Digital advancement and the cashless effect

Chyung Eun-ju

Joel Cho

By Chyung Eun-ju and Joel Cho

After three years of lockdown caused by the pandemic, spending has started to come back to pre-pandemic levels.

Among the effects of the pandemic was an increase in online transactions. As we were forced to stay indoors, offline shopping became extremely limited. Inadvertently, we fell into a routine of online shopping. Consequently, the market had to adapt to this forced change in behavior, and a spike in e-commerce investment took place.

This change in our behavior and market environment seems to have accelerated the cashless effect. In brief terms, the cashless effect infers that we are more likely to spend money and make a purchase if the payments being made are less tangible.

According to Drazen Prelec, a professor at the MIT Sloan School of Management and George Loewenstein, an economic and psychology professor at Carnegie Mellon University, when consumers make a purchase, they experience a pain of payment, also known as a "psychological burden of payment," or a "hedonic cost." When the pain of payment increases, the willingness to pay decreases. For instance, when consumers use a more painful mode of payment, such as cash instead of a credit card, they tend not to spend as much. With cash payments, consumers must physically part with cash during the purchase and can tangibly see the amount being spent.

Classic economic theory states that the utility of a consumption experience depends on the sum of the experience's benefits minus the associated costs. Thus, paying less money, in general, would increase our satisfaction, because of the pain of payment. So, if we feel less pain of payment with online payments, it is important to take into consideration what the repercussions will be.

Nowadays, practically anything we want to buy can be found on the internet. With social media platform giants integrating marketplaces into their platforms, supermarkets adopting e-commerce and even companies setting up virtual shops in the metaverse, we have a plethora of digital stores to meet all of our everyday demands. This has pushed us to an era of digital transactions, where the payment method is non-tangible and overspending becomes easier and more likely.

In this cashless society we are living in, the pain of payment has become lighter, as we do not have to participate in a physical transaction involving cash. The idea that we feel less pain of paying when it involves forms of transaction other than cash has already been intensely studied.

"Several researchers have suggested that the mode of payment can influence the pain of payment. Based on their model of hedonic mental accounting, Prelec and Loewenstein (1998) posited that paying in cash elicits greater pain than paying by other modes of payment even when the modes are normatively equivalent," stated the researchers Manoj A. Thomas, Kalpesh Kaushik Desai, and Satheeshkumar Seenivasan. Indeed, cash is the most painful form of payment according to New York University professor, Priya Raghubir and Temple University professor, Joydeep Srivastava.

The effect of our changing spending habits poses the danger of falling into a path of overspending. It is not a coincidence that we find ourselves increasingly scrolling through social media, seeing an ad that has been targeted specifically for us, and purchasing the advertised product at the simple click of a button.

The act of paying has become almost painless in the digital world. Even the need for physical cards for payment has been eliminated, with our cards registered in our e-wallets, everything is happening digitally.

We are not, of course, ignoring the fact that the sensitivity to the pain of payment has a universal standard. However, the fact that digital transactions are becoming more and more ingrained in our routine, has definitely impacted the general population's spending habits.

Right now, the metaverse is an early adopter but once it is adopted by the majority, most of our shopping transactions may occur there. McKinsey & Company estimates the yearly global spending by consumers and firms regarding the metaverse may increase to $5 trillion by 2030. With all the interactivity, personalization and inclusivity the metaverse offers, the shopping experience may become a perfect getaway to temporarily forget about our budgets and spending limits.

As inflation has rippled through South Koreans' wallets for over a year and the economy faces uncertainty, we have to be even more mindful of our spending. South Koreans in their 20s and 30s have been borrowing larger amounts of money and as a result, falling into more debt. The larger amount of credit card debt and increasing rates indicates South Koreans are spending more than they think they are, which means they will be put in an even costlier debt. As our purchases move online, we have to consciously account for what we spend and not avoid the unpleasant pain of payment, as it may be the one emotion that can help us spend only what we can afford.

Chyung Eun-ju (ejchyung@snu.ac.kr) is studying for a master's degree in marketing at Seoul National University. Her research focuses on digital assets and the metaverse. Joel Cho (joelywcho@gmail.com) is a practicing lawyer specializing in IP and digital law.