Article Review

“Scarcity”: a book review

What is scarcity?

“Scarcity” was published in 2013, written by Sendhil Mullainathan, professor of Economics at Harvard, and Eldar Shafir, professor of Psychology and Public Affairs at Princeton. The greatest strength of this book is also its greatest weakness: it’s educational. On the one hand this is good, because it brings Behavioral Economics to the general  public and we certainly need it; on the other hand, the lack of a model makes the analysis shakier than we would like.

At the very beginning the authors define scarcity as “having less than you feel you need”; traditionally, development economists focused only on physical poverty. However, with this definition, they want to emphasize that scarcity can be both physical and mental. The main takeaway of the book is that scarcity is a mindset that lures people into a poverty trap, the leaving of which is very difficult.

To better illustrate this point, throughout the book they refer to  several experiments that have taken place both in developed and developing countries. The best feature is that they test physical and mental scarcity in both settings, and more importantly how they interact. The interaction is fundamental, because their thesis is that physical scarcity causes mental scarcity, i.e. the scarcity mindset. It’s easy to imagine physical scarcity, it ranges from not having enough food, money, time or (spoiler alert!) enough blueberries in a videogame. However, it is more difficult to think of mental scarcity, even though we constantly experience it. To explain it, they use the concept of bandwidth, or mental capacity. We can think of it as the “RAM of our brain”, the precision and speed at which we process information and execute decisions.

What are the effects of scarcity?

When we experience  scarcity we tunnel, i.e. we get extremely focused on solving the scarcity at hand. This focus can have 2 effects: one positive, and one negative. In the short run it is generally positive, because it makes us focus on the task at hand, operating at maximum capacity. However, it can have a negative effect too, since in this case when we are focusing we are actually tunneling, i.e. leaving everything else out of the picture, with possibly dire consequences. Moreover, in the long run scarcity erodes the availability of mental capacity, given that we can focus on nothing else.

To support this view, they refer to  several experiments and I’m going to explain three of them to help you understand. There is one experiment where people with less bullets available in each round of a shooting  game scored proportionately higher than people with more bullets: having less prompts efficiency. In another one, dieters found more difficult to concentrate on the next task if the previous one mentioned pastries: scarcity captures the mind and lets us focus on nothing else. The final experiment concerns Indian farmers, who score lower on an IQ test (measured with Raven’s matrix test) just before harvest than just after it. Why? Because they typically squander their harvest money in the months immediately following it, and the closer they get to harvest period, the poorer they are. That causes what is called a “bandwidth tax”; part of the brain continuously focuses on the scarcity at hand, leaving less room for other thoughts. It is really important to notice that all kinds of scarcity could cause that tax, ranging from money, time, love, etc.

Before turning to how to escape the scarcity trap, they focus on another negative side effect: borrowing. When tunneling, we leave everything else outside the tunnel, such as future consequences. To illustrate it , they make their case against the utility of payday loans. These loans are extremely short ones, with high interest rates. Moreover, they are extremely easy to get: in the US there are more payday lenders than McDonald´s and Starbucks outlets combined! Hence, once inside the tunnel, payday loans seem like the best way to get money, but in the long run they’re extremely detrimental.

How can we help people escaping the scarcity trap?

Seeing as scarcity is a lack of something, there are essentially 2 solutions: a windfall of the something needed or a more efficient use of the quantity at our disposal.

However, scarcity is insidious. For instance, they once gave Indian traders enough money to extinguish their debts, drastically increasing their disposable income, since they did not need to pay interests anymore. However, one by one they started borrowing again, eventually reverting to their previous situation. So a one time payment wasn’t enough to escape the poverty trap because they were not efficient, i.e. they did not reserve any slack. Indeed, the main reason to fall into the scarcity trap is that we are at the limit of the resource in question, so that when we face an unexpected “expense” we start borrowing from the future and taxing our bandwidth. Hence, the authors strongly advocate for the creation of slack, both to exit and to avoid (re)entering the scarcity trap.

