Saving by buying lottery tickets

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."

My first reaction was: how unbelievably stupid. Paying off credit card debt provides a guaranteed after-tax return of 29 percent. The expected after-tax return from lottery ticket purchases is negative - that is, the expected winnings are less than the cost of a lottery ticket.* Yes, it is hard to grasp the true odds of winning the lottery. Yet surely it is not that hard?

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.

Comments

[Jack]

I think it's an intriguing suggestion in line with the behavioral economics literature and perhaps ''nudging''; if I understand correctly a bond would pay off, in addition to the principal, coupons that are stochastic rather than fixed, and therefore offer savers a small chance of a huge payoff. Even if the big payoff doesn't occur, the individual still ends up with the principal at the end.

[Frances Woolley]

Jack - you've got it. What's nudging?

[Mike Moffatt]

Nudge = Thaler and Sunstein's book:

http://nudges.org/

[anon]

Assuming that the woman's liability is limited by bankruptcy and that she is unable to renegotiate/consolidate her debt, buying lottery tickets may be rational. Heads she wins, tails creditors lose. Of course, the "lottery tickets" should be call options on the capital market, but low-income people have limited access to capital markets.

[Rob]

"But why deprive people of a source of pleasure? A better approach is to harness people's gambling impulses for a good cause."

What makes you think that saving is innately "good"? That seems like the real puritan bias to me.

I'm with Keynes. Personal savings are a (temporarily) necessary evil. Saving and hoarding is a grotesque behaviour that has been useful for the last 300-400 years (as a means of accumulating capital) but will soon cease to be, and will go back to its status of vice. The problem is not the perfectly natural and mentally healthy dislike of saving. The problem is a system that necessitates and rewards saving. We should be aiming at eliminating savings by rendering saving pointless. We have the means: fiat currency, central banking for credit extension, central government to administer pensions, etc. Saving is just a second-best solution to a host of coordination problems.

The problem in this situation was the woman's lack of access to reasonably priced credit, and NOT her dislike of saving.

[Frances Woolley]

Rob - "The problem in this situation was the woman's lack of access to reasonably priced credit"

I agree with you 100% on high priced credit. And since we agree, it's a boring topic for a blog post.

What is (I hope) the interesting take-away from this post is that lotteries can be used in creative ways to help people acquire capital.

Even though there may be fundamental problems with the idea that people can/should finance their own retirements with their own savings, there are all sorts of good reasons why one might want find a lump of cash much more useful than little bits of cash. A washing machine, for example, might save hundreds of dollars because it's cheaper than a laundromat (and it frees up time that can be used for other things) - but if you're spending all of your change at the laundromat, you'll never be able to afford a washing machine.

[anon]

"Saving and hoarding is a grotesque behaviour that has been useful for the last 300-400 years (as a means of accumulating capital) but will soon cease to be, and will go back to its status of vice."

Um, no. Capital accumulation is far older than just 300 or 400 years, and without savings there is no way of accumulating capital.

Consider a peasant who needs drinking water from a distant spring. He might go to the spring each time he is thirsty and drink out of his hands, but this would be very inefficient. The peasant will be better of if he takes wood from a felled tree, hollows it out into a container, and uses it to carry his water from the spring to his home. The container is a capital good, and creating it requires investing time and effort in order to reap future benefits.

[anon]

"Even though there may be fundamental problems with the idea that people can/should finance their own retirements with their own savings"

Financing retirement with one's own savings has many advantages, including relaxing liquidity constraints, since one can always self-finance from retirement savings.

"there are all sorts of good reasons why one might want find a lump of cash much more useful than little bits of cash."

Yes. Effectively, lotteries can make discrete goods continuous for the individual consumer.

[Nick Rowe]

Today's obscure cultural reference, only vaguely related to the post, but running through my head:
"Saying -- how's your granny and good old Ernie: he coughed up a tenner on a premium bond win."
Thick as a Brick, Jethro Tull.

