Wednesday, January 07, 2004

Why Scrooge wouldn't take the cash

Conventional wisdom says we are self-indulgent but covert stinginess is all around, writes Peter Martin.

If your New Year's resolution was to go to the gym, to give up smoking or to get your finances in order, you are in good company. Most of us make resolutions requiring us to do things we hate. That's why resolutions exist. Or so we thought.

There's now a whole new school of thought among economists about a different type of resolution - one in which we resolve to force ourselves to do things we enjoy. And the implications are immense.

If the idea makes little sense to you, bear in mind that the entire concept of resolutions makes little sense to economists...

They have traditionally assumed that human beings are rational - always in control.

Rational people don't need to make resolutions because they always know what they want to do and then they do it. But many of us are not entirely rational. We fight with ourselves. A shopaholic will hide her credit cards in the freezer; an alcoholic will beg a friend to make sure that he doesn't drink; a friend of mine used to paint her fingernails with a bitter substance to stop herself biting them.

About 20 years ago economists began to develop a way of explaining this sort of behaviour. They said we each had within us two quite different personalities: a long-term strategic thinker, and a short-term hands-on fun-lover. The strategic thinker might want to save or exercise; the fun-lover wants to spend.

Most of the time the fun-lover makes the decisions. But from time to time (especially around the start of each year) the strategic thinker takes charge and tries to tie the fun-lover's hands. Flushing cigarettes down the toilet and hiring a personal trainer are among the preferred methods.

It is an idea that makes some sense to economists because it fits in with one of their core beliefs - that, left to our own devices, we prefer to enjoy ourselves now rather than wait. We are natural spendthrifts. That's why banks need to offer us interest to persuade us to lend them our money.

Or so it was thought. The new findings turn that thinking on its head.

Ran Kivetz and Itamar Simonson are professors at Columbia and Stanford universities. They have published their conclusions in a study entitled Self-Control for the Righteous.

Their belief is that about one in four of us acts quite differently. This "joyless consumer" seriously dislikes spending. Faced with a choice between spending on a luxury or on a necessity this person's instinctive reaction is to go for the necessity. Spending on luxuries appears to cause him or her something close to physical pain.

On a day-to-day basis this behaviour appears to make sense. As the professors note: "Spending on necessities has a distinct advantage over luxuries because one cannot do without necessities whereas spending on luxuries is often seen as wasteful, irresponsible, and even immoral."

But a life lived without ever spending on luxuries isn't responsible, and it certainly isn't enjoyable. The strategic thinker within such a person needs to trick the Scrooge into occasionally lashing out. Kivetz and Simonson set a trap to catch the strategic thinker at it.

They offered 6000 Americans the chance to take part in a lottery. They were given a choice of what to accept as a prize in the unlikely event that they won. They could opt for cash or a luxury prize of lesser value. One lottery offered the choice of either $55 in cash or a premium bottle of red wine (retail value $50). Another offered the choice of either $85 in cash or a one-hour facial (maximum retail value $80).

As financial decisions, they are dead easy to make. It is best to go for the cash. If you really want a bottle of wine or a facial you can buy one with the cash and have some money left over. And yet about a quarter of the Americans tested went for the luxury prize.

Asked why, they said things like: "If I chose the cash, I would probably spend it on something I need rather than something I would really enjoy" and "This way I will have to pamper myself and not spend the money on something like groceries".

The long-term planner within these people is desperate to get out from under the thumb of the short-term Scrooge. It may be one of the reasons why Australia's FlyBuys program is so popular, much more popular than it would be if it merely offered cash as a reward. (Incidentally, the professors have also discovered that one of the best ways to get FlyBuys users to take their rewards as flights rather than cash is to make the points harder to get - it makes the flights more acceptable to the Scrooge within us.)

I believe it is one of the reasons why so many Sydneysiders want to buy a second house down on the coast rather than (more cheaply) rent one when needed. The planner in these people knows it would be hard to convince the Scrooge to part with the rent.

It is also the reason my wife and I bought a season subscription to the Sydney Theatre Company at the start of last year.

We knew we would never lash out and treat ourselves to seeing a play each month if it meant parting with the money each time.

Instinctive Scrooges are all around us. They are doubtless far more common than Kivetz and Simonson's work suggests. Their experiment effectively asked people to admit to stupidity.

Entire national programs are based on the economists' stereotype that left to our own devices we won't save enough for our own good.

What if, instead, as many as half of us are inclined to save too much for our own good?

We would be able to get an idea if only we could find out what each of us promised ourselves on New Year's Eve.