Housing demand – a role for status concerns?
January 27, 2011 Leave a comment
Housing is a complex commodity. Economists think about the demand for housing as having both a consumption and an investment component. Trying to integrate the two components is a challenge. But is this approach sufficient? Economists differ in their views on the success of conventional approaches to understanding housing markets, particularly in the light of the recent experience of the house price crash. There is enough debate to suggest that exploring new angles could be valuable. More specifically, does the analysis of housing demand need to embrace social status concerns?
Interest in status concerns as a driver of demand is by no means new or novel. It is most likely self-evidently important for those interested in the sociology or anthropology of consumption. Even in the economics community it is an issue that has recurrently, albeit intermittently, attracted attention.
We are currently in an exciting period for economics. Those working in many branches of the discipline are open to exploring the consequences of breaking away from the traditional atomistic vision of the economic agent. The impact of interpersonal influences on demand has emerged as a significant strand of research.
This has been influenced by the so-called “happiness” literature, on the one hand, and the rise of behavioural economics, on the other. A central concern in the happiness literature is the Easterlin paradox, originally identified back in the 1970s. The paradox is that rising real incomes should, according to standard theory, deliver higher levels of welfare because people have more money to spend on stuff. But time series data suggest that while, on average, real incomes in industrialised countries have risen substantially in the post-Second World War period (except perhaps in Coalition Britain!), average happiness scores have not improved correspondingly. Yet, if we look at populations in cross-section we see that those who are relatively wealthy report higher levels of happiness/well-being than those who have relatively low incomes. A conclusion drawn from this observation is that relative, more than absolute, income drives well-being. At the same time, behavioural economics identifies a broader range of reasons for economic decision-making departing from standard neoclassical economic assumptions about rationality. These can include the importance of reference levels in shaping consumption choices. Of course, introducing reference levels raises the question of how reference levels are formed and who the relevant reference group might be.
But these are not new concerns. For example, in 1848, in his Principles of Political Economy, John Stuart Mill argued that:
a great portion of the expenses of the higher and middle classes in most countries, … , is not incurred for the sake of the pleasure afforded by the things on which the money is spent, but from regard to opinion, and an idea that certain expenses are expected from them, as an appendage of station. (Book 5 Chapter VI.2)
Leibenstein, some sixty years ago, offered us the distinction between functional and non-functional bases for consumption. Functional consumption refers to the characteristics of a good or service that fulfil the needs and wants of consumers. Non-functional consumption refers to the range of other reasons for consumption that do not relate directly to the needs the good satisfies. This can include so-called snob effects – where consumption benefit is enhanced by exclusivity – and Veblen effects – where consumption benefit is enhanced by paying a relatively high price for ‘premium’ goods. And it is now more than thirty years since Hirsch identified the importance of the ‘positional’ economy, alongside the material economy. In the positional economy a component of demand again relates to exclusivity. But here the definitions can be more fundamentally relative and socially defined. We cannot all live in the ‘best’ neighbourhood, and if we want to live there then we are going to have to pay for the privilege. If more people seek to access this positional good it will push the price of relative position higher, thereby reinforcing exclusivity.
So clearly there are ideas out there in the ether of economic thought that speak to the issue of relativities and social status. But is there any reason for thinking we can usefully put them to work in the analysis of housing markets?
I think we might identify several reasons. Here I’ll just mention a few.
We are all familiar with the phenomenon of households who are obsessed with what is colloquially known as ‘keeping up with the Jones’. This is nothing more than a example of the importance of interpersonal (peer group) influences on consumption and the way in which one’s reference levels for consumption is defined dynamically. The consequence of ‘keeping up with the Jones’ is to stimulate changes in housing demand not for ‘functional’ reasons but for status reasons. Because each household forms part of someone else’s peer group, if they move they can trigger others who are concerned to ‘keep up with the Jones’ to move in response.
We are not great at explaining the turning points in the market – why booms and recessions end, why upswings turn to downswings and vice versa. A typical explanation would point to economic fundamentals – affordability deteriorates as prices increase to the point where the market stalls, while in a recession price-income ratios eventually improve sufficiently to tempt households back into the market. But we might suggest that status concerns could have a role to play in this story. At the bottom of the market affordability has improved. This suggests to the ‘Jones’ that want to move ahead of their peers that it is a good time to enter the market and improve their relative housing position. This in its turn could trigger a process of ‘retaliatory’ moves by status conscious peers. But it could also trigger moves by households who are not interested in status per se but spot that prices are moving upwards and think they’d better enter the market before they are priced out. Or those who feel they lack information: if the market starts to move it is a signal to them that it is time to act, because they assume others are better informed about the trajectory of the market.
Finally, if housing is a key indicator for social status – which, given its relatively costless observability, it is likely to be – then it is likely that in an economy populated by status conscious economic agents resource allocation will be distorted, leading to the over-consumption of housing. This, in turn, has non-trivial environmental consequences. It also has consequences for things like labour market participation: status conscious households worried about falling behind their peers work longer and harder, taking on second jobs within the household, in order to obtain the resources to maintain relative position. It results in what has been termed ‘the positional arms race’. This is an argument that the economist Robert Frank has developed in a number of publications from Choosing the Right Pond onward. A solution typically advocated is an expenditure tax on those goods acting as status signals. The aim is to try to attenuate the non-functional component of demand.
These are some examples of issues that I think it would be well worth devoting a bit of time to exploring further in the housing context. There are big challenges in the empirical identification of such status concerns, alongside the myriad other influences on housing demand. We lack the right sort of data, and some of the techniques to conduct the analysis are still in the process of elaboration. But that’s not a reason to avoid engaging with the challenge.
Note: You can find a powerpoint presentation associated with this argument here (Cardiff – Social status and the demand for housing 27-01-11 2003) It gives a bit more detail. It was prepared for an academic audience.