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PROFESSOR: Why do people save?
Well, that seems like--
I assume you know the answer to that.
Well, one answer is the economics, in the sense of two
standard answers to that question.
One is consumptions smoothing.
Consumption smoothing is the idea--
what's consumption smoothing?
AUDIENCE: It means you're living kind of like-- let's
say one day I purchase all these different things and I
eat really well on this day, but tomorrow I starve.
The idea is that I'd spread it out over a period of time so
that each day I would have the maximum possible to make it as
easy as possible over all those days.
PROFESSOR: Right.
So not have too much variation in consumption.
And what's life cycle?
It's another code word that economists use.
What's the life cycle reason to save?
AUDIENCE: Special events in a person's life, like childbirth
or marriage, [INAUDIBLE] with your parents, marriage.
PROFESSOR: Yeah, so saving for special events in your life.
What's the most important event a lot of people in the
US save for?
Retirement.
So I think, among other things, saving for--
you guys are kind of revealing your age, I guess.
But retirement is the single biggest
reason why people save.
And that's one life cycle event which is very
predictable.
At least, if you get there, you'll need money.
And then as you said, other events you can predict, like
your child's wedding, own wedding, child, but all kinds
of other predictable events.
Any others?
Any other reason to save?
Yeah?
AUDIENCE: [INAUDIBLE]
or an opportunity.
Like, maybe you want to start a business [INAUDIBLE].
PROFESSOR: Right.
The last reason, very important reason is to take
advantage of opportunities.
Starting a business is one.
What else could you do if you saved up?
AUDIENCE: Buying a home, buying land.
PROFESSOR: Yeah.
Buying home, buying land.
Just paying for school fees.
Sometimes, many places you have to pay a big part of the
school fees at the beginning of the year, so you want to
have money saved up so that when this beginning of the
year shows up, you can pay the school fees.
So there's are all kinds of very standard reasons why
people save.
So now coming to why they may not save.
So sometimes, I'm going to say, it's
efficient not to save.
What are situations where you shouldn't save?
AUDIENCE: [INAUDIBLE]
PROFESSOR: Right.
So one possibility is that today, your marginal utility
of consumption is very high.
You're sick, and you need money today.
But let's say on a more long-term basis, is there a
situation where it makes sense not to save, even over five
years or something.
Yeah?
AUDIENCE: Well, if you know if you save, and then you're not
going to get very much back from the savings, there isn't
much point.
For instance, if the money you put away under floorboards
rots or something like that.
PROFESSOR: Right.
Another possibility is that it's may be you can't save, or
it's just difficult.
High inflation--
you have to save in money, and so that makes
it you can't save.
But I'm asking an even simpler question--
or, maybe not simpler, but different question, which is,
imagine that you could save--
there's no problem saving--
would there be a situation where you would actually find
it optimal not to save?
AUDIENCE: If you didn't expect to be [INAUDIBLE]
by it.
PROFESSOR: Right.
So one possibility is that you have lots of money now, and
the future looks very sharp, you should not save for sure.
But that's something important.
We'll come back to it.
Yeah?
AUDIENCE: If Social Security is very good, state-based,
[INAUDIBLE]
PROFESSOR: Right.
So if, for example, you are in the US, social.
security covers a large part of your earnings if you are
poor, and not a large part of your earnings if you're rich.
So if you happen to be quite poor, you know that actually
once you turn 65, Social Security is going to start
paying you a fair amount of money.
And let's say Social Security pays you $30,000 a year.
You're making $20,000 a year now.
There's no reason for you to save, right?
So Social Security, the government has guaranteed you
$30,000 a year once you're retired.
You are 62, you're making $20,000 a year.
You have no reason to save, because you know actually, if
you saved, your consumption today would go down to, let's
say, $15,000.
And then your consumption after retirement will go up to
$35,000, but that makes no sense.
You want to actually smooth.
So the general principle--
what's the general principle there?
Much more generally, where would you expect
people not to save?
AUDIENCE: When they're expecting [? some money ?]
might not be worth what it is now [INAUDIBLE]
where there's not really [INAUDIBLE]
PROFESSOR: Right.
So you are saying there's no way to save.
But let's assume there's a way to save.
I'm just asking the general principle from the Social
Security example.
Think about it, what's the general principle.
When do you want to not save?
AUDIENCE: When the utility of the money becomes [INAUDIBLE]
PROFESSOR: Which means what?
AUDIENCE: You're saving less.
[INAUDIBLE].
PROFESSOR: When you say usually money decreases over
time, what are you saying about the future?
AUDIENCE: Maybe that you'll burn more [INAUDIBLE]
PROFESSOR: You're getting richer.
Imagine you were someone who expects to
get richer over time--
a lot richer over time--
that person should not be saving, because if I think my
wages are going to grow at 10% a year, then I have no
business trying to save, because essentially my
consumption tomorrow in any case will be higher, even if I
didn't save any.
So I have no reason to save.
So if I think the future's a lot better than today, I
should not save.
That's a general principle about savings, which is that
you're trying to make small consumption.
If you're trying smooth consumption, and you know your
consumption is going to be non-smooth in any case, then
you want to counteract that by not saving.
So in general, people who expect--
so here's a fact.
I'm not going to actually spend a lot of time
elaborating on it-- today at least--
which is, what's the country in the world which is growing
the fastest?
Or at least, one at of the countries in the world.
AUDIENCE: China.
PROFESSOR: China.
Do you know what the personal savings rate in China is?
AUDIENCE: [INAUDIBLE]
PROFESSOR: 40%, or 30%.
30%, I think.
[? Possibly ?]
