Wednesday, May 05, 2010

Robert Frank, Status, and Income Redistribution

Economists usually assume that what individuals care about is their absolute level of income, that if my income goes up by ten percent and everybody else's by twenty that is still a plus, not a minus, for me. Many years ago, in Choosing the Right Pond, Robert Frank pointed out that that is not an accurate description of real human behavior. People care about their absolute level of income (and other things), but they also care about their relative status, which depends in part on how their income compares to that of others. The point itself is fairly obvious; what was interesting about Frank's work was that he went on to show how a taste for relative income could be incorporated into an otherwise conventional economic analysis.

Consider a firm that employs a variety of workers of varying productivity. A standard competitive model would predict that salaries would scale in proportion; if one worker produces twice as much as another, he will be worth twice as much to an employer and will end up being paid twice as much.

Suppose, however, that workers care about both absolute and relative income, the latter being defined relative to fellow workers in the firm. The low productivity worker now contributes an additional input, immaterial but real, to the firm—his presence raises the relative status of the more productive workers, making them happier. The high productivity worker contributes a similar, but negative, input, since his presence lowers the status of other workers, making them less happy. Changes that make workers more or less happy ultimately show up in the firm's bottom line, since it costs less to hire workers the more they like the job. Hence, under Frank's assumptions, the low productivity worker will be paid more than in proportion to his physical output, the high productivity worker less. The market outcome thus incorporates something that looks rather like income redistribution.

In a recent New York Times Op-Ed, Robert Frank offered this analysis as a justification for explicit income redistribution by government, writing:

"Enlightened libertarians believe that the best social institutions mimic the agreements people would have negotiated among themselves, if free exchange had been practical. Private pay patterns suggest that our current tax code meets that test."

It is an ingenious argument, but there are at least three problems with it:

1. Frank's analysis of the effect on pay of concern with status implies that what people care about is not their status relative to the rest of the world but their status relative to those near them—in his case, their fellow employees. The more distant someone is from me, the weaker the effect—a fact some of whose implications I discussed long ago on this blog. Most of the people who benefit from income redistribution are very far from me. That does not eliminate his argument, but it weakens it. When he writes

"For starters, high-ranking members of society, who also tend to have the highest incomes, know they will be able to send their children to the best schools and have access to the best health care."

he fails to distinguish between absolute and relative values. Getting good health care is very important to me, but its value does not depend, so far as I can judge by introspection, on other people having worse health care.

2. Back when Lyndon Johnson was pushing the War on Poverty, his claim was that it would eliminate poverty, result in poor people no longer being poor. If Frank is correct, that claim should have been a death sentence for the program. On his argument, after all, I benefit by other people being poor, since it raises my relative status, and so would be worse off if they stopped being poor. The great majority of voters, then and now, are not poor, so if he is right the great majority should have viewed what Johnson claimed to be doing as hurting them, and voted against it. That isn't what happened. For Barack Obama to center his proposals for health care on making it available to the small minority of uninsured individuals should have been political suicide if Frank is right. But the bill passed.

3. The most serious problem with Frank's argument, suggested by the previous point, is that if it is correct he ought not to be making it, since its implications are ones of which he clearly disapproves. He puts it in terms of what "enlightened libertarians" think social institutions should be. But as an economist, he surely believes that people's behavior mostly reflects their perception of their own interest. The implication of his op-ed is that it is in the interest of everyone to make everyone else poorer, thus raising his relative status. The rich ought to be in favor of grinding down the poor, the poor ought to be in favor of pulling down the rich, and the people in the middle ought to be in favor of both. I do not think that describes the policies that Robert Frank, who is a nice man as well as an able and original economist, wants.

16 Comments:

At 12:37 PM, May 05, 2010, Anonymous RKN said...

As I see it his point is that libertarians who oppose income redistribution should wake up and realize that the private pay model effectively accomplishes the same thing. Maybe it does, maybe it doesn't, but in any case his argument doesn't address the moral libertarian objection, that government redistribution is coercive, whereas "private redistribution" isn't. At least in the private model one can become aware that they are effectively subsidizing less productive workers and move to a higher rank (and pay) job, start a company of their own, etc. If, on the other hand, I object to who or how government redistributes my taxes there is practically nothing I can do about it.

 
At 12:55 PM, May 05, 2010, Blogger Skip said...

