NPR's Planet Money Podcast

Last week, Child No.1 and I recorded an interview with Chana Joffe-Walt for NPR. You can download and listen to the result on the Planet Money podcast. The topic for the interview was supposed to be the economics of allowances but it steered more broadly.

Before I get on to the economics of allowances, I have to just say how proud I was of Child No.1's (now known as 'B's') performance. We were in a hot small studio for 90 minutes with the interviewer in another city. Nonetheless, she rose to the challenge of communicating the complexities of our household to a global audience including speaking in American rather than Australian (although you can see, she hasn't lost her accent).

Child No.1 would also like to make it clear that she is not buying any dresses and will resist all efforts to have her wear one. There was some ambiguity in the interview but she would like it to be known that that all has to do with higher little sister.

In preparation for the interview I put some thoughts on the economics of allowances into an email and I thought I'd just share that here:

There are two main economic motives for allowances: (i) giving children incentives to work hard and/or (ii) giving children incentives to purchase well. In each case, the parenting goal is supposed to be generating good habits and experience so that 'cash doesn't become king.'

The idea that allowances are a form of payment for effort is fraught with difficulty. Basically, if I say to a child you will get your allowance if you take out the garbage each week (without being nagged), the child may want to broker a fee for any household chore. When it comes down to it, most parents think the child is part of the household and when they can they should contribute without some extended negotiation and possible legal claims based on precedent. That doesn't mean you can't use payments to get something extra but my guess it is better to have an independent bonus system than having that as part of a regular wage.

The other motive for allowances -- getting children to purchase well -- makes more direct sense. The idea is that a budget constraint can teach kids the 'value of money' or to translate it into another form -- it can allow parents to say 'no' to stuff more credibly. 'No you can't have those silly bandz. If you want them, you should use your own money.'

But here is the difficult part with that -- it works well in theory but what happens when your child wants to buyer what for want of a better word you consider 'crap.' The idea of giving them a budget of course is for them to make crappy decision so that they learn from their mistakes. You just have to grit your teeth and let it happen. The problem is that it may be that they want to spend their hard saved pocket money on special treats. So you think it is crap but they don't. That's a tougher issue and it is the one Tim Harford grappled with.

Here is how I dealt with the issue with our eldest daughter. She could purchase sweets but every time she did so, I would impose a health tax to compensate us for the additional expected health costs this behaviour would cause. The tax as a pretty hefty 100% of the sweet purchase price. My ever frugal daughter decided that was too much and figured that she would wait until she left home and enjoy the full benefits of the likely sizable fortune she would accumulate by that time.

That all leads me to another thing I have been thinking about and comes out nicely with allowances: how much should parents use behavioural economics to guide them (i.e., Thaler and Sunstein's Nudge)? For instance, you can get your child to save their allowance rather than spending it but not giving them cash but doing transfers to their bank accounts. They don't spend because it is 'out of sight, out of mind.' Another thing you might do is a create a friction. The kids wants to buy X on impulse at the store and you say, well, not now but if the next time we are here you ask again then you can buy it. That quashes the impulse and more often than not, they forget.

It seems like that would work but in some respects is killing the whole point of providing a budget for the purpose of learning about the value of money. You actually want to set them up for mistakes. That way, when they make them, it is off small amounts of accumulated savings. If you nudge towards saving, then they have a ton of money and when they make a mistake it is a big one. That strikes me as problematic.

Anyhow, it is a great issue and a big one for parents. I haven't even got to the amount of the allowance. We do $1 times their age per week but that is just poetic. Others eventually use some benchmarking. I suspect that I would want our kids to suffer a little from a low amount and then use evidence to negotiate a higher allowance. At the moment, with all of their money transferred directly to savings they haven't thought to do that. But it will come.