[INAUDIBLE]
So you think of all of these people whose wages are growing
at 10% a year, or 6-7% a year, are saving 30% of their
incomes right now.
So it's a very, very odd--
economists are completely baffled by why Chinese are
saving so much.
So that's just to remind you that this sort of analysis we
went through actually has a very clear implication, which
happens to false, which is the Chinese should be not saving,
because their wages are going up very fast.
Our theory clearly said that, and we don't really know why
they say so.
Well, we have some theories.
I might come back to that next time.
But I want to just keep this general principle in mind,
which is that the one solid reason not to save is you
expect your income to grow a lot.
Whether that works or not isn't--
AUDIENCE: [INAUDIBLE] essay, they can write about
that if they want.
PROFESSOR: Sorry?
AUDIENCE: Meaning an essay with an accompanying reading
about China's and savings.
So if anybody's interested.
PROFESSOR: Yeah, so that's a good topic to write.
Chinese savings is a great topic to write an essay about.
OK, another reason people often cite for why people
don't save is they don't have any money.
How could they save?
Does that argument make sense?
When does it make sense?
So it's a very common argument.
How could the poor save?
They don't have any money.
Is savings primarily about having money?
So let me put it differently.
To a first approximation, savings is about making sure
that there isn't a future where I've eaten everything
that I have.
So if I have money today, unless I expect to get richer
tomorrow, then even if I'm poor, I should save, because
it's not about whether I have money or not.
If I'm poor today, then I'm going to be poor tomorrow.
Then it's no different from I'm rich
today, I'm rich tomorrow.
We have the same incentives to save, because what you're
trying to achieve is efficient division of consumption
between today and tomorrow.
So the fact that I'm poor should not, per se, say
anything about whether I should save or not, because
savings is about trading off consumption today with
consumption tomorrow.
And that same trade-off exists, whether
you're poor or rich.
If I'm poor, I still have it tomorrow.
And if I have it tomorrow, then I should still save.
Because if I'm worried that tomorrow I'm not going to have
any money, that's true for somebody poor
and somebody rich.
So the fact that I have little money today--
if I'm going to have even less money tomorrow, I should save.
So it's not about how much money you have, but how much
money you expect to have in the future.
That's the same general principle that we
went through a minute.
Having said that, is there a case where being poor might
make you not save?
What's a case where this argument kind of fails?
AUDIENCE: Well, if your income is so small that you have to
consume all of it today just to make it tomorrow.
PROFESSOR: Exactly.
Excellent example.
So one reason even the poor may not want to save if
they're really so poor that tomorrow will not show up if
they don't eat today.
In that case, there's no argument for saving, because
then you would, in any case, not get there.
So you're desperately poor and you're starving, you probably
shouldn't save.
But if you're not that poor, then the fact that you don't
have income should not matter that much.
Or even a lot of income should not matter that much.
So another example how many of you already suggested, another
argument for why people don't save is that people just don't
have opportunities to save.
Like many of you suggested, inflation.
So imagine that the only way I can save is by
keeping cash at home.
And prices go up, so cash becomes less valuable.
In other words, there's just no point in trying to save in
that world, because you're in a hyperinflation or something,
and any money you put away is going to be valueless
tomorrow, why bother saving?
So one answer to that is that, well, why not put it into a
bank account, or into an investment account?
So you buy something that that's inflation-proof.
Why don't you buy an inflation-proof government
bond or something?
So there are assets.
You could buy gold.
So if you still make the argument that the poor are
particularly handicapped, because they don't have a
place to save, you have to make the argument that they
have less access to bank accounts.
And that's true.
In the world, it's true.
It's completely true that the poor have very limited access
to bank accounts.
Most countries--
like below 20% of the poor- have access to bank accounts.
So that's very true.
And if you take investment accounts or other money market
accounts, or other accounts which are protected against
inflation, that's even more true.
Very few people have access to them.
But why is that?
Why don't the poor have access to bank accounts?
Why should it be that they have not
access to bank accounts?
What are arguments?
Yeah?
AUDIENCE: They might live in a region where it doesn't make
sense to have a bank.
Like, if you're in a small-world village, there's
really not the infrastructure or the skill for the bank to
be sustainable there.
Likewise, the size of their deposits might make it where
even if they are in, say, urban slum, where there might
be banks generally around them, banks aren't interested
in catering to them because there are certain fixed costs,
like we've seen in certain money lending, that the size
of their deposit wouldn't be worthwhile for the hassle that
it would involve.
PROFESSOR: Right.
So that's exactly right.
So basic argument is that whenever I want to have a
deposit-taking institution--
any institution that takes your money--
once I take your money, there is a cost of that, which is
kind of fixed, and doesn't entirely scale with
the amount of money.
So if I'm putting in $5, and the cost is $5 to take care of
your money, nobody's going to be willing to do it.
So you need enough deposits to make a bank work.
What will be reasons why there's a fixed cost, the
fixed cost of banking?
Why does banking have a fixed cost?
Why should it have a [INAUDIBLE]?
AUDIENCE: Well you need to at least hire some number of
people to set up the system.
[INAUDIBLE]
someone working at the bank, someone who will keep track of
all the records. things like that.
PROFESSOR: Right.
So I think one version of that is that banks are required by
law to keep good records of any deposits they take.
And so even if the deposit is $5, they can't just say, well,
we're going to just scribble it down on a piece of paper.
So basically, every deposit that comes to a bank has to be
recorded in a proper way.
Given that, even if it's $5, somebody has to have a
computer there, open a computer, enter the amount
into the computer, send it to some place.
So there's a lot of reasons why they're
fixed costs of banking.
And I think that's the single biggest reason why most poor
people don't have access to bank accounts.
Now the alternative is to save at home.
