It's all in the Mind: How Behavioral Science Presents a Golden Opportunity for Financial Inclusion

With the “golden age of behavioral research,” as New York Times columnist David Brooks recently described, comes a golden opportunity for the asset building and financial inclusion fields.  Indeed, the latest breakthroughs in social science and behavioral research beg – or perhaps even force – us to think differently about poverty reduction and the policies and mechanisms that can enable it. Already, a deeper understanding of human behaviors born out of this research has inspired small tweaks in initiatives across various fields to create big changes – in health policy to increase HIV/AIDs testing, education policy to promote school attendance, and financial policies to increase savings behaviors. At the Global Assets Project, considerations of the complexities of human behaviors and their impact on social and economic lives of the poor are woven through the various threads of our work – on the psychology of poverty, conditional cash transfers, and youth savings – increasingly informing the global asset-building strategies we advocate around the globe.  

Most recently, on June 27^th we co-hosted an event with Innovations for Poverty Action (IPA) to release a new Global Assets Project paper, ”Accelerating Financial Capability among Youth: Nudging New Thinking” and to discuss Dean Karlan and Jacob Appel’s new book, More than Good Intentions. One of the major themes of the book is behavioral economics, which is beginning to shed light on how development initiatives that consider human irrationality or psychological barriers to positive financial behavior can improve the lives of the poor. Our paper extends this exploration of the human irrationality-financial behavior relationship, largely by emphasizing that psychological variables in the standard financial capability equation – financial education + access to financial services = sound financial decision-making — is grossly lacking. In actuality, temptations to consume, lack of self-control, and other psychological biases can prevent positive financial behaviors, such as saving regularly, even when a person has the ability (through financial education), opportunity (through access to financial services), and desire to do so, which should not be underestimated.

In fact, the financial choices that the poor have to make can be both emotionally and mentally draining. In a provocative article, “Why Can’t More People Escape Poverty,” Jamie Holmes, Policy Analyst at the Global Assets Project, highlights evidence from psychology and economics showing that “exerting willpower in one area [like resisting dessert] makes us less able to exert it in other areas” because resisting temptations induces a ‘psychic cost.’ Financial tradeoffs (i.e. paying rent today versus buying food today) can create mental fatigue and causes errors in decision making.  So how can saving be encouraged if it requires tradeoffs and if decision-making resources are often depleted?

One strategy is to make it easy for the poor to manage their finances, lessening their stress and leaving more expendable willpower for other needs and goals. For example, CGAP’s Mark Pickens advocates in his recent blog that employers pay wages via mobile money and offer “clients the option of automatic deduction into an illiquid savings account geared to some savings goal.” This simple idea of automated or direct savings deposits can be taken a step further and tied to other behavioral outcomes in healthcare and education. For example through its work on savings-linked conditional cash transfers, the Global Assets Project is exploring how behavioral economics can help inform innovative twists on traditional social protection programs. We hypothesize that savings-linked social protection payments could potentially spur development outcomes beyond those in education and health (for which CCTs are best known), by promoting asset accumulation and financial inclusion for the poor. In one attempt to test this theory, in November 2010, the Bayelsa State Government in Nigeria launched its Child Development Account (Savings, Training and Rewarding Savers, or CDA STARS) as the first child savings policy pilot in a developing country. The program, which was designed by Columbia University and the Global Assets Project, provides for automatic account openings (seeded with a lump sum of money) for 1 thousand junior secondary students from public schools throughout the state. Students’ participation in the program is conditioned on school attendance. Moreover, savings-linked CCTs may help overcome one critical challenge to saving: self-control. Rather than giving cash in-hand to recipients (which can tempt immediate consumption), the payments would be deposited directly into a formal account, perhaps even designed with withdrawal restrictions or incentives to save. (Several insights, ideas, and examples on savings-linked CCTs came out of a two-day expert global colloquium, held last November at the Ford Foundation and are summarized in this report.)

Another (and one of the best) ways to counteract psychological biases to saving is to start young. As Jamie Holmes indicated in his interview with the New Republic, the optimal time to improve long-term willpower strength is during executive function development, or when young people are developing their mental capacity to delay gratification and inhibit impulses. An unlikely case in point? In a hilarious Colbert Report episode, Stephen Colbert playfully mocked Sesame Street’s new initiative to teach children the importance of saving and self-control (despite the contradictory messages of consumption that the cookie monster exemplifies) by conducting his own version of the famous 1970s marshmallow experiment in which, 600 4-year olds were offered one marshmallow to eat right away, or if they waited, offered two marshmallows to eat later. Led by Dr. Walter Mischel of Stanford University, this test of self-control showed that kids who were able to delay gratification were much more likely to lead healthier and wealthier lives as adults.

Although largely untested, around the world, several youth savings initiatives are working towards generating the savings habits of low-income youth, taking the available information on youth financial behaviors into consideration for the initiatives’ design. For example an important component of the YouthSave Project – dedicated to developing, delivering, and testing savings products accessible to low-income youth – is financial capability. In order to design interventions that will hopefully make young people sound financial managers, the Project has looked to the innovative work of practitioners and researchers globally, many of which have drawn on behavioral science to design SMS reminders to save, workshops on financial education, and convenient delivery channels (in order to make saving easy and accessible).

As Ben Shell of Women’s World Banking (WWB) commented in his recent blog post, “the ability to delay gratification makes perfect sense as an important driver of asset building behavior, especially saving.” However, for the poor exerting willpower to save especially in the face of competing needs (i.e. food, clothing, education, and health), can be very challenging indeed. Therefore, lessons from behavioral economics and psychology can help policymakers, development practitioners, and researchers consider a more holistic approach to creating programs that address the financial needs and constraints of low-income households. For the Global Assets Project, these emerging disciplines will certainly continue to impact our work on asset-building, financial inclusion, and poverty reduction.