Shiller: Philanthropic Finance

Robert Shiller on how we might help the poor save more:

Laying a retirement lifeline for the poor, by Robert Shiller, Project Syndicate: ...Today's huge companies and the financial wizards who lead them -- or buy and sell them -- may be generous to their churches, favorite charities, and families and friends, but their professional lives are defined solely by the relentless pursuit of profits.

That perception may be largely true, but not entirely so. Consider Muhammad Yunus, who won the Nobel Peace Prize last October. His Grameen Bank ... has offered tiny loans to some of the poorest people in the world, helping to lift many borrowers out of poverty. The bank made a profit and grew over the years...

But was money Yunus' ultimate motive? In interviews, he reveals that he was actually motivated by a deep sympathy for the plight of the poor in his country. ... He tried to make a profit ... to prove the creditworthiness of these neglected people...

Paradoxically, while Yunus was pursuing profit, he was apparently not doing it for the money. ... Indeed, the history of financial institutions for low-income people is largely a history of philanthropic or idealistic movements...

The cooperative movement of the 19th and 20th centuries was associated with a long list of financial and insurance institutions -- including savings banks, building societies, and savings-and-loan societies -- to help less-advantaged people.

Such philanthropic finance continues today. Peter Tufano, a finance professor at Harvard Business School, has quietly been doing nonprofit work with the foundation he created, Doorways to Dreams, to help low-income people improve their financial prospects. As far as I can determine ..., [h]e doesn't seem to care about making money for himself.

According to Tufano, the fundamental problem in encouraging low-income people to save is that they need the money ... to deal with short-term crises. ...[I]f government programs designed to promote saving by low-income people don't tie up their money for many years until retirement, they will often succumb to temptation and spend the money frivolously.

Tufano approaches the problem with real sympathy for these people, and a realistic idea about how to help them: premium savings bonds.

In addition to normal interest payments, these bonds have an attached lottery -- an enticement to keep the money in savings. Low-income people manifestly enjoy lotteries, and they will acquire the habit of looking forward to the lottery dates, which will deter them from cashing in their bonds. But if a real emergency arises, they can get their money.

In fact, lottery bonds have a long history. In 1694, the English government issued a 10 percent, 16-year bond called "the Million Adventure," which awarded prizes randomly each year to its holders. Likewise, Harold MacMillan's government created a lottery bonds program -- called premium bonds, or "saving with a thrill" -- in Britain in 1956. The program ... has grown, and today premium bonds have a place in the saving portfolio of 23 million people, almost 40 percent of the British population. Sweden, too, has such bonds, as do other countries.

But, while such bonds have succeeded in raising savings rates in the countries that have created them, they have not had advocates in the United States. Tufano's strategy to change that is to test his ideas in partnership with firms. He has launched pilot tests of "prize-linked" accounts in cooperation with Centra Credit Union, based in Columbus, Indiana. If the product helps families save, he hopes to persuade lawmakers to make this type of savings scheme easier to offer in America. ...

[P]eople like Yunus and Tufano show that ... with the help of disinterested but passionate advocacy ..., [t]hese ideas hold out the hope of a brighter future to everyone, especially those who are most in need.

I thought this statement

Low-income people manifestly enjoy lotteries, and they will acquire the habit of looking forward to the lottery dates

was a bit condescending but moving beyond that (and the statement that addressing "short-term crises" is to "succumb to temptation and spend the money frivolously"), would these have a better payout than a standard state-run lottery? And how does this help? For example, let 10 people save $200 for a total of $2,000. With no lottery involved, suppose the risk-free asset pays 10% so that each person earns $20.

Now take 5% of the earnings ($10 each) and turn it into a lottery with a 100% payout. Instead of all ten people getting $20, nine will get $10 (i.e. 5% of $200) and one of them will win the lottery and get $100 + $10. The total payout is the same (though if administration costs are involved, then the overall payout could fall), but the distribution is much different and much more unequal. With one person better off and nine worse off, how is it that we know welfare has improved?

This is identical to each person putting $200 into the risk free asset, earning $20, then taking $10 of the earnings and putting into a lottery (with the other nine people doing the same). All it does is save each of them a trip to 7-11 to buy the tickets. Either way, most of them lose $10.

