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 1

Monkeys’ Relative Concerns 012/10/12/income-inequality-in- action-monkey-style/

3 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: oDefine the reference group oCalculate its average income oPlug this into a happiness regression oLook at the coefficient Direct survey evidence (McBride 2001, Senik 2009, Clark and Senik 2010) Lab experiments (Falk and Ichino, 2006, McBride, 2007)

4 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.

5 Clark and Oswald (1996)

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7 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.

8 Ferrer-i-Carbonnell (2005)

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10 Papers with hypothesized reference groups C) Close Neighbours Luttmer, 2005: average income in locality ( 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

11 Luttmer (2005)

12 Luttmer (2005)

13 Luttmer (2005)

14 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 China Questions 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 Survey Former colleagues, former school-mates, parents, own standard of living, before Clark and Senik (2010): European Social Survey. Colleagues

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

16 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 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.

17 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.

18 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 19

20 Clark and Senik (2010)

21 Clark and Senik (2010)

22 Clark and Senik (2010)

23 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)

24 Two Different Effects of Reference Income on Satisfaction Direct effect: Comparisons Indirect effect: Information Hirschman (1973): “tunnel effect” U A = V(Y A, E A (Y B ), Y B ). dV / dY B = (dV / dE A. dE A / dY B ) + V3 V3 is the direct effect of Y B on V; negative. Test: sign of dV / dY B : negative sign: ocomparison effect V3 is negative and dominates the information effect (dV / dE A. dE A / dY B ) positive sign: o information effect dominant

25 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).

26 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.

27 DATA Russian Longitudinal Monitoring Survey, panel, (5 waves, individuals), TARKI Hungarian Household Panel, (6 waves, 8237 individuals), NORBALT II: Estonia, Latvia, Lithuania, 1999, individuals, Polish Household Survey: 3 separate panels : , et (about 2000 individuals per wave). European Community Household Panel, ( observations for 14 countries and 8 waves) + French household survey (90000 observations). General Social Survey (United-States): cross- section, (44000 observations) European Social Survey, 2002, 21 countries (42319 observations).

28 Estimation in two stages

29 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).

30 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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33 Senik (2008)

34 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

35 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 37

Card, Mas, Moretti, Saez (2010) " Inequality at work: the effect of peer salaries on job satisfaction" Controlled experiment on the work place. 38

Card, Mas, Moretti, Saez Opening of the website in March 2008 Experiment in Fall 2008.

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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

46 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.

47 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

48 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.

49 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