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November 2015

An Experimental Study of the Impact of Inequality on Investment

Gary A. Hoover
Erik Kimbrough

Originally published in Social Science Quarterly

With increasing attention being paid to inequality and poverty, this article attempts to shed light on mechanisms by which the poor arrive at decisions that are suboptimal and lead to “poverty traps.”

Objectives

Methods

We design a laboratory experiment in which we induce wealth and income differences between subjects to compare their behavior in a simple, two-period life-cycle savings and consumption task that controls subjects’ homegrown risk preferences and isolates the impact of social comparison.

Results

We find evidence that social comparison leads to suboptimal investment choices among the income-poor.

Conclusions

One interpretation is that this is driven by a discouragement effect among those who are less likely to benefit from their investments—despite that fact that, by design, investment by all types leads to the same increase in expected utility.

Objectives: With increasing attention being paid to inequality and poverty, this article attempts to shed light on mechanisms by which the poor arrive at decisions that are suboptimal and lead to “poverty traps.”

Methods: We design a laboratory experiment in which we induce wealth and income differences between subjects to compare their behavior in a simple, two-period life-cycle savings and consumption task that controls subjects’ homegrown risk preferences and isolates the impact of social comparison.

Results: We find evidence that social comparison leads to suboptimal investment choices among the income-poor.

Conclusions: One interpretation is that this is driven by a discouragement effect among those who are less likely to benefit from their investments—despite that fact that, by design, investment by all types leads to the same increase in expected utility.