Clark's 'A Farewell to Alms' touches on some of this briefly. It's a fascinating book that I really don't know how much of it I agree with.

I've always thought that this is why the really stratified societies that socialism produces are so pervasive - by equalizing, or at least flattening, the range of prosperity in one's peer group, on average that group may be happier, even though the actual level of prosperity is much lower. It's a trap that I really don't know how to get a society out of.

 
At 1:31 PM, May 05, 2010, Blogger Michael F. Martin said...

2 and 3 confuses the is with the ought. Can't he (and we) describe group behavior with an economic model without implicity or explicitly approving it? This gets back to the positive vs. normative debate in law & econ community. Do economic actors perform an actual cost-benefit analysis before acting? Not often, but this doesn't falsify the rational hypothesis. Nor does the instrumental value of the rational hypothesis lead ineluctably to any prescriptions with well-defined political valence. The end reason for this is that politics is about us/them where as economics (along with all empirically driven theory) is about facts and explanation.

1 is a more interesting counter-argument, but it's impossible to answer it without your elaborating on the scale of near and far. As I understood him, Frank was talking about immediate coworkers, not people in other divisions. How does 1 undermine that point?

 
At 1:50 PM, May 05, 2010, Anonymous Anonymous said...

I find it hard to take seriously the premise that people care very much at all about relative status. Why would they?

 
At 2:00 PM, May 05, 2010, Blogger Michael F. Martin said...

Anonymous,

See here:

http://falkenblog.blogspot.com/2010/03/why-envy-dominates-greed.html

 
At 2:33 PM, May 05, 2010, Blogger norm said...

People vary dramatically in their need for relative status ( absolute status also). I suppose anonymous is one who has a low desire for relative status.

Status can be relative, as you note, to people of various distances from you geographically, but also distances measured culturally or temporally. I sense that my pleasure in my status is relative to what I expected when I was growing up, not to that of my current neighbors or friends.

Low relative status is often felt to be unfair. But the basis for defining unfair varies tremendously. In my managerial career I spent quite a bit of time trying to overcome bureaucratic inertia to improve the relative pay and status of people I perceived as high performers. I also spent quite a bit of time dealing with those who felt they deserved more when I strongly disagreed.

Given these complications it is easy to imagine a company of all high achievement and high status relative to those not in the company. I don't see any need to overpay poor performers so the rest of us can feel good. Just let them work for the government.
The variety of individuals' needs for relative status explains a lot about politics, particularly libertarian versus socialist groups.

 
At 5:46 PM, May 05, 2010, Blogger Nick Weininger said...

Building on what norm said, Frank is here ignoring the moral argument against his position, which is simply: caring about relative status is a vice, not everyone does it to an equal extent, and those that indulge in more of it should not be rewarded at the expense of their betters. The blame for the negative effects (if any) on a firm of high-productivity employees' "making" others feel lower-status lies entirely on those others: their envy is rightfully their problem, and no one but them should bear the consequences.

 
At 5:54 PM, May 05, 2010, Blogger Nick Weininger said...

There is also another practical problem with the argument: it is far, far easier to leave a firm than to leave a country. The high-productivity worker for whom the disutility of having to work with bozos is greater than the utility of being able to see herself as superior can easily go somewhere else, perhaps an unusual sort of firm where she can be paid according to her productivity even if she has to suffer the psychological pain of working with extremely productive people who are paid much higher still. That same worker will have a much harder time finding a place to escape the redistributive taxation demanded by her envious bozo fellow-citizens.

 
At 6:47 PM, May 05, 2010, OpenID hudebnik said...

"high-ranking members of society, who also tend to have the highest incomes, know they will be able to send their children to the best schools and have access to the best health care."

he fails to distinguish between absolute and relative values. Getting good health care is very important to me, but its value does not depend, so far as I can judge by introspection, on other people having worse health care.


I agree that in health care, absolute quality is probably more important to most people than relative quality (although a person with low-quality health care might be justifiably irked to hear about more fortunate people getting necessary, and even elective, procedures promptly). The story is different for education, where relative quality of, say, high schools affects who gets into the best college, whose relative quality can affect job placement.

 
At 7:02 PM, May 05, 2010, OpenID hudebnik said...

For Barack Obama to center his proposals for health care on making it available to the small minority of uninsured individuals should have been political suicide if Frank is right. But the bill passed.

