Information: Poverty Traps

Information (who knows what and how that affects their decision making) is a big deal in economics. Because people have imperfect information, they make mistakes and markets can become less competitive, sometimes even breaking down completely (see health insurance in the US). Information is also an area where I've done a little work, so I thought I would share some of the research I am doing.

Consider the following problem: a prospective college student is trying to decide whether to go to college. She begins by looking for guidance online, but the advice she receives is confusing and contradictory. Hvard_grad_98 says that college is only worth attending if she goes to a top school, ariz_st_sun_dvil says going to college is important but where she goes is not, and rich_plumber claims that a college degree is a waste of time and money. More reputable sources also disagree: Professor Bryan Caplan argues in The Atlantic that the benefits of a college degree are overstated, while David Leonhardt argues in The New York Times that almost everyone should be getting a college degree. People Ivy know personally also disagree on whether she should go. Overwhelmed and not knowing who to believe, Ivy looks around her. How well are people she knows who went to college doing compared to people who didn't?

For better or worse, Ivy knows people who are similar to herself and her parents.  For example, if she comes from a low income community, she is more likely to know people who have low incomes.  How might this affect how Ivy views big decisions, such as whether to go to college?

I have been investigating this question, and have found two interesting theoretical results. The first is that most people will think that the world resembles the world they see personally more than it actually does. This causes most people to underestimate the impact of big decisions, such as whether to go to college or to move for a job.

Why? Let's say Ivy is middle class. She mostly knows other people who are also middle class. She doesn't know many very rich or very poor people. Since most very poor people didn't go to college and most very rich people did, she underestimates the chances that she ends up very poor if she doesn't go to college and also underestimates the chance that she ends up very rich if she does. As a result, she thinks that people who don't go to college are on average richer than they actually are and she thinks that people who did go to college are on average poorer than they actually are. So, she underestimates the benefit of going to college.

This effect does not effect people of all backgrounds equally. Many decisions that are on average good for people (such as attending college or moving for a job) are also somewhat risky (dropping out of college is a disaster and if moving for a job goes poorly, it goes really poorly because you usually don't know many people in the place you are moving to). This causes low income people to underestimate the benefit that big but risky choices could have on their lives, while medium-to-high income people have a more accurate view of the impact of big life decisions.

This results in a poverty trap: where poor people stay poor not because there's something wrong with them but because they are poor. Poverty traps are studied by economists, and what makes this one unusual is that it doesn't depend not on absolute poverty (can you afford basic food, shelter, and other essentials). Instead, it depends on relative poverty (how much do I earn compared to other people in my country), meaning that it can apply to rich countries such as the US (many poverty traps explain long-lasting poverty in poor countries like India, but have trouble explaining poverty in rich countries with social safety nets such as the US).

My other finding is that people with more diverse groups of friends should make better decisions. A major paper published in 2022 found that areas of the US where low income adults have more high income Facebook friends also have high rates of low income children entering the upper-middle and upper class. Most of the explanations for this can be summed up in the phrase "it's good to have rich friends."  What makes my explanation different is that it says "it's good to have a diverse group of friends" because they broaden your perspective and make your worldview more accurate (of course, having rich friends is nice too).

For those of you curious about what economic research looks like, here's a rough outline of what my next steps are:

• Continue to think more about the problem from a theoretical perspective. Right now, I'm thinking about what happens if more talented people get more out of college. How might that effect people's decision to attend college?

• Get real world data to back up my claims. We know people act like my model predicts they will in a lot of contexts, but proving that information is the reason why is difficult. For example, rich people make more risky but on average profitable decisions for many reasons (for instance, they can afford to lose).

• Run some experiments in a lab to see if people behave like my model predicts they will in a controlled setting.