Bestiary of Behavioral Economics/Commitment Devices

DefinitionEdit

A commitment device is a choice that an individual makes in the present which restricts his own set of choices in the future, often as a means of controlling future impulsive behavior and limiting choices to those that reflect long-term goals. Typically, in order to classify as a commitment device, two conditions must be satisfied: (1) The decision does not have any type of strategic purpose with respect to others. (2) The person would pay something (on the margin) and make it more expensive in the present, even if he or she received no other benefit from the payment. [1]

BackgroundEdit

Humans have always used commitments devices, sometimes unwittingly, in at least one form or another. Only more recently, however, have economists come to define and study this type of device in depth. Thomas Schelling, a pioneer in the fields of Game Theory and Behavioral Economics, was one of the first economists to write about them at length. In 1960, Schelling clarified the usefulness of commitment devices with his famous 'kidnapper's dilemma.' The dilemma arises when a kidnapper has a change of heart and wants to release his victim, but is unable to because there is no way of guaranteeing the victim will not turn him into the police upon release. A simple promise by the victim to not turn the kidnapper into the police is an insufficient guarantee for the kidnapper. The kidnapper knows that it will be in the victim's best interest to renege on the deal after he is let go. The solution to the dilemma lies in the form of a commitment device: "if the victim has committed an act whose disclosure could lead to blackmail, he may confess it; if not, he might commit one in the presence of his captor, to create a bond that will ensure his silence."[2] Blackmail becomes the commitment device, binding the future actions of the victim before the kidnapper chooses to release him. Since the release of Schelling's seminal work, The Strategy of Conflict, numerous economists have expanded upon his work and have formulated mathematical equations to model the effects of commitment devices.

Time Inconsistency and Inter-temporal ChoiceEdit

Inter-temporal choice is an economic term to describe the study of how consumption in one time period affects consumption in a future time period. Time inconsistency is the concept that a person has different selves in distinct time periods that do not agree on a single best course of action for that person to take. Time inconsistency leads to the idea that there is a 'general self' and multiple 'everyday selves,' with each self making different choices to pursue its own view of the person's best interest. Commitment devices are based on a fusion of inter-temporal choice and time inconsistency, as they allow a self in one time period to restrict the set of choices available to future selves.
The dual-self model of humans, as articulated by Drew Fudenberg and David Levine, is one of the most recent takes on the 'multiple selves' concept.[3] Fudenberg and Levine argue that there exist two "selves" spanning a given time frame. The self at time 0 has different preferences than the self at time 1 (the time at which an event is occurring or a decision must be made). The self at time 0 tends to value long-term benefits more than short-term ones. Conversely, the self at time 1, influenced by its environment and the pressure of short-term desires, chooses preferences that may be harmful in the long run, but desirable in the short run. In order to overcome these conflicting preferences, the self at time 0 can use a commitment device to limit the choices available to the self at time 1, therefore changing its preferences to match those of the self at time 0.

Commitment Devices and PovertyEdit

Economists at Yale, led by Dean Karlan, believe commitment devices could be useful in combating poverty traps, or the phenomenon where increases in income result in a loss of benefits, leaving an individual no better off than he was before the change in income.[1] They argue it is more difficult for poor people to consume responsibly in the short term because their basket of goods contains a disproportionate amount of temptation goods. In this context, a temptation good is operationally defined as a good that satisfies a short-term craving, but offers no long-term utility to its consumer. Economists have found that as income increases, the proportion of income spent on temptation goods decreases. This is illustrated by the example of consumption of two different goods: candy (temptation good) and houses (durable goods). It is assumed that most people like candy and, since candy is a cheap temptation good, that poor and rich alike choose to consume it. But as income increases, consumers are able to buy more durable goods, like houses, which are classified as non-temptation goods. Clearly the amount a consumer spends on candy will be negligible when compared to the amount he spends on a house, and therefore the proportion of income spent on temptation goods decreases as income increases. Commitment devices, such as Rotating Savings and Credit Associations, offer a way for the poor to break out of poverty traps and increase their well being.

