The Heavy Cost of False Signaling
I have previously admitted my affinity for the field of academic economics. Not that I’m a scholar in the field—far from it—but whenever I encounter a concept or principle in economics I am usually struck by the beauty of the logic that is used to predict outcomes. This is so even though we now know that in practice this academic thought process is mostly useless since very few people behave in reality like the emotionless, unfailingly rational academic test-subject referred to as Homo Economicus. Nevertheless, a topic that I’ve been thinking about a lot recently is what economists refer to as “signaling.”
Signaling can of course have many meanings and applications in different fields and contexts, but I’m using the construct of the academic economist here. In this context, a simplified summary of the concept of signaling is when two parties to a potential transaction have an asymmetry of information—that is, one of the parties (maybe the seller of goods or services) has more information about the product than the other (maybe the potential buyer of the goods or services). In order to facilitate the transaction, the party with the superior information undertakes to do something that sends a signal to the other party. The signal is credible because in theory it is something that the signal-sender could only do if the message were credible, and it thereby facilitates a transaction between the two parties because it allows the party that is information-deficient to overcome the disparity of information and move forward.
An often-used example is the college degree. Employers are the buyer and the job applicant is the seller (of his services as an employee). The employer can only learn so much about the applicant’s true nature, skills, and work ethic through the interview process, so the college degree has at times served as a helpful signal to the employer. One that says of the applicant: “I’m competent, I’m hard-working, and I’m reasonably intelligent. Otherwise I would not have been able to graduate from Acme U with grades like these.” (I’m putting on the growing list of topics for future posts the issue of whether college degrees adequately serve this signaling purpose any longer.)
When this complex signaling machinery works as designed and intended, all of the market participants benefit. The employer gets a good worker with minimized transaction costs, the applicant gets a job that justifies the years of work and expense related to college, and the highest-skilled workers fill the available job slots. Done and done.
Bad Results from (In)Credible Signaling
But there’s a problem: we have become a culture that encourages and regularly engages in false signaling. Today it seems that more often than not, those individuals that go out of their way to signal to others that they possess a trait or status very rarely actually do. Two false signals that really chap my ass:
—Virtue signaling. This used to be predominantly the province of politicians, but the practice of sending signals indicating your great personal virtue are now rife through our society. Now when I hear someone touting their own personal virtue (implicitly or expressly) I usually conclude that they likely have none. None at all.
There’s a residential electrician services firm in my area that has a slogan that includes the phrase “the honest one,” and it uses this language in its radio jingle and other branding. Every time I hear it this is how I translate the message from this service-provider: “look, we know that everyone in this industry is dishonest, so you must know that too. So if we declare that we’re the only honest one, then surely we’ll get the work.” Well, I don’t presume that everyone in the industry is dishonest, and if you do it must be because you are dishonest. Thanks for telling me up front.
—Wealth signaling. Of course this was where we were going. If you buy a $100k Range Rover and don’t have at least a six-figure balance of cash money sitting in appreciating assets somewhere else, you’re signaling wealth that you don’t have, plain and simple.
In the case of both false virtue and wealth signaling, the irony is that the signal itself belies the veracity of the assertion. If you are truly virtuous, then by definition you are not vain and don’t need the acclaim of the public to feel good about your virtue. You would be virtuous even if no one else could know; in fact you would prefer that no one else knew.
Similarly, the act of ostentatiously displaying the consumption of your income by definition means that you have less wealth than you would have had if you had not consumed that income. Yes, the truly wealthy do signal their wealth too, but here we’re talking about the ordinary Working Joes that we rub elbows with every day. Remember the very telling stat from The Millionaire Next Door: roughly 80% of luxury car drivers do NOT have $1 million in net worth. (That’s a ballpark recollection of the statistic; I’ll get the Trapped In Work fact-checking division to verify that ASAP.)
The sine qua non (or “without which not”) of textbook signaling in economics is that the signal is an act, accomplishment, or communication that the signaler could only pull off if he did in fact possess the trait or quality that was being signaled. He can’t fake it—at least not without incurring prohibitive costs that are contrary to his own self interest.
