Savings & Self-Control: Conceptual Considerations With an Experimental Application

1. Savings & Self-Control: Conceptual Considerations With an Experimental Application KarnaBasu Hunter College, City University of New York January 12, 2011

2. Motivating Points • Financial access matters. • The poor lack access to formal financial markets because of informational and contractual limitations. • Informal substitutes (ROSCAs, SHGs, MFIs) can partially plug this gap. • Nevertheless, the poor in developing economies have access to a relatively short menu of financial products. • The goal of this presentation is to think about how some of these products might be designed in light of new results from psychology and economics.

3. Informal Savings • Informal finance extends beyond loans to insurance, savings, etc. • In many ways, savings can be a suitable substitute for loans: • When people need funds for consumption (rather than income-generation), disciplined savings can lead to better long-run outcomes than repeated loan cycles. • How can savings products be designed to encourage this “discipline” without being paternalistic? • There is evidence that seemingly trivial design elements (defaults, pictures, etc) can make a difference.

4. Time-Inconsistency • Traditional economic theory suggests that, if a regular saving plan is in the interest of the individual, then she will indeed implement it. • However, experimental research shows that, in some ways, we systematically fail to act in our own long-run interest. • In particular, there is evidence that we are time-inconsistent– we place too much emphasis on instant gratification and too little on future well-being.

5. Under-Saving • Stated another way: we would like to act in our long-term interest, but fail to act when the opportunity presents itself. • What this implies for savings: • I recognize that I should save consistently for emergencies and old age. • Yet, I succumb to temptation by spending my liquid cash and even digging into accumulated savings. • I seek ways to regulate my own behavior.

6. Commitment Savings • Individual failure to save optimally calls not for coercion but for an understanding of root causes of this failure. • Features that assist self-regulation: • Reduce transaction costs associated with saving • easy access to deposit facilities • Commitment savings: raise costs associated with withdrawal • Saving in a bank rather than under the mattress • Offer the option of illiquid accounts, like fixed deposits (explicit penalty for withdrawal). • Offer the option of penalty for failing to achieve savings targets.

7. Why Commitment Can Help • As an individual with time-inconsistent preferences, I seek out contracts/products that prevent my future selves from engaging in behavior that is detrimental to my long-run interests. • Computer software to restrict internet access. • Deadlines • and Commitment Savings • If withdrawal is costly, I will withdraw less. • Knowing I will withdraw less in the future encourages me to deposit more today. • Net result: saving is more in line with long-run needs.

8. Mann Deshi Background • Mann Deshi is an NGO headquartered in the village of Mhaswad (Satara District, Maharashtra). • Services offered: • Vocational training • Loans • Wide range of deposit schemes: • Regular daily/weekly deposit accounts • Monthly deposit accounts • To be expanded: pension scheme linked to UTI

9. Mann Deshi Pension Product • UTI offers a pension savings plan that allows monthly deposits until client turns 55, and matures when client turns 58. • Upon maturity, clients may withdraw lump-sum or receive a recurring pension payment. • Competitive interest rate linked to the market. • Penalties for early withdrawal: • Severe penalties in first three years after account is opened. • Mild penalties beyond that (interest rate cut). • Mann Deshi links clients to UTI scheme – each client deposits monthly into a Mann Deshi account, then transferred to UTI. • Clients open new accounts either directly at a Mann Deshi branch or through an agent.

10. Observations • This is a complex scheme—extremely difficult to correctly estimate yields based on fluctuating interest rates (the wealthy go to financial advisors; the poor must rely on information provided by agents). • The pension scheme must compete with “attractive” private schemes that present the terms in a misleading manner. • But, interesting combination of commitment and flexibility: • Described as a long-term commitment product, and indeed there are penalties for early withdrawal. • Yet, beyond three years, penalties are sufficiently small that interest rates remain close to competitive. • Research goal: • A pension scheme is associated with saving for predictable consumption needs in the future, so this is a natural area to test the role of commitment. • How much does actual commitment and perceived commitment matter for takeup, deposits, and welfare?

11. Experimental Plan • Team: KarnaBasu, ShailendraBisht, Justin Oliver (CMF), BurgenBelltawn (CMF), Ujjawal (CMF RA) • Work with Mann Deshi to identify a set of target clients for the pension scheme. • Offer each of these clients the pension scheme using standard Mann Deshi procedures (information sent through agent or at branch). • Randomly assign potential clients into a control and three treatment groups: • Basic attention, Reframed penalty, Weekly deposits • The researchers and Mann Deshi will jointly hire marketers to visit individuals in the treatment groups.

12. Treatments • Control: this group will be surveyed and observed, but otherwise treated like any other Mann Deshi client. • Basic attention: Marketers will visit potential clients and describe the pension scheme in neutral (relative to agents) detail, with an attempt to clarify how interest will compound. • Reframed penalty: Basic attention, plus re-framing the scheme in the following way—rather than “penalty” for early withdrawal, display charts that show rising interest rates for longer terms. • Weekly deposits: Basic attention, plus the option of depositing weekly (on weekly market day) rather than monthly.

13. Conclusion: What we hope to learn • Basic attention vs control: • How much does clarity matter? Might it hurt pension deposits relative to other schemes? • Reframed penalty vs Basic attention: • Does perception of commitment matter? • If so, how do takeup and deposits respond to a scheme that appears to offer less commitment than before? • Weekly deposits vs Basic attention: • For people without commitment problems, the option of weekly deposits should not have an impact (they could save up at home and deposit at the end of the month). • If commitment problems (personal or social) exist, individuals might respond positively to the option of making their assets “illiquid” with greater regularity.