Discounting the Future Can Be a Rational Strategy

We discount the future when we place lower value on the same event or object at some future time than we place on it right now. In other words, a dollar today is worth more than a dollar tomorrow. How much less it's worth tomorrow is how much you discount the future.

Experiments about discounting the future typically take the form of "Would you rather get twenty dollars today, or twenty-five dollars a month from now?" If you take the second one, your discount rate is 25% or lower per month. All humans do this to some degree, but countries differ in how much their residents, on average, discount the future. The residents of developed countries discount the future less than the residents or poorer countries.

In its relationship to economic development, discounting the future is often thought of as a proxy indicator for ability to delay gratification or even general intelligence (and therefore accumulate capital) and this is probably useful. However, ability to delay gratification has a different value in different environments. If someone offers twenty dollars today or twenty-ve dollars a month from now, it makes more sense to go with the future money if you're in Japan than in Somalia. In Japan, things are predictable; when you go to collect your money, the train will come at the same time as the last time you went, the experimenters can be trusted to be there, there are institutions to enforce the contract if they don't honor it, and most importantly, no one will try to kill or rob you on the way and the Psychology Department will still be there, rather than having closed or been blown up. Also, you will not have been killed or lost all your money in the meantime. In Somalia (or places like it) these assumptions do not hold. In Somalia, you're stupid to make those assumptions; you can't know what's going to happen a month from now, or even tomorrow. Discounting the future heavily in unpredictable places is actually a rational strategy.

This is unfortunate. It stands to reason that everyone choosing a heavily discounting strategy in unpredictable places would reinforce the very unpredictability it's accounting for, creating a vicious circle.

Economic Rationality Index

It's been fashionable to point out that Homo economicus is not a fully rationally self-interested animal. Kahneman and Tversky were instrumental in waking us up to the reality that the human brain is not a universal well-rounded problem-solving machine - and of course, as a product of the accumulated exaptations and legacy systems and local optima and ad hoc functionalities of evolution, why would we expect it to be? Rather than serving as cause for hand-wringing, appreciating this fact lets us either do something to address and correct it, or at least to call it out and create hacks and workarounds. To me this is the promise of the Late Enlightenment.

I recently moved from the Bay Area to San Diego. Looking at gasbuddy.com, I noticed that the spread on gas prices in San Diego seemed greater. My experience of actually price-comparing gas stations has borne this out. There is greater variation over smaller areas in San Diego than there is in San Francisco. Sometimes there are ten cent differences at service stations across the street from each other. What's more amazing is that there are quite often cars filling up at the more expensive one. I've been tempted to walk up and ask people why. Clearly, this bothers me.

This suggests a way to compare the degree of rational self-interest between two geographic areas - take the price on 87 for all the gas stations within two predetermined square miles. Find the standard deviation for each square mile. Take repeated readings over some period of time and average, if you're worried about changes in supply cost rippling through the market and driving up the SD out of instability, rather than irrationality (non-100%-efficient markets is not that same as irrationality). Then look to see if the localities are consistently different. If there are consistent differences, next step: does it correlate with certain chains? Or with demographics of the area (education, income, income distribution)? Or some cultural intangible (i.e. San Diego is too relaxed for its own good)?

The square mile should be controlled so that there aren't geographic barriers (busy highways or streets, water, etc.) that would actually make consistent price differences more rational. The differences I've seen are ones between gas stations across the street or opposite ends of the block from each other. Since the index would consist purely of posted price as reported online, rather than sales, it's assuming that people are actually buying gas at the more expensive stations. But unless there's some bizarre detail at work here, this is a fair assumption - service stations aren't going to set a price at which nobody buys gas. (The bizarre detail could be something like - the local area is dominated by a single chain that profits from products other than gasoline, so its prices are less sensitive to actual consumer behavior; or, a frequent-flyer style gas club not available in both cities. This is why I should actually ask people what they're thinking filling up at the more expensive station, because maybe they are actually thinking something.)

In fairness, I'm very sad to have left San Francisco, and very eager to jump on anything that points the Bay Area or its residents as better than San Diego. But what I've observed anecdotally suggests strongly that San Diegans just can't be bothered to drive an extra 2 minutes to save three dollars. That is to say, it seems that San Diegans are truly less rationally self-interested than San Franciscans, and this provides a way for me to make sure it's not just my own confirmation bias operating against poor San Diego.

The next step is to actually do the calculation, which will take a while. If you run across this post and know of a similar index that's already established, please comment.