Decision Making Under Poverty

Understanding how the poor make their decisions is important for many reasons. It allows us to better target our economic policies such as poverty alleviation, social welfare, literacy etc. Since poverty (and income inequality) is such a large part of our society, it also helps us better understand our society and its values.

There are three different narratives about the link between decision making and poverty.

  1. Low intelligence leads to poor decision making, causing poverty. This is arguably the most comforting view, from the perspective of the well-to-do. There is an assumed correlation between low IQ and poverty. It is easy to see this as being a causal relationship: poor intelligence leads to poor poverty.
  2. Poverty leads to low intelligence, causing poor decision making. Certainly, there is a known causal link between parental poverty and childhood malnutrition, leading to lower IQ scores for the children, which translates into lower incomes in their adulthood. There is also evidence to suggest that poverty has an impact on social relationships, which could also affect a child’s development and therefore future economic prospects. It is also an unfortunate fact that poverty has a significant impact on people’s IQ (13 points), attributable to a cognitive burden of working with their limited resources.
  3. Independent of intelligence, poverty can lead to poor decision making. This is the rather surprising narrative that is best illustrated by the quote in this post in the Atlantic. The limited resources and bleak prospects mean that the poor may disregard their long-term interests in favor of short-term interests. This was also the case made in the wonderful Poor Economics by Duflo and Banerjee. In randomized trials, they observed behavior that we would classify as irrational. For instance, when the poor in Maharashtra, India as well as in Philippines, were given a food subsidy, they chose to spend the extra income on sweets and other “luxury” food items, rather than more nutritious alternatives that would have been more beneficial in the long term. Similarly, they found poor, unemployed men in a village in Africa who had televisions at home, even though their primary concern “ought” to have been feeding the family. What we must understand is that in the context of sustained poverty, the long-term becomes irrelevant, and the rational decision is in fact a short-term focused one.

All of these narratives have some merit, and are probably at play to different extents. This is one of the things that makes development economics so difficult.