Tyler Cowen reviews Charles Karelis’ Persistence of Poverty which describes why economic ideas from wealthier individuals and societies do not help the poor. The problem is not the amount of money or lack of effort.

The poor, due to their position, have different marginal preferences than the rest of us.

Poverty is not produced by lack of money.

An old example is the Irish Immigrants to America. Many lived the poor slums of New York. You could break them up into two general groups: The shanty Irish and the lace-curtain Irish. Both lived in the same neighborhood and had the same incomes.

The lace-curtain Irish decorated their shanty homes revealing Middle Class aspirations. They valued education and improvement of themselves and their homes. The shanty Irish? You found them in the local pub or fighting in a street brawl with their gangs. Both were “poor” in monetary terms, but their values were strikingly different.

While the lace-curtain Irish quickly rose into the Middle Class and left the ghetto for the suburbs, the shanty Irish kept sinking lower and lower and lower. Even if the Shanty Irish wanted to change, they couldn’t after awhile. They became locked into a way of life that was perversely rational yet self-destructive. Thus the persistence of poverty. It’s hard to take the first step to self-improvement.

Tyler Cowen:

If your car has lots of scratches and dents, getting rid of just one doesn’t help much either.

More generally, if pains and troubles are high enough, extra pain and trouble just isn’t so bad. You hardly notice it. But that overturns standard economic assumptions of diminishing marginal utility, and the rest of Karelis’s model follows directly.

Poor enough people will accept risk in the downward direction rather than smoothing consumption, so they buy lots of lottery tickets. They also commit more crime, so they can have at least some joyous times, and they take lots of “stupid” chances. Yet the poor are not irrational or necessarily dysfunctional in terms of procedural rationality, but rather they are optimizing given constraints. They are taking the Friedman-Savage model very very seriously.

How much is self-improvement worth to you? This is partly subjective and partly environmental which places constraints on your opportunities.

If you’re really bad off, taking that first step to improvement doesn’t seem worth the cost. It’s a marginal preference that is completely rational yet self-defeating. Why bother fixing one scratch on your banged-up car? Would you seriously sink more money into that car or would you just duct tape it up and keep riding?

Poor people seem to behave in ways that reinforce their poverty. And this is true in many ways but that’s only part of the problem. Poor, Middle Class, and Wealthy like to live beyond their means at times, they indulge themselves with luxuries and live in the moment. The Middle and Upper classes spend their money on pleasures that benefit them over the long-term, like reading. The poor spend money on luxuries to relieve pain and suffering for the short-term, like drugs.

The middle and upper classes noticed this behavioral differece but never figured out a way to change it.

Blaming the poor doesn’t seem to help. As Tyler Cowen points out, punishing bad behavior backfires and makes the poor act even worse. Some, like socialists, thought it was purely environmental. Give the poor money and they will behave the same way as the working middle class. After spending billions of dollars, every poor person should have become a millionaire by now, so something obviously didn’t work.

Karelis argues that this is because the marginal utility of the poor encourages them to take excessive risks for instant gratification rather than long-term benefit.

One of the results is indebtedness. If you give a man in extreme debt $10, he isn’t going to spend the money paying back a tiny portion of his debt. He’s going to buy lotto tickets, booze and cigs. And why not? What does paying off $10 of debt get him? Cancelling the debt doesn’t help either, since he’ll just run up the debt again.

If you give money to those in deep poverty, they will immediately squander it. This only seems irrational to rich people, but it makes perfect sense for a homeless man to take the cash and buy alcohol. This is why many cities are outlawing panhandling – they finally realized giving cash to the homeless makes the homeless worse off.

This is not always due to behavioral choices. Behavior and economic structures reinforce each other.

Both wealthy and poor engage in risky behavior but of completely different sorts. Rich people put their extra money in the stock market, or take out a second mortgage on their home to start a business. They take risks which involve short-term losses for long-term benefit. And this is how the rich get richer.

Poor people, especially those in deep poverty, lack access to long-term planning and capital. In informal economies, they do not have formal property rights to their home, so they cannot take out a mortgage or start a formal business. So how do they behave given these constraints?

The poor live for the short-term. Instead of investing in self-improvement, they tend to horde their small amounts money. Which, compared to rich people, is actually really conservative. They spend their money in much riskier and seemingly pointless ways.

But from their position, it makes sense. This is rational behavior. Switch positions with them and imagine yourself in deep debt and poverty in a rural country. You have no long-term opportunities. You spend money for your daily needs – food, water, clothing, pain relief – not on paying back the debts you have. And if you can’t pay back the debts, you sink further into poverty. After awhile, more poverty doesn’t seem so bad because you can make-do each day.

The poor have a different perspective on economics than the middle and upper class. The countless failed anti-poverty initiatives never take this into account. They try to fix the structures of the economy, give the poor money, property rights, education, opportunity… but this presumes the poor behave like Middle Class individuals who will take advantage of these opportunities.

One suggestion is to look at the historical disappearance of the Shanty Irish in American slums. At some point, their values changed enough to become lace-curtain Irish … and then suburban Middle Class Irish. This involves a cultural element which is hard to understand and even more difficult to address through anti-poverty initiatives.

Then again, I sometimes wonder if anti-poverty initiatives are just to make the Upper Class feel good.

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