Earmarking Money: Partitions, Guilt And The Decision To Spend
HERE IS WIDESPREAD CONCERN about declining savings rates among consumers. Indeed, the problem defies boundaries, ranging from sophisticated western economies with a high prevalence of consumer credit to more traditional economies in rural areas of the developing world, where banking infrastructure is almost nonexistent. Record numbers of personal bankruptcies and delinquencies have been reported in North America, while observers have commented that the rural markets of India and China will only emerge as a force if these consumers learn how to manage their money.
Washington University’s Amar Cheema and I recently set out to study one particular approach to personal money management: earmarking money. The term ‘earmarking’ is typically used to describe the labeling of funds for a specific use. However, it often describes a more specific practice, in which earmarked money is kept distinct from other funds, either through physical segregation or other forms of categorization, such as a separate bank account. For example, many households open separate bank accounts for their children’s education expenses or for home-repairs.
When money is deposited into such accounts, the thinking goes, it becomes ‘sticky’ and stays there rather than being spent on other things. Earmarking thus represents a selfimposed rule that is used to control spending, and following such a rule requires the exertion of willpower to control impulsive short-term behaviour in favor of longer-term benefits. Breaking such a self-imposed rule can be psychologically costly, leading to feelings of failure or a loss of faith in oneself. But is the possibility of such a negative effect a strong-enough deterrent to lead one to follow the self-imposed rule?
In prior research conducted in 2007, Prof. Cheema and I found that taking a particular quantity of a resource – say, food or money – and physically partitioning it into smaller quantities changes the temporal pattern of consumption of that resource, leading to greater self control [see “The Effects of Partitioning on Consumption”, Rotman, Spring 2008]. We set out to build on these findings by studying the effects of partitioning an earmarked amount of money on the guilt associated with using that money for an unrelated expense.
Given our previous findings, we expected to find that using partitioned money (i.e., money from two separate accounts) for expenses unrelated to the intended earmark would lead to a higher amount of guilt than using funds from one account. Consequently, the desire to avoid this guilt would lead to greater self-control when the earmarked money is partitioned into two accounts than when it is pooled in one account.
Specifically, we expected that the act of spending ear marked money on an unrelated expense – rather than the magnitude of the expense – is what would induce guilt. This expectation is consistent with the ‘hedonic editing’ practice of aggregating monetary losses – whereby one $20 loss hurts less than two separate losses of $10 each.
We tested our hypotheses in a field setting featuring low income consumers at the ‘bottom of the pyramid’: labourors at an infrastructure-construction project in rural India. The chosen project had been ongoing for eight months and was expected to last for more than another year. Labourers received cash wages with a frequency ranging from once a day to once a week, and a workweek had six days. Such infrastructure projects usually spawn-off several small townships in the general vicinity. It is important to note that while these townships are full-fledged in other regards, they often lack services such as banks and post offices. Only about seven per cent of such Indian villages are served by banks.
Of particular interest to our study, none of the townships included in this study were served by banks, and hence people in these townships were habituated to a cash economy. None of them even had any banking experience: they earned cash and they spent cash.
Of our 146 participants, 20 had previously pawned possessions for cash and another eight were aware of the existence of moneylenders and pawn shops. While all participants could converse fluently in the local language and could understand simple written instructions, many could not read beyond a few lines of text. All participants could count, add and subtract with ease and bargain at the local markets.
For the purpose of our study, we recruited households where the labourer was the sole wage earner, belonged to a specific trade, had two children aged between two and seven and lived with a spouse and two children in a township within walking distance of the project. Given that all participants were from the same profession, they all earned the same amount: 670 Rupees [CAD$15.50] per week, paid in cash on Saturday. We eliminated potential participants who had unusual additional financial burdens (e.g., covering household expenses for extended family elsewhere).
Our interviews suggested that the frequent pay periods resulted in the participants living their lives ‘one week at a time’. They budgeted in very narrow temporal frames and ended up making poor economic decisions. All participants reported that they would have liked to save more money so they could afford to feed, clothe and educate their children, but they had barely enough to make ends meet.
A financial planner, accompanied by a social worker, visited each of the 146 families, helping participants identify better money-management strategies. The planner further told each household that one simple way of saving more money was to set a savings target.
The current savings rate for this group was very low: in the six months prior to our experiment, the mean savings rate was 0.75%, with 90 per cent of participants saving less than or equal to two per cent. In the context of our study, the financial planner determined that saving Rs. 40 each week (a rate of six per cent) was achievable. In addition, we gave some participants a more ambitious savings target of 12 per cent. The planner gave each participant their target savings amount, and said that the social worker would help put aside this amount each week in sealed envelopes.