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Thursday, September 11, 2008

What Does Neuroeconomics Say about Lotteries and Credit Cards?

George Lowenstein on lotteries, credit cards, and the future of neuroeconomics:

Lottery Tickets and Credit Cards: The Dangers of an Irrational Brain, by George Loewenstein, Scientific American: LEHRER: Your most recent paper looked at some of the factors that seem to influence the purchase of lottery tickets. What did you find?

LOEWENSTEIN: We [Emily Haisley, Romel Mostafa and I...] have two papers addressing the motives underlying lottery ticket purchases. All of the research was conducted with low income samples recruited at the Greyhound bus station in Pittsburgh. In all of the studies, we paid travelers $5 for completing a survey on their attitudes toward Pittsburgh, then give them the opportunity to purchase lottery tickets with the money. The variable of interest was ... the number of tickets they purchased. ... We conducted two experiments to examine whether making people feel poor makes them want to play the lottery.

We randomly assigned subjects to either feel relatively poor or relatively rich by having them complete demographic questions that included an item on annual income. ... The group made to feel poor purchased twice as many lottery tickets (an average of 1.27) than those made to feel relatively wealthier (0.67 tickets, on average).

In the second experiment, we indirectly reminded participants that, while different income groups face unequal prospects when it comes to education, employment and housing, everyone has an equal chance to win the lottery. This reminder that the lottery is a kind of “social equalizer” also increased lottery tickets purchases. The group given this reminder purchased 1.31 tickets, on average, as compared with 0.54 for those not given such a reminder.

LEHRER: Have these experiments changed how you feel about the lottery? Would you advocate any changes to the way the lottery system is run?

LOEWENSTEIN: Clearly there is a demand for playing the lottery, and people seem to get something out of it; otherwise they wouldn't keep playing. But it is well established that low income people spend a higher percentage of their income on the lottery than other income groups (with one study finding that those earning incomes less than $12,400 spend an average of $645 on lotteries each year), so the lottery ends up taxing the poor at a higher rate when it makes much more sense to tax the rich at a higher rate.

The finding ... that when you make people feel poor they play more, is especially sad since playing the lottery is on average a massively losing proposition. The propensity of low income individuals to play the lottery has the perverse effect of exacerbating their poverty. ... It probably makes sense for the state to sell lottery tickets, because otherwise they will be sold by organized crime. However, does it really make sense for the state to be inducing, through advertising, poor people to play who wouldn't play in the absence of such inducement?

Similarly, states could promote and offer more games that appeal to wealthier players,... and not those popular with poorer players, such as instant scratch-off tickets. Another obvious solution, though one that is even less likely to be implemented, would be for the state to increase the payout on the tickets, and perhaps to increase the number of moderate size prizes.

Finally, a third option would be for financial institutions to issue investment instruments that have lottery-like qualities (for example, offered in small amounts, available at many convenient points of purchase, provide a small chance of a large upside) but offer a positive rate of return, providing the pleasure of playing the lottery without the steep cost. In many other countries “prize bonds” or other savings instruments are available that pay lottery winnings in place of, or in addition to, regular interest. Regulations in the United States have stymied the development of such offerings.

LEHRER: In a recent paper on the neural mechanisms underlying our purchasing decisions, you speculated that the "abstract nature of credit cards" might "anaesthetize consumers against the pain of paying." How might that occur?

LOEWENSTEIN: Unlike cash, where you are turning something over (bills and coins) as you are receiving something (a good or service), with credit cards you or the store clerk simply swipes the card, which doesn't feel like giving something up. With credit cards it is also easier to miss, or deliberately ignore, how much one is spending. ... Worse, with credit cards it is unclear whether or when you are going into debt because there is uncertainty about whether you will be able to pay for your cumulated expenditures at the end of the month. Credit cards allow people to go into debt passively... How many credit card users who end up with $10,000 of debt at the end of the year would have been willing, at the beginning of the year, to take out a $10,000 loan to finance those same purchases? ...

LEHRER: You are a leading figure in neuroeconomics... What do you think are some of the most successful and important findings in the field so far? And what topics do you hope neuroeconomists address in the future?

LOEWENSTEIN: Neuroeconomics is still in its infancy, and many of the existing findings are speculative or contradictory. As of the present, neuroscience has mainly been used to test existing economic, and especially behavioral economic, theories. I am unaware of new, or at least definitive, insights that have emerged from the field so far. I believe that there is a danger that the field has been oversold, and perhaps “over-bought,” leading to inevitable disappointment and disillusionment. People get very excited about any research that includes colorful pictures of the brain “lighting up”—however weak the methods or results might be. However, any progress on the research frontier that links brain activity to complex behaviors, such as economic decisions, is inherently interesting and important. Give us another five to 10 years and there will almost surely be some very exciting developments.

I personally am most excited about existing and in-progress work examining the impact of emotions on economic behavior. So much of what we see in the economy—such as market booms and busts—is clearly driven by emotions. Conventional economics fails to account for the role of emotions and only captures the more rational, calculating side of human behavior. Neuroeconomics research has already begun to enhance our understanding of the role of emotions in economic behavior. Ultimately, I believe, neuroeconomics is going to provide a perspective on human decision that integrates the duality of emotion and deliberation.

On lotteries: If the states are worried about organized crime, and hence have an interest in regulating or running lotteries, and if people get pleasure from gambling, fine, then let lotteries exist and let the state play a role. But that doesn't mean lotteries have to be a means of raising state revenue, that is where my objection comes in. Instead of having this somewhat hidden, clearly regressive tax, bring the taxation out in the open and make legislators responsible for it. Would anyone actually propose an explicit tax this regressive, this unfair to the poor? I doubt it, so why do we have it at all? If it was my choice, the state would take a strong hand in regulating these games and in educating the public about them, but would not make a penny off of them.

    Posted by on Thursday, September 11, 2008 at 02:34 PM in Economics, Regulation, Taxes | Permalink  TrackBack (0)  Comments (12)


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