Duesenberry Effect

Despite being mysteriously ignored and displaced by mainstream consumption theories, Duesenberry’s relative income hypothesis is highly relevant to contemporary societies where individuals are increasingly obsessing over growth. What makes it so difficult to overcome this obsession?

One challenge seems to have something to do with wrong assumptions and is demonstrated in the Duesenberry Effect. It observes that consumer spending is driven by social psychology, not rational calculation, despite classical economists insistence on consumers being rational agents. According to Duesenberry, instead of looking purely at absolute bank balances, people base their expenditures on two benchmarks: their own historical earnings and the consumption of their peers. Because humans are inherently social and status-driven, to maintain self-esteem, we experience intense psychological pressure to emulate the habits of our social circle. Even if your income rises but your neighbour’s grows faster, most people feel poorer and increase spending to catch up. Secondly, once someone experiences a higher income, what felt like a luxury before quickly upgrades into permanent psychological necessity. When a recession strikes, the psychological pain of downscaling causes people to fiercely maintain their standard of living. Instead of cutting back, they drain savings or accumulate debt. Duesenberry effectively modernized Thorstein Veblen’s concepts of status consumption into a universal behavioral law. In 1974, the Easterlin Paradox empirically validated Duesenberry’s model by proving that as a nation’s average income rises over decades, overall happiness doesn’t increase. At a certain level of affluence our relationship with growth is almost purely a psychological and social need. We consume the planet because we compete with our neighbours, not because we don’t have enough.