Saturday, February 25, 2012

Current vs. Delayed Consumption .... Marshmallows and Free vs. Paid Lunches

Today we'll consider the negative effects of failing the marshmallow test, or what economists commonly refer to as time inconsistency.

It says a lot about us as individuals and as a society when we not only want what we want but demand that we get it now, and frequently demand or allow government to provide it to us for free or almost free.

We tend to neglect the simple and inescapable fact that government doesn't generate anything of economic substance. If B doesn't contribute or pay high enough taxes to pay for the benefits he later receives from government, after deducting government's operating expenses, government acquires the rest of what B receives in benefits by taking some of what A has produced and then, after deducting government's cut, redistributes the remainder to B.

As an example, we receive from the government ~$3 for each $1 we contribute to Medicare during our working years. That $2 doesn't come from government. Instead it comes from A or future taxes on descendants of B or A.

In a broader sense, the tendency to fail the marshmallow or time inconsistency test reveals much about our sick political system and how it considers only "today" when making decisions. Sadly, what will likely happen tomorrow as a result of what we do today frequently doesn't factor into politics.

That is, tomorrow only becomes relevant to politicians when the inevitable crisis resulting from "today" thinking and acting takes center stage, and delay is no longer possible. Unfortunately, by then tomorrow has become today. As is the case now, at least in my opinion.

That's because we've run out of time to leisurely address and act on our nation's financial problems. And if we're not yet at the financial crisis stage in the U.S. and world at large, we're certainly getting close. Real close.

Obama's Budget Flunks the Marshmallow Test understates the case by observing that individuals and countries who aren't able or willing to defer gratification tend to be less successful than their counterparts.

Here's what the editorial says, and it's worth quoting at some length:

"The president's proposed new budget has three noteworthy characteristics: continuing unfunded entitlements to the middle class, runaway deficits to be repaid in the undefined future, and immense tax increases on the entrepreneurial class. Many commentators have complained about the damage this budget would do to our national prosperity. Less has been said about the effect it will have on something far more important: our national character.

There is a tremendous amount of research on the links among success, character and the ability to sacrifice. It all reaches the same conclusion: People who cannot defer current gratification tend to fail, and sacrifice itself is part of entrepreneurial success.

In one famous study from 1972, Stanford psychologist Walter Mischel concocted an ingenious experiment involving young children and a bag of marshmallows. He put a marshmallow on the table and told each child that if he (or she) could wait 15 minutes to eat it, he would get a second one as a reward.

About two-thirds of the kids failed the experiment. Some gave in immediately and gobbled up the marshmallow; videotape shows others in agony, trying to discipline themselves—some even banging their little heads on the table.

But the most interesting results from that study came years later. Researchers followed up on the children to see how their lives were turning out. The kids who didn't take the marshmallow had average SAT scores 210 points higher than the kids who ate it immediately. They were less likely to drop out of college, made far more money, were less likely to go to jail, and suffered from fewer drug and alcohol problems.

But the evidence goes beyond a finding that people who can defer gratification tend to turn out well in general.

When we hear about successful entrepreneurs, it is always as if they had the Midas touch. . . . In real life, that's not how it works. . . . the average entrepreneur fails about four times before succeeding. . . .

Why this emphasis on the struggle? Entrepreneurs know that when they sacrifice, they are learning and improving, exactly what they need to do to earn success through their merits. Every sacrifice and deferred gratification makes them wiser and better, showing them that they're not getting anything free. . . .

What does all this have to do with public policy? The present administration believes we should be able to get our country fiscally back on track without the vast majority of Americans having to accept less from government. Year after year, no entitlement recipient is asked to give up benefits—even benefits well above a basic safety net.

Bailouts for homeowners, auto companies and financial firms have protected many from the consequences of poor decisions. And even as we run up unprecedented debt, public-sector workers continue to receive pay and benefits that exceed those of their private-sector counterparts.

The expanding welfare state exists, in no small part, to shove marshmallows into our collective mouth. The government . . . is aggressively moving us away from the national entrepreneurial ethos, teaching dependency and changing our relationship to the state.

This is not conservative dogma. Look at Greece. . . .

Is this where we want to go? If not, then we had better recognize that the right path to fiscal consolidation is not to find creative new ways to push debt into the future or vacuum more taxes out of the wealthy. It is to cut spending and reform entitlements right now. It means actual sacrifice—and that is not a bad thing."

Summing Up

Recently we discussed the fact that production has to precede consumption. In other words, that there is no such thing as a free lunch, and that government programs which create demand unaccompanied by production are harmful to our nation's well being.

Today we've simply added the marshmallow or time inconsistency piece to the conversation.

If on average we believe that we've earned all the government benefits we receive, even though we're receiving much more than we contributed, we're kidding ourselves. Somebody will have to pay for what we didn't fund ourselves. And that somebody will be either someone paying higher taxes today or somebody else paying higher taxes "tomorrow."

As long as we genuinely believe, or pretend to believe, that the government can do something for us financially that we haven't done for ourselves, the politicians will pander to that actual or pretend belief. We receive a free lunch, and they get to stay in office. Of course, the free lunch part is untrue, even if we all pretend otherwise.

Only when we stop practicing insanity (doing the same thing over and over and expecting a different result) will politicians begin to act responsibly and appropriately.

At that point, but not before, we will be able to function as free people in a free society, behaving in an adult and self reliant manner. And when we do that, we'll very much have the ability to take care of those truly in need as we'll again have the necessary resources to give a "hand up."

Perhaps Pogo said it best. We are our own worst enemy.

We have to stop believing or pretending, as the case may be, that we can consume that which we don't produce, and that applies to paying for our own lunch, too.

Lunch is never free, and free people will never wish for it to be free.

That's never been the American way, and it never will be.

Thanks. Bob.

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