Brief Signaling Response

This started out as a tweet that got too long. It is a response to this blog post about signaling.

Because of decreasing marginal value of money, willingness-to-pay is not an effective signal in upper classes. Upper classes signal via exclusivity. As a result, adding new alternatives does not have the desired effect.

Rolex is considered an entry-level mass-produced luxury watch because of this. The true luxury watches are Patek Philippes, etc. Last year Rolex made about 1,000,000 watches. Patek Philippe has made about 1,000,000 watches since they started operating in 1839. Collectors say they "invest in the heritage, design, and Patek DNA," but - like all luxury goods - watches are either a conceit or a signal.

Before the cheap quartz watch, Rolexes was a quality watch for the everyman priced around $70 ($630 in 2016 equivalent dollars). The advent of a cheaper, more-accurate competitor sent the entire mechanical watch industry into a tailspin. They released the Swatch in response, which bought time for the industry to rebrand mechanicals several steps up the luxury ladder.

Non-signaling watches like Rolex became willingness-to-pay signals. Willingness-to-pay signals became exclusivity signals. "Luxury quartz" is an oxymoron. The new competitor, although objectively better in almost every way, drove up the price of mechanicals, and increased their signaling power.

Generalize to diamonds:
If synthetic diamonds are taxed to be the same price as natural diamonds, natural diamonds will still be more exclusive. Upper class signalers and social climbers will pay a premium for this exclusivity, and call it the price of 'authenticity' or 'heritage.' Now there is a definable difference in price, which attracts willingness-to-pay signalers. Putting a tax on synthetic diamonds has now driven up the price of natural diamonds, and increased their signaling power in the upper and middle classes. Cobra Effect in action.