Learning Incentive Schemes for the Working Poor Catherine Eckel University of Texas, Dallas Cathleen Johnson CIrANO Claude Montmarquette University of Montreal and CIRANO Evidence-Based Public Policy: New Tools from Experimental Economic 2005 Catherine Eckel University of Texas, Dallas Cathleen Johnson CIrANO Claude Montmarquette University of Montreal and CIRANO Evidence-Based Public Policy: New Tools from Experimental Economic 2005

Why Experimental Economics? l The effectiveness of a policy can be enhanced substantially if it is tailored to the preferences of the target population

New Addition to Economist’s Toolkit l Has the potential to outperform the two traditional empirical methodologies : l Outcome based measures l Survey questions l Has the potential to outperform the two traditional empirical methodologies : l Outcome based measures l Survey questions

Advantages of Laboratory Experiments l Decisions involve real money, costly decisions l Real, not hypothetical decisions l Control for situational variation by placing subjects in identical settings l Decisions involve real money, costly decisions l Real, not hypothetical decisions l Control for situational variation by placing subjects in identical settings

Securing External Validity l Relevant aspects of the decision-making context are incorporated l Substantial stakes l Relevant aspects of the decision-making context are incorporated l Substantial stakes

Key Research Question Given the right incentive, will the working poor save to invest in human capital?

The Laboratory Experiment The laboratory experiment focused on three major questions: (1)Will the working poor invest in various assets? (2)Are these subjects willing to delay consumption for substantial returns? And (3)How do these subjects view risky choices?

Subjects l Community groups whose membership primarily consisted of working poor helped with recruitment

Subjects l 256 subjects l 2/3 women l Seventy-two percent of subjects partcipate in the labor market l 256 subjects l 2/3 women l Seventy-two percent of subjects partcipate in the labor market

Subjects l Far from being uneducated l 78% high school diploma l And 26% university degree l 72 percent had a family income of less than 120 percent of Statistics Canada Low Income Cutoff (120-Lico) l Total household income $20-25,000 on average l Far from being uneducated l 78% high school diploma l And 26% university degree l 72 percent had a family income of less than 120 percent of Statistics Canada Low Income Cutoff (120-Lico) l Total household income $20-25,000 on average

Experimental Instruments Two surveys: l Information questions (43) l Socioeconomic l Behavioural l Attitudinal l Compensated questions (64) Two surveys: l Information questions (43) l Socioeconomic l Behavioural l Attitudinal l Compensated questions (64)

Protocol l $12 Show-up fee, child care and bus fare l Practice Choice Questions l Bingo balls used for random draw process l Dice were used for gambles l Distributed 2 surveys l As individuals finished they left the room and were paid privately for one choice question l $12 Show-up fee, child care and bus fare l Practice Choice Questions l Bingo balls used for random draw process l Dice were used for gambles l Distributed 2 surveys l As individuals finished they left the room and were paid privately for one choice question

Compensated Questions - 64 l Investment Preferences l Cash v. Investment choices l Time Preferences l Cash v. Cash later l Risk Preferences l Cash v. Risky cash l Investment Preferences l Cash v. Investment choices l Time Preferences l Cash v. Cash later l Risk Preferences l Cash v. Risky cash

Investment Preferences l Cash v. Investment Choice l Cash alternative made the choice of investment costly to the subject l pinpoint optimal match rates for the learn$ave demonstration and l Gather the information necessary for determining preference ordering between different forms of investment l Cash v. Investment Choice l Cash alternative made the choice of investment costly to the subject l pinpoint optimal match rates for the learn$ave demonstration and l Gather the information necessary for determining preference ordering between different forms of investment

Figure 1a: All Population

Figure 1b: All Population

Labour Force Participants Non-Labour Force Participants % of participants choosing family member’s education over $100 one week from today

% participants that chose retirement savings over cash one week from the day of the experiment

Time Preference l We elicit a series of time preferences by asking subjects when they prefer to take their compensation l Choices vary in terms of l initial payoffs and l alternative payoffs with respect to day lapsed and discount rates l We elicit a series of time preferences by asking subjects when they prefer to take their compensation l Choices vary in terms of l initial payoffs and l alternative payoffs with respect to day lapsed and discount rates

Time Preference l Using these responses l Measure overall degree of patience l Shape of the subject’s discount function l Using these responses l Measure overall degree of patience l Shape of the subject’s discount function

