Manufactured Inequality: the bright side of wealth disparities
Manufactured Inequality: the bright side of wealth disparities
Ricardo Nicolás Pérez Truglia
www.ricardotruglia.com.ar
Beyond ethical concerns, there are two arguments frequently employed to contend against "too much" redistribution of income. The first argument is that redistribution distorts incentives and thus carries a severe loss in efficiency. For example, when a government levies taxes on incomes, people have incentives to make a lower effort (since they will not be able to receive the entire product of their work).
The second argument is that monetary income (consumption) is a poor proxy for actual welfare. Consider the following example: an undergraduate student in economics can pursue a career in finance with a high profile of future incomes, or he can pursue an (equally effort-demanding) academic career, with noticeably lower incomes. Usually the decision is not easy, what might indicate that, in spite of the differences in incomes, the well-being under both activities is pretty much the same. The parity in well being is partially explained by the consumption of some goods and services (in a wide sense) "purchased" by a cut in salary (e.g. time flexibility, lack of stress, taste for that particular job, etc.). Since the consumption of those (costly) goods and services is not measured in the surveys, a comparison of the incomes (or even the expenditures) of individuals in both situations would be simply erroneous.
I propose a third argument against "too much" redistribution of income. Notice that economic condition was extremely important in the early stages of economic development, when the fulfillment of basic needs was in the centre of every discussion. But nowadays in many societies the role of income in life satisfaction is more frequently related to factors such as conspicuous consumption and social comparisons (e.g. envy, ambition, income comparisons). In Pérez Truglia (2007) I try to re-examine the welfare discussion on income inequality taking into account the growing preponderance of those issues.
I need to provide a simple definition of status goods (services) in order to continue with my explanation: a particular good (service) will be considered more conspicuous the more it satisfies certain basic properties: i. It must be observable; ii. Others individuals should know its price (and then it should be distinguished from a fake); iii. Its price must be above what it would be if consumption was not observable (beyond functional characteristics); iv. It should not be socially condemned (e.g. burning money).
One the one hand, consider as an example a donation to a university: the amount is public, the evidence suggests that the donations would be significantly lower if the names of donors were not public, and it is even socially supported (for details see Glazer et al., 1996). On the other hand, consider a $150,000 automobile: people can see if someone is driving it, and it is not particularly disapproved by society; but the price if it was not observable (e.g. if the Mercedes-Benz logo was hidden) would be still high.
Take a look around and you will realize that you are surrounded by conspicuous goods. The original explanation for that fact was that people simply enjoy showing to their neighbors how much richer they are. As an immediate reaction, several economists argued that relative concerns take individuals to an unnecessary high level of social competition (i.e. to a "rat race") and to an unnecessary waste on "luxury goods".
But I claim that people care about relative standings not only because of their greediness but, at least to some extent, because through a signaling mechanism (that I will introduce below) they can get some goods and services (in a wide sense) not available in formal markets. The implications are obviously diametrically different.
A "non-market" good or service is by definition a good or service that cannot be bought in a formal market, at least not without receiving a social or even legal reprimand (e.g. friendship, sex, confidence). For example, people usually have to select a small number of individuals from a wide set of candidates: people looking for a job or a particular position inside a corporation, businessmen in search of business partners, teenagers in search of new friends, etc. In formal markets all the relevant information is collapsed into the relative prices of the goods. However, for the allocation of non-market goods seldom decision-makers can observe every relevant aspect to make the right choices. Consequently, they might want to rely on "signaling mechanisms".
For instance, consider an investor who has to choose between two candidates for doing business with. The investor would like to know which is the candidate with higher business skills. But the talents are not observable. The investor might have access to their resumes, recommendation letters, education, and other signals associated with business skills, but he cannot see the business talents of the individuals.
Nevertheless, the wealth of individuals may be a very good signal for business skills, since the most talented businessmen (by definition) are expected to have made more money. However, there are many problems to show that information directly (e.g. credibility, security, availability, tax evasion). Instead of showing his bank account, the individual can simply go to the meeting in a car of U$D 200,000. As a consequence, he will "signal" his income and get the deal.
My argument "against" the redistribution of income is now very clear. The accumulation of capital has an informational role: signaling the industrial virtue of individuals. The redistribution of income clouds the distinction between talented an untalented businessmen in the same way than the redistribution of scientific achievements (if they were fungible and transferable) between scholars would cloud the distinction between clever and inept researchers.
The argument can be extended to a wide variety of situations. The redistribution by the state degenerates the signaling of income whenever income can be a signal for talent. A painter might find optimal to rent a very expensive gallery in order to signal the (high) prices of her paintings. Then, for the otherwise uninformed buyers it will be very easy to know which are the most appropriate paintings for them.
Some parents may find useful to send their kids to an expensive school in order to show to the other parents that their kids come from a safe and sound environment as well. In spite of the absence of a "formal" market for choosing friends for their kids', the parents can still influence considerably that choice.
I try to find the root of the conspicuous behavior: envy (or ambition, avarice, etc.) may not be the innate expression of a perverse human feature (as usually suggested), but an optimal behavior designed by nature thorough social and biological evolution for solving an informational problem (as in the mechanism introduced above).
Brosnan et al. (2003) found strong evidence that monkeys have developed relative concerns through evolution. ¿Would it be odd to think that the same could have happened to human beings? Therefore, envy should not be seen as a negative aspect of human nature, but as a spontaneous arrangement of Nature for the creation of incentives towards competition, which allows for the identification of human virtue and thus to a proper allocation of non-market goods.