And there are many reasons why it's difficult to ave at home.
One has something to do with inflation.
If you keep money and the prices go up.
Another problem is crime.
You keep money at home, somebody comes and
takes it, it's gone.
You kept it a bank, it's a bank's duty to keep it safe.
So that's another reason why you can do it.
And then there are what I'm calling the self-controlled
and spouse-controlled reasons.
So self-control is, if I have money, I spend it.
If I don't have it, maybe
I don't spend It.
So it's in the bank.
It's not in my hand.
I'm not going to be able to spend it.
If it's really in my pocket, I'll just spend it.
I see something I want, I buy it.
What's spouse control?
What do you think it is?
What's your guess?
AUDIENCE: Your spouse might ask you for money [INAUDIBLE]
because they want it for something [INAUDIBLE]
based on [INAUDIBLE]
PROFESSOR: Right.
So it may well be that some people in the family might--
this is more general than that.
So some people in the family who have money might be
worried that other people in the family who don't will come
and lay claims on it.
So if you have nothing, you can say you have nothing.
But if not, your husband or your cousin shows up and says,
well, you know, I really need some money.
I feel like I drink, or I want to buy something.
How do you say no to people?
So one other issue that arises is that--
at least, you hear a lot of reports of-- is people saying
that, look, I don't keep money at home, because if it does,
then somebody always shows up and asks for it.
And it could be a spouse, could be your brother, could
be some friend.
But if there's a lot of people who come and ask money from
you, then you may actually not want to keep money at home.
Now the poor have evolved a lot of different ways to save.
One of them is called a ROSCA.
Do you know what a ROSCA is?
Who knows what a ROSCA is?
AUDIENCE: It's like a type of merry-go-round [? layover ?]
attributes a set amount And then a particular day, you get
all the money from the ROSCA.
PROFESSOR: And then what happens after that?
AUDIENCE: I mean, it continues usually until a set point
where it stops.
PROFESSOR: But like, let's say five or four
of us are in a ROSCA.
So we all put in $10.
What happens?
AUDIENCE: So you all put in $10, and each individual in
the ROSCA gets that lump sum on alternating days.
So each individual will get the lump sum at some point
PROFESSOR: Exactly.
So one form of ROSCA is one where there's a fixed order.
We all join the ROSCA.
We have a lottery.
And then the lottery decides the order of people.
Somebody goes first, somebody goes second, somebody goes
third, somebody goes four, somebody goes
fifth, let's say.
They're five people in the ROSCA.
Now once that's set, then what happens is that first day,
everybody puts in, let's say, $10.
And Mr. One gets all of it.
Next week, everybody puts $10, and Mr. Two gets all of it.
And so, in the end, everybody gets all $50.
But a lottery determines who gets it first.
So if you think of a ROSCA, what's the advantage of a
ROSCA over just saving at home?
Is there an advantage?
What are the advantages?
Yeah?
AUDIENCE: You don't need the discipline to make sure that
you're saving money, because if you have money at home,
people tend feel tempted to ask [INAUDIBLE]
use it.
PROFESSOR: So you get your $50, and then
isn't that a problem?
AUDIENCE: But you have a larger amount of money that
you can use for a larger investment, versus like the
$10 you might use that on a short amount [? of time ?].
PROFESSOR: So you're saying, if i have a goal associated
with the money, then I'm going to join a ROSCA where-- let's
say I need $50 one of these days.
Then I'm going to join a ROSCA, which has
the price of $50.
That way, when I get it, I buy it, rather than if I have to
save up to $50, then I'll have $5 someday.
I'll have $42, but not $50.
And therefore, I still can't buy the thing I want to buy,
but I now have $42.
Maybe I feel like maybe I could spend $2 out of that on
some pack off cigarettes or something, and so.
And you never reach $50.
So the fact that there's a matching between the amount of
the ROSCA and the amount to what I
want to buy is important.
That's part of the reason to solve the self-control problem
is because of this matching.
Because once I have the money, I can just spend it.
If I need $50, if I have to save up to it, then there'll
be a lot of times when I have less than $50.
And I could say, well, maybe I'll just spend $2 out of it,
and wait another day, and put in $2 back,
you never get there.
Whereas this gives you $50 all at once, and you
immediately spend it.
So one advantage of it is delivers the amount you want.
What's another advantage?
Think of the group of us.
Let's say we each need $50.
How long on average would it take us to get to $50 if we
saved by ourselves, and we saved, let's say, $10 a week?
AUDIENCE: The advantage of a ROSCA would be potential for a
immediacy, access to the large sums of funds.
And even if you're the last person in the ROSCA, that
amount of time it takes you to deal with that amount of money
would be the same as if you were saving it by yourself,
whereas the guy who's first gets it immediately, and then
it averages out to half the amount of time [INAUDIBLE].
PROFESSOR: Exactly.
So if you save $50, it would take five weeks for each of
you, whereas the expected delay for somebody in a ROSCA
is two and a half weeks, because the
Mr. One gets it today.
Mr. Two gets it in a week.
Mr. Five gets it in five weeks, but he's the last.
So you bring it forward by two and a half weeks.
So it's a large gain.
You immediately get a large gain from it.
So that's another big advantage.
So one is that it solves the self-control problem.
Another is it just brings it forward to where you want.
Now you know what a bidding ROSCA is?
Yeah?
AUDIENCE: It's when people bid for the right to get the money
this time around.
So if you get, say, an amount of $50, you might bid up to, I
don't know, [INAUDIBLE], but realistically up to maybe $25
or so just for the right to get the money today.
PROFESSOR: Right.
A bidding ROSCA is instead of having a fixed order, we bid
on who's going to get it today.
