Tuesday, March 05, 2013

Why Do Top Income Shares Matter?

From a recent YouTube lecture by UC Berkeley economist Emmanuel Saez, he discusses income inequality. As an introduction he makes the following claim, and it's pretty clear he doesn't find this very controversial:
Inequality matters because people evaluate their economic well-being relative to others, not in absolute terms

He's a pretty conventional, leading academic economist. It's interesting that he can say this as if it's not debatable and move on, because if this is true, many of the fundamental results of economics are simply wrong. For example, there is no risk premium, a theme of my now back ordered book, which discusses why this inconsistency persists.

Yet, I'm pretty much alone in arguing this in finance. In other words, in some fields of economics relative utility is obvious, in others it's applied piecemeal, in others it is not used at all . Such is the science of economics.


Mercury said...

Wow EF! are those volume-less stub quotes on the secondary market or is your book approaching the valuation of a first edition Hemingway?

With the general caveat that I am of course only human I like to think that I am more attuned to my own absolute as opposed to relative economic well-being than most other people because this is usually the more rational approach, because I think I am that much more grounded in terms of values and priorities and because I’m pretty good at making my own fun.

That said, if someone (as an absolute economic well-being guy) chooses the proverbial $100k salary (which causes everyone else to get $200k) over the $75k salary (which causes everyone else to get $75k), he runs the risk that the prices of things he needs and wants will be driven up beyond his ability to buy/consume them at desired levels. There should be less risk of this outcome if everyone’s salary is tighter to the mean – no?

So, I think being on the low end of relative economic well-being can end up pushing you downward in terms of absolute economic well-being too. I can’t say to what extent average people understand this intuitively or if envy simply trumps greed in most such cases.

I know that in places like Bermuda there are all kinds of restrictions and barriers between foreigners and real estate ownership to prevent relatively low-income locals from being priced out of their own native country for similar reasons. Even if the natives are fairly and well compensated for their modest homes they might not be able to resettle somewhere else with that cash and enjoy the same economic well-being they once did.

Tel said...

Robert H. Frank uses similar reasoning to conclude that we must tax large houses, and expensive weddings and stuff like that. Use the money to pay for roads apparently.

I accept that envy does exist and that it is to some extent a natural behaviour. However, I have a lot of trouble making the next step to accept that envy is a sensible basis for a moral system.

Patrick R. Sullivan said...

I agree, Tel. Especially given that one of the Ten Commandments is against covetousness.

Eric Falkenstein said...

Well, I agree it's better to be greedy than envious, but that's a normative issue. Describing how people actually behave is something else. Ought vs. Is. The moralistic fallacy is the formal fallacy of assuming that what is desirable is inherent in nature.