Another sad news day. An older woman, living on a fixed income. Faced with an emergency, she had paid for purchases with a department store credit card. The card's interest rate, including service charges, was 29 percent. She was barely able to pay the interest on the card. To reduce the amount owing was impossible. She sat on her immaculate, though slightly faded, sofa and explained her strategy for getting out of this mess:
"I buy lottery tickets."
But the task of an economist is to explain people's choices, not question their preferences. A classic explanation of why people buy lottery tickets is "non-convex preferences." A little bit more income makes life a little bit better. But enough income to pay off all debts would make life much better. A small chance of a big payoff might be worth more in "well-being" or utility terms than a certain return of 29 percent. The hope of a better life makes buying lottery tickets easy.
And our human desires for immediate gratification make saving hard. Given a choice between $100 a month from now and $110 a month and a day from now, people will generally choose $110. But given a choice between $100 now and $110 tomorrow, people will often choose $100 now. Yet the two situations are essentially the same in that waiting an extra day generates a $10 payoff. People wish to save, but when it comes down to "should I get up and pack myself a lunch so I can save $5 today or should I stay in bed for another ten minutes?" it's pretty tempting to hit the snooze button.
There is, in fact, a long history of using people's love for lotteries to counteract their dislike of savings. Since 1957, British "premium bonds" have offered lottery tickets in lieu of interest payments.
We hold a prize draw every month with a £1 million jackpot plus over a million other tax-free prizes. The more Bonds you have, the better your chances of winning...Why choose this product? If you want an investment which offers the fun and excitement of a chance of a big win.
A survey by Guillen and Tschoegl reports that lottery-linked deposit accounts make up a significant portion of savings accounts in a number of Latin American countries, and describes combined lottery-savings schemes used in countries as diverse as Japan, Pakistan, Sweden, Kenya and Germany.
If such accounts were allowed in the Canada, there's every reason to believe that they would be popular here, too. Peter Tufano reports that "21 percent of Americans—and 38 percent of lower-income Americans—felt that winning the lottery was the most practical way to accumulate a large sum of money." (A finding that also reflects people's poor ability to calculate the true odds of winning a lottery, and America's lack of social mobility). Recently a number of Michigan credit unions introduced a lottery-linked savings account that generated a high take-up rate.
What are the policy implications of recognizing that lottery tickets are used, particularly by people with lower incomes, a means of saving and accumulating capital?
The puritan in me is tempted to say "ban lottery tickets!" But even if every government lottery in Canada was wound down, tickets would still be available for purchase from elsewhere over the internet. Financial literacy programs might help, as might health warnings on lottery tickets: "Consumption may be harmful to your long-term financial well-being."
But why deprive people of a source of pleasure? A better approach is to harness people's gambling impulses for a good cause.
Promoting lottery-linked savings accounts may be a way of increasing low income people's savings rates. Restrictions on such accounts could be eased, and the accounts could be regulated to ensure that they are providing a reasonable rate of interest on investments.
Alternatively, state lotteries could be redesigned so that a person who bought, say, $15 worth of lottery tickets a week had a good chance of winning a $1,000 prize once every two years, as well as the usual miniscule chance of winning a big payoff. That's an amount of capital similar in size to loans the Grameen Bank is now giving in New York. It might not sound like much, but it's enough do much needed car repairs, pay for shoes and snowsuits for children, or buy tools or materials for a small business. If people are using lotteries to accumulate capital, they could at least have a reasonable shot at getting some capital.
Sure, giving out more prizes would reduce the amount of money raised from government lotteries. But the morality of raising funds from the desperate hopes of indebted old ladies is a bit questionable in the first place.
*Lotteries will have a positive expected return when there are large jackpots created by roll-overs from previous draws.