Unleashing the Consumer Class

Engel, Wedgwood, beer, and Why Relative Income Matters

Unleashing the Consumer Class

Open an introductory economics textbook, flip to the section on the theory of consumer choice and demand, and you will find a curve – the Engel Curve – well known to economists and, at least for a few months or so, students. It depicts the relationship between income and consumption. The vertical axis is labeled income, the horizontal is the name of a consumable good, and together they describe a direct relationship between the two. The more (or less) income you have the more (or less) you demand that good.

Consider the special case of food, otherwise known as Engel’s Law. As income rises, the proportion of income spent on food will fall. The same insight was generalized to other goods and gave birth to the economic notion of elasticity.

 

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Ernst Engel – not to be confused with Friedrich Engels – was born in a separate German state a year after his revolutionary counterpart. He experienced firsthand the revolutions sweeping Europe in 1848, the last and one of the most violent of which took place in 1849 in his hometown of Dresden. After the turmoil he accepted a position in the Kingdom of Saxony’s statistical bureau with the goal of uncovering quantitative social laws – something the government desperately needed to understand.

The bureau asked Engel to examine the relationship between business and labor. While reviewing the budget data of Belgian working class families he noticed something interesting. The less income a family has the higher the proportion spent on food. The more money a family has, the less they spent on nourishment. The conclusion still stands a century and a half later. Indeed it is used to define poverty.

When economists debate poverty, they speak of poverty traps and S curves. The latter measures the income someone may expect to have in the future given the income that person has in the present. If they fall below some absolute income threshold – say $1 to $2 per day – their future income will likely fall, or at least they are unlikely to ever pass above the income threshold. But if they are on the other side of that threshold – at the middle of the “S”– then the S-curve begins to look more like an L-curve. Over time, they will progressively move up the curve, earning more and more income. And at some point, they will have enough money that it becomes disposable, meaning the proportion of income spent on necessities such as food decreases and they shift spending to wants, including other consumer goods.

In other words, they become middle class. So when international consulting companies or development banks laud the rise of the middle class, or the 3 billion new consumers, they refer to the people sitting on the right side of an absolute income threshold and who are moving up the curve. They are implicitly saying that that there will be less poverty. Why? Because economists implicitly relate consumption to living standards and living standards to per capita income, a path (or curve) that Engel originally blazed.
The poverty S curve represents the traditional economic theory of consumer behavior found in introductory textbooks. People who fall below some absolute (purchasing power parity adjusted) income level may be considered poor. Those above it move into that golden zone of the new global consumers. Such a perspective implies that consumption – or at least discretionary consumption – does not exist for a certain percentage of the global population. Below the line, they are poor. They don’t consume, or at least not in the way that makes consumer goods companies view them as potential buyers of their products.

Such a perspective implies that consumption – or at least discretionary consumption – does not exist for a certain percentage of the global population. Yet we know that this is not the case. After all, poor Charlie Bucket in Roald Dahl’s tale still ate the Willy Wonka chocolate bar. The poor in the Philippines don’t eat just eggs and bananas. Economics textbooks might lead us to think that people only indulge in discretionary consumption once they have satisfied their basic needs – for food, shelter, clothing, fuel.

“Such a perspective implies that consumption – or at least discretionary consumption – does not exist for a certain percentage of the global population.”

The consumption or use of material goods has existed since our species roamed the plains. Hunter-gatherers ate, drank, wore items and groomed. The accumulation of materials goods – and the explosion in private property – began with the advent of farming and human settlements, roughly 11,000 years ago. We know of the existence of trade since the earliest times, and this shows exchange of wanted, not just needed, material goods. Artifacts lying in Greek shipwrecks at the bottom of the Mediterranean testify to the existence of household goods, of trade and accumulation.

But modern consumption is quite different to how it was in Homer’s time. Modern consumption begins when masses of individuals and households enter more fully into cash economies, when they begin to rely on earning a wage that they then must use to buy a basket of goods that they can afford. When life becomes so much about earning money, then absolute income becomes a hugely relevant concept, and it becomes possible to draw clean economic curves that describe modern consumption.

Status predates money and the purchase of market goods, but not consumption.

Status predates money and the purchase of market goods, but not consumption.

Josiah Wedgwood was among the first to learn this lesson at the dawn of the Industrial Revolution. Born in 1730 into a family of potters from the village of Burslem, outside Birmingham, Wedgwood learned his trade through work in his fathers then his brother’s then in an independent potter’s workshops. Having suffered from a childhood illness that left him with a pockmarked face and a gimpy leg – prompting amputation below his knee in adulthood – Wedgwood’s apprenticeship focused more on the mastery of design. Not until his late 20s did he start his own workshop and hire a handful of employees.

On the eve of the Industrial Revolution, an industrious revolution was already well underway. Household consumption of tea, sugar and even chocolate (then just a drink) as well as linens, cutlery, furniture and clocks grew steadily. It was only natural that these new consumers wanted to serve their tea and sugar in porcelain earthenware and place them on a table covered with a linen cloth, and sit in chairs beneath a clock. A few middleclass (or middling class) was forming. And with the purchase of these new goods, consumers sought novelty. People even wanted to be hung in new ways, Samuel Johnson quipped.