Moving on to the strictly efficient part, they refer of the St.John’s Regional Center in Missouri: they were  constantly operating at maximum capacity, so when an unexpected surgery came up all the elective ones needed to be rescheduled. The solution was brilliant: keep an Operating Room (OR) only for the unexpected surgeries. Having one less OR available actually increased the number of surgeries performed: the creation of slack solved the problem. The last example highlights another important feature of scarcity: it does not concern only individuals, but also organizations.

In conclusion, the authors offer an exciting, novel interpretation of  poverty, tackling it from different angles, following a new framework: scarcity. Even though they lack a formal model (so far), the book offers an interesting view on one of the oldest problems, using several hints from Behavioural Economics. In short: a must read.

Article Review

Through the psychology of poverty

What explains the differences in economic decisions amongst poor and rich individuals?

In 2014 Johannes Haushofer and Ernst Fehr, professors at Princeton and Zurich University, respectively, have written the article “On the Psychology of Poverty” for the Science magazine (original version here). They show evidence that poverty causes psychological consequences such as negative affectivity and stress with unexpected changes in economic behavior by changing individuals’ revealed preferences and leading to short-sighted and risk-averse decision making. But what are the channels through which poverty could arise and perpetuate itself?

Bear in mind two things when interpreting their findings. First, although poverty is defined as the lack of sufficient income, it is also characterized by the exposure to dysfunctional institutions, violence, crime, poor access to health care, etc. Second, being born in such an environment can trigger processes that reinforce poverty. For instance, lower willingness to take risks, adopt new technologies, invest in education and health, together with present-biased income preferences, make it harder to escape from poverty.

The effect of poverty on economic behavior. Some laboratory experiments have randomly assigned individuals to income shocks after they have earned some money in an effort assignment. Then, researchers compared the discounting of future payoffs between “treated” individuals with negative income shocks and the “control” group, who didn’t experience any changes. Such exogenous manipulation of income eliminates any potential reverse causality between discount rates and income. They found that individuals with negative shocks on income showed more present-bias behavior than others. No analogous effect was obtained for positive shock on income.

The effect of poverty on psychological characteristics. Recent findings show a positive correlation between income and happiness/life satisfaction both within and across countries (see fig.1).

Fig.1. Relationship between income and life satisfaction within countries

According to the World Health Report, the poorest population quintiles in rich countries have records of depression and anxiety disorder up to twice as large as that of the richest quintiles. Besides, there are numerous findings that poverty is positively correlated with the stress hormone cortisol, as well as depression, anxiety and unhappiness. One should already expect such relationship, but is it a causal one?


Causal effect of poverty on affectivity and stress. A study by Haushofer and Shapiro (2013) evaluated the effects of an unconditional cash transfer program in Kenya on psychological well-being, by measuring characteristics such as happiness, life satisfaction, depression and stress. Individuals were randomly selected to receive transfers of $0, $400 or $1,500, and they found positive effects for all variables whenever receiving any positive transfer. However, levels of the stress hormone cortisol decreased only for the ones receiving a large transfer.


Fig.2. Z-score happiness response and levels of stress hormone cortisol

A series of natural experiments (e.g. lottery payouts, introduction of guaranteed incomes, access to pensions) suggest causal links between increases of income and well-being (e.g. reduction in hospitalization, lower consumption of anxiolytics, increased self-reported mental health). Randomized control trials also show that offering households access to health insurance, better housing conditions and access to water have a significant effect on psychological well-being.

The takeaway from this review is that the poor may intrinsically have identical time and risk preferences to those of wealthier people, but their discount rates and risk-taking behavior can change if living in a chronic condition of poverty. Should a welfare state intervene to avoid the creation of a poverty trap? According to the authors, there are three possible courses of action to break this vicious circle, which requires directly targeting:

  • poverty through poverty alleviation programs (e.g. cash transfers), proven to increase general welfare;
  • its psychological consequences (e.g. interpersonal psychotherapy);
  • its deriving economic behaviors (e.g. commitment savings account, reminders to save), which usually lead to considerable increases in savings.

These interventions allow us to better understand the relationship between poverty, its consequences and their potentially negative effects on decision-making, giving us a fresh perspective on how development economics can help to tackle poverty.