In his latest column in the New Yorker, financial writer James Surowiecki reports the return of a retail phenomenon not seen since the Great Depression: the layaway purchase. Before the financial crash, the default payment mode for consumers was the credit card. Buy now, pay later. Now, as the financial crunch continues to pinch pockets, more stores are offering layaways. Here's how they work:
You pick out the product you want, make a down payment, pay a service fee (typically five dollars), and then make regularly scheduled payments over a period of time until you’ve paid off the full price. There are no interest payments, and if you don’t make all the payments you get your money back, minus a cancellation fee. It’s the exact opposite of installment credit, where you get the product, and then pay for it.
According to standard economic theories, Surowiecki explains, rational consumers would not choose the layaway. Why not simply save enough money in a bank account and then head to the store? Or why not use your credit card and pay the balance in a sustainable manner? But Surowiecki cites RSF-funded research in the field of behavioral economics to explain the appeal of layaways:
But in the real world most of us rely to some extent on what the economist Richard Thaler calls "mental accounting"—we split our money into different mental accounts, and treat it differently depending on what account it’s in. Money that’s in the bank is more likely to be spent on other things, while layaway insures that it’ll be spent on one thing. As Sendhil Mullainathan and Eldar Shafir show in a fascinating essay on the savings habits of low-income consumers, layaway is a popular way of making big purchases (like washing machines), because, if you don’t have a lot of money, the presence of a sizable sum in the house or even in the bank means that you’ll be constantly tempted to dip into it.
Read Surowiecki's full column. Be sure to also check out Shafir and Mullainathan's research on poverty and decision-making.