So after we each put in $10 dollars, then the bidding
opens, and whoever wins.
So we basically say that, look, I paid my $10.
I'll pay $10 extra to get the $50.
And then next week, somebody else would do the--
maybe he'll say, I'll pay $4 dollars extra to get the $50.
And then the guy who gets it last, obviously, is going to.
And what's happening, notice, is that the pot
is now going up.
So I pay $10 into the pot to get the extra $10.
That can be distributed among everybody else.
And so, everybody else is paying less to get $50.
And if the person who gets it today is paying
more to get the $50.
So instead of everybody paying $50 to get $50, some people
are paying $60 and some people are paying $40.
Now why would that make sense?
What's the advantage of that/ why would we want to have a
bidding ROSCA, rather than a fixed order ROSCA?
AUDIENCE: Because that means that it rises for a year,
[INAUDIBLE]
rises earlier than you were scheduled, so you want to make
the argument earlier.
PROFESSOR: Right.
So you may want to be able to express your preferences.
You might be able to say, look, I just discovered I have
this opportunity if I buy this bale of cotton, I can produce
these shirts, and sell them for a lot of money.
I need the money now, so I'm going to step in.
I'm going to put in the money now quickly, and it's worth it
for me to pay some extra.
What's the advantage of the other?
So basically, what's the advantage of that too is
others, it's effectively like I am paying interest to other
people, right?
What it works out to be is if I am bidding to get it early,
I am paying more.
That's like saying other people are getting interests
on their savings.
So they they're paying $10, but I'm actually
giving them $10 back.
So they're getting some interest on their savings.
This turns it into much more like a bank.
A bidding ROSCA is much more like a bank, because it's a
way for us to decide, I want the money now, I pay the extra
to others to get it.
So it turns it into much more like a bank.
Now, we talked about the advantage of ROSCAs.
What are the disadvantages?
What is a ROSCA not good for?
Yeah?
AUDIENCE: ROSCAs can be very short-lived because the cycle
only goes on for as long as you have members.
So if you're looking to save over a long period of time,
the ROSCA probably doesn't meet your need.
And it's also inflexible that every member has to save the
same amount at the same time.
And so, if you have a variable income, then it might not be
suitable for you to try to save that same amount
[INAUDIBLE].
PROFESSOR: Exactly.
So two disadvantages.
One is it's inflexible.
You are to put in $10 every time, and if your income is
variable, you may not want to save $10 every time.
And the other is that it's typically short-term.
So if you want to save for retirement, it's not a very
good way to get there, because it's something that takes--
it's going to end fairly so.
And therefore, you're not going to be able to save for
retirement using it.
Any other disadvantages or limitations, let's say?
Yeah?
AUDIENCE: [INAUDIBLE]
PROFESSOR: Right.
So the amount in ROSCAs tend to be quite limited, and
they're limited precisely by the fact that it creates an
incentive problem.
Once I've got the money, I got my $50.
At that point, I have no incentive
to stay in the ROSCA.
So you need leverage over me.
And if that was $10,000, you may not have that much
leverage over me.
So $50, the ROSCA will be small, that I can save small
amounts with ROSCA.
It's going to be hard to save a large amount, because
somebody's going to be very tempted by it.
So one other way people save--
I remember, the house I grew up in India was built--
my grandfather used to write textbooks for high school.
And whenever he got a contract, he would build
another room in the house.
So the house was like--
the first rooms were built in 1939.
The last room was built in 1959.
20 years, he kept adding rooms.
And that was because there were not very many good
savings products available.
And well, for him, it was something that was going to
always have value.
And so, for him, it was a very logical way whenever he got
some money, he would park it into
another room in the house.
So if you look, every room in the house
has a different floor.
And you can tell that the tiles that were used to buy
for room one had run out by the time you got to room two,
because that was five years later.
So there was a different set of tiles,
or different flooring.
So every room had a different floor, different color,
different tile, something.
And that was very normal in houses constructed in a
particular period, where especially access to financial
assets was very limited.
So people didn't have much financial assets.
They usually save in this way.
Now if you go to developing countries, one thing you
notice is this tons and tons of unfinished houses.
Like just in the outskirts of any big city, you see all
these houses which are half-finished.
Like there's a couple of walls, or a wall and a roof,
but then on the roof there are still these pillars sticking
up from the roof, and the house is not painted.
It doesn't have any doors.
That's a reflection of exactly the same fact-- people are
actually building these houses over time, partly because they
don't have good credit markets, so they can't borrow
to build the house, partly because they don't have good
savings opportunities.
This a perfect way to solve their savings problem.
They're getting an asset in the long run.
And so when my mother had somebody who used to drive her
car for her, and he would, like, once in three months,
take leave and go build a wall in his house.
And he didn't even build a whole wall.
He would just have enough money.
He would save up enough money to build half a wall, and he
would go build half a wall.
And then he's show up two days later looking all grimy,
because he'd been building for two days.
Then again, three months later, he'd
build the next wall.
And now he has a house.
He built his whole house.
He his goal in life was he will not get married until he
had a house.
So he's now gotten married, because he had postponed his
whole marriage till he could build his own house.
So his whole strategy was he would buy a door--
this was all an investment towards his marriage.
So once he got all of that fixed, he went
ahead and got married.
So that's a classic example, but you see it everywhere.
And it's quite a nice way to say.
What's a disadvantage?
What's a disadvantage of saving brick by brick?
What's the obviously disadvantage?
Yeah?
AUDIENCE: Stuff can happen to the
house before it's finished.
PROFESSOR: Sorry?
AUDIENCE: Things can happen to the
house before it's finished.
PROFESSOR: Things could happen to the
house before it's finished.
That's true.