Even if the poor do somehow have a taste for risk (manifestly) so that adding the lottery increases the amount put into these assets, it's not clear to me they are better off in general, though one of them would be. That is, suppose people do save more because of the lottery. Why is the person earning 5% on $300 better off than they would be earning 10% on $200 over a period of years (after 8 years with dividends reinvested the $200 asset is worth more, though the difference in interest rates wouldn't be this large so the earnings difference is exaggerated in this example)?

I also don't buy the argument that the lottery would prevent people from cashing in the bonds when they need the money (in fact, from Shiller's description, I would expect the poor to cash the bonds at the first sign of trouble and use it all to play the daily state lottery in the hopes of hitting it big - but in any case cashing the bonds in does not prevent them from playing the state lottery later). It's late - I must be missing something - how does adding a lottery help? Shiller does use the term "philanthropic finance" to describe these lotteries, so maybe the payout comes from donations, though that doesn't seem to be the case from the description.

Comments

[Barry]

"Even if the poor do somehow have a taste for risk (manifestly) so that adding the lottery increases the amount put into these assets..."

If the default is just getting by, until something happens to ruin oneself, then playing the lottery is not as risky as it might be for a middle class person.

[ken melvin]

Lottery dumber than asking people who don't have enough to live on to save for their retirement? Face it, for some the odds for the lottery are better than any other for their (breaking the cycle) getting ahead.

[anne]

"I thought this statement

'Low-income people manifestly enjoy lotteries, and they will acquire the habit of looking forward to the lottery dates'

was a bit condescending...."

Precisely what and who Robert Shiller is; though only the poor gamble, I suppose. Duh.

[Meh]

1) Condescending as Shiller is, he is stating an observable fact. Poorer people play the lottery more. This is actually rational behaviour in a lot of ways. If you can set aside 2 dollars a week to play the lottery, then you might change your life. Saving those 2 dollars (even with the magic of compound interest) is unlikely to net you more than $7500 over 30 years at typical interest rates. $7500 isn't nothing, but it's not exactly lottery money.

2) Logical or not, "premium bonds" have worked as a savings mechanism for the less well off in the UK. Reasons? A) Psychology: They are safe, safer than banks. B) Psychology: You could win the "lottery" and win a million.
C) Psychology: You can pass them on to your grandchildren.
D) Psychology: You get them at the post office. Every place here has a post office, whilst banks are retreating from poorer areas.

That's the history of them. You can argue that some of the reasons are less operative these days, but I think they could still be useful.

[Mark Thoma]

Tim Worstall reports:

That Gambling Epidemic
Truly, the nation is verily in the grip of a massive gambling epidemic:

The average British family spends more on gambling than fresh vegetables, fresh fruit or holidays abroad, according to an official analysis of family spending...

[anne]

"Poorer people play the lottery more."

More than who or what?

"Logical or not, 'premium bonds' have worked as a savings mechanism for the less well off in the UK."

By what standards.

I am willing to look to a premium bond policy, but I would need to know a lot more. For now, I find the idea of such a program of no discernible value and at least vaguely demeaning.

[Tim Worstall]

Well, yes Mark, and the next line is:
"We can see the Four Horsemen saddling up, presaging the destruction of the very civilization."

Somewhat overblown rhetoric verging on the satirical perhaps?

Out of £443 average household budget:

"£3.60? That's, err, 0.81%. Now whether you look at gambling as the purchase of a mild thrill (one view) or a long shot attempt at getting a life changing amount of money (another, and there are plenty of highly respectable investment counsellors who would say that 1% of your portfolio on such long shots is an entirely valid approach) no, that sort of level of spending is not a threat to civilization. "

Add to the premium bonds that they are tax free and that the average winning across a maximum holding (£30 k now I think? Maybe 50) are calculated so as to be the same as that on gilts (our Treasuries) minus tax.

I think it's entirely logical that a poor person (hey, I've been one and I did!) buy a lottery ticket even at the 13.9 million to one against odds. A couple of days of dreams, escapism and fantasies is worth £ 1 of anyone's money.

If it isn't then maybe we'd better ban the poor from going to the movies?

[Lafayette]

MT: "I must be missing something - how does adding a lottery help?"

Not all people are fixated on leaping out of poverty into wealth, as those who buy lottery ticks often believe. The odds of multiple-millions-to-one against any single buyer are well known.

Many, perhaps, simply want to make their lives a bit better and not a lot better. So, linking a lottery to a long-term savings bond is an incentive for them to keep the bond.

The poor are not calulating any "rational man" risk versus return of different lotteries. The savings-bond lottery is simply another advantage to buying the bond in the first place and then keeping it.