Credit Cards and Pain of Paying
By Adrian Pedroza
Credit cards are on the rise, and with increased competition by major suppliers in the credit card industry offering generous rewards and enticements to attract consumers, applying for and receiving credit has perhaps never been easier. Noting that the average American has four credit cards, it should not be surprising that credit card debt per capita has increased by 1,500 percent between 1980 and 2010.
One might now ask what is the driving force behind this rapid expansion in credit card debt; to that, there are many explanations. However, one that appears to be particularly significant is the decreased pain of paying, a phenomenon explored profusely in the realms of behavioral economics and finance, which refers to “the psychological discomfort experienced when parting with one’s money.” The Atlantic illustrates how “at one extreme would be painstakingly counting out each penny at the register … and near the other would be credit cards.” This difference in psychological discomfort plays major roles in the magnitude of consumer spending. As first published in The New York Times and then in The Atlantic, studies found that “in certain contexts, people were willing to pay up to twice as much for the same item when paying with a credit card instead of cash." Professor Richard Feinberg of Purdue University even found in a 1986 study that “simply seeing a credit-card logo was enough to make people willing to spend more money on a product.” Perhaps the issue of such extremity in these findings is that consumers tend to believe they are immune to these effects, that it is impossible their rational mind would fall for such deception. They find comfort in telling themselves they would never be like those experimental subjects that were willing to pay $60 using a credit card when cash users were only willing to pay $30 for the same tickets. After all, it is easier to consider ourselves immune to these psychological effects than admit to our mental shortcomings.
While solutions have been explored to combat our mental fallibility, most would require the help of major credit card companies, which have their business models revolving around consumers spending more, making them reluctant to contribute. As a result, responsibility falls to the individual, and we, as consumers, must take action. An essential first step is coming to terms with our shortcomings, acknowledging that we are imperfect and are not the perfectly rational “homo economicus” many economics textbooks make us out to be. We are flawed, and there is no disputing that fact. Therefore, we can either let our irrationality work against us or in our favor. If we know that a decreased pain of paying, partly attributed to the rise of credit cards and electronic payments, causes us to spend more, then we should theoretically be able to get ourselves to spend less by increasing our pain of paying. One simple way to do this, as suggested by behavioral economist Dan Ariely, is to make a spending list, which makes us more conscious of our everyday financial choices. After reporting a story regarding the pain of paying phenomenon, reporter Joe Pinsker decided to take his financial health in his own hands. He illustrates how, after every purchase, he would “log the transaction on [his] phone, recording the price and what [he] bought.” Later, after looking at past bank statements, he found that his “monthly discretionary spending dropped somewhere between 10 and 15 percent in the five months after [he] introduced this system,” a significant result for such a simple task.
A study by Moody’s Analytics noted that “increased use of electronic payments added 0.8% to GDP across emerging markets and 0.3% for developed markets.” Intuitively, it makes sense that an increase in consumption due to lower spending friction would benefit economic growth. However, the natural question we have to ask is at what costs? A 2018 report by the Federal Reserve has highlighted that “if faced with an unexpected $400 expense, 4 in 10 adults said they would not have the money to cover it.” This figure is scary, highlighting the extreme financial instability of American adults, who only saved approximately 7.6 percent of their income in 2019. For comparison, the national savings rates in Singapore and China in 2017 were 48% and 47%, respectively.
According to Investopedia, “most experts say your retirement income should be about 80% of your final pre-retirement salary.” Therefore, an individual making $100,000 at retirement would ideally require an annual income of $80,000 to maintain a comfortable lifestyle in retirement. As noted by US News, the maximum possible Social Security benefit in 2020 with collection beginning at the full retirement age of 66 is $3,011 per month, or approximately $36,132 per year. The difference between Social Security benefits and one’s ideal retirement income should in theory be covered by retirement savings. However, a study by the Economic Policy Institute found “that Americans 56 to 61 had a median balance of $21,000 in their 401(k) accounts in 2016,” which reflects approximately 30 years of saving. With the typical American spending “about $3,900 a month [in 2018] on basics such as food, housing, utilities, transportation and health care,” it is clear that we have what can be considered a savings crisis. Only exacerbating this lack of retirement savings is our aging population: “the number of Americans ages 65 and older is projected to nearly double from 52 million in 2018 to 95 million by 2060,” which will put additional pressure on the federal government to sustain Social Security benefits to a population with very minimal supplemental retirement income.
An economy’s health can only be as good as the wellbeing of its individual participants. Thus, individual financial health must become a priority. Clearly, our demand for more convenient payment methods comes with, to some degree, less financial responsibility. Just consider, would it be easier to part ways with $27 counting out physical bills from your wallet or through a few clicks on Venmo? Is it not easier to forget and mentally diminish the magnitude of a purchase made with an electronic transfer than with cash? Just imagine how psychologically painful it would be to pay for a new car with cash; maybe then we would step back and take the time to fully consider our opportunity costs and if we can afford the purchase without significantly undermining our future self. Without the help of credit card companies, who profit from more spending by the consumer, or politicians, who take credit for and thus encourage increased GDP during their term, we, the individual, must protect our future self financially and be more conscious than ever of our spending behavior in a world that will only make it easier and easier to spend now, not later.