Time Preference

Creating Indexes l It is well known that impatience and attitude toward risk influence both the decisions to invest in human capital and to save for future consumption l Our experiment uses choice questions with monetary payoffs to construct measures of these characteristics l It is well known that impatience and attitude toward risk influence both the decisions to invest in human capital and to save for future consumption l Our experiment uses choice questions with monetary payoffs to construct measures of these characteristics

Determinants of the Impatience Index for Each Individual l Younger subjects and men favour the earliest choices l We can conclude that the women were more patient than the men in our sample, choosing on average to delay payment for three more decisions than men l The number of children does not seem to affect patience l Younger subjects and men favour the earliest choices l We can conclude that the women were more patient than the men in our sample, choosing on average to delay payment for three more decisions than men l The number of children does not seem to affect patience 256

Determinants of the Proportion of Subjects Choosing Early Payoff l Delaying alternative payoff reduces the incentive to pick the latest alternative l Increasing the rate of return induces subjects to delay reward l Absolute difference encourages the subjects to delay their reward l Delaying alternative payoff reduces the incentive to pick the latest alternative l Increasing the rate of return induces subjects to delay reward l Absolute difference encourages the subjects to delay their reward

Risk Preference l Elicit the participant’s attitude towards risk l Obtain a behavioural measure of risk aversion with 14 pairs of lottery questions l Risk aversion for monetary payoffs l Elicit the participant’s attitude towards risk l Obtain a behavioural measure of risk aversion with 14 pairs of lottery questions l Risk aversion for monetary payoffs

Risk Preference

Risk Aversion Index l LESS RISKY CHOICES is a simple count of the number of times the subject has chosen the safest payoff (0-14)

Descriptive Statistics l 16.4 % of sample always chose the earliest payoff (5.1% always saved) l 16.4 % of sample always chose the safest lottery payoff (2.3% riskiest) l 15.2% chose cash over every investment option (5.5% investment over cash) l 16.4 % of sample always chose the earliest payoff (5.1% always saved) l 16.4 % of sample always chose the safest lottery payoff (2.3% riskiest) l 15.2% chose cash over every investment option (5.5% investment over cash)

Analysis Education Preference Overall intensity of preference for education (No, some, strong, very strong) Is a function of l Time Preference (experimentally measured) l Risk Preference (experimentally measured) l Other attitudes and perceptions (survey) l Socioeconomic characteristics (survey) Education Preference Overall intensity of preference for education (No, some, strong, very strong) Is a function of l Time Preference (experimentally measured) l Risk Preference (experimentally measured) l Other attitudes and perceptions (survey) l Socioeconomic characteristics (survey)

Determinants of Choosing Educational Expenses over Cash l Impatient subjects exhibit a higher probability to choose cash over education l More risk averse subjects show a lower probability of investing in human capital l Younger subjects more likely to invest l Those with some post secondary education were also more likely to invest l Impatient subjects exhibit a higher probability to choose cash over education l More risk averse subjects show a lower probability of investing in human capital l Younger subjects more likely to invest l Those with some post secondary education were also more likely to invest

Probabilities of Investing in Own Education Never InvestAlways Invest Most Patient Least Patient Risk Seeking Risk Averse

Determinants of Choosing Cash over Family Member’s Education l Children increase probability of investment l Students have higher probability of choosing cash l Impatient subjects have higher probability of taking cash l Risk aversion measure plays no role l Children increase probability of investment l Students have higher probability of choosing cash l Impatient subjects have higher probability of taking cash l Risk aversion measure plays no role

Probabilities of Investing in Family Member’s Education Never InvestAlways Invest Most Patient Least Patient Risk Seeking Risk Averse

What Have We Learned So Far? l In general, the working poor in our sample are risk averse and impatient l Nevertheless, many can be induced to invest in their own education l 44 percent accepted analogous learn$ave offer l Overall, own educational expenses was preferred to family member’s education and retirement savings l Some couldn’t be induced to invest in any asset even when return approached 500% l In general, the working poor in our sample are risk averse and impatient l Nevertheless, many can be induced to invest in their own education l 44 percent accepted analogous learn$ave offer l Overall, own educational expenses was preferred to family member’s education and retirement savings l Some couldn’t be induced to invest in any asset even when return approached 500%

What Have We Learned So Far? l Savings programs may benefit from higher take- up rates if they l Offer high returns l Stress absolute returns l Allow short term savings horizons l Savings programs may benefit from higher take- up rates if they l Offer high returns l Stress absolute returns l Allow short term savings horizons