Johan Fourie's blog

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Posts Tagged ‘wealth

How social status drives our consumption – and inequality

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louis-vuitton

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.

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Written by Johan Fourie

July 12, 2017 at 11:02

Stellenbosch, Sandton and Soweto

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Andile Khumalo, a Johannesburg venture capitalist, recently raised the following vexing questions in a blog post (and Sunday Times column): “Is Stellenbosch going to continue to be the economic capital of South Africa, whilst Africans, in their townships and villages, remain the systematic consumers of its myriad of goods and services? Think about where you do groceries? Afrikaans capital. Think about where you bank? Afrikaans capital. Who grows your food? Afrikaans capital?”

Then the conundrum: “Why can’t Black people think-up, develop and roll out these ideas for themselves by themselves… to themselves?”

Stellenbosch is widely seen as the bedrock of white, mostly Afrikaans-speaking capital, and for good reason. According to the most recent Forbes list, five of the wealthiest forty Africans live in or close to Stellenbosch, and a sixth teaches at the University. Johann Rupert, fourth on the list, is chairman of Richemont, which owns brand names such as Cartier, Alfred Dunhill and Montblanc. Christo Wiese, eight, is the chairman and largest single shareholder of the continent’s biggest retailer, Shoprite. Twenty-seventh is GT Ferreira, chairman of the financial services company RMB Holdings. Jannie Mouton, executive chairman of PSG financial services (which he founded in 1995), is thirty-first on the list, while Michiel le Roux, thirty-third, founded Capitec in 2001.

The perceived wisdom is that Stellenbosch is a legacy of Apartheid, that most of this is “old money” from the days when whites were fortunate to have access to protected markets and state resources. Certainly some of this money is “old”, but there is little evidence that a large share of it was acquired with considerable government support; in fact, as an excellent history of Apartheid economics in the latest Cambridge history of South Africa (and, more anecdotally, Johan Rupert’s biography) clearly suggests, in many cases the needs of white entrepreneurs (for example, the need to appoint blacks in skilled or semi-skilled positions, the need for a high-educated, black labour force) were subordinate to the interests of a government committed to the vision of a racially segregated country. In truth, most of Stellenbosch’s “white capital” is “new capital”, acquired after the fall of Apartheid when white business was forced to enter a more equal playing field.

But how is that the former oppressor, now with less political freedom, gained in economic wealth? Clem Sunter, in a 2010 News24 column, eloquently answered this when he wrote:

“During the years of apartheid, there was a culture of entitlement among the volk (white, Afrikaans-speakers). With a good education you could end up as a Cabinet minister, a top civil servant, head of a parastasal or a senior executive in an Afrikaans-owned business like the Trust Bank or Sanlam. If you weren’t so privileged, you could get a job on the railways as an artisan, join the ranks of the army or police or work for a municipality.

After 1994, all these expectations came to an end. Suddenly Afrikaners were out of power. They had to take a leaf out of Steve Biko’s book: you are on your own and you will have to fend for yourself. And they have done so – fantastically well. I was told the other day that the fastest growing element of the Johannesburg Stock Exchange are companies owned and run by Afrikaners. The whole coast north of Maputo in Mozambique is now a string of safari lodges and dive shops established by entrepreneurs from Pretoria. The list goes on and on all around South Africa, and increasingly north of the border and elsewhere in the world.”

1994 liberated not only black South Africans. Instead, I would argue, white South Africans were liberated from an incentive structure that guaranteed a ‘safe’ job in the public sector, or in white-owned, state-supported business. Whites were forced to create jobs for themselves, not simply fill jobs; entrepreneurship, not political (or Broederbond) contacts, became a way to gain power. This is true of many cultural minorities across the world that has little political power: why is it that Somalians thrive in South Africa while their own country falls apart? It is because they know that here they are on their own. There’s an attitude of “if we fail, there is no one to blame but themselves”.

Ironically, the 1994 transition may have had exactly the opposite effect for black South Africans. While a democratically elected government brought political freedom, it also created an incentive structure of entitlement. The attitude was that “we had suffered enough during those dark days and should now share in the economic spoils”. Government policy made this easier: black economic empowerment, for all its good intentions, did not create entrepreneurs, it created a class of connectors, networkers, tenderpreneurs or whatever you would like to label those with the skills not in creating something new, but in redistributing. A few years ago I gave a lecture in parliament on trade policy. During tea, a PAC MP came over to ask one of the most important questions we’ve not answered as a collective. In his village, he told me, the farmer, the baker and the shopkeeper (read: the entrepreneurs) are still there, two decades after Apartheid, doing what they did back then. Only those with political connections have moved up, out, working in government departments. (I guess he included himself in this list.) Of course the next generation realises this. All the kids want to become politicians, not engineers, because that’s how you make money. In contrast, I told him, Afrikaans kids don’t dream about becoming president of South Africa; in Stellenbosch, at least, they dream about becoming Mark Zuckerberg. How to change this?

Andile Khumalo writes: “Black man, wake up! Your ‘real’ freedom is being outsourced to the minority, whilst you occupy yourself with meaningless politics and tenders. You are busy drinking skinny cappuccinos in Melrose Arch, whilst your markets are being penetrated by those who dare to dream, and do.”

Khumalo is correct in saying that Afrikaans capital has prospered. But it’s not because white South Africans are inherently more entrepreneurial (or, worse, that they have mafia-like tendencies that aim to control the lives of the masses), or that black South Africans tend to enjoy the luxuries of Melrose Arch more. Stellenbosch is thriving because it has accumulated a group of highly skilled individuals – black and white – that realise that prosperity is not tied to political contacts, but to innovative ideas and to the people that help turn those ideas into reality. Their attitude is: You are not on your own – Khumalo knows this when he says that great ideas always secure funding, and Stellenbosch is not the worst place to start looking – but that creating wealth is your responsibility. These are the virtues – creativity, diligence, responsibility – our society must reward. The only way South Africa – and especially black South Africans – can prosper, is if we start spreading these ideas (Khumalo calls them dreams) to the Sandtons and Sowetos of our country.

Written by Johan Fourie

May 20, 2012 at 21:23