True, only a small minority of people in the U.S. are uninsured at any given time. But a much larger number have reason to fear being in that condition: since most Americans get health insurance through their employers, they're one layoff away from being not only unemployed but uninsured too. The current recession, I have no doubt, brought that possibility to the front of a lot of people's minds. So supporting some kind of major health care reform is perfectly consistent with (not losing) one's own relative health-care status.

And, as I said above, the concern for relative vs. absolute status is probably less in health care than in many other commodities.

 
At 1:32 AM, May 06, 2010, Anonymous Henry said...

2. Back when Lyndon Johnson was pushing the War on Poverty, his claim was that it would eliminate poverty, result in poor people no longer being poor. If Frank is correct, that claim should have been a death sentence for the program. On his argument, after all, I benefit by other people being poor, since it raises my relative status, and so would be worse off if they stopped being poor. The great majority of voters, then and now, are not poor, so if he is right the great majority should have viewed what Johnson claimed to be doing as hurting them, and voted against it. That isn't what happened. For Barack Obama to center his proposals for health care on making it available to the small minority of uninsured individuals should have been political suicide if Frank is right. But the bill passed.

That assumes that status is the only salient factor. But there may be others that simply outweigh it, such as empathy. Perhaps many people are willing to sacrifice some status in exchange for a "warm glow". However, few empathise with the rich.

Also, the way in which status matters is important. How important is your "ordinal ranking" versus your "cardinal ranking"? Helping very poor become "just" poor does not adjust the rankings of those in the middle class, so they will be likely feel their status is threatened if they're concerned with ordinal rankings. Only if they gain some utility from the "distance" between them and those less fortunate will this matter.

 
At 4:00 PM, May 06, 2010, Blogger Robin Hanson said...

Sometimes people talk about "inequality aversion" might that better explain the policy preference data?

 
At 10:48 AM, May 07, 2010, Blogger AlexxKay said...

Suppose, however, that workers care about both absolute and relative income, the latter being defined relative to fellow workers in the firm. The low productivity worker now contributes an additional input, immaterial but real, to the firm—his presence raises the relative status of the more productive workers, making them happier.

This overlooks the question of whether the workers *have* that information. There is a strong tendency in American culture -- enshrined in explicit policy in many corporations -- to regard income information as a matter of extreme secrecy. I have never know what my friends or coworkers made, except in one job where I had to help manage payroll -- and it was made very clear to me that I was verboten to divulge any of that info.

(I do not like this tradition, and think it serves the corporations far more than the workers. But it's definitely the status quo.)

 
At 1:31 AM, May 09, 2010, Blogger Doc Merlin said...

People should care about relative status and money and such, because of politics. In a perfectly libertarian world, relative money doesn't matter, because regardless how rich someone is, they can't force me around. In the real world, people can use money to control positions of political influence, which means that suddenly relative status matter a lot.

In short: more collective decision making means that relative status maters more than otherwise. This leads to the prediction that the more free a country is, the less relative status would be important to its citizens.

 
At 10:59 AM, May 10, 2010, Blogger Les Cargill said...

Another hypothesis w.r.t the Great Society is that it makes public the "good" of the desire of people for social equality. It's "I gave at the office" writ as public policy. Anti-poverty programs relegate the poor to the much smaller flows of public funds, and may insulate them from private improvement in lot.

As to differentials between individuals within the firm, this is not a permanent equilibrium. Much effort and thought goes into balancing the opportunity offered to individuals. Perception of productivity is very frequently radically different from the actuality of it. Since firms depend heavily on something a lot like social networking within the firm, with vendors and with customers, outcomes are not evaluated objectively, but according to conformance to the norms within the firm.

In other words, the "class president" will not likely be chosen from the A students, but from a self-selecting "upper class" within the firm. In some cases, like in Wall Street firms, the stakes are high enough that you can tell winners from losers
(because there is instrumentation within the firm to tell you so), but most firms can't afford the instrumentation needed, and those who operate the administration of the evaluation process have significant incentives to use that as power.

 
At 3:27 PM, May 11, 2010, Anonymous Andrew said...

People care most about what they can *get* for their income. In areas like NYC or the Bay Area with very high real estate prices and limited land, relative status is of prime importance because most of your income goes to saving up for a house, and you're competing with all of the other people who are saving up for a house.

 

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