Conspicuous consumption and poverty traps

Poverty is no barrier to conspicuous consumption. As Banerjee and Duflo wrote in Poor Economics:

One hidden assumption in our description of the poverty trap is that the poor eat as much as they can. …

Yet, this is not what we see. Most people living with less than 99 cents a day do not seem to act as if they are starving. If they were, surely they would put every available penny into buying more calories. But they do not. In our eighteen-country data set on the lives of the poor, food represents from 36 to 79 percent of consumption among the rural extremely poor, and 53 to 74 percent among their urban counterparts.

It is not because all the rest is spent on other necessities: In Udaipur, for example, we find that the typical poor household could spend up to 30 percent more on food than it actually does if it completely cut expenditures on alcohol, tobacco, and festivals.The poor seem to have many choices, and they don’t elect to spend as much as they can on food.

In a paper published earlier this year, Moav and Neeman proposed an explanation for the relatively high levels of consumption on goods other than food in poor societies. They suggested that some of this consumption is conspicuous consumption, which is driven by the difficulty in signalling status and wealth where it is not recognisable through professional titles or other markers:

[W]we suggest that those with high human capital have a recognisable ability (professional titles, degree certificates etc.) and relatively little need to signal success, whereas those without certified accomplishments, such as the poor and the ‘newly rich’, have a relatively stronger motivation to impress via conspicuous consumption. As a result, the fraction of income allocated to conspicuous consumption can decline, on average, with the level of human capital, resulting in a larger share of income allocated to savings and investment in education.

Conspicuous consumption is only useful to the extent that someone is signalling a quality that cannot otherwise be determined. If the quality is observable, there is no need for the signal.

To explore this idea, Moav and Neeman developed a model in which a person’s knowledge, skills and experience (what is called human capital) is observable to others. However, a person’s income is not directly observable, although it is imperfectly correlated with their human capital. To attempt to signal the unobservable variation in income, a person can engage in conspicuous consumption.

In each model generation, an adult must divide their resources between normal consumption, conspicuous consumption and a bequest to their children, which determines that child’s level of human capital. The adult gets utility from the three options.

Moav and Neeman showed that depending on the relationship between human capital and income, it was possible for the share of conspicuous consumption as a proportion of income to be decreasing with income. That is, the poor would engage in relatively more conspicuous consumption as a share of their income than the rich. The condition for this to occur is that human capital acts as a buffer to negative income shocks, meaning that variation in income is likely to be relatively less as human capital rises.

When this is put into a dynamic context over generations, this situation can turn into a poverty trap. Adults with low human capital tend to invest more in conspicuous consumption, which then prevents investment in the human capital of their children. As a result, the human capital of that dynasty remains low and they stay in a poverty trap. Those with high human capital, however, invest relatively less of their income in conspicuous consumption, which leaves resources for increasing the human capital of their children. As the share of conspicuous consumption as a portion of someone’s income declines with increasing income, the high human capital dynasty ends up in a virtuous circle of increasing human capital and wealth.

I am not convinced of the conclusion of conspicuous consumption leading to poverty traps, as human capital is not purely a function of parental investment. Further, to the extent that conspicuous consumption is a signal of resources and leads to differential reproductive success, the people in the successive generations will only be a subset of the dynasties that were initially in existence. However, as the authors note, there is potential to test this idea by exploring conspicuous consumption across societies and to see whether it varies with variation in the transparency of income.

I would have like to have seen the model placed in an evolutionary setting, particularly given Moav’s background in the area (Moav is one of the authors of the seminal Natural Selection and the Origin of Economic Growth). It is possible to frame the model in evolutionary terms with little need for any model modification. This would answer questions such as why the people prefer to conspicuous consumption, and what is the fitness benefit that allows it to continue to occur? Evolutionary dynamics may be beyond the length of time for which Moav and Neeman seek to explore, but the evolutionary foundations of people’s actions would give robustness to the preference to conspicuously consume.