Explaining the Easterlin paradox

• Easterlin’s proposed explanations:

Income comparison and relative utility

Adaptation

• Both imply thresholds in the individual utility function

Benchmarks: self-regarding/ other regarding

• This section presents the empirical evidence of relative income concerns

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Monkeys’ Relative Concerns

http://www.freakonomics.com/2012/10/12/income-inequality-

in-action-monkey-style/

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I. Comparisons

• U(C, C/C*) indirect utility U (Y, Y*)• Coefficient on reference income  Y* in

the regression of individual satisfaction: negative sign => comparison effect.

• Who are the reference groups?Reference groups hypothesized by the

researchers themselves:o Define the reference group

o Calculate its average income

o Plug this into a happiness regression

o Look at the coefficient

Direct survey evidence (McBride 2001, Senik 2009, Clark and Senik 2010)

Lab experiments (Falk and Ichino, 2006, McBride, 2007)

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1. Papers with hypothesized reference groups

• A) Colleagues, co-workers, workers with same productive characteristics:

Clark and Oswald (1996): BHPS

Senik (2004, 2008): Russia RLMS, Transition countries + ECHP

Bygren (2004): Swedish Survey Panel (LNU)

Clark, Kristensen and Westergård-Nielsen (2007): Danish component of the ECHP.

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Clark and Oswald (1996)

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Clark and Oswald (1996)

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Papers with hypothesized reference groups

• B) Average co-citizens with the same characteristics

Van de Stadt et al. (1985): education level, age and employment status

Blanchflower and Oswald, 2004, average income of the state (USA).

Ferrer-i-Carbonnell, 2005: people with same education level, age group and region (East versus West Germany), GSOEP

Caporale, Georgellis, Tsitsianis, Yin, 2009: age cohorts (age of respondent +- 5 years) / education level, age group, country? European Social Survey.

McBride, 2001: cohort of people living in the USA, who are in the same age ± 5 years as the respondent.

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Ferrer-i-Carbonnell (2005)

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Ferrer-i-Carbonnell (2005)

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Papers with hypothesized reference groups

• C) Close Neighbours

Luttmer, 2005: average income in locality (100 000 inhabitants), NSFH (National Survey of Families and Households) panel data

Helliwell and Huang, 2009, Census tract of Canadian GSS

Fafchamps and Shilpi, 2008, Nepalese Living Standard Measurement Survey: mean ward consumption

Kingdon and Knight, 2004: South Africa, average income in the district, in the immediate neighborhood, race

Akay and Martinson, 2008, Ethopia: age, size of land holdings, geographical area

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Luttmer (2005)

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Luttmer (2005)

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Luttmer (2005)

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2. Some papers with direct information about reference groups

• McBride (2001): American household survey Standard of living of parents at same age

• Knight and Song (2006): Chinese national household survey, rural ChinaQuestions about comparisons to other

people in one’s village/county/other cities/China as a whole “Wider orbits of comparisons are associated

with unhappiness”

• Senik (2009): Life in Transition SurveyFormer colleagues, former school-mates,

parents, own standard of living, before 1989.

• Clark and Senik (2010): European Social Survey.Colleagues

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Subjective questions

• To what extend do you agree with the following statements:

I have done better in life than most of my high school mates.

I have done better in life than most of my colleagues I had around 1989.

I have done better in life than my parents. My household lives better nowadays than around

1989. All things considered, I am satisfied with my life now

(henceforth Life satisfaction). The gap between the rich and the poor today in this

country should be reduced .

• seven proposed modalities: “strongly disagree/disagree/neither disagree nor agree/agree/strongly agree/not applicable/don’t know”.

• Two other comparison questions were asked:

“Please imagine a ten-step ladder where on the bottom, the first step, stand the poorest people, and on the highest step, the tenth, stand the rich. On which step of the ten is your household today?”

“Now imagine the same ten-step ladder around 1989, on which step was your household at that time?”

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Identification strategy

• There is no reason a priori why some people should estimate that they have done better than their colleagues but worse than their former high school mates, or better then their parents but worse than in 1989.

• Looking at the effect of such opposite evolutions in different dimensions thus helps avoiding the risk of collinearity of comparison benchmarks due to omitted variables.

map the different modalities of each pair of variables, creating a series of interaction terms that constitute a total partition of the sample.

estimate Life Satisfaction on these interaction categories, controlling for the usual socio-demographic variables and for country dummies.

