It’s not just how much you get paid

“Pay him his wages each day before sunset, because he is poor and is counting on it. Otherwise he may cry to the Lord against you, and you will be guilty of sin.” — –Deuteronomy 24:15

I’m not really one to quote the bible, but in this case the 2,700(ish) year-old text is backed up by a 2011 academic paper titled The Timing of Pay by Christopher A. Parsons and Edward D. Van Wesep.

The paper doesn’t quite go so far as suggesting pay “each day before sunset”, but it does make an important link between how often workers are paid and their ability to budget.

Managing a monthly budget requires discipline and the foregoing of immediate gratification in favour of long-term goals. People who are more likely to give in to short-term impulses will often have achieved lower qualification levels, because qualifications require us to sacrifice immediate gratification in exchange for a more distant reward. Lower qualification levels in turn often lead to lower paid employment. It’s a kind of viscious cycle whereby those least able to budget are those that are most likely to fall into a low income group.

As with most things, self-control isn’t something that some people have and others lack entirely. Rather, we all exhibit traits of self-control at certain times and self-indulgence at others. Whether it be through retail-therapy or putting off doing an important piece of work until the night before its due, I don’t think anyone can say they’ve never made a decision that gave them short-term pleasure but left them in a worse position overall.

The most famous experiment on self-control must be what has become known as The Marshmallow Experiment. The idea was simple: put a marshmallow in front of a four to five year-old child and tell them they could eat it now, but if they waited fifteen minutes they would get two marshmallows.

Some of the children just ate the marshmallow, some managed to hold off for a few minutes, and a few found ways to distract themselves and hold out for the full fifteen minutes — and were duly rewarded for their patience.

The study gained a lot of attention some time after it was completed, not because of the results of the test itself, but because follow-up studies showed that those children that held out longest in the marshmallow test were now doing somewhat better later in life than those that caved immediately.

The children who were willing to delay gratification and waited to receive the second marshmallow ended up having higher SAT scores, lower levels of substance abuse, lower likelihood of obesity, better responses to stress, better social skills as reported by their parents, and generally better scores in a range of other life measures.

More recently, however, doubt has been cast on whether the study measured intrinsic self-control at all. Failure to replicate the results indicated that it might have a lot to do with the background of the children in the original study, which consisted of a small sample of 90 that were all enrolled in the same pre-school at Stanford. A second test was conducted, this time with over 900 children and with a closer match to the general population. It failed to confirm the findings of the first test.

“Instead, it suggests that the capacity to hold out for a second marshmallow is shaped in large part by a child’s social and economic background — and, in turn, that that background, not the ability to delay gratification, is what’s behind kids’ long-term success.” — The Atlantic

A better explanation for the results of the marshmallow test is that background is one of the biggest factors affecting our ability to defer gratification as a child as well as influencing how successful we are in later life. Other reasons have been suggested as to why poorer children were unable to resist the lure of the first marshmallow, but many boil down to the basic idea that if you have very little in life then you grab anything that’s offered to you before it can be taken away.

And whether it’s choosing to forgo one marshmallow now on the promise of two in the future or deciding to spend our money today instead of saving it for a rainy day, we all suffer from a certain degree of what is known as time inconsistency.

Time-inconsistent decision-makers are commonly described as having ‘different selves’ at certain points in time that make inconsistent choices with each other.

Think of it like splitting into a present self and a future self. My present self has very good intentions for my future self and signs me up for the gym, despite not really feeling like exercising right now. Then, surprise surprise, when it’s future self’s turn to make a decision, going to the gym still seems like a poor alternative to firing up Netflix. (Although for some the commitment of a gym membership is an expensive way of making sure they exercise at least occasionally instead of wasting their membership fee entirely.)

A tendency to choose immediate gratification is known as present bias, and when it comes to the frequency of receiving a paycheck and deciding what to do with that money it’s very relevant indeed. Simply put, individuals with strong present bias are much more likely to feel money burning a hole in their pocket without considering how it affects their monthly budget. They were the kids that would take the first marshmallow every time.

It should come as no surprise that lower paid workers tend to be more present-biased than those on higher incomes.

“Consider a savings problem involving a present-biased worker. When she receives a paycheck, she faces a strong urge to consume a large fraction of it immediately, even though she knows this will leave her poor in future periods. Although she recognizes her own self-control problems, she cannot stick to a pre-determined consumption schedule. Consequently, her realized consumption path will not maximize her ex ante welfare.” — The Timing of Pay

And it turns out that a simple way to mitigate the issue of time-inconsistency when it comes to managing the peaks of income and expenditure is simply to pay a worker more frequently.

“Workers who make less — and therefore have less — of a savings buffer with which to smooth consumption — should be paid more frequently, a finding overwhelmingly true in the data.” — The Timing of Pay

This is not only good for the worker, it also benefits the employer: increasing the frequency of pay checks is equivalent to a measurable boost in income which, according to The Timing of Pay, is about 4% for a worker who is paid weekly compared to one who is paid every four weeks.

As the length of pay-period increases, the wage must increase for present-biased workers. A worker with β = 0:7 being paid quad-weekly must be paid 4% more than one paid weekly.

Effectively, shortening the time between when someone is paid and when they actually need the money enables them to make better decisions.

“When workers have self-control problems, they under-save and experience volatile consumption between paychecks. Thus, pay whose delivery matches the timing of workers consumption needs will reduce wage costs… Because time is the culprit, it follows that her employer can improve her welfare by closing the gap between when she receives money and when she would prefer, ex ante, to spend it.” — The Timing of Pay

When stated like that it makes a lot of sense. Whenever we explain the idea of Wagestream the first objection we hear to the idea of getting income as it’s earned is that people will somehow spend themselves into trouble, not leaving enough for the “end of the month”. The data, and theory, shows entirely the opposite: when it comes to both the frequency of salary payments as well as the total amount paid, more is definitely better.