AUDIENCE: If real value occurs, then it could
[INAUDIBLE] all of the investment.
So if you just have [INAUDIBLE].
PROFESSOR: It's not liquid.
It's very illiquid form of savings.
You can't sell usually two walls and a door.
So therefore, if you need money suddenly, it's a very
bad asset to have.
If you knew that there was a future which was very
predictable, like this guy who wanted to get married, and he
knew that one day he will need this, so it's very
predictable--
that's an excellent asset.
But if something which is unpredictable, then it's a
very bad asset, because it's very illiquid.
It's like any other illiquid asset.
Now another similar asset, which you see a lot in
developing countries, is jewelry.
You see very poor people wearing gold jewelry all over
both India and China.
You look at poor people, even very poor people are wearing
gold, having a small piece of jade or something.
These things are expensive.
But again, part of the reason is that they are very good
real assets.
They are inflation-proof.
Gold goes up.
Actually, right now, gold is at $1,500, which
is impressive actually.
I wish I bought some gold last year.
But it's inflation-proof.
It's very divisible.
You can buy very, very small amounts of it.
You just buy a pair of earrings.
That's not a lot of money.
And it's sort of nice while you have it.
You get some use value out of it.
And partly, gold is very favored, because the quality
of gold is cheap to verify.
This is why gold was always made into currency.
And as a result, it's very liquid.
So if you have a gold jewelry, you can go to the local
jeweler, and he'll give you a loan in two
minutes against it.
It's very easy to mortgage basically, because its quality
is very well known.
If you try to mortgage your house, people have to come and
do an inspection, figure out if your house is actually
worth anything or not.
Gold is gold.
And so, you'll find in very poor neighborhoods, in poor
countries, a jeweler, and the jeweler's actually somebody
who's constantly giving and taking money.
It's very much a two-way business.
He's taking gold and giving money, and giving gold and
taking money.
And it goes in both directions all the time.
And the reason why gold is essentially a more attractive
asset-- it has less use value than a house.
Obviously, a house--
maybe not.
I don't wear a lot of gold, so.
But
I suspect it has less use value than a house, but it has
a lot more liquidity.
It's extremely liquid.
You can just take it to the local jewelry,
you get money back.
So liquidity is extremely important for the poor,
because there are often problems, and if somebody gets
sick, you need money.
The alternative to all of this is financial savings of one
form or another.
Some form of financial savings.
Financial savings are like assets in
banks, or paper assets.
Now these are different ways to access paper assets.
Even if you don't have a bank account, these are ways to
access paper assets.
Does anybody know what a money guard is?
Maybe you're going to do your readings a bit more carefully
[INAUDIBLE].
Yeah?
AUDIENCE: If someone else [INAUDIBLE]
PROFESSOR: Yeah.
A money guard is somebody in your neighborhood who just
accesses a bag.
AUDIENCE: How does that differ from a savings collector?
Isn't that basically what a savings collector--
PROFESSOR: No, a savings collector--
how does it differ from?
Anybody want to try to answer that?
AUDIENCE: Is that where they actually visit your house on a
regular basis, collect small amounts?
PROFESSOR: Savings collectors typically
take you to the bank.
So the difference is a savings guard is someone
who keeps it herself.
AUDIENCE: But I thought in the reading the woman in the
village, I didn't think she was taken to the bank.
They said--
PROFESSOR: She was depositing it somewhere else.
AUDIENCE: And not at her house?
So really, the only distinction is
where they keep the--
PROFESSOR: Yes, but I think it's very different.
The incentives are very different.
So imagine that you deposit all your savings with me, and
you have no documentary proof.
I say, well, tough, I have no idea where it went.
What do you do?
If somebody is putting it in the bank, then the maximum
they can steal from you is that today's flow.
So if you put it in the bank, then I give it to them.
They put it in the bank, they get this stamp in a book that
says that they put it in a bank.
I know that essentially all they can steal is the amount
they collected today, not be the entire stock up to today.
AUDIENCE: So when they put it in the bank, aren't they
[INAUDIBLE] in your bank [INAUDIBLE]
PROFESSOR: The could either put it in your name, or
sometimes what people do is they have to put in--
let's say 10 of us have to each give you $1, and you have
to put in $10 into the bank.
So it's an easy check.
AUDIENCE: But I mean, assuming that, couldn't the savings
collector--
I mean, if the bank [INAUDIBLE] their bank, can
they still steal everything that they [INAUDIBLE]?
PROFESSOR: It's not in their name.
Typically, they can't take it out.
The accounts are such that it's deposited into an
account, and to take it out, somebody else has
to authorize it.
So these are different designs, because in some
sense, if there's somebody in your neighborhood who is very
reliable, you can just give them the money.
Somebody very reliable, they can save the money for you.
But if you don't have somebody very reliable in your
neighborhood, then you often use a savings collector.
Savings collector is basically someone who doesn't hold on to
the money, and therefore is much less able to run away
with the money.
What are self-help groups?
Yeah?
AUDIENCE: It's where a group of people basically collect
and they stay together [INAUDIBLE]
the process.
It's [INAUDIBLE]
PROFESSOR: Right.
But a self-help group, in a sense, is more
flexible in a ROSCA.
It basically takes the money.
Whoever gives them money, they take it, and then they lend it
to other people within the group.
Or, sometimes what they do is they just
deposit it in a bank.
That sort of turns them into a savings collector.
So I think the more--
AUDIENCE: But isn't a ROSCA a type of a self-help group?
PROFESSOR: Yes, I guess you're right.
You're right.
ROSCA is a type of self-help group, but a lot of self-help
groups are much more flexible than a ROSCA.
