Fellow of the Association for Psychological Science and the author of Good Thinking: Seven Powerful Ideas That Influence the Way We Think (2012, Cambridge University Press); learn more at denisecummins.com.
Posted September 26, 2013.