There's individual saving, and there's aggregate saving. The latter requires investment in real capital; the former does not, because individual savers can lend to individual dissavers.

[Frances Woolley]

Nick: "Saying -- how's your granny and good old Ernie: he coughed up a tenner on a premium bond win."

Related, and not just vaguely - premium bonds are targeted to a very specific demographic - low income people who want a bit of fun with their savings but can't afford the rich man's casino, i.e. the stock market. The lyrics capture that demographic perfectly, just like Jon Lajoie's Everyday Normal Guy paints a precise picture of the life of a certain slice of the Canadian population (I'd link and blog it, but unfortunately it's not suitable for an older audience)

"There's individual savings, and there's aggregate savings. The latter..."
Is macro stuff. I'll stick with the former.

[Patrick]

I drive by the casino just about every day. The parking lot is always full.

If one likes to gamble why not do it here:

http://www.myc4.com

At least some good might come of it.

[Andrew F]

I might feel better about lotteries if they were run by the government with the intent to break even net of costs. The expected value of lottery tickets as a % of purchase should be in the ~95% range or higher. Using lotteries as a revenue source strikes me as regressive.

[Nick Rowe]

The other advantage of premium bonds is that it lowers transactions costs of paying small dividends.

[just a thought]

your statement that " the expected winnings are less than the cost of a lottery ticket" is indeed correct, but would you say to someone who actually won the lottery they were idiots for buying the ticket?

[edeast]

Andrew F, They may be regressive but at least they are counter-cyclical.

[Frances Woolley]

Patrick, Andrew F, Nick, edeast - thanks for the comments. Excellent points.

Just a thought - My knee-jerk reaction would be to say "you're an idiot, you're just a lucky idiot". But saying to someone who buys a lottery ticket that they are an idiot is not only rude, it's bad economics.

The intelligent response is to think about why people buy tickets. There's thousands (millions?) of people who buy lottery tickets knowing that it's a bad bet, but do so because, as my mother-in-law would say, they "enjoy a flutter." And who am I to criticize? I do lots of bad for me/stupid things too, e.g. eating pecan pie with whipped cream. A few bucks isn't much to pay for a hope of a better life, or a promise of escape from drudgery.

[Patrick]

In University, I worked evenings in a magazine shop on Queen Marie Road in Montreal. Haven't been back in years, but in the early 90's it was a poor area of town. We had two types of regulars: locals and wealthy people (mostly men) who stopped in on their way to Outremont or other similar 'nice' areas of town. Both bought smokes and skin mags in prodigious volumes. But only one group bought lottery tickets - and it wasn't the group who also bought Barron's and Yediot Ahronot.

[larry macdonald]

Worse is buying lottery tickets, putting them in a drawer and forgetting to look at them, like a certain spouse of mine.

[Rob]

"A washing machine, for example, might save hundreds of dollars because it's cheaper than a laundromat (and it frees up time that can be used for other things) - but if you're spending all of your change at the laundromat, you'll never be able to afford a washing machine."

Not if you finance one -- which is exactly my point.

"Um, no. Capital accumulation is far older than just 300 or 400 years, and without savings there is no way of accumulating capital."

Is that what I was arguing? You might want to take a closer look at what I actually wrote.

"Consider a peasant who needs drinking water from a distant spring. He might go to the spring each time he is thirsty and drink out of his hands, but this would be very inefficient. The peasant will be better of if he takes wood from a felled tree, hollows it out into a container, and uses it to carry his water from the spring to his home. The container is a capital good, and creating it requires investing time and effort in order to reap future benefits."

Yeah, obviously, but again I don't think that you read what I wrote very closely. I'm referring to personal, individual saving, and no, it is not at all necessary for the accumulation of capital in a modern economic system with fiat money, credit and a federal government. Why do you think that Chinese aggregate saving is higher than the sum of individual Chinese saving?

[Frances Woolley]

Rob - "Not if you finance one -- which is exactly my point."