They allow you to the option of putting the money into--
I put whatever, either $2, $1, et cetera, into it.
So the trade-off between a ROSCA and a self-help group is
that as self-help group-- particularly the ones that
work well--
have to have a good accountant.
A ROSCA is very simple.
We don't need to have any accounting.
We know there's $10.
We put it in each.
There's $50.
Somebody gets it.
Requires zero accounting, right?
A ROSCA requires zero accounting.
Self-help group requires some accounting, and there's some
evidence that when there's no one that can do accounting,
they collapse.
Because you basically need to make sure, I'm making a
flexible deposit.
I'm putting $3 today, you put in $5, and she borrows $7.
So somebody has to keep track of all those numbers.
And that's much harder if you're not really comfortable
with reading and writing.
So in a sense, a ROSCA is a very specific, very simple
form of a self-help group, and it's simplicity is a huge
advantage, because it's something that
makes it quite clear.
Nobody needs to know accounting to run a ROSCA,
whereas to run a self-help group, typically you need to
know some accounting.
Yeah?
AUDIENCE: [INAUDIBLE]
self-help group without the same [INAUDIBLE]
ASCA [INAUDIBLE]?
PROFESSOR: Yeah.
An ASCA is a broader category.
Yeah.
Self-help group is an example of something where there is--
so the trade-off between--
so I already answered the question.
A savings collector typically charges money for it.
It's somebody who comes into your place,
collects the money.
She keeps accounts for it.
She's a professional.
She charges money for it.
People to pay up to 5% per month, negative interest to
get these things.
So huge.
So you might get might actually pay
someone quite a lot.
Typically, a self-help group is one where you don't have to
pay anybody.
It's like a ROSCA, where the loss is relatively limited.
The constraint is accounting.
So saving collector is someone who can
typically keep good accounts.
She, or even a money guard, is someone
who keeps good accounts.
You go and give her the money, she can show a book where she
keeps exact records of how much you put it.
It's not easy to find someone in your neighborhood if you're
poor who has good accounting skills.
Whereas if you think a ROSCA, for example, is beautiful in
that it doesn't require a lot of accounting.
So the trade-off between these come on how much accounting
they require.
So self-help groups are intensive in accounting.
They require that somebody keeps track of who's putting
in money, who's taking out money.
So if that's not being done by a professional, then it
depends very much on the quality of the group.
If there's no one in the group that can do the account well,
the group will collapse.
If you compare that with like, say, a savings collectors--
saving collectors typically are someone who is good at
accounting, and therefore can be relied on to do that job on
their own--
gets paid for it.
So that sort of the trade-off between these things, is that
if you have someone around who is a good accountant who is
part of your group, you can have a self-help group.
If you're willing to pay someone a lot to do the
accounting for you, you can have a savings collector.
And if you have neither, you can have a ROSCA.
So ROSCA is the simplest product.
It's the least flexible product.
But it's the one that doesn't require any skilled person to
do the job for you.
So that's the big trade off between these things is that
some of them rely on having skilled people around to do
the job, other don't.
Microcredit is another possible savings instrument.
How could that be?
How could microcredit be a savings instrument?
AUDIENCE: It's like [INAUDIBLE]
savings [INAUDIBLE]
your fixed savings [INAUDIBLE].
PROFESSOR: Right.
So in a sense, it's a funny way to save, but a lot of
people to save that way.
So you want a television.
You can either save-- let's say a color
television costs $200.
You can save $2 a week for 100 weeks.
That's very difficult.
$2 a week, you forget, you spend some of the money.
You're keeping a lot of money at home.
The alternative is somebody gives you $200.
You buy the television, and then you pay them $2 a week,
but then they charge you some interest.
You pay $2.50 a week.
But because you're paying $2.50 a week, they're willing
to give you the money early.
And then it is their job to make sure you pay.
They come and pester you if you don't pay.
So you transfer the burden of repayment, and in instead you
having to do the saving, somebody else forces you to do
the saving.
It's expensive.
You're paying 24% a year to get save, basically.
It's like giving up 24% of your money, but it has this
advantage that you don't have to wait.
OK, so some little math.
So all of this we've been discussing.
We've been sort of going back and forth, and saying, well,
it's difficult for the poor to save.
Maybe they don't want to save.
Maybe there's some good reason why they don't save.
So we haven't shown any smoking gun that there really
is an efficiency in savings.
So I wanted to give you an example of how you would make
the reason that is actually people actually under-save.
So how would you make the case that people under-save?
So to me this case, we'll have to do a little bit of algebra.
So let's think about it carefully, OK?
The first line in that slide is what's
called the Euler equation.
The Euler equation is a condition for savings
optimality over time.
What it says is the marginal utility of consumption today--
how much consumption is worth to you today--
should be equal to--
so something times [? marginal ?]
consumption tomorrow.
What's the question being asked?
It's asking the question, imagine I saved one more
dollar today.
What would it be worth tomorrow?
Well, one thing that's going to work is [INAUDIBLE].
So it's going to be worth 1 plus r.
If the interest is r, I'm going to get 1 plus r for it.
Yeah?
But then, utility tomorrow isn't worth as much as it's
work today.
It's like tomorrow is in the future.
I want it now.
So that's delta.
Delta is a number less than 1.
So it says that utility tomorrow is worth only a
fraction delta of utility today.
And then the last is [? marginal ?]
consumption tomorrow.
So basically, imagine that the right-hand side of that is
less than the left-hand side, OK?
Then, what should I do?
Well, I should [INAUDIBLE] says the [? module ?]
utility today is higher than what it
will be worth tomorrow.
Or actually, let's do it the other way If [? module ?]
utility today is less than delta times 1 plus r times U
prime [? c ?] plus 1, that means that $1 today saved will
give me more utility than I would get it today, right?
