A couple of years ago I attended a focus group for Finweek. The magazine was rebranding and it had invited a diversity of people to comment on the content it should offer. The conversation turned to investment options for young professionals: should young people invest their monthly savings in a new property, or stocks, or something else? The facilitator asked the thoughts of a young woman that had been quiet for most of the meeting. 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 have known since Adam Smith already that people buy luxury goods not only for the value they derive from consuming it, but because these goods offer something else: social status. Conspicuous consumption, as economist Thorstein Veblen coined our affinity for status goods, has helped explain economic phenomenon like our excessive expenditure on weddings or the difference between black and white incomes in America.
However, so far economists have struggled to differentiate between our affinity for nice things (in economics jargon: our unobserved consumption utility) and our affinity for the status that those nice things signal. In other words, I might buy a Ferrari not only because I really like fast and furious cars (consumption utility), but also because I want to signal to the everyone else that I am rich (status).
A team of five economists, in a new NBER Working Paper, has now found a way to test the importance of social status. They worked with a large Indonesian bank that distribute credit cards to clients. (Indonesia is a great place for a test like this, because it is in developing economies, as Veblen theorized, where you are most likely to see conspicuous consumption. Also, Indonesia has 74 million middle-class consumers, expected to double by 2020.) They used platinum credit cards, which come with a number of benefits like a higher credit limit and discounts on luxury purchases and is typically sold to high-income individuals, in their experiment.
How do they show that social status matter? They randomly offered a fancy-looking platinum and standard-looking credit card to their customers at the same price and with the same benefits. If customers only cared about the utility of the new card (like the benefits on offer), there should be no difference in the take-up of the fancy-looking or standard-looking card. And yet, there is a 7 percentage point difference: 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 about the experiment is that poorer individuals bought more of the fancy-looking card. The rich, in contrast, showed 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 signaling tool for those with comparatively lower incomes”. This also explains the behaviour of the young woman in our focus group; she was more limited in her ability to show social status and thus had to resort to clothing.
In a second experiment, the authors then look at how the customers use their cards. Consistent with their theory, they find that the customers that bought the fancy-looking card (remember: it had the same privileges as the standard-looking card) used the card more often in social settings, such as spending in 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. In other words, they chose to ignore the discount just so that they can use the fancy-looking card that gives them 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 with a fancy-looking card), imagine what people are willing to forego for luxury products with a larger audience, like clothes and cars.
The authors conduct several other experiments, all of which support the authors’ theory that social status matter in explaining our consumption behaviour. We do not only buy luxury goods because they provide us with utility; we buy them because they signal something about our social status. And because poorer individuals tend to have fewer ways of signaling social status than richer ones, they are the most eager to grasp at opportunities for showcasing their 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 your meager 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 Finweek 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 any policy, like a purported wealth tax, can do to prevent that instinctive human yearning for status.
*An edited version of this first appeared in Finweek magazine of 15 June 2017.