The origin of time preference

Time preference is one of the fundamental primitives in our economic models. It is crucial in investment decision problems were you have to incur a cost today to get a (higher) return at a later point in time. The famous “Marshmallow Test” (here is a funny Youtube video) is one of the most canonical examples of such a problem. You’re given one Marshmallow now together with the promise that if you wait for a certain time without eating it you’re getting another one as a reward. So eventually you will end up with two marshmallows, but only if your preference for immediate gratification (eating the delicious thing right now) is not too large. I.e., you have to exhibit a certain degree of long-term orientation and need to be able to psychologically project future utility to the present in order to sit out the pain of waiting and looking at the marshmallow.

Longt-term orientation is a particularly important concept for R&D investments where costs are high and returns are very uncertain*. So ultimately it’s linked to growth and human progress. But what determines individuals’ long-term orientation? A new paper** by Galor and Özak published in the American Economic Review has a very interesting answer. Observed differences in long-term orientation across countries can partly be explained by differences in crop yields in pre-industrial times. That means that long-term orientation was acquired by our ancestors at least several hundred years ago because they saw that there farming efforts were fruitful. For example, a farmer had a higher reward from tilling his field in Central Europe than in the Middle East, which increased long-term orientation in European societies. Acquired time preferences then became culturally embodied and were carried over to the present via selection, adaptation, and learning. This basically means that our ancestors taught us the value of investing in our future over generations until today (do you know the fable of the grasshopper and the ant?).

The authors present a battery of empirical tests to support their theory. With the help of the natural (or better historical) experiment of the Columbian Exchange—which exogenously increased crop yields in many parts of the world***—they are able to substantiate the causal claims of their theory and discriminate between competing mechanisms that could explain a relationship between crop yields and long-term orientation. In particular, the experiment shows that there is no reverse causality resulting from long-term oriented people simply moving to places where agricultural conditions are good.

I must admit I still have to digest the whole of the paper. But it seems very well executed (otherwise it probably wouldn’t have been published that well in the first place). It’s a very interesting example of the interplay between economics and culture. Economic conditions way back in the past shape cultural and psychological traits today, which has an effect on growth in the future. And with the tools of state-of-the-art econometrics we’re actually able to disentangle the complex social mechanisms at play and make real progress in the social sciences.

* E.g., I’m currently working on a project where the frequency of performance evaluations together with the behavioral concept of loss aversion explains the R&D investment behavior of family-owned businesses.

** An ungated working paper version, with an inconceivable amount of 144 pages, can be found here.

*** A good example is the tremendous impact of the potato in Europe. A plant which originated from South America and quickly replaced other domestic crops because of its high calory yield.

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