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The Necessary Evil

Michal Solcansky explores the economic logic behind conspicuous consumption and its societal benefits.

When Thorstein Veblen first suggested that some people tend to spend excessively in public to show off their wealth and power he probably did not imagine how popular the notion of conspicuous consumption would become. Squandering large sums is understandably very unpopular with the general public. The following joke illustrates how society may view conspicuous consumers: ‘Late 1990s. Two New Russians meet in London. They start talking: “Look, I bought a new tie. Paid £200” “You idiot. Just around the corner you could get it for £500.”’

To get an idea of the extent of criticism of opulent displays of wealth, you could just look up the number of times this issue has made the headlines in the last 50 years. An online search for ‘Fat Cats’ yields approximately 650,000 articles by British newspapers alone. ‘Keeping up with the Joneses’ seems to be slightly less popular with roughly 465,000 writings.

Economists usually view conspicuous consumption in a bad light; a manifestation of large income inequality and a source of status concerns that decrease overall utility. Many promote increased taxation and other redistributive measures in an attempt to fix the resulting inefficiencies. While they certainly make some very good points, the question of whether such spending may also be helpful has largely been ignored. Does conspicuous consumption possess economic logic? Does it create additional benefits for the society as a whole? And if it does, what should policymakers do?

Who are Conspicuous Consumers?
When being asked to describe the average conspicuous consumer, a picture of the idle rich will likely spring to mind. Surprisingly, this seems to be wrong. Recent economic research suggests that the typical spendthrift is relatively poor and suffers self-worth issues.

In 1996, a book called The Millionaire Next Door noted that the most affluent people tend to drive older cars bought for cash, while those worse off take out loans and opt for brand new models. Studies in the United States found that African-Americans, especially in poorer states, tend to spend a significantly greater portion of their incomes on cars, jewellery, and clothes, as all of these outwardly visible goods serve as status symbols.

Conversely, the upper class is more content with spending on less visible products. Warren Buffett has been living in the same house since 1958 and driven the same used car for decades. Similarly, Bill Gates was very careful not to draw any attention to his wealth when he visited Easter Bush this January. Interestingly, what the upper class actually spend money on are high-quality services such as premium healthcare, education or house furnishing. According to various anecdotes, an easy way to determine whether a person is really rich is to look at the furnishings of their bathroom.

Such spending patterns among the rich and the poor may seem puzzling. One answer for this can be found in interactions between individuals coming from one social group. Poverty is seen as a highly undesirable characteristic in social interactions; visibly poor individuals are excluded from certain social activities and finding a partner is relatively difficult for them. In this sense, conspicuous consumption can be considered a means of rebuffing the perception of being poor rather than a ‘proof’ of wealth.

Competitive Pressures
Bankers, particularly the investment variety, are often seen as the ultimate indulgers of conspicuous consumption, which often makes them an object of derision. However, large spending may in fact be a necessary requirement for their jobs as it is an effective way of competing for clients.

Imagine you had to choose between two bankers to administer your retirement savings. One would come to meet with you in an old Fiat wearing a £30 Primark suit. The other would greet you in a perfectly tailored tuxedo having come out of the newest BMW. Which one would you trust with the task of securing your pension? The vast majority of people would choose the latter. Crucially, there is no real evidence that one banker is better than the other. Still, a common heuristic suggests that great individual spending is mirrored by great income. In the banking market, great income implies great ability and competence (barring fraud).

Rational bankers are aware of this heuristic. An ambitious banker will invest heavily in outward appearance to attract clients. The problem with this strategy is that other bankers are aware of this as well and will act accordingly. The competition among bankers is thus translated into increased spending. If any one of them wanted to attract more clients, they would have to outspend the competition. Refusing to lose clients, others literally follow suit. As a result, a perpetuating circle of conspicuous competition is put into motion.
Outside of banking, this behaviour is observed in highly competitive markets where first impressions between clients and providers are critical. Another common example is lawyers — especially solicitors. Similarly, employers try to lure new recruits by promising a variety of benefits: free gym memberships, commuting allowances or even free childcare. Companies do not provide them out of goodwill but to attract employees in fierce competition from other firms.

When thinking about conspicuous consumption, we rarely consider how useful it may be. Most of what conspicuous consumers buy are pointless luxury goods. Right? Nevertheless, conspicuous consumption may produce positive externalities to the rest of society — art being an obvious example.

Measuring the economic worth of art promotion is extremely difficult, but the idea that conspicuous consumption may be helpful for creators of art is worth considering. One of the first great patrons of art was Gaius Maecenas who worked as a ‘talent finder’ for Roman Emperor Augustus. Artists deemed good enough were given generous government commissions. While this alone may not automatically result in quality art and hence benefit society, it is not a coincidence that the three Greatest Roman poets — Virgil, Horace and Ovid — all created their works in this period.

Of course, increased spending on art comes at a cost. Although the generous support for artists provided some intangible benefits, it created very tangible economic strain and funding deficits in other areas. As such, when Augustus died he left one of the most beautiful and artistic cities of the time, but with it a massive deficit that threatened to tear the Roman Empire apart as there were not enough funds to cover military expenses.

Policy Considerations
Conspicuous consumption should not be taken as uniformly bad. Given that discussions on excessive spending focus on how to eliminate it through policy measures, it would do no harm if economists tried to consider more carefully its workings, logic and effects on the economy. Such a debate could show whether the story of ‘rich people conspicuously consuming because they can’ is actually true. While conspicuous consumption is in all likelihood inefficient, increasing redistributive policies aimed at limiting it may yield even larger inefficiencies. Greater redistribution will mainly harm wealthier people, who may not necessarily be the ‘real perpetrators’. Financial, legal and other services could be disrupted by the implementation of luxury taxes that limit the ability of professionals to signal their quality. Considering this and possible benefits conspicuous consumption may bring, it would perhaps be optimal if policymakers simply frowned upon, but tolerated conspicuous consumption as ‘the necessary evil.’

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