Wedgwood studied these trends, detailing his thoughts in personal logbooks. He thought about manufacturing innovations: how to improve the colors and prints, strengthen the pottery, reduce distribution costs. He eventually learned how to print intricate scenes onto a creamware surface, resembling porcelain but hardier. By the early 1760s he recorded ideas for how to improve his workshop’s productivity, since he lacked the capacity to keep up with demand for his goods. He expanded to six workshops with 16 employees. But it was not enough.

After investing in a 350-acre estate where Wedgwood built a home and a factory, he soon found himself in a reverse dilemma. He had lowered the costs of production and had excess capacity, while competition in the marketplace became ever more fierce. The sale of china grew in England’s new and growing urban centers – Newcastle, Liverpool, Bristol, Birmingham, and, most of all, London. He needed to find a way to better market his goods, to distinguish his products and make them desirable for a larger percentage of the population. At first he opened showrooms. But Wedgwood needed something more. His answer: appeal to status and, given social mobility, exploit the notion of relative income. His answer: appeal to status and, given social mobility, exploit the notion of relative income.

First, Wedgwood created a brand. With the exception of luxury brands like Chippendale furniture or Meissen porcelain, household goods weren’t known by their manufacturer’s name at the time. And even though the middling class may have known the name Chippendale, they lacked the absolute income to buy such goods. This didn’t mean that they didn’t aspire to owning them. There was a “perpetual restless ambition in each of the inferior ranks to raise themselves to the level of those immediately above them,” said one Englishman at the time. Wedgwood understood the consumer’s motivations. He needed to imprint his product with prestige. So he put a name – his name – all over it.

But Wedgwood also needed to define the status of the brand. He manufactured a special breakfast set and in 1763 gave it to Queen Charlotte, wife of King George III. A couple of years later she purchased a tea set and he was named “Potter to Her Majesty.” Wedgwood creamware became known as Queensware. Orders from aristocrats followed. In Wedgwood’s own words, they were the “legislators of taste.” He even came to name lines after his aristocratic clients.

Endorsements in hand, he then advertised in papers, promising the chance to possess a piece of noble prestige at more affordable prices. Wedgwood knew that from business perspective, his profits lay not in expensive and time-consuming commissions for the nobility. “The Great People have had their Vases in their Palaces long enough for them to be seen and admired by the Middling Class of People, which Class we know are vastly, I had almost said, infinitely superior in number to the Great,” he wrote.

Consumers were willing to pay premium prices and Wedgwood knew this. His prices were on average double that of his competitors. He was careful to manage the difference, and he intuited the Law of Demand still being worked out by political economists. Lower prices will increase the quantity demanded. This is the influence of absolute income. People have limited budgets, and the lower the prices the larger the number of goods they can buy. But Wedgwood also understood the law of Relative Income, which mainstream economics has yet to fully integrate into its theoretical apparatus. “Low prices … must beget a low quality in the manufacture, which will beget contempt, which will beget neglect, & disuse, and there is an end of the trade,” he said

Matthew Bird is a Professor in the Graduate School of Business at Universidad del Pacífico. He was formerly a Research Director for the Advanced Leadership Initiative at Harvard University and a Research Associate at Harvard Business School. He received his Ph.D. from the University of Chicago.

Matthew Bird is a Professor in the Graduate School of Business at Universidad del Pacífico. He was formerly a Research Director for the Advanced Leadership Initiative at Harvard University and a Research Associate at Harvard Business School. He received his Ph.D. from the University of Chicago.

The price of a good signals quality and prestige. Given their aspiration and yearning to emulate those above them in absolute income terms, people are willing to spend just a little bit more to access those goods. The Law of Demand is thus reversed in relative-income terms. In some cases, higher prices increase demand.

Centuries later, Wedgwood’s mass-produced goods for the middle classes would become antiques. They would be found in American garages and fetch tens of thousands of dollars. This was not the last time that the power of status and the influence of relative income would apply, even in absolute terms, to the middling or the poor.

Diageo, the British multinational drinks company and owner of Guinness, launched a bottom-of-the-pyramid beer in Kenya. The company intended to make a cheap beer that cut into the market for homemade and illicit brews. Diageo differentiated the product by tapping into consumer aspirations and thirst for status. They named the beer “Senator.” It launched at a price point just above that of illicit brews in late 2004, when a little-known American politician, the son of a Kenyan native, won a US Senate seat. Senator was an immediate success. The poor, the many consumers of Kenya, were willing to pay the premium. Soon the beer became known as Obama beer, and sales continued to soar. After Obama won the presidency in 2008, the brewery relaunched the brand: President.

Workers in Kenya in 2008, just like ones from Bristol in 1760, desire these everyday luxuries because despite their limited absolute income they still have a need for a pleasant life. They want these consumer goods because despite their limited absolute income they still compare themselves to others – to those whose income bracket is immediately above theirs – and aspire to more. This consumption is not something that comes when they surpass an absolute income threshold. They were already consumers.

When considering the consumption boom associated with the globe’s bourgeoning middle classes, it is tempting to think about it as billions of people crossing an economic threshold. For the first time they have the disposable income to buy discretionary goods. We’re told: Consumption is born. But that is not accurate. Consumption is unleashed. Instead of passing an absolute income threshold, people express their relative income on a new scale. Instead of moving from needs to wants, they act out their lifelong needs and wants in new ways.

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