An Economic Fallacy Economists Believe About the Poor?

I recently finished reading a short but fascinating book by Charles Karelis called The Persistence of Poverty: Why the Economics of the Well-Off Can't Help the Poor. Karelis is a professor of research philosophy at George Washington University and a past president of Colgate University. His topic is essentially about marginal utility and the poor.

What is marginal utility? Wikipedia defines utility as "a measure of the relative satisfaction or desiredness from consumption of goods." Marginal utility is the relative satisfaction we achieve from consumption of the next unit just beyond (or at the margin of) what we've already consumed.

Think of it this way. You have a craving for Oreo cookies. You go to the cupboard and retrieve a package. The first cookie you eat brings you great satisfaction. The second and third cookies may give you nearly as much satisfaction. But maybe somewhere around the fifth cookie, you get slightly less satisfaction. Each succeeding cookie brings you less and less satisfaction until, at some point, you no longer care about the next cookie. (For me, this is around the fifth package, but this post isn't about my eating disorders.) Economists call this diminishing marginal utility. The more you get of something, the less satisfying each successive unit becomes.

Diminishing marginal utility (DMU) has figured heavily in the thinking behind social policy debates. Drawing on DMU, liberal policymakers argue that each additional dollar received has far greater utility for a poor person than a wealthy person. Shifting some modestly missed dollars to others where they will be greatly valued is a better distribution of resources for society.

Drawing on DMU, Conservative policymakers argue that the poor need to be motivated to provide for themselves. Alleviating their misery by distributing unearned money relieves them to the point that the marginal utility of the next dollar they could earn if they worked is not enough to motivate them to work. Both liberals and conservatives take DMU as a given.

Karelis raises the issue that everyone who has ever worked with people in chronic poverty knows: The poor don't seem to reason according to declining marginal utility. When the chronically poor get income, they blow through it immediately. There is no attempt to save for more lean times. Once they have collected a small amount of money, they often disappear rather than devoting themselves to the opportunity to create a continuous flow of money. Furthermore, the money earned is often "wasted" on big-screen TV, gambling, cigarettes, drugs, or liquor. Being so poor, the next dollar they could garner should mean so much to them that they would optimize their behavior to obtain it.

Since the poor don't respond rationally to DMU, the theory is that something must be wrong with the poor. Some suggest a culture of poverty. Some suggest diminished capacity through substance abuse or mental illness. Others suggest disheartened apathy as a possible contributor. Clearly, there is evidence that these problems are real among the poor, but are they the primary cause of "irrational" behavior? Karelis believes they are not. He believes that the decisions of the poor are very rational. Instead, because researchers come from a position of affluence, they have failed to notice that there are two types of utility, and one type leads to increasing marginal utility.

Karelis calls the two types of utility "pleasers" and "relievers." Oreos would be an example of pleasers, as would dollars for most economically stable people. Each additional unit brings pleasure but at a diminishing rate. Relievers work differently. Karelis asks us to imagine being on a picnic when suddenly we are stung by a bee, on the hand, let's say. Our mind is now directed toward the pain in our hand to the exclusion of whatever other physical discomfort we may be experiencing. Karelis has one dab of salve at hand, and he applies it to our bee sting. Our pain is relieved. The salve has a high degree of utility for us.

Now instead of one sting on the hand, we are stung on the hand and the neck. There is still only one dab of salve. Its application to one sting will decrease pain but still be left in considerable distracted discomfort. A second dab of salve would have more marginal utility than the first.

But now let's say we have six bee stings at various locations on our body and still only on dab of salve. The one dab of salve provides minimal relief for us. But each successive dab supplies an increasing quantity of relief.

So what if you woke up daily with six bee stings and had been supplied with six dabs of salve to cover your next six days? Would you allocate them one a day across the next six days, or would you use them all in one day to have at least one day out of the six pain-free? The chronically poor routinely choose the one blissful day. (Karelis draws on cases throughout human history to illustrate this preference. He recounts a case during a prolonged period of famine in Greece where half the population ate on one day and went hungry the next, while the other half ate and fasted in the reverse order, instead of everyone not having enough to eat every day.)

