The Cashless Effect

Digital payments do not only indicate a change in the method through which we perform our transactions; the cashless effect means that digitized transactions cause us to change our spending habits. We are much looser with our money when it only exists in an evasive digital form, and often spend money that we wouldn’t if we had to make the same transaction with physical cash.²

The cashless effect is dangerous because it can lead to overspending. We make large purchases on our credit card at ease, because we find it harder to understand the value of money when it isn’t tangible. We often forget that a credit card is literally a line of credit, that we later have to repay. The cashless effect, because we end up spending more money than we actually have, can quickly cause us to fall into debt. Apart from the financial downfalls of debt, research has also shown that individuals who have debt are twice as likely to suffer from depression and anxiety disorders.³

When transactions are digital, it also means that there is a digital trace of all of our activity. We lose anonymity and the ability to make discrete transactions.4 Platforms use our spending habits to hit us with targeted ads, causing us to spend even more money, demonstrating how the cashless effect can quickly bring us into a vicious spending cycle. The loss of anonymity through financial surveillance can also give a lot of control to the government and reduce our freedom.⁴

Essentially, most of the developed world now operates in a “cashless society”. While cashless societies have always existed, in terms of trading commodities instead of cash, in recent years, the term has taken on a new meaning. Our trading is almost entirely digital, with money only ever ‘passing hands’ through the Internet.¹ Bitcoin is the most recent evolution of our turn towards being totally cashless.

The ubiquity of using digital platforms for payments has only increased in light of the COVID-19 pandemic, with many retailers actually banning cash transactions in fear of the virus spreading through money exchanging hands.⁵ Outside of potentially helping reduce the spread of COVID-19, cashless societies also mean that the cashless effect is much more prominent today, and is impacting far more individuals. The fact that forms of payment are becoming more and more opaque, such as in the case of bitcoin, also suggests that the impacts of cashless effect will increase.

The cashless effect becomes a real problem when the individuals that are tempted to overspend do not have money. When individuals spend more because transactions are digital, they sometimes are unable to pay that money back. In America alone, consumer debt was close to 14-trillion in 2019.⁶ Not only does this have negative consequences for individuals, but because debt and financial problems can cause a lot of stress, it can actually lead to increased healthcare costs for the federal government.³

The cashless effect occurs because we don’t have as much difficulty parting with money when it isn’t tangible. It is actually considered painful for us to give up physical money, as we feel the loss of it, known as the “pain of payment”. ¹ This may be because physical money has more obvious value than digital payments, meaning we more readily understand what we are giving up.⁷

When money is exchanged digitally, it is harder to quantify what we are parting with. Giving someone our credit card feels like a far smaller commitment than handing someone wads of cash. Afterall, giving someone our credit card is just handing them a piece of plastic, which in itself, isn’t worth much.

Additionally, we often make short-sighted decisions without properly and rationally determining the long-term effects of our decisions (see the projection bias for more information on why we make decisions based on short-term tastes). If we pay in cash, we have to immediately give up our money. However, if we pay through a credit card or another form of digital payment, we have more time to come up with that money. It may feel like less of a commitment at the time, but the cashless effect makes us susceptible to being in debt.

Payment mechanisms should have no impact on our consumer behavior decisions if we are purely rational decision-makers. However, the cashless effect demonstrates that this isn’t the case; our spending habits change when we don’t have to pay in physical cash. Irrational purchasing decisions can have negative consequences, such as overspending, debt, and increased stress.

Cashless payments are so ubiquitous in our society, shown by discourse that suggests we are moving into cashless societies. It is therefore very important that we understand how changing our payment methods changes our consumer behavior, so that we can adjust accordingly. We may not be able to avoid using different forms of payment, but if we understand that digital payments detract us from making rational purchasing decisions, we can be more careful about how and when we spend our money. Being a little more diligent with our consumer behavior leads to more optimal decisions that better fit our budgets and financial goals.

Obviously, sticking to cash as a form of payment would absolve us from the cashless effect. However, this is not always a viable option. Some retailers and restaurants will not accept cash, whether that be to avoid the fees associated with cash-handling costs or to avoid the spread of diseases like COVID-19. It also isn’t convenient or safe to carry around large amounts of cash. So, what can we do?

We can use techniques that help us avoid overspending in general. That can mean creating a budget or taking a few days to sit on the decision to make a big purchase. When it comes to ensuring we don’t overspend on a credit card, we should try and spend according to the money that we already have in our account, rather than our credit limit. We can even lower our credit limit to more aptly match our monthly budget. Instead of using our credit cards as a way to be able to purchase things we wouldn’t be able to afford in hard cash, we should think about whether we would have bought the item otherwise.⁸

Another answer may be to leave our credit cards at home unless we specifically intend to go shopping. The cashless effect occurs in part because we never have to be prepared to make a purchase; there’s no need to run to an ATM to buy an expensive item, because we can just use our card. We therefore make rash spending decisions we later regret. If we leave our credit cards at home the majority of the time, we are less likely to make impulse purchases.

The cashless effect was first studied by Elizabeth Hirschman, a prominent theorist in marketing and economics, in 1979.9 Hirschman acknowledged that most research into consumer behavior rested in exploring why people spent, but she was interested in how people were spending their money, believing it could also give insight into consumer spending habits. She believed that people would spend more when using a credit card than if they were paying in cash.