Today I will get $1 will give me U prime [? c ?].
If I saved it, I would get 1 plus r.
That's going to be worth delta U prime [? c ?]
times 1 plus r.
So basically, I'm getting more utility by putting money into
the future.
So that's the standard condition for consumption
optimality.
The next line says, imagine the utility function that's a
standard form of the utility function is that it has that
form, consumption to the power of
something divided by something.
It's a fairly standard form of utility function.
Actually, you should notice that even when sigma is
greater than one, that works.
Why?
Because c to the [? r1 ?] minus sigma is then decreasing
in c, but is divided by a negative number.
So it's again increasing by c.
So it works even for that.
So if I did that, then I substituted U of c into both
sides I would get that the question in the third line.
The third lines comes from the second line, U of c equals c
to the power 1 minus sigma divided by 1 minus sigma, U
prime is then what?
What's U prime?
Take the derivative.
What do you get?
It's MIT.
You know the answer.
Come on.
All too superior to answer?
You all feel like, how could you ask me
such an inane question?
Tell me what it is.
AUDIENCE: c to the negative sigma.
PROFESSOR: Yeah, c to the negative sigma is U prime.
I put that into the first equation, I
get c to the power.
And then you can see that I'm gonna get the third line out
of that if I substitute U prime into that equation.
And then I invert that to get the fourth line.
Now reasonable values of delta, standard
values are, like, 0.9.
People use that number 0.9, 0.95.
I'm taking a low number.
You'll see that a low number is going to make it less.
If I do the higher number, then my case
will be even stronger.
Sigma, people think it's a number like two, three, four.
That's the kind of number of people usually find.
Sigma is a measure of risk aversion, and when they
measure that, they find something like that.
So take those numbers.
Trust me, they are standard numbers.
And then the last thing is, what is r?
And I want to say that we looked at data last time where
it said that people were borrowing at 80% a year.
If you're borrowing at 80% a year, you're an asset.
That's exactly like having an asset which pays 80% a year.
Because if I borrowed $1 less, I would pay $1.80 less on it.
So anybody who had an asset which has an interest rate of
80% is sitting on an asset with an 80%
interest rate on it.
It's exactly the same thing.
I just borrow $1 less.
So anybody who has a loan which is paying 80% is exactly
like having an asset which is 80% on it.
So now, I plug that in.
So think of somebody who has a loan, who is borrowing at 80%.
67% of the people-- yeah, we saw that actually last time,
were borrowing, had loans, and the average
interest rate was 80%.
So this is not an unreasonable, these numbers.
So let's take those numbers, plug them in, and you get
consumption growth will be 17% per year.
That's a huge growth rate.
That I would say poverty would vanish in five years, because
17% per year is a very, very fast growth rate.
What's the logic here?
Say, these guys have an investment opportunity which
pays 80% a year.
They're not using it.
So there must be, only reason you don't use an investment
opportunity that's paying that much is that you're going to
be much richer in the future, so you don't want to invest.
Otherwise, you should use this opportunity.
So people who are forward looking, and they have an
investment opportunity which paid them 80% a year, they
should be pumping all their money into the future.
80% a year is a great investment opportunity.
Only people who will do it are people who are getting rich
very fast, because if you're getting rich very fast, then
you don't want consumption in the future.
So that says that if we take assume people are rational,
then the fact that people are persistently borrowing-- and
I'll show you this in a minute.
I'm not making this example up.
So I'll show you the problem in a minute.
The fact that people are persistently borrowing at 80%
a year means that they must be getting rich very fast.
But in other words, since they're not getting rich very
fast, the poor seem to remain poor.
Something is wrong with this calculation, so we're going to
try to figure out what's wrong with it.
But if I take the model seriously, and say, this is
how people save, it is clear that this implication is that
the poverty should be the vanishing phenomenon, because
basically these guys have such a wonderful investment
opportunity.
You an just save at 80% a year and get a lot richer.
So that's--
yeah?
AUDIENCE: What's the logic to why sigma is equal to 3?
PROFESSOR: Sigma is equal to 3?
So sigma is the coefficient of risk aversion.
If you look at the utility function, and you look at--
given that utility function, how would
people react to risk?
That will be measured by sigma.
So you can actually look at how people
actually react to risks.
I offer you $10 for sure, or $4 with probability 1/3 and
$15 with probability 2/3, and I see whether you want then
bet are not.
And from that, people back out of risk aversion.
And to do that, they get a number like 3.
So this is sort of a hint at what's going on.
And I want to show you kind of something more worrying.
So here's an experiment which is kind of a different way of
getting at the same point.
I showed it to you kind of theoretically.
Now I want to show it to you as an experiment.
Here's an experiment.
It's an experiment with fruit vendors and vegetable vendors
in India and the Philippines.
Two separate experiments doing identical things.
So fruit vending is a very, very simple production
function, OK?
Very, very simple, meaning you buy fruits in the morning, you
sell all day, you get money in the evening, you go home.
Next morning, you come back, and you buy fruit again.
You sell it.
It's very predictable, very continuous, daily production.
Not very high risk, actually.
It's mostly you know what you can sell, you can see the
price, et cetera.
So here's a table which kind of summarizes a bit about
these people.
So most of these people make one trip a day to the market.
This one's for the Indian experiment.
They buy fruits worth about 1,000 rupees in the morning.
They sell it, and they get profits of over 100 rupees.
That's the 10% profits during the day.
Not bad, actually.
How do they run the business?
70% take a loan every day.
Every month--
26 days-- somebody takes a loan.
So this is to buy fruit.
The interest rate on the loan per day is 5%.
