Thought of the Week – Keeping up or hanging out with the Joneses

Economists sometimes try to explain spending and savings decisions in relation to this urge to compare ourselves to friends, neighbours, colleagues and others. The idea is that if we think our peers are richer than we are or make more money than we do, we increase spending to seem to the outside to be just as well off. In fact, there is mixed evidence as to whether this concept really works in practice. In general, the effects found in the past range from relatively small to significant and it is typically not possible to prove causation.

This is why new research among Dutch households is interesting. That research used randomised control trials (the gold standard of economics experiments) to examine both correlation and causation. In a series of experiments, people were made to believe that they had more or less debt than their peers. They were then asked about a range of decisions, not just about spending, but also about their willingness to spend time with friends and families, their political views on redistribution, and their willingness to volunteer for charitable organisations.

Making people compare themselves in terms of the debt they hold is a bit unusual. It may lead to different results than the more common approach of making people believe they are richer or have higher incomes. Therefore, we should take the results as merely one more piece in the puzzle, rather than the definitive word on consumer behaviour. Besides, asking Dutch people about keeping up with the Joneses is bound to result in small effects, since they are famously relaxed about life and don’t have a reputation for frivolous spending like, say, the Americans.

So, when it comes to consumer spending, this study does not find a significant impact – or rather, it does not find a significant impact on overall spending. What the study does find is that when people are told they are 1% less well off than their peers, they increase spending on durable goods like cars by 1.3% but cut spending on nondurables by 1.5%. The net effect is a statistically insignificant decline in spending of 0.2%, but there is definitely only a minor impact from frivolous spending to impress peers who are perceived to be better off.

Where things become interesting, though, is in the impact of perceived relative wealth on other behaviours. To nobody’s surprise, people who are made to believe they are poorer than their peers become more in favour of wealth and income redistribution. But they also become less willing to spend time with friends or volunteer for a charity.

On the other hand, people who are made to believe they are better off than their peers become more social and more willing to volunteer. They aren’t willing to share their wealth, but they are willing to share their time. It is a shame, though, that the people who believe they are worse off won’t be there to meet with them.

I can only speculate here, but it seems to me if this experiment were repeated with Americans, the effects on consumption and prosocial behaviour would likely be greater. Americans not only are well-known victims of conspicuous consumption, but volunteering has a much deeper tradition in the US than in the Netherlands, and is more common there. Hence, my guess is that Americans who were made to believe they are worse off than their peers would likely increase consumption more than the Dutch. Likewise, Americans who were made to believe they were better off than their peers would likely volunteer more than the Dutch.

Thought of the Day features investment-related and economics-related musings that don’t necessarily have anything to do with current markets. They are designed to take a step back and think about the world a little bit differently. Feel free to share these thoughts with your colleagues whenever you find them interesting. If you have colleagues who would like to receive this publication please ask them to send an email to joachim.klement@liberum.com. This publication is free for everyone.