And it's a good point, and one that I didn't address completely earlier.

The question is: if buying a washing machine is a good investment, why aren't banks prepared to loan people the money to buy a machine?

The reason is that a percentage of people will default on loans, not because they're bad or evil people, but because they lack the will power to put money aside (or get up 10 minutes early to make lunch to save money, or cycle to work instead of taking the bus to save money, etc).

Grameen Bank schemes work because they harness the power of social networks - knowing that you'll have to explain to your friends why you're behind on your payment helps to boost your will power.

Lottery linked saving schemes could, potentially, be another will power booster.

Am I going to go out and start a national campaign for lottery linked savings accounts? No. Do I think it's kind of a cool idea? Yes.

[edeast]

http://ewjordan.blogspot.com/2010/10/poor-people-should-probably-gamble-more.html

[edeast]

The link being in similar vein to Anon @9:25. Just posted it because it popped up in another feed.

[Leigh Caldwell]

I've noticed a couple of surprising comments from the authors of this blog recently.

Today, Frances: "What's nudging?"

A week or two ago, Nick: "I'm not familiar with Dan Ariely"

I had assumed that behavioural economics was now sufficiently mainstream that these would be common knowledge - at least among economics professors. Apparently not.

No personal slight intended, by the way - this is illustrative of the still-low status of behavioural econ, not anything about you two!

[Pacer]

Larry, are you saying that personal accumulation of wealth is a bad thing? That it would be preferable for the government to accumulate all the wealth and spend it for the good of 'the people' as determined by enlightened policymakers?

If that's what you're getting at, I understand the concept. And I'd add that such a policy would be outstandingly good for full employment, what with the attendant need for police and prisons to stimulate/simulate the individual incentive to be productive in the absence of material reward.

I'm pretty sure that even in pre-Colombian days, the indigenous tribes probably conditioned group benefits upon indidivual contributions--though they didn't use money per se. And retirement was generally a fleeting affair, maybe a few years in one's 30s, 40s or 50s, so saving therefore was a bit less important.

[Frances Woolley]

Leigh - "Today, Frances: "What's nudging?""

Nick Rowe is extraordinarily good at managing comments as if he were moderating a graduate student seminar. I'm not as good at this as he is, but I try. Sometimes that means getting people to explain what they mean when they use terms that our target audience may not understand.

[Leigh Caldwell]

Fair enough, sorry for misinterpreting!

[Frances Woolley]

Leigh - it is also true that some of our human capital has depreciated over time...

[Roland]

The old lady didn't lack credit.

She lacked income.

Making credit a bit cheaper wouldn't solve her problem, unless loosening credit increased her income.

But would it?

What have we done during the past decade, except lower the interest rates?

There has been more monetary stimulus in recent years than ever before.

But what's happened to median incomes? Answer: basically stagnant, if not falling.

Easier credit does not by itself mean higher incomes. That's the reality.

As for the lottery tickets, it's simple enough to understand. When your income is that low, saving or investing a few bucks isn't going to make much difference to your plight. Get real already!

The lotto ticket is better understood as a regular minor religious ritual than an investment choice. This is homo religiosus looking for a cheap opiate that offers a small chance of vaulting up to be one of the Capitalist Elect.

[Frances Woolley]

Roland - "The lotto ticket is better understood as a regular minor religious ritual than an investment choice."

Religion has serious economic functions e.g. insurance.

[Rob]

Pacer: I'm pretty sure that comment was meant for me.

"are you saying that personal accumulation of wealth is a bad thing? That it would be preferable for the government to accumulate all the wealth and spend it for the good of 'the people' as determined by enlightened policymakers?"

No, that's not what I'm saying. I'm saying that a system that necessitates the buildup in wealth in order to pay for large purchases is a bad system. A system wherein you run the risk of bankruptcy due to liability every time you drive a car is a bad system. A system where you need to save up the money for an open-heart surgery in advance is a bad system. A system wherein you have to save the full price of a car or home before purchasing one is a bad system. You should not have to save for these things.