And here’s the rub: our culture appears to be encouraging individuals to send false signals, thereby incurring prohibitively high costs that impair their interests for far into the future. For the fraudulent virtue signaler, the cost is simple enough: when you are discovered to be a fraud—and it’s a question of when, not if—you will lose all credibility. It will take years to regain the trust of those that you previously deceived, if you are ever able to do so.
For the bogus wealth signaler the cost is a bit more complex, but similar in its final effect: borrowing from tomorrow’s earnings to fuel ostentatious consumption today will put you in a vice that you will likely spend years trying to wiggle out of. Incurring debt to finance signaling consumption in the form of cars, boats, houses, whatever, often puts you at odds with the compound-interest machine—a force that, much like gravity, is terribly difficult to overcome.
Homo Economicus is a completely logical and rational being. One that weighs all of the costs and benefits associated with various options and impartially selects the one with the greatest net benefit. But the vast majority of our peers are choosing to act irrationally. Taking on wealth-prohibitive debt and voluntarily forfeiting one of their greatest wealth-building assets—long stretches of time for invested money to grow—in order to strut and fret on the stage and falsely signal their financial accomplishments to each other before they are actually financially accomplished. As a result of this false signaling they receive (presumably, even though I don’t understand it) the acclaim and admiration of their peers who are all doing the same thing. And the cost is that they are perpetually on unsettled financial ground, one lost paycheck away from ruin and therefore trapped in work as an unwitting yet voluntary indentured slave.
But while the actors playing the part of Homo Economicus fail to achieve the normative objective of behaving with perfect rationality, the economic theory executes with ruthless efficacy. Because a signal was sent that should not have been sent, the irrational actor bears the exorbitant cost of the signal.
Counter-Signaling?
While doing some light reading in the process of thinking about some of these topics I came across the concept of counter-signaling. When an individual reaches the highest levels of the quality or trait to be signaled, he may decide to implicitly prove this status by not signaling at all, thereby distinguishing himself from all the other mediocre signalers. In effect, as wikipedia describes it, he is showing off by not showing off. One stated example, interestingly, is how “old money” will often forego as gauche the lavish spending on ostentatious luxury items that are often the trappings of the nouveau riche.
Now this is an interesting concept, and certainly one that I find less irrational than false signaling. No doubt there are some FI-ers out there who flaunt their frugality while also ensuring that their wealth is somehow otherwise publicly understood, thereby engaging in a form of counter-signaling. I’m exploring the option of trying to convince Mrs. JF that the $3 t-shirts that I buy at the arts & crafts store and wear just about every day (and that she hates) are really a form of counter-signaling to our peers how truly wealthy we are. I’ll let you know how that discussion goes.
In Opposition to Wealth-Signaling of Any Sort
It seems to me that when it comes to wealth the best answer is to forego signaling of any sort (except in those rare occasions when it is economically necessary because of information asymmetry and the need to send a credible signal). False signaling is irrational and leads to adverse long-term financial outcomes. Counter-signaling, while superficially attractive, is ultimately petty.
To the false signalers: why would you want anyone to think you’re wealthy when you’re not? To the credible signalers and the counter-signalers: why would you want anyone to know you’re wealthy when you are? When you advertise your wealth—credibly or otherwise—you are simply making yourself a target for poison to be served in a gold cup.
So I encourage you to behave rationally. Avoid signaling at all, except when absolutely necessary and when it can be done credibly. There are very few occasions where wealth needs to be signaled. And if you find yourself compelled to signal wealth to those around you, at least wait until you have actually achieved it. If you don’t, you may never get there.
Epilogue: Speaking of poison being served in gold cups (and maybe involuntary wealth signaling), as I was writing this I recalled with a smile a strange and frequently occurring phenomenon from my days at the law firm. My prior firm was a large, international “white shoe” firm that was on every publicly available list of big, rich law firms. And the firm has a website where the pictures, bios, and contact info for all attorneys is public. As a result, at least once every week or two, I would receive a cold call from a different “Wall Street broker” seeking to sell me on the latest hot stock tip or investment strategy. It was entertaining to listen to their fast-paced pitch; I presume that they knew that they had little time to try and boat the bass (and yet they kept calling; odd). At any rate, with my name and face no longer on the website, alas, no more calls from Barry on Wall Street. He’s trying to serve poison to someone else.
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