Hirschman conducted her study by collecting data from surveys of consumer shopping in different branches of a department store chain. Field interviewers would ask consumers about the products they had purchased, and what method of payment they had used. After analyzing the data, Hirschman found that people who possessed either a store-issued card or a credit card made larger purchases than those people who paid in cash, and people who had both store-issued cards and credit cards spent the most.⁹

From these results, Hirschman concluded that using alternative forms of payments other than cash resulted in greater spending, although she never coined this the cashless effect. She also demonstrated that when we have more method payments available to us, we spend even more, suggesting the cashless effect will only increase as society comes up with novel ways to pay.⁹

Dilip Soman, a professor at the business school at the University of Toronto, believed that despite the recent proliferation of payment mechanisms, there was not enough research on how they were affecting consumer behavior. Following his interest in Hirschman’s study, Soman wanted to examine how and why using cashless methods affected purchasing behavior.⁷

In his study, Soman wanted to show that one of the reasons for the cashless effect was because when we pay with a plastic mechanism, like a payment card, the payment is less transparent that when we pay with cash and is, therefore, less painful. He wanted to show that different levels of transparency changed consumer spending habits, even for a small purchasing decision, doing their laundry.⁷

Soman completed a pretest questionnaire with laundry-doers, asking them whether they knew the benefits of separating their colors and whites in the laundry. While 95% agreed that it was better, 64% of those respondents said that they didn’t because they didn’t want to pay for two loads.⁷

Soman conducted his study in the laundry rooms of two apartment complexes. Previously, laundry had operated through a coin system, but they recently had changed to a prepaid laundry card system. In both instances, it cost $1 to do a load of laundry; the difference was only with the transparency of the payment, with coins being more transparent than the prepaid cards. Soman examined how many laundry-doers would separate their laundry now that there were prepaid cards.⁷

Soman found that when participants were paying in coins, 44% of them separated their laundry into two separate loads. In comparison, when they were paying with the prepaid card, 60% of participants separated their laundry. To dispel the effect of novelty, Soman went back to survey laundry-doers’ habits 16 months after the initial survey, and found that then, 65% of participants separated their laundry. From these results, Soman concluded that consumers spend more money when the payment mechanism is less transparent, such as in the case of the prepaid laundry card.⁷

Most of us have heard of Pavlov’s experiment, where a dog comes to salivate at the sound of a bell after that bell has repeatedly been rung when food is served. Although we may not be susceptible to drooling at the sight of food, us humans can similarly be affected by the association of stimulus to certain habits, and this may contribute to the cashless effect.

Richard Feinberg, a leading name in the international political economy, conducted a study in 1986 that examined whether credit cards, and credit card logos, acted as a spending stimulus. He believed that through repeated use, credit cards became able to elicit more spending. He thought that even the presence of a credit card logo would influence people to spend more.¹⁰

Feinberg conducted his experiment on 60 undergraduate students, split into two groups. Both groups were told the experiment was about attitudes to consumer products, asking them to look at pictures of various products and then later answer questions about them. One group, the experimental condition, saw credit cards stimulus next to the pictures of products, but were told it was not part of the current experiment.

After viewing the products, both groups were asked how much money they would be willing to spend on each product. Feinberg found that for each of the seven products that participants had been shown, those that had seen credit card stimulus consistently answered that they would be willing to spend more than those who had not. As such, Feinberg concluded that credit cards, or credit card logos, can sometimes produce supplementary spending reactions.¹⁰

Feinberg’s study suggests that one of the reasons the cashless effect occurs is because we associate credit cards with spending, and therefore are more easily prompted to spend money when using them.

What it is

The cashless effect describes our tendency to spend more money when we are using payment methods that do not require physical cash.

Why it happens

Many factors contribute to the cashless effect. There is thought to be less pain associated with using non-tangible forms of payment, such as a credit card, potentially because the transaction is less transparent. Credit cards also enable us to spend money we have not yet acquired, meaning that we are able to spend more than if we had to pay in cash. As we become used to using credit cards as a form of payment, it also may end up acting as a stimulus for spending.

Example 1- Cashless effect and small purchases

It is understandable that using credit cards or other digital forms of payment makes us more likely to make big purchases, since we may not already have the money in our accounts. However, it has been shown that the cashless effect occurs even for purchases as small as $1, and for simple day-to-day purchasing activities, like doing our laundry.

Example 2 - Credit cards as a stimulus for spending

Even a logo of a credit card company could be enough to induce the cashless effect. As we become used to using our credit cards as a form of payment, we come to associate credit cards with spending money. As a result, when we see credit card paraphernalia, we may spend more money, as the credit card acts like a stimulus just like the bell does in Pavlov’s study.

How to avoid it

It is hard to avoid using digital forms of payment in our modern society. More practical advice may be more similar to any techniques used to avoid overspending, such as creating a budget and try not to make rash decisions about large purchases. One way to avoid making impulsive purchases on our credit cards would be to leave them at home unless we know that we need them. To make it easier to stick to our budget, we can also set our credit limit to reflect how much we want to spend in a month.

This is Your Brain on Money

In this article, our writer Fahima Mohideen, a graduate student in Applied Psychology, explores the different ways in which our purchasing decisions deviate from rationality. She explores the way that we create mental accounts of our money, instead of understanding that all money is the same. She attributes these mental accounts to being one of the causes as to why we treat purchases made on a credit card differently to purchases made in cash. Mohideen also outlines another study that demonstrates the cashless effect, where people were willing to pay more money for auctioned tickets to sporting events when they were using a credit card.

How Scarcity Affects the Working Poor

If you were interested in how digital forms of payment are a form of discrimination against the poor, you should take a look at this article by Arash Sharma, who is involved in behavioral business research. In the article, Sharma explains how credit cards, and strategies banks implement using them, can be crippling to low-income individuals.