The great thing is that we have two wonderful inventions: insurance and credit. They have made it possible to buy washing machines, cars and homes without saving for 30 years. They make it possible to have healthcare without saving mass amounts of money for surgeries. They make it possible to start a factory with a positive NPV without saving up all of the money needed to buy the land and equipment.

My point here is that instead of asking how we can motivate people to save up enough money to cover chemotherapy in the event that they need it, we should be thinking about designing a system where they do not need to save. In my opinion, just about every major economic function fulfilled by saving can be better handled by credit and insurance.

In this particular instance, it's not too hard to think up a solution (although it may not be the best one). You could have a government lending facility for retirees that have unforeseen expenses. Have them come in and speak with a counsellor, give them an advance on their CPP payments at a low interest rate, and decide on an affordable rate of repayment garnished from the monthly payments. If the woman can even barely afford to pay the interest at 29%, I'm sure that she could manage to pay down the loan at a low interest rate, given a reasonable timeframe.

[Rob]

"The old lady didn't lack credit.

She lacked income.

Making credit a bit cheaper wouldn't solve her problem, unless loosening credit increased her income."

But it would solve her problem. It would significantly decrease her expenses. Right now she is paying let's say $290 in interest on a $1000 loan. The principal is not being paid off.

If you reduce the interest rate to 5% from 29%, then she only pays $50 in interest, and her overall payment could be reduced to $200/year, with $150 going towards the principal. She would be able to lower her monthly payment and pay off the loan.

[Rob]

Frances:

"The question is: if buying a washing machine is a good investment, why aren't banks prepared to loan people the money to buy a machine?"

Well, this may just be kind of a bad example, but I'm pretty sure that the vast majority of washing machines ever sold were on monthly payments. Anyways..

"The reason is that a percentage of people will default on loans, not because they're bad or evil people, but because they lack the will power to put money aside (or get up 10 minutes early to make lunch to save money, or cycle to work instead of taking the bus to save money, etc)."

Yes, credit rationing due to information asymmetries is a real problem as per Greenwald and Stiglitz. I just don't think that our current solutions are anywhere near optimal. Credit ratings and credit rationing are the current solution, and they work reasonably well despite our lack of debtors' prisons. I still think that we could do much, much better. Social networking could be one solution, but I think there are more promising avenues.

This is getting pretty off-topic now. My only point wrt the original post was just to not lose sight of the forest for the trees. I agree that it is beneficial to encourage saving under the current system. I just wanted to point out that I think the problems solved by saving can be solved in other ways, and that encouraging saving is almost always a second best solution, compared to improving the system. It still is a solution though and is worthwhile since more fundamental changes are not likely to be undertaken any time soon.

[Frances Woolley]

Rob, "I just wanted to point out that I think the problems solved by saving can be solved in other ways, and that encouraging saving is almost always a second best solution, compared to improving the system."

It sounds as if we're more or less in agreement on this - and on the devastating financial impacts of high interest credit cards (and it's so sad - at the other end of the socio-economic spectrum people are *paid* hundreds or thousands of dollars a year in cash rebates and/or free flights to use credit cards. It just doesn't seem fair.)

Has anyone ever shown that, in general, saving to finance purchases is worse than borrowing to finance purchases? I can think of a plausible story why it would be - e.g. for "productive" spending, such as the washing machine case, where the funds to pay for the washing machine come from the money/time savings from having a washing machine. But for, say, holidays in California, I can see no reason to think that borrowing to pay for a holiday is in some sense better than saving to pay for a holiday.

[Roland]

Rob, cheaper credit won't solve her problem even if you get her card down from 29 to 5, which is a pretty ridiculous supposition in any case.

What you seem to forget is that it was the inadequacy of her income that forced her to borrow in the first place.

Unless she can borrow at zero percent, with a zero minimum payment, with no credit limit, indefinitely, she is in trouble.

