Why do financially constrained

Mechanisms that reduce the adverse impact of discretionary consumption are critical. Thus, plans like the “Save More Tomorrow Program” that enrolls people in a pension scheme with small contributions could immensely benefit them, studies show

Experience of financial scarcity is a universal problem. In March 2021, the revolving debt, which is mostly the revolving credit card debt, increased by 7.9 percent to about $980 billion in the US. Ideally, individuals with scarce financial resources, such as those with high amounts of debt, should manage their money efficiently. However, even consumers who have high consumer debt, engage in discretionary consumption. 

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For example, the amount of credit card debt in the US was higher in 2019 than in the period of the 2008 financial crisis, and according to a recent poll, 32 percent of the adults who said they had credit card debt, identified discretionary spending as the primary contributor to that debt, while only 23 percent of necessary purchases contributed to their credit card debt, which suggests that these people need to have a clear understanding of their living expenses (i.e., nondiscretionary and discretionary expenditures) for a good successful financial future.

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In our “Journal of the Academy of Marketing Science” article, we demonstrate that individuals with greater financial scarcity can perceive the future to be more optimistic, resulting in more discretionary expenditures (i.e., spending, borrowing, and investing). We test and find support for this finding in three large-scale studies, including a survey, two longitudinal archival studies, and two preregistered online experiments. In our studies, we investigate both subjective and objective perceptions of financial scarcity using different samples (i.e., samples from India, Italy, Germany, and the US). The results of the studies consistently show that consumers with scarce financial resources have more discretionary expenditures, and theoretically, their optimistic future perceptions explain why these individuals with scarce financial resources have more discretionary expenditures.

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Discretionary expenditures for people with financial scarcity lead to serious consequences. For example, financial debts for people with financial scarcity lead to severe mental health issues, including finishing one’s life, which suggests that public policymakers urgently need to tackle this growing problem with appropriate interventions. We suggest that these findings can be used by public policymakers by nudging consumers and using persuasive communication in different ways. 

One way that public policymakers can urge these people to save or enroll in a pension scheme rather than spend, borrow, or invest in discretionary investing is by using choice architecture and message framing. Choice architecture can be used by bringing the future desired option temporarily closer to the present and making the desired future behavior an opt-out option. This approach is similar to the “Save More Tomorrow Program”, in which there is a default choice of enrolling people in a pension scheme with the added provision that they only start off making small contributions. 

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Rather than urging consumers with scarce financial resources to start saving and enrolling in the pension schemes at the present when they are only focused on their financial scarcity, a default option of saving and enrolling in the pension scheme starting in a year would be better for these consumers. This approach will bring the future temporarily closer to these consumers. Moreover, rather than making this choice an opt-in option, it can be presented as an opt-out option. This type of choice architecture, where the future temporarily is closer to the present and in which saving and enrolling in the pension scheme in a year is the opt-out option, could be better for the well-being of these consumers with scarcer financial resources. 


Relatedly, social trust is used extensively in nudging, and public policymakers can show examples of people who have benefited from these types of schemes, in which consumers start to save and enroll in pension schemes in a year when financially scarce, which can also help these individuals with scarcer financial resources.

From a managerial perspective, while targeting people with financial scarcity to sell discretionary goods would be profitable but unethical, inducing more consumption of nondiscretionary products would be a win-win situation for companies and consumers. The latter approach would make people spend on things that are truly necessary for them in their daily lives.

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In summary, given the severe consequences of discretionary consumption for people with financial scarcity, both policymakers and managers should develop mechanisms that reduce the severe consequences of discretionary consumption.

(The author is a faculty member at the IIM Bangalore).

Disclaimer: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organization directly or indirectly.

Financial constraints definition and meaning – Collins Dictionary

https://www.collinsdictionary.com › dictionary › english

Financial constraints definition: A constraint is something that limits or controls what you can do. | Meaning, pronunciation, translations and examples.

