Time preference - what is it and why is it important #2

In my last post, I hopefully made clear what is time preference. But what are the factors that influence it? We can distinguish for types of them - external, biological, personal and social or institutional factors.

External factors are things we cannot directly or indirectly control. Of course - external factors can only affect time preference if they are expected. There can be two kinds: positive and negative factors. Positive factors affect the time preference in such a way that the marginal utility of future goods will fall relative to present ones. For example, you may stop saving if you expect some inheritance in the future. On the other hand, we have negative factors. This can be a wildfire for example. In these kinds of events marginal utility of future goods rises, we will have a decreased time-preference and increased savings. But, it can be the case that a negative event will increase time-preference if an actor knows that he will "lose everything" including savings.

Biological factors like longevity and health can be affected, but for practical purposes, we treat them as given, similar to external events. It is given that we are born as children, we grow until our adulthood, we procreate (most of us), we age and we die. As children, we have a low time preference that increases as we get older. As we approach the end of our lives our time preference tends to rise. The marginal utility of future goods tends to fall because there is not much of a future left. However, if we procreate our time-preference can decrease slower or even stay the same until our death.

Within the constraints imposed by these external and biological factors, we set our time-preference rate in accordance with our subjective evaluations. For example, we may not care about anything but the present i.e. we may just live "for the moment" - almost like children. Some of us may worry more about our future and the future of our offspring so we save, we acquire capital and durable consumer goods in order to provide for an increasingly larger supply of future goods and an even longer period of provision. We may be somewhere in between these two extremes.

Sadly, economists(in particular those of the "Austrian school") are a bit lonely in their recognition of phenomena of time preference, sociologists and political scientists do not pay so much attention to it. A notable exception is an American political scientist Edward Banfield, author of The Unheavenly City. There, he writes: "For the purpose here, namely, analysis of social problems from a policy standpoint the most promising principle seems to be that of psychological orientation toward the future".

Further, we writes... "The lower class person lives from moment to moment, he is either unable or unwilling to take account of the future or control his impulses. Improvidence and irresponsibility are direct consequences of this failure to take the future into account (which is not to say that these traits may not have other causes as well), and these consequences have further consequences: being improvident and irresponsible, he is likely also to be unskilled, to move frequently from one dead-end job to another, to be a poor husband and father..."

"It is useful to employ the same principle - ability or willingness to provide for the future - to account for the traits that are characteristic of the other class cultures as well. The working class is more future-oriented than the lower class but less than the middle class, the middle class, in turn, is less future-oriented than the upper. At the upper end of the class-cultural scale, the traits are all "opposite" those at the lower end."

When we think about "lower classes" we associate it with family breakdown, promiscuity, STDs, alcoholism, drug addiction, violence, crime, high infant mortality, and low life expectancy. All of these have common cause in high time preference, not unemployment or low income - these are just the effects.

If within a given population distribution of time-preference rate is low enough to allow for any savings and capital or durable consumer-goods formation at all, a tendency toward a fall in the rate of time preference is set in motion, accompanied by a "process of civilization".

As time passes, the time-preference rate approaches zero, without ever reaching it. As a result of the surrender of present money, savers can expect to receive a higher real-money income later. With higher income, the marginal utility of present money falls relative to future money, the savings proportion rises, and future monetary income will be even higher.

Also, in an exchange economy, effects of saving and investing "spill over" i.e. others who do not save and invest also experience a lower time-preference rate. When capital is accumulated, the relative scarcity of labor services increases, and wage rates, all other things staying the same - rise. Higher wages rates imply a rising supply of present goods for previous nonsavers. Even those individuals who were previously nons non-savers will see their personal time-preference rates fail. Additionally, an indirect result of the increase in real income that is brought about through savings, nutrition and health care improves, and life expectancy tends to rise. In a development similar to the transformation from childhood to adulthood, with a higher life expectancy more distant goals are added to an individual's present value scale. The marginal utility of future goods relative to that of the present one's increases and the time-preference rate declines further.

In the process of building up and expanding the structure of capital and durable consumer goods, the saver-investor also expands the range and horizon of his plans. He takes more and more variables under his control. The consequence of that is an increase in the number of future events that concern him. He is interested in acquiring and steadily improving upon his knowledge concerning an increasing number of variables and how are they intertwined. When he acquires or improves his own knowledge and verbalizes is, that knowledge becomes a "free good" that is available to others.