Now you can change the system by resorting to full social insurance, but unless the "premiums" are levied in a strongly progressive fashion, all that would happen is that instead of racking up a big credit card bill, her "coverage" would run out instead.

[Rob]

"Rob, cheaper credit won't solve her problem even if you get her card down from 29 to 5, which is a pretty ridiculous supposition in any case."

Uh, I just explained exactly how it would. You can substitute 10% or 15% or 20% instead of 5%, but the result is still the same, just with a longer repayment period or higher monthly payments.

"What you seem to forget is that it was the inadequacy of her income that forced her to borrow in the first place.

Unless she can borrow at zero percent, with a zero minimum payment, with no credit limit, indefinitely, she is in trouble."

No. Her problem isn't excessive fixed monthly expenses against insufficient income, which cheaper credit wouldn't solve. Notice that it is a one time expense and that she is able to afford to pay back 29% of the value of her loan every year. Unless you assume that this emergency expense is recurring and will happen again before she is done paying off the first loan (~4 years, depending on the interest rate) then there is no problem. But why would you assume that this "emergency" expense is a frequent one?

You need to go back and read the example.

[loser but covered]

I thought this thread was about CPC-voting-boomers, and how they have bet their future healthcare quality-of-living on the hope that the world of the future, progressively shocked more and more by AGW disasters, that the world will welcome the oil sands our tax rates and Mike Duffy, have forced upon us as revenue. Not Norway and their sizeable sovereign fund they've accumulated from sources not 130% as intensive as oil...
My idea is to pay the public for ideas. Start off with two or three figures for a report. Raise this if useful to government or fed-paid crowns/thinktanks. Just like Harper's lobby improvements don't really address legal conflict of interests that happen when golf buddies are oil sands players; but do help incrementally. In lieu of a GAI, instead of going towards USA 85% of wealth earned by top 5% (who only make tar and banking here), you could pay people in multiple fields including to commenters and bloggers here, for what the government already occasionally asks for. Give MPs and Senators somethiong to do and hiring a few people now might not be such a bad idea unless the top 5% of Americans start making what 300M chinese make, vindicating CPC ambitions. Pay Canadians $200 for an essay on how to avoid GOP Great Depressioning our economy (voting CPC seems to encourage this since are supporting a tax policy that leads empiracally to recessions and empoverished purchasing power says Reich, though if Encana made turbines at least the supply side of a 3rd world tax rate would be justified).

[Roland]

Rob, if it's truly a one-off that she faced, then a lower interest rate may help, as you say.

I am glad that you acknowledge that cheaper credit doesn't help people facing chronic inadequacy of means.

When you're an elderly person on a fixed income, I rather think "emergencies" tend to come up. The scantier one's means, the more often such "emergencies" arise. The previous emergency doesn't get cleared up before the next one happens. With ampler means, some emergencies would not be regarded as such in any case.

It is very interesting that more than a decade's worth of very easy monetary policy should also have been a time of stagnant median income.

[mad]

Isn't it kind of ridiculous to use the average expected return in this case? The distribution is nowhere close to being normal. No matter how large the pot is, the median expected return that an individual gets is negative. Basically this post is saying that the median player should have an expected return of 0, ie: make the distribution a tiny bit more normal. It's really not that different from the argument to ease up on income and wealth inequality.

Anyway, statistics won't help us understand why people play on the individual level. It helps lots in understanding why the gov't runs them, and at what point they'd stop running them, but it doesn't work for individuals. All tools have a scope, that we cross at our peril.

People play the lottery because the costs are distributed, while the benefits are concentrated. It's no different from banks or insurance. Everybody puts in a little bit so that a few people can get a lot, like buy a house, or get needed surgery.

By losing a little bit now, you get to change somebody's life for the better. And hey, maybe one day that somebody could be you. Besides scale, the only difference between a bank and a lottery - and poor people understand this better then most - is that when it comes to deciding who gets the better life, lotteries are fairer.