Part of the Transformation Montgomery model is to offer a pathway out of poverty for individuals that starts with understanding where they are at, and then offers hope for total life transformation—not just money, but in the mind as well. That means understanding how the working poor tend to think about money, and how they can begin to think differently to achieve long term financial health. The following is an excerpt from an article by Joe Carter entitled “How to Think About Money Like the Working Poor,” posted to the Acton Institute Power Blog.
The fact is that the working poor do tend to make terrible financial decisions — and not just because they lack resources. The working poor think about money differently than other economic classes. I’d like to take a crack at explaining why that’s the case.
Before we begin, though, let’s me first clarify a couple of basic economic terms:
Income – the sum of all individual or household earnings.
Savings — income not spent, or deferred consumption.
Consumption — the use of goods and services by households which are paid for by income and/or savings
Life-cycle hypothesis – the claim that individuals both plan their consumption and savings behavior over the long-term and intend to even out their consumption in the best possible manner over their entire lifetimes.
Consumption smoothing — balancing out spending and saving to maintain the highest possible standard of living over the course of one’s life.
These are all standard economic definitions. But because there is less agreement on how to conceptualize and define the term “working poor” I’ll propose my own definition:
The class of workers who (a) derive the majority of their income from their employment (as opposed to government benefits, such as welfare), (b) have incomes that are frequently insufficient to provide basic necessities, and (c) do not have access to savings apart from their income.
To understand the working poor we must first understand the working class. Let’s start by considering how the life-cycle hypothesis applies to a young high school graduate from a middle class background. Most likely the young person will to college since they know that higher education can increase their lifetime earnings potential. They will receive some money from their parents, work a part-time job to pay the bills, and take out a student loan to pay for the rest.
After graduation they get a full-time job, get an apartment, start paying off their student loan, and start consuming the goods and services of the middle class lifestyle. Their income generates enough to pay for the necessities, but not everything they want (e.g., a new Playstation 4). They recognize, though, that while they may only be earning $40,000 a year today, after about a decade – and a few raises – they will be earning $60,000. To smooth their consumption, they can buy items on credit (cars, clothes, etc.) since they know they will be able to pay for them over the next several years. By the time they reach the mid-point of their life, they can pay for all of their basic consumption and still have some left over to save, that is, to defer consumption for their future retirement. So the middle years of their career serve to smooth both the consumption of their youth (through credit) and the consumption of their old age (through savings).
The result is that while they may have some rough patches along the way, the middle class worker will be able to balance out spending and saving to maintain the highest possible standard of living over the course of their life.
For most Americans, from the lower middle-class to the one-percenters, this consumption smoothing life-cycle model represents the general arc of their economic life, from first job to retirement. The same is not true, though, for the working poor. Rather than one broad, life-spanning pattern, this cycle occurs repeatedly throughout their lives. The pattern repeats anywhere from once a week to several times a year. But it repeats frequently and has a profound impact on shaping how the working poor think about income, savings, and consumption. This is key difference between the economic classes.
Depending on where they are in their economic life-cycle, the middle class worker typically either has the income needed to cover current consumption or has access to savings (previously delayed consumption) and/or future income (in the form of credit) that can be used to supplement their present income. This is why when a young accountant has an unexpected expense, such as having to replace the transmission in their car, they don’t generally pay for it by taking a second job as a cashier at Wal-Mart. They can pay for the expense through money they’ve saved in the past or money they’ll earn in the future.
But what happens to the working poor when they have an unexpected expense? Since most, if not all, of their income goes toward current consumption, they have inadequate savings. And since their prospects for increased income in the future are negligible, they have no excess future income to apply to current consumption. Even if they are able to obtain credit to pay for the unexpected expense, they are merely delaying the problem rather than solving it.
Consider the difference this makes. Imagine that instead of having to deal with consumption smoothing decisions, at most, several times a year, you had to deal with them several times a month, or even several times a week. Now also imagine there is no workable solution that will actually smooth the short-term consumption problem and the best that you can hoped for is a temporary fix that delays having to deal with the issue.
That is what it’s like to be the working poor.
By gaining a better understanding of this type of constraint we can gain both an increased level of empathy for their plight and an understanding of what is necessary to help alleviate the problem at both the individual and societal level. (For instance, thinking through this model can help us understand why increasing wages can be helpful in the short-term but does not alleviate the fundamental problems.)
By applying this framework, some of the seemingly irrational choices made by the working poor become easier to understand. So in my next post I’ll highlight some of the specific ways that these constraints affect the thinking of the working poor and their relationship to money.