The
Weekend Herald contained a small news item about the CEO of PayPal Scott
Thomson who claimed that wallets will soon be obsolete. Thomson suggested that
by 2015 digital currency will be accepted everywhere, at least in the US. Soon
you will not have to carry around either cash or cards but be able to make all
your payments via your cell phone.
Experts
believe that PayPal’s CEO is being overly optimist about the timeline. Nevertheless
the fact remains that the advent of digital currency is not too far away in the
future.
What
are the implications of digital currency for consumer debt? Not good, I am
afraid. Drazen Prelec and Duncan Simester of MIT suggest that digital
transactions fundamentally change the way we spend money. When we pay via
credit cards we tend to spend a lot more than if we paid with cash.
When
we pay with cash, there is a sense of loss when we have to hand over the dollar
bills to complete the transaction. Credit cards make the transaction abstract and
as a result digital transactions do not affect our brain the same way that
paying with money does.
The
part of our brain which deals with feelings of aversion (such as a reaction to
a bad smell) is called the insula. Economic decision making experiments using
brain imaging suggest that when we pay with our cards, as opposed to cash,
there is reduced activity in the insula. This implies that we do not feel as
bad about spending money when we use our cards rather than cash. Ergo, we end
up spending more.
Prelec
and Simester organized a sealed bid auction of tickets to a Boston Celtics
game. Half the participants in the auction had to pay with cash while the other
half could pay with a card. When Prelec and Simester looked at the average bids
they found that the average credit card bid was twice as much as the average
cash bid.
Cell
phone transactions will further increase the disconnection between the pleasure
of buying and the pain of paying and will almost certainly exacerbate the
tendency to spend money.
Think
of this as a tussle between the emotional and rational parts of our brain. The
emotional part looks at things – shoes, handbags, golf-clubs and silk ties – and
wants to buy them. The rational brain thinks about the cost of paying for these
and holds us back.
Brian
Knutson, a neuroscientist at Stanford, along with colleagues carried out an
ingenious experiment to understand how people make purchasing decisions.
Participants were given an amount of money to start with and then shown various
different objects they could choose to buy. If they bought something then the item’s
cost was subtracted from their starting balance.
While
people made these decisions the researchers were studying their brain activity
using fMRI scans. They found that when people first encountered the goods for
purchase, this activated their nucleus accumbens (NAcc) which is the part of
the brain that deals with pleasure and rewards.
Then
they are told the price of each item. At this point the insula and the
prefrontal cortex (PFC) got involved. The insula, as I mentioned, is engaged
when we find something distasteful like actually having to fork out money for
things we want to buy.
The
PFC is the rational part of the brain which is involved in decision making or
handling complex cognitive tasks. Faced with the NAcc wanting to buy the pair
of shoes badly while the insula objects at the price tag, the PFC tries to
figure out if this is actually a good deal or not.
By
looking at the activity in the different regions the researchers could predict
how people would decide. If the activity in the insula was stronger, then
people would end up not buying the good. But if on the other hand the NAcc was
more active or if the PFC was saying that this was indeed a good deal, then the
participant ended up buying the good.
So
what’s the catch? If you want to get people to buy things then you have to increase
the activity in the NAcc. Think about the prominent displays in duty free
stores for a minute. These are designed to appeal to your pleasure centre and
make it harder to stop yourself from buying something.
But
stimulating the NAcc is not enough; you also need to deactivate the insula. One
way of doing that is to postpone the act of paying. Credit cards, digital
currency or instant financing all contribute towards that end. Signs saying
“sale!” or “huge reductions!” achieve similar goals of inhibiting the insula or
convincing the PFC that this is indeed a great deal.
The
end result is the same. We end up buying things we don’t need and often cannot
afford, simply because the rational part of the brain loses out to the emotional
part.
Do
you have a problem with debt? Do you find yourself compulsively buying things
and later regretting? Then here is my advice: forget the cell phone, hang on to
your wallet and if you have to buy something, try and pay with cash.
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