How Rising Inequality Stimulates Energy Demand

Robert H. Frank

St. Gallen Symposium

June 2, 2007

World B: You and your family live in a 3000-square foot house, others live in 2000-square-foot houses.

Which world would you choose?

World A: You and your family live in a 4000-square foot house, others live in 6000-square-foot houses.

Which world would you choose?

C: You have 2 weeks of vacation each year, others have 1 week,

or

D: You have four weeks of vacation each year, others have 6 weeks?

Housing = positional good

Leisure = nonpositional good

1. People care about relative consumption, more in some domains than in others.

2. Such concerns lead to expenditure arms races focused on positional goods--those goods for which relative position matters most.

3. Positional consumption is more energy intensive, on average.

4. Inequality stimulates positional consumption and energy use.

Adam Smith’s invisible hand:

Self-interested demands will result in a socially efficient allocation.

Charles Darwin: Traits are selected because of their impact on the reproductive fitness of individuals, not groups.

Traits that benefit individuals often work to the disadvantage of groups.

Why do male elephant seals weigh five times as much as females?

The exception that “proves” the rule:Very little sexual dimorphism in

monogamous species like the albatross.

Gaining access to mates

= a positional good

Minimizing the risk of death from predators

= a nonpositional good

The Conflict Between Individual and Group

Positional goodsNonpositional goods

Bombs

Toasters=

Robert H. Frank. “The Demand for Unobservable and Other Nonpositional Goods.” American Economic Review, 75, March, 1985, pp. 101-116.

Changes in the Before-Tax Distribution of Income

1949-1979.

1979-1999

Bottom20%

+116%+100%

Middle20%

Fourth20%

Top20%

Top5%

Second20%

+111% +114%+99%

+86%

Bottom20%

-1%

+6%

Middle20%

Fourth20%

Top20%

Top5%

Second20%

+11% +19%

+42%

+66%

Changes in the After-Tax Distribution of Income1979-2000

Fractal earnings change pattern for virtually every labor market group:

Bottom quintile: Absolute earnings decline

Middle quintile: Negligible earnings growth

Top quintile: Substantial growth

College graduates

Dentists

The top 1 percent

The top 1/10th of 1 percent…

2000: 531 x average worker’s earnings

Earnings of CEOs of largest U.S. corporations

1980: 42 x average worker’s earnings

Hedge fund manager James Simons: $1.7 billion in 2006 (38,000 x average worker’s salary)

Top 25 hedge fund managers: $14 billion in 2006

Context and the demand for quality

A memorable meal

An effective interview suit

A suitable gift

In a poor country, a man proves to his wife that he loves her by giving her a rose. In a rich country he must give a dozen roses.

Richard Layard

If you were society’s median earner, which option would you prefer?

1) You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

2) you save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests?

The cost of sending a child to a school of average quality is linked to the price of the average house in the community.

Median size of a newly constructed house:

1980: less than 1600 square feet

2004: more than 2100 square feet

Expenditure Cascades

• Top earners spend more because they have more money.

• And so on all the way down the income ladder.

• That, in turn, shifts the frame of reference for those next below.

• This shifts frame of reference for those just below them, who also spend more.

How heavy should your car be?

Honda Civic: 2449 pounds

Ford Excursion: 7648 pounds

The Progressive Consumption Tax

Consumption + Savings = Income

Consumption = Income – Savings

Taxable consumption = Income – Savings – standard deduction

Taxable Consumption Marginal Tax Rate

0 - $39,999 20 percent

$40,000 - $49,999 22 percent

$50,000 - $59,999 24 percent

$60,000 - $69,999 26 percent

$70,000 - $79,999 28 percent

$80,000 - $89,999 30 percent

$90,000 - $99,999 32 percent

$100,000 - $129,999 34 percent

$130,000 - $159,999 38 percent

$160,000 - $189,999 42 percent

$190,000 - $219,999 46 percent

$220,000 - $249,999 50 percent

Taxable Consumption Marginal Tax Rate

$250,000 - $499,000 60 percent

$500,000 - $999,999 80 percent

$1,000,000-$1,999,999 100 percent

$2,000,000-$3,999,999 150 percent

$4,000,000+ 200 percent

Viking Professional, $5,000.

1989 Sunbeam, $90

Gas Grills Then and Now

Talos Outdoor Cooking Suite, $35,000.