Matt Zeitlin: Impetuous Young Whippersnapper

One of Daniel Gross’s examples of “relative deprivation” seems to acidentally illustrate some misgivings I have about including (or how much to include) relative deprivation in utility valuations:

   A Web surfer with a 56K modem today knows, intuitively, that he is better off than he was 20 years ago, when he had to rely on a 1,200-baud modem. But when everybody else has broadband, that 56K makes you feel like a cyberloser.

This is the wrong example of relative deprivation, at least to prove Frank’s point -  that wide consumptive gulfs produce welfare reducing positional arms races.  In fact, this example arguably cuts the other way, that we need to except the rich spending more than everyone else so as to drive economic growth that will increase the welfare of everyone.  For example, the growth in the economy has allowed for infrastructure development and enough people being wealthy enough to drive down the price of processing power and personal computing.  Combined with advances in video technology, this means that what’s available for people on the internet has vastly increased – thus the 56K modem is no longer good enough, even though it’s much better than any internet connection 30 years ago.  Welfare has increased, while positional rank has crashed when everyone else has DSL and can download way, way more porn than you can.  The problem for Frank and Gross is that the “arms race” for internet has increased welfare in a way that, say, buying bigger houses hasn’t.  The “arms race”, or just increased wealth and the cost of various IT technology and hardware going down, has increased the options, choices and opportunities for everyone.  The person with the 56k modem is absolutely worse off due to his positional status in a different way than someone with a smaller house than his rich neighbor is.

The good examples Frank provides (warning PDF, warning best article explaining Frank’s concept)  are when the increase in income underestimates the increase in consumption, like how models incorporating the importance of relative position have better explained the increase in housing consumptoin among the top 1 percent of the income distribution:

Changes in the distribution of income provide yet another opportunity to test for the
presence of positional concerns. The permanent income and life cycle theories of consumption
predict that consumption in every income category will rise in proportion to changes in income.
Given observed income growth rates in the U.S., the top one percent of earners should thus be
spending about three times as much now as in 1979, the median earner only about 15 percent
more.

In contrast, models that incorporate positional concerns predict that sharply increased
spending by top earners will exert indirect upward pressure on spending by the median earner.
When top earners build larger houses, for example, they shift the frame of reference that defines
what others slightly below them on the income scale consider an acceptable or desirable house.
And when those people respond by building bigger houses, they in turn shift the frame of
reference for those just below them, and so on, all the way down. Thus the median size of a
newly constructed house, which stood at less than 1600 square feet in 1980, had risen to over
2100 square feet by 2001—more than twice the increase predicted by traditional theories.

The implication is that this increase in square footage is wasteful. Though there seems to obvious benefits to people spending lots of money on stuff – ie supporting the consumer economy, creating jobs etc – is it possible that the increase stress and resultant lack of happiness due to the positional arms race have made everyone, besides those buying the biggest houses, worse off?

It’s hard to see how any income redistribution would be able to hedge back against this phenomena – besides large scale confiscation of the rich’s income.  And it would have to be confiscation, not just redistribution.  If you say, increase taxes on the rich to fund universal health care and other ways to decrease middle class stress, the positional arms race would still happen.  There would still be very rich people who are building those large houses with the trickle down status effects.  There are reasons for increased inequality besides government tax policy.  Quite simply, it’s a whole lot easier to get super rich these days than it was 25 years ago.  These are structural conditions. So, the only solution to Frank’s conundrum is large scale confiscation of the rich’s income -  the actual bringing the rich down, not a peg, but many, many pegs.  And here, we’ll probably have some welfare reduction (not counting positional goods, of course).

When you frame the debate as Frank has, around relative position, the left seems to be playing into the hand’s of the conservative economics.  If we adopt this mindset where we focus on using tax policy to redress status and relative deprivation, we’ll then institute taxes that really will decrease growth for everyone.  We’d be proving the supply siders correct.  If instead we use tax policy to focus on just improving outcomes – ie more focus on poverty, health care, EITC etc – we won’t slay the golden goose.  Of course, I want to see more numbers on how these positional arms races are decreasing the absolute outcomes of people.

PS – Will Wilkinson, as I expected, has written about the wisdom (and foolishness) of using relative deprivation in evaluating welfare.  Also, he defends positional arms races in the context of entrepreneurship here.