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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/2
012/10/12/income-inequality-inaction-monkey-style/
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,
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2006, McBride, 2007)
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 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
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?”
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 “Now imagine the same ten-step ladder around 1989,
on which step was your household at that time?”
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
significant impact on subjective well-being.
a
• Comparisons are asymmetric: under-performing
one’s benchmark is always more important than
out-performing it.
• “intra-personal”
comparisons
are
important than inter-personal ones.
more
• 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.
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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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Clark and Senik (2010)
• Income comparisons are acknowledged as
important by a vast majority of Europeans.
• They are associated with lower levels of selfdeclared 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 familyoriented: 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. 23
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, 19942001 (919000 observations for 14 countries and 8
waves) + French household survey (90000
observations).
• General Social Survey (United-States): crosssection, 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/statepa
y/
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
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 lowincome 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