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Results

• Comparisons are relevant and exert a significant impact on subjective well-being.

• Comparisons are asymmetric: under-performing one’s benchmark is always more important than out-performing it.

• “intra-personal” comparisons are more important than inter-personal ones.

• Local comparisons (to parents, former colleagues or high school mates) are more powerful than general ranking in the social ladder and its evolution.

• Comparisons that affect subjective well-being trigger a “compensating” demand for redistribution,

• but self-ranking on a general affluence scale is the most important determinant of the demand for redistribution.

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Clark and Senik (2010)

• Wave 3 of the European Social Survey (ESS)

• 22 European countries

• direct information on the intensity and the direction of income comparisons.

Comparisons are important for the poorer

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Clark and Senik (2010)

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Clark and Senik (2010)

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Clark and Senik (2010)

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• Income comparisons are acknowledged as important by a vast majority of Europeans.

• They are associated with lower levels of self-declared happiness and a greater demand for income redistribution.

• Colleagues are the most frequently cited reference group,

• but is also the most innocuous one.

• Cultural differences:

the negative welfare effect of comparisons is more important in Continental countries and less so in the British Isles, which is also the region in which comparisons most frequently concern colleagues.

Southern Europeans seem to be more family-oriented: they compare more to family members and suffer more from this type of comparisons than inhabitants of other parts of Europe.

• Income comparisons are also associated with a greater demand for income redistribution.

It is comparisons to family members and “others”, much more than comparisons to colleagues, that prompt the demand for income redistribution.

Clark and Senik (2010)

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Two Different Effects of Reference Income on

Satisfaction

• Direct effect: Comparisons

• Indirect effect: Information

• Hirschman (1973): “tunnel effect”

UA = V(YA, EA(YB), YB).

dV / dYB = (dV / dEA . dEA / dYB) + V3

V3 is the direct effect of YB on V; negative.

• Test: sign of dV / dYB :

negative sign:

o comparison effect V3 is negative and dominates the information effect (dV / dEA . dEA / dYB)

positive sign:

o information effect dominant

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Indirect informational effect:

• My own welfare can increase if I observe the

progression of my peers;

• stronger effect in a context of uncertainty and

volatility.

importance of the economic environment

Stabilized economies versus transition

economies (Senik, 2004, 2008).

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Senik (2008) « Ambition and Jealousy. Income

Interactions in the Old Europe versus the New Europe and the United States”

Identification• 2 types of variability:

- Time variability (panel data) fixed effects,

- Distinction Western Europe versus Eastern

Europe: higher volatility in the East

- Distinction Europe/USA: higher perceived

mobility in the USA.

• Relate these differences to the perception of

reference income.

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DATA

• Russian Longitudinal Monitoring Survey, panel,

1994-2000 (5 waves, 11130 individuals),

• TARKI Hungarian Household Panel, 1992-1997

(6 waves, 8237 individuals),

• NORBALT II: Estonia, Latvia, Lithuania, 1999,

10539 individuals,

• Polish Household Survey: 3 separate panels :

1987-1990, 1994-1996 et 1997-2000 (about 2000

individuals per wave).

• European Community Household Panel, 1994-

2001 (919000 observations for 14 countries and 8

waves) + French household survey (90000

observations).

• General Social Survey (United-States): cross-

section, 1972-2002 (44000 observations)

• European Social Survey, 2002, 21 countries

(42319 observations).

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Estimation in two stages

• First stage estimation: country by country, year by year :

• log real individual income = . [education, experience,

profession, branch, region, sexe] + it

Predicted income --> Reference income

• In a second stage, I use the post-estimation predicted income as a proxy for

the individual’s reference group’s income. I include Reference Income in an

equation of individual well-being :

S it = 1 . Reference Income + 2 . it + 3 [household

size, marital status, age, year dummies, (health, etc.)] +

v it + i

• Exclusion restrictions , Bootstrap reference income’s sd (1000 replications)

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Rationale

• This constructed variable is the average pay-off

associated with the productive characteristics of

a given individual.

• In a context where the association between

skills and pay-off is changing rapidly, this is a

good indicator of what an individual can expect

for himself.

• But is can also be a comparison benchmark (in

stable economies).

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Results

• Reference Income is a comparison income in

stabilized European economies

• But it essentially exerts an information effect

in Post-Transition countries, where

information is more scarce.