Basically, the way it works is you go to the fruit seller,
and he says, you want to buy cash or credit?
Cash price is this, credit price is that.
Which one's higher?
AUDIENCE: Credit.
PROFESSOR: Credit price is higher, right?
Basically, you get the same fruit, so you pay more if you
buy it in credit.
But the advantage of credit is you don't have to pay for it
in the morning, you paid it in the night.
You go back in the evening, and you pay for it.
5% per day.
So most of these people have been in--
no, I'm missing one table.
Most of these people have been in business for nine years.
They do this day after day.
Nine years they've been in business.
Every day, they borrow at 5%, meaning that they come in the
morning, they take, let's say, 1,000 rupees worth of fruits,
but they actually get 950 rupees worth of fruits, and
then they go sell it.
They say this is 1,000 rupees, but in fact get 950 rupees at
first first, and then go sell it.
Remember that daily income is about 100 rupees.
They pay 50 rupees out of 1,000 as interest.
So if they didn't pay interest, they're earnings
every day would be 50% higher.
It would go from 100 to 150, roughly.
So that's a huge interest cost.
Now here's a way to think about 5% a day, what it means.
Suppose I took the following strategy.
Drink one less couple of tea every day.
A cup of tea costs, in this same
currency, 2 and 1/2 rupees.
So let me take one less cup every day, and I reinvest that
in the business.
So what I do is I drink one less cup of tea, so I borrow.
2 and 1/2 rupees less today.
That means I don't pay interest on the 2 and 1/2
rupees, so I get a little bit extra money.
I reinvest that.
I do that for 30 days.
Every day, I drink one less cup of tea for 30 days.
At 5% a day--
you should do this calculation.
It's stunning.
Compound interest really is impressive.
So once you do this for 30 days, you would have doubled
your capital.
So these women could double their capital by simply having
one less cup of tea every day for 30 days.
They've been in this business for nine years.
Their earnings would be 50% more if they did this.
They could pay down their entire 1,000 rupees debt by
doing that for 30 days, basically.
So your 1,000 rupees are essentially just the price of
30 days worth of tea.
So that's sort of stunning, if you think about it.
So this goes back to the same point I was trying to make,
which is that there's some reason to get worried that
these people are somehow--
they're not managing.
What they're trying to do in this experiment is they offer
two treatments.
They basically think that two possible ways in which we
could-- maybe one possibility is that these people are now--
they need 1,000 rupees to survive, 100 rupees to eat
every day, so they can't save.
And so they're stuck.
So it's not clear why they couldn't have
one cup of tea less.
So they say, well, maybe if we just pay their debt.
So let's say they owe 1,000 rupees, we'll
give them 1,000 rupees.
Imagine that there's some reason they can't get out it.
Do they stay out of debt if I pay them 1,000 rupees?
Second possibility is that I teach them what compound
interest is.
I explain to them that if you just did this, you could save
yourself a lot of money.
So there are two treatments.
They're experimental, so some of them get one, some of them
get the other, some of them get both.
So do you see what the experiment is?
I either go to someone and say, you owe the food seller
1,000 rupees.
Here's 1,000 rupees.
You're done.
Now from now on, you start from scratch.
Or I go to them, and I say, come to a class.
I'll explain to you compound interest.
Or, I offer them both.
So what happens?
So that's the question.
So some of these people, for some reason, they had
got into this debt.
Let's say they were liberated from the debt.
Some people were educated on the arithmetic component of
compound interest.
So training was half a day training, where they were
explained how much they spent on interest, all these
illustrations.
If you save just one cup of tea a day, it will
be enough, et cetera.
So all of that.
Skip.
So here's the result.
This one's from the--
[INAUDIBLE]
let's see which country this is.
Philippines.
From the Philippines.
Here's the basic result.
[? Force ?] times payoff says if you--
ignore everything else that says, but just
look at what it says.
Do you have a debt?
The question is, do you have a debt from a money
lender after two weeks?
That number says you are 33% less and less likely to have a
debt from a money lender after two weeks.
So two weeks after I pay your entire 1,000 rupees down,
you're back to having a loan for 5% a day.
So 33% don't have a loan, so 67% have a
loan after two weeks.
After six weeks, 60% have a loan.
After 10 weeks, 80% have a loan.
So basically, after 10 weeks, that 1,000 that they had been
given just vanishes.
They don't seem to be able to stay out of debt.
The same results are true for--
this is the India study.
So debt payoff after--
first, follow up.
After three months, so this negative 10% don't have a
loan, so 90% after three months have got back a loan.
So even though these the loan was paid down, that went away
within three months.
And the training, just 2% had nothing.
There was no effect of training.
OK, you can see, people were trained.
If you look at the training row, that row says nothing
significant in that row.
That's just saying that force times training
is the effect of--
if you had had a training, what's the
probability you have loan?
It's positive, meaning you're more likely to have a loan,
but it's suddenly not significance.
So it's basically no effect on whether you
have a loan or not.
So the fact they would explain compound interest seems to
have no effect on whether you get a loan or not.
It's kind of stunning, actually, these results.
How are people slipping?
Why are they getting back into?
So one thing that you find is that when
they get any shocks--
like somebody gets sick--
if your debt was paid off so that you were given the money,
you are much more likely to deal with the shock with your
own money rather than by borrowing.
So what these people are doing is they seem to be using the
money to deal with shocks.
So basically, there's so much uncertainty in these people's
lives that there's always something that comes up.
And when that comes up, you use the money to
deal with the problem.
And then you're back borrowing, basically.
We'll start to think about what these results mean on
Tuesday, OK?
So think about them.
Do the reading.
We'll talk more about it on Tuesday.