Identifying financial constraints – European Central Bank

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by M Verschelde · Cited by 1 — Financial constraints are often characterized as an inelastic supply of external finance, im- plying a constraint on firm decisions whenever internal financing 

Effect of financial constraints on the growth of family and 

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by B Ergün · 2020 · Cited by 10 — Financing constraints are considered a significant obstacle for firms that need external financing for their intangible or fixed capital 

How Financial Constraints Influence Consumer Behavior

https://carlsonschool.umn.edu › sites › files › Ham

by RW Hamilton · 2018 · Cited by 90 — For example, money is more salient when people have a limited budget to achieve a goal or when they are chronically living with limited income. As we will 

Financially Constrained Firms: The Impact of Managerial 

https://www.ersj.eu › journal › downloa

Diversification as an underlying factor of financial constraints can create several costs. Diversified firms have the tendency to over-invest in lines of 

The real effects of financial constraints: Evidence from a 

https://www.sciencedirect.com › science › article › pii

by M Campello · 2010 · Cited by 2582 — For example, 81% of the CFOs that we categorize as financially constrained say they have experienced credit rationing (quantity constraint) in the capital 

Financial Constraints, Investment, and the Value of Cash 

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by DJ Denis · 2010 · Cited by 1420 — Previous studies report that cash holdings are more valuable for financially constrained firms than for unconstrained firms. We examine (i) why this is so 

How Financial Constraints Influence Consumer Behavior: An 

https://myscp.onlinelibrary.wiley.com › doi › jcpy

29-Oct-2018 — Resource Scarcity. Financial constraints can be characterized as a lack of resources that are required to satisfy consumers’ needs or wants. At 

Are financially constrained firms susceptible to a stock price 

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by G He · 2022 · Cited by 12 — Financial constraint is defined as frictions that prevent a firm from funding its desired investments (e.g. Lamont, Polk, and Saá-Requejo 2001 

Do financial constraints really matter? A case of understudied 

https://onlinelibrary.wiley.com › doi › full › ijfe

by M Machokoto · 2021 · Cited by 4 — This pecking order of prioritizing savings and dividends ahead of other uses-of-funds highlight difficulties in accessing external finance and a 

The Effect of Financial Constraints on Word-of-Mouth

https://marketing.wharton.upenn.edu › 2018/03

by A PALEY — In particular, Spiller (2010) demonstrates that financially constrained. Page 9. FINANCIAL CONSTRAINTS AND WORD-OF-MOUTH. 9 consumers are more likely to think 

“How do financial constraint and distress measures compare?”

https://www.businessperspectives.org › pdf › assets

by J Kim · Cited by 9 — Consistent with this hypothesis, it is found that both. KZ “constrained firms” and financially distressed firms exhibit higher debt reduction-cash flow 

Financial Constraints, the User Cost of Capital and Corporate 

https://www.rba.gov.au › rdp › pdf › rdp2005-12

by G La Cava · 2005 · Cited by 37 — investment of financially constrained firms. Cash flow is found to affect investment, though the effects appear more complicated than 

Financial Constraints on Corporate Goodness

https://www.nber.org › files › working_papers

by H Hong · 2012 · Cited by 412 — But heterogeneity in firm financial constraints can induce a spurious … For example, firms that are less financially constrained can have better financial.

48 pages

Do Financially Constrained Firms Earn Higher Returns than 

https://www.researchgate.net Stock Exchange

05-Jul-2022 — impossible for firms to get external finance from the capital markets (Balafas,. 2015) and these frictions are known as Financial constraints.

How Do Financial Constraints Affect Creativity? – ResearchGate

https://www.researchgate.net › publication › 259553558

05-Jul-2022 — The results suggest that constrained financial resources may be beneficial to creativity. Financial constraints lead to the ideation of more 

Does Corruption Hurt Employment Growth of Financially 

https://openknowledge.worldbank.org › handle

This paper hypothesizes that financial constraints magnify the harmful effects of corruption. It applies this idea to the impact of corruption on employment 

Financial Constraints and Firm Dynamics

https://www.ec.unipi.it › uploads › 2017/12

by G Bottazzi · Cited by 198 — The sub-diffusive nature of the growth process of constrained firms is compatible with the distinctive properties of their size distribution. ∗The research 





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