• In Poland, the relative weight of the two

effects changes over the period (pre/post

Transition).

• In the United States, Reference Income has a

positive effect on satisfaction.

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Senik (2008)

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Recent papers on comparison versus information

• Clark, Kristensen and Westergård-Nielsen

(2007).

• data with a very clear definition of the

reference group

• matched employer-employee panel

• individual job satisfaction can be considered

as a function of the earnings of other workers

within the same firm

• estimate job satisfaction regressions

controlling for the wages of all colleagues in

each firm

• across a representative sample of industries

and occupational groups in the economy

• Panel data fixed effects

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Clark, Kristensen and Westergård-Nielsen (2007)

Results:

• Job satisfaction rises with co-workers’

wages.

• This Hirschman effect is stronger:

for men

for highly-educated young males,

in larger firms than in smaller firms

In the private sector.

• “These findings are consistent with the

signal effect dominating the jealousy

effect for the subgroups that are most

likely to be promote.”

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SALSA paper

• See separate ppt file

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Card, Mas, Moretti, Saez (2010)

"Inequality at work: the effect of peer salaries on job

satisfaction"

• Controlled experiment on the work place.

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Card, Mas, Moretti, Saez

• http://www.sacbee.com/statepay/• Opening of the website in March 2008• Experiment in Fall 2008.

http://www.sacbee.com/statepay/

Experiment in 2 stages• 0) Define a stratified sample in 3

Californian universities (6411 employés)Faculty, staff, medical

• 1) Send an information message to a randomized sub-sample inside each university (treatment group).Control group = those who did not receive

the information• 2) 10 days later, survey the entire

sample:Did they look at the site?Job satisfaction, willingness to quit job?

• Matched sample with administrative data on wages

First stage message

Second stage questionnaire

Results

• Those who received the information

were twice more likely to consult the

website (50% versus 20%).

• 4/5 looked at the wages of their

collleagues in the same department.

• Asymmetric effect on satisfaction.

• Correlation between treatment and

actual job quits within 3 years.

Impact of treatment on job satisfaction

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3) Experimental evidence on income comparisons

Michael McBride « Money, Happiness, and Aspirations: An

Experimental Study » (2008)

• experimental study of how multiple factors—

past payments, social

• comparisons, and expectations—influence

reported satisfaction.

• expectations and social comparisons

significantly affect reported satisfaction,

• subjects care relatively more about social

comparisons once they have achieved a

satisfactory outcome.

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California Social Science Experimental Laboratory

(CASSEL), UCLA

• The core of the experiment is a version of the matching pennies game.

• In each round, each subject is randomly matched with one of the five following computer partner-types:

• 20% heads – 80% tails

• 35% heads – 65% tails

• 50% heads – 50% tails

• 65% heads – 35% tails

• 80% heads – 20% tails.

• The computer then tells the subject the partner-type

• Each partner type is equally likely

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• Next, the subject chooses heads or tails for each of five coins.

• Then, the computer randomly and independently selects heads or tails according to partner-type distribution.

• If the subject’s first coin and the computer’s first coin match (either both are heads or both are tails), then the subject wins the coin, and so on for the other coins. Thus, a subject can win anywhere from 0 to 5 coins in any given round.

• After the computer partner’s choices are made, the computer reports to the subject the coin choices made by the computer and the number of coins won by the subject.

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In Treatment A, the subject is told only

her own outcomes for each round.

In Treatment B, the subject is told her

own outcomes and also the average coins

won by the other subjects in the

experiment.

In Treatment C, the subject is told her

own outcomes, and the average coins

won by others by partner type.

• Immediately after being told the outcome of

a round, the subject is asked “How satisfied

are you with the result of this round?” She

then reports her satisfaction on a scale of 1 to

7.

• Estimation of satisfaction over own payment,

expected payment and average own type

payment.

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Are Relative Income Concerns a Luxury?

• Evidence of relative-income concerns in low-income countries (increasing availability of surveys):

Venezuela, Mexico, Peru, and 20 other Latin American countries

China, India, Nepal, Tajikistan

Ethiopia, Kenya, Malawi, South Africa, Tanzania

• Comparisons are mostly upward. Relative deprivation.

• Development of information and communication technologies

Global relative-income concerns

=> Income comparisons are not luxuries