Therefore, the poor are rationally inclined to spend a small pile of money in one big bang. Buying expensive clothes gets you esteem for at least a moment. Entertainment, gambling, or substance abuse provides at least temporary distraction and relief. Experience tells you there is an inadequate supply of relievers around, so when you have the fortune to get an amount that gives you complete temporary relief, do it!

Now what Karelis points out, using the bee example again, is that dollars can function as relievers for the person in poverty. Those dollars will have increasing marginal utility but only up to the point of achieving significant relief. Once we cross that line, the money becomes a pleaser utility, and diminishing marginal utility kicks in. At this point, our cash contributions begin discouraging the poor from working because they are getting pleasure utility without effort. Each unearned pleasure utility beyond the line makes the recipient less and less inclined to work for any additional utility.

Karelis is not an economist and doesn't give much policy direction. What I find interesting is how well this comports with the Old Testament ethics. Jubilee provisions preserved permanent ownership of one's land and labor, reducing land transactions and bonded labor to lease agreements that expired at the Jubilee. Jubilee laws did not redistribute the nation's wealth but did prevent anyone from falling perpetually below the pleasure/relief utility line.

I think the challenge in our culture is that the pleasure/relief utility line varies on a situation-by-situation basis. That means personal involvement with the poor can't be replaced by impersonal bureaucratic cash and benefit distributions based on formulas. It seems to argue for a level of safety net support but within the context of accountability to the local community.

I haven't seen much response from economists on the Karelis thesis, but I'll be interested to see.

Comments

[Peter]

I wonder if one might synthesize Karelis' ideas with the notion of social pathology. It seems that many trapped in perpetual poverty suffer from social pathologies rooted in the lack of the kind of tacit knowledge many of us have for navigating the economy. I am thinking of things such as knowing how to keep a job, show up on time, etc. These are real things that some tragically do not have built into their lives and suffer because of it.

Combining the idea of social pathology with Karelis' ideas might create a powerful typology for understanding persistent poverty. If this typology is on the right track, then I think your suggestion that, "Personal involvement with the poor can’t be replaced by impersonal bureaucratic cash and benefit distributions based on formulas," is right on track. I do not think this negates the need for government involvement through transfers payments of some sort. Perhaps transfer payments can be thought of as necessary but not sufficient.

Thanks for a great and helpful post.

[Michael W. Kruse]

"Perhaps transfer payments can be thought of as necessary but not sufficient."

I should have made that explicit but that is indeed what I was driving at.

Thanks!

[T]

This is very interesting and pursuasive. Hope of real change, or the lack thereof, seems to be an important factor within this theory: "Experience tells you that there is an inadequate supply of relievers around" or at least, no supply you believe you can access regularly.

I agree with how this squares with the goal of the Jubilee and related laws--to prevent economic holes from becoming too deep or too permanent, or too overwhelming.

[RonMck]

Thanks for a fascinating post. One solution that we need to look at more seriously is the role of the Deacon. They need to be good managers of their households so that they can teach poor people how to do the same. The older women teaching the younger women will be part of this.

Bill Bonner said "True prosperity doesn't come from money…but from habits, ideas, and attitudes". Tranfering money will not eliminate poverty. Habits and attitudes will have to be transferred as well. Bureacracies cannot transfer attitudes and habits, but deacons can.

[Brad Cooper]

Hey Michael,

Phenomenal analysis by Karelis. Thanks for providing a summary to help us get a handle on it. Some excellent comments by Peter, T, and Ron Mck, also. All very helpful insights on a very important topic.

We need more of this kind of wisdom and understanding if we are truly going to help the poor. That's why not just anyone could be appointed as a deacon (as Ron pointed out). The primary prerequisites being "full of the Spirit and wisdom."(Act 6:3)

Peace.

[will spotts]

Mike - Thanks for this post. The analysis Karelis offers is brilliant and original. OK - it was new to me ... I don't know if it is original or not. But it seems almost self-evident: there really is an easily understood difference between relievers and pleasures. I think this is an important piece of the puzzle we have been missing - in terms of finding ways to actually help.

[Michael W. Kruse]

Thanks everyone. I glad you found Karelis' ideas as insightful as I did. And Will, this the first time I've heard this put in this way.