How social status drives our consumption – and inequality

Jun 08 2017 11:52
Johan Fourie

A few years ago I attended a focus group for finweek. The magazine was rebranding and had invited a diverse group of people to comment on the content it should offer. The conversation turned to investment options for young professionals: should young people invest monthly savings in property, or stocks, or something else?

The facilitator asked for the thoughts of a young woman who had mostly been quiet up to then. Her answer, and its consequences for many young South Africans like her, stunned me: I invest in expensive clothes, because I have to signal to a potential husband that I am wealthy. In other words: I buy brand names, because I want to improve my social status.

Economists going back to Adam Smith (1723-1790) knew that people buy luxury goods not only for the value they derive from consuming them, but because they offer something else: social status. Conspicuous consumption, as economist Thorstein Veblen named our affinity for status goods, has helped explain economic phenomena like our excessive spending on weddings.

So far economists have struggled to differentiate between our affinity for nice things (in economics jargon: unobserved consumption utility) and our affinity for the status that those things signal. In other words, I might buy a Ferrari because I really like fast cars (consumption utility), but also because I want to signal that I am rich (status).

A team of five economists, in a new National Bureau of Economic Research (NBER) Working Paper, has now found a way to test the importance of social status. They worked with a large Indonesian bank that distributes credit cards to clients. (Indonesia is a great place for such a test, because, as Veblen theorised, you are most likely to see conspicuous consumption in developing economies. Indonesia has 74m middle-class consumers, expected to double by 2020.)

They used platinum credit cards, which come with a number of benefits like higher credit limits and discounts on luxury purchases, and are typically sold to high-income individuals, in their experiment.

How did they show that social status matters? They randomly offered a fancy-looking platinum and standard-looking credit card to customers at the same price and with the same benefits.

If customers only cared about the utility (or benefits) of the new card, there should be no difference in the take-up of the fancy-looking or standard-looking card. Yet, 21% purchased the fancier card versus only 14% for the standard card. The mere fact that the fancy-looking card was associated with a higher status meant that people purchased it.

Perhaps it is not that surprising that people purchase something because it conveys an additional status element, but what is surprising is that poorer individuals bought more of the fancy-looking cards. Among the rich, in contrast, there was no difference in demand for the fancy or standard card.

The authors ascribe this finding to the fact that “richer individuals already have ways to signal their income, while the platinum credit cards are a more powerful signalling tool for those with comparatively lower incomes”.

In a second experiment, the authors looked at how the customers used their cards. Consistent with their theory, they found that the customers who bought the fancy-looking card (remember: it had the same privileges as the standard-looking card) used the card more often in social settings, like restaurants, bars and clubs, where the card is more visible to others.

Here, too, there is somewhat of a surprise: the use of this card comes at a cost, because in 48% of the cases the customers have another card that would have given them discounts on those purchases. They chose to ignore the discount in order to use the fancy-looking card that gives social status!

If this is true for credit cards where there is a limited audience (only your buddies who joined you for dinner can see you paying), imagine what people are willing to forego for luxury products with a larger audience, like clothes and cars.

The authors conducted several other experiments, all supporting the theory that social status matters in explaining our consumption behaviour. And because poorer individuals tend to have fewer ways of signalling social status than richer ones, they are the most eager to grasp at opportunities for showcasing status. (That is why direct marketing is never aimed at the wealthiest individuals!)

Such findings have implications for the distribution of wealth. The choice for a young person between investing meagre savings in stocks or a new car may not only depend on the financial returns they can get, but also the psychological returns they might get from purchasing a luxury good.

If poorer individuals tend to buy more luxury goods to earn social status, like the young woman in the focus group, while the rich invest in assets that yield positive financial returns (because they already have assets that give them social status), the only logical conclusion is a widening wealth gap. There is little that policy, like a purported wealth tax, can do to prevent that instinctive human yearning for status.

Johan Fourie is associate professor in economics at Stellenbosch University.

This article originally appeared in the 15 June edition of finweekBuy and download the magazine here.

spending  |  inequality