The Frontal Cortex

One question that came up yesterday during the radio show was whether or not Americans can learn, once again, to delay gratification and save money. Can we get back the thriftiness of earlier generations? Or are we destined to be a nation with a negative savings rate?

I certainly wouldn't want to underestimate the malleability of consumer habits, or the motivating force of seeing foreclosure signs in your neighborhood, but I think it's worth pointing out that the steep decline in American savings rates coincided with lots of financial innovations that make it much easier for us to spend money. Just the other day at the drug store I marveled as the lady in front of me simply waved her keychain (it contained a tiny credit card) at the counter. A mere flick of the wrist - that was all it took to spend $19.95.

Why does this matter? Because there's some suggestive evidence that the brain makes simple consumer decisions by comparing our desire for the item (as represented by areas in the dopamine reward pathway, such as the nucleus accumbens) with the pain that comes from having to pay for the item. The problem with credit cards is that they abstract the payment: Instead of taking cash out of our wallet, we just swipe this thin plastic card. As George Loewenstein, a neuroeconomist at Carnegie-Mellon says, "The nature of credit cards ensures that your brain is anaesthetized against the pain of payment." Spending money doesn't feel bad, so you spend more money.

Of course, there's nothing inherently wrong with using your Visa or Mastercard. (I hate carrying around cash, so credit cards have made my life much more convenient.) But when it comes to the question of whether or not Americans can suddenly reverse long-term consumption trends - we want that shiny new HDTV, and we want it right now! - it's worth pointing out that this isn't simply a case of modern decadence, or of the baby boomers/Generation X not having any self-control. Instead, it's an example of how seemingly insignificant cultural tweaks - in theory, it shouldn't matter how we pay for things - can have profound implications.

Consider this experiment: Drazen Prelec and Duncan Simester, two business professors at MIT, organized a real life, sealed-bid auction for tickets to a Boston Celtics game. Half the participants in the auction were informed that they had to pay with cash; the other half had to pay with a credit card. Prelec and Simester then averaged the bids for the two different groups. Lo and behold, the average credit card bid was twice as high as the average cash bid. When people used their Visa or Mastercard, their bids were much more reckless. They could no longer constrain their desire, and so they spent way beyond their means. (Prelec and Simester entitled their paper: "Always Leave Home Without It".)

If we want to get serious about our anemic savings rates, we're going to have start finding ways to make ourselves more sensitive to the pain of payment, not less.