Commitment Devices and the IMFEdit

The International Monetary Fund acts as a commitment device for countries to commit to their government policies. In order for countries to borrow from others, they usually need to change their policies to fit the standards of the IMF in order to receive the financial resources they wish to gain. The IMF acts a contract for such transactions because, as a well-recognized organization, the press follows activity within the IMF. With the media following the countries involved in these deals, the press can expose a country when they don’t abide by their government policies [4]. Bad publicity is generated from a country’s inability to uphold their agreement on enacting changes in their policies. This bad publicity can lead to long-term effects on the country such as having a hard time forming trade agreements and attracting foreign investment as well as the leaders of these countries will often face consequences in upcoming elections [5]. A country demonstrates their credibility of their commitments by enacting reforms in their policies in exchange for financial help. This credibility then signals to other investors that the international community is in support of the country’s program in which they need funds[6]. This is especially important for non-democratic countries seeking financial help from democratic countries [4]. The commitment device is not only that a country sticks to its policies, but also that the IMF supplies the resources necessary in order to serve as an alternative for a country’s reserves [6].

CommercializationEdit

Dean Karlan commercialized commitment devices with the launch of stickK.com in 2008.[7] The site takes advantage of the the low transaction costs afforded by the Internet to create and execute "commitment contracts." To complete a commitment contract, a StickK user picks a goal he wants to achieve, sets a time limit for achieving it, chooses stakes that will be lost if he does not complete the goal, and invites friends and family to referee his contract. The purpose of these contracts is to increase the short-term financial costs of quitting on a long-term goal, thus making it more likely that a user will complete his goal. StickK makes money off this arrangement by taking a cut of the stakes. As of October 21, 2011, 113,340 contracts have been made on StickK, totaling more than $8,000,000 in value.[8]

Classic ExampleEdit

The classic example of a commitment device, and the one frequently cited as the first on record, is the tale of Odysseus ordering his men to lash his body to the mast of the ship so he would be able to hear the sirens' song without jumping overboard. Odysseus' choice to be tied to the mast of the ship is his 'present' choice. That choice restricted his future choices, preventing him from impulsively jumping overboard. By using a commitment device, Odysseus was able to achieve his goal of hearing the sirens' song without jumping ship, a decision that would not have been in his long-term self-interest.

ExamplesEdit

  • Buying long-term gym memberships, as opposed to single day passes
  • Cutting up credit cards to avoid shopping binges
  • Checking into rehab to avoid habitual drug use
  • Deciding to give something up for Lent
  • Leaving work at the office, so it cannot be done at home
  • Buying junk food in small packages, rather than in bulk
  • Not keeping alcohol in the house, to prevent consumption[1]

ReferencesEdit

  1. a b c Bryan, Gharad, Dean Karlan, and Scott Nelson. "Commitment Devices." Annual Review of Economics 2.1 (2010): 671-98. Print.
  2. Schelling, Thomas C. The Strategy of Conflict. Cambridge: Harvard UP, 1960. Print.
  3. Fudenberg, Drew, and David K. Levine. "A Dual-Self Model of Impulse Control." American Economic Review 96.5 (2006): 1449-476. Print.
  4. a b Fang, Songying (2010), Subtle Signals, Limited Device: International Institutions and Credible Commitment of Non-democracies 
  5. Edward D. Mansfield; Helen V. Milner; B. Peter Rosendorff (2002), Why Democracies Cooperate More: Electoral Control and International Trade Agreements 
  6. a b Ashoka Mody; Diego Saravia (2003), Catalyzing Capital Flows: Do IMF-Supported Programs Work as Commitment Devices?, http://www.imf.org/external/pubs/ft/wp/2003/wp03100.pdf 
  7. "An Idea for Lent: Carrot and StickK." The Economist. The Economist Newspaper Limited, 7 Feb. 2008. Web. 20 Oct. 2011. <http://www.economist.com/node/10661442>.
  8. StickK. StickK.com. Web. 21 Oct. 2011. <http://stickk.com>.
Last modified on 7 May 2012, at 06:19