Growth and Redistribution with a Taste for Status Lewis Davis Union College Presented at NYU, May 4, 2012

Overview I develop a model of growth and distribution with productive public goods in which agents have a preference for status. Status preferences mean that agents care about both absolute and relative consumption levels. The model suggest that societies can be divided into three types depending on their preferences and the distributions of economic and political power. These societies have different outcomes regarding tax policy, economic growth and redistribution They also respond differently to preference and democracy shocks.

Motivation Why did some countries adopt policies “that protected the privileges of the elites and restricted opportunities for the broad mass of the population?” SE (2000, p. 221). General Answer: Policies affect level and distribution of output  look to distributional consequences. – Olson (1982): special interest politics distort relative prices – Easterly and Levine (1997): Ethnic politics favor growth- retarding redistributional policies – Acemoglu and others (various) and Bourguignon and Verdier (2000): Economic development threatens political power. (No political Coase theorem.)

Why look at preferences? Criticism: Any outcome can be justified by appealing to arbitrary preferences: “People in poor countries just happen to like poverty, disease, war, etc.” Response: Not an arbitrary preference structure. Large lit documenting existence of status preferences: Heffetz and Frank (2011), Clark et al. (JEL, 2008) Status interesting b/c reject otherwise Pareto improving policies Davis and Wu (in process): find the taste for status differs systematically across countries as a function of national culture. Does this matter for policy outcomes? Need a theory to provide testable hypotheses.

Davis and Wu: Status and Culture Controlling for age, age squared, sex, marital status, children, educational attainment, employment status, wave of WVS, income category, and Hofstede’s power distance index Note: coef. biased b/c happiness increasing in national income. life satisfactionCoefficientStd. Err.t-stat mean_income pdi*mean_income number of obs Adj. R-squared Coef. evaluated at:mean pdi+1 sd pdi-1 sd pdi mean income

Model Overview Model: Positive theory of growth and redistribution with a taste for status Status Preferences: utility is decreasing in the level of average consumption Production: Alesina and Rodrik (1994)  productive public goods financed by a tax on capital Politics: Preferred tax of the pivotal voter depends on level of democracy and wealth inequality

Production Output: Public goods: Relative labor endowment:

Factor Incomes and Returns Labor Income: Capital Income: Individual income:

Preferences Lifetime Utility: Instantaneous U: Roles of Absolute and Relative Consumption:

Consumer’s Problem

Solution Growth: Consumption: Average C: Lifetime U:

Status and Lifetime Utility Egoistic: Pure status: Status shock:

Preferred Tax Rate A max exists for large enough sigma-i F is C1, so the max obeys FOC and SOC.

Special Cases Sigma-i = 1: – distribution doesn’t matter Gamma = 1: – only distribution matters

Proposition 1: The existence of a preferred tax rate

Intuition and comparative statics

Distributions of wealth and political power

Proposition 3: Democracy, Inequality and the Pivotal Voter

Does the preferred tax rate max growth? Preferred tax rate Growth-max tax rate:

Proposition 4: The pivotal voter and the rate of economic growth

Income and Consumption Ginis

Proposition 5: The Comparative Statics of Inequality

Tax rates increase going to the right  = 0: above  = 0 locus dg/d  > 0: left of  -hat locus d  /d  < 0: left of  -bar locus

Societies A society is defined by an ordered triple involving preferences, the political system and the resource endowment: These map into an ordered pair: which determines a society’s location in one of four regions of Figure 2.

Types of Societies Region I: Above the  * = 0 locus. “Non-Developmental Society” Region II: B/w  * = 0 and  -hat loci – Unequal political power and high taste for status – “Status-Oriented Oligarchy” Region III: B/w  -hat and  -bar loci – Includes Egoistic societies. Pivotal voter is rich – “Plutocratic Democracy“ Region IV: to the right of the  -bar locus. – Includes Egoistic societies. Pivotal voter is poor – “Proletarian Democracy”

Figure 4: Status Shock

Preference Shocks: gamma rises Status Oriented Society: – Rich Pivotal Voter: tax rate falls – Under Supply of Public Goods: dg/d  > 0 – Growth falls, Inequality rises Plutocratic Democracy: – Rich Pivotal Voter: tax rate falls – Over Supply of Public Goods: dg/d  > 0 – Growth rises, Inequality rises Proletarian Democracy: (A+R case) – Poor Pivotal Voter: tax rate rises – Over Supply of Public Goods: dg/d  > 0 – Growth falls, Inequality falls

Figure 5: Democracy Shock

Democracy Shocks: Sigma-i rises All Societies: – equilibrium tax rate rises  Inequality falls Status Oriented Society: Under Supply of Public Goods: dg/d  > 0 – Growth rises Plutocratic and Proletarian Democracy: – Over Supply of Public Goods: dg/d  > 0 – Growth falls Growth is an inverted U-shaped in democracy, e.g. Barro (1996) Inequality is monotonically increasing in Democracy:

Democratization, Growth and Redistribution

Summary of Comparative Statics

Conclusions Status effects interact with economic and political inequality in non-trivial ways to generate equilibrium policies that influence growth and redistribution The model suggest societies fall into three categories based on the taste for status and the relative labor endowment of the pivotal voter. As democracy rise, growth rises and falls, (Barro, 1996), while inequality falls (Li, Squire and Zou, 1998). An stock to the taste for status may either increase or decrease growth and increase or decrease inequality.

Extensions Alternative policies and political environments: e.g. Alesina and Drazen’s (1991) delayed adjustment model. Endogenize democratization, e.g. Bourguignon and Verdier (2000) or Acemoglu et al. (2xxx). Empirical testing