In Pérez Truglia (2007) I studied this phenomenon quantitatively based on data for 10,000 respondents in Russia for 2000-2002. The statistical analysis gave considerable support to the predictions of the theoretical model: expenditures inequality within the reference group does increase individual happiness. Moreover, the evidence presented by several papers seems to be consistent with my conjecture.
Since I do not want to hurt sensibilities, I explicitly recognize that my claim goes below the primordial problem of poverty. I do not believe that people without access to the basic goods and services worry about status goods. As well, I explicitly affirm that the redistribution of income is vital for the development of poor economies, as long as it can guarantee a floor of opportunities for the disadvantaged (provided that the mechanism for redistribution relies in a democratic procedure and that its scope of action has been properly limited).
Conspicuous consumption is the natural and efficient response to the absence of certain markets. Hence, some portion of the observed income inequality is endogenous, the desired product of the decision of every person within the society. People need such level of inequality to allow for the signaling of income through conspicuous consumption. That portion of inequality is known as "manufactured inequality".
Both the theoretical and empirical findings suggest, for example, that the government of the United States should not worry about the rise in income inequality experimented in the last decades. The redistribution of income by the state would be not only inefficient, but it would also disappear in the short run, since the individuals would find optimal to be involved in riskier activities to recover the (optimal) previous level of inequality.
About the Author
Ricardo Nicolás Pérez Truglia coursed his M.A. and B.A. in Economics at the Universidad de San Andrés (Argentina), where he currently holds a Teaching Assistant position. He also held research positions at different organizations, such as the Center for Financial Stability and the Buenos Aires Stock Exchange. He has shown a profound interest towards the understanding of political realms in developing countries. Ricardo is a Fulbright Scholar and member of the Argentinean Association of Political Economics. For further details visit his personal web site: www.ricardotruglia.com.ar
References
Brosnan, S.F. and De Waal, F.B. (2003), "Monkeys reject unequal pay" – Nature, No. 425, pp. 297-299.
Glazer, Amihai and Konrad, Kai A. (1996), "A Signaling Explanation for Charity" - The American Economic Review, Vol. 86, No. 4, Sep. 1996.
Pérez Truglia, Ricardo Nicolás (2007), "Can a rise in income inequality improve welfare?" - Working Paper, Universidad de San Andrés.
Pérez Truglia, Ricardo Nicolás (2006), "¿Cola de león o cabeza de ratón? El impacto de la distribución del ingreso en el aporte marginal del ingreso a la felicidad subjetiva" - Annals of the Asociación Argentina de Economía Política, XLI Annual Meeting.
The second argument is that monetary income (consumption) is a poor proxy for actual welfare. Consider the following example: an undergraduate student in economics can pursue a career in finance with a high profile of future incomes, or he can pursue an (equally effort-demanding) academic career, with noticeably lower incomes. Usually the decision is not easy, what might indicate that, in spite of the differences in incomes, the well-being under both activities is pretty much the same. The parity in well being is partially explained by the consumption of some goods and services (in a wide sense) "purchased" by a cut in salary (e.g. time flexibility, lack of stress, taste for that particular job, etc.). Since the consumption of those (costly) goods and services is not measured in the surveys, a comparison of the incomes (or even the expenditures) of individuals in both situations would be simply erroneous.
I propose a third argument against "too much" redistribution of income. Notice that economic condition was extremely important in the early stages of economic development, when the fulfillment of basic needs was in the centre of every discussion. But nowadays in many societies the role of income in life satisfaction is more frequently related to factors such as conspicuous consumption and social comparisons (e.g. envy, ambition, income comparisons). In Pérez Truglia (2007) I try to re-examine the welfare discussion on income inequality taking into account the growing preponderance of those issues.
I need to provide a simple definition of status goods (services) in order to continue with my explanation: a particular good (service) will be considered more conspicuous the more it satisfies certain basic properties: i. It must be observable; ii. Others individuals should know its price (and then it should be distinguished from a fake); iii. Its price must be above what it would be if consumption was not observable (beyond functional characteristics); iv. It should not be socially condemned (e.g. burning money).
One the one hand, consider as an example a donation to a university: the amount is public, the evidence suggests that the donations would be significantly lower if the names of donors were not public, and it is even socially supported (for details see Glazer et al., 1996). On the other hand, consider a $150,000 automobile: people can see if someone is driving it, and it is not particularly disapproved by society; but the price if it was not observable (e.g. if the Mercedes-Benz logo was hidden) would be still high.
Take a look around and you will realize that you are surrounded by conspicuous goods. The original explanation for that fact was that people simply enjoy showing to their neighbors how much richer they are. As an immediate reaction, several economists argued that relative concerns take individuals to an unnecessary high level of social competition (i.e. to a "rat race") and to an unnecessary waste on "luxury goods".
But I claim that people care about relative standings not only because of their greediness but, at least to some extent, because through a signaling mechanism (that I will introduce below) they can get some goods and services (in a wide sense) not available in formal markets. The implications are obviously diametrically different.
A "non-market" good or service is by definition a good or service that cannot be bought in a formal market, at least not without receiving a social or even legal reprimand (e.g. friendship, sex, confidence). For example, people usually have to select a small number of individuals from a wide set of candidates: people looking for a job or a particular position inside a corporation, businessmen in search of business partners, teenagers in search of new friends, etc. In formal markets all the relevant information is collapsed into the relative prices of the goods. However, for the allocation of non-market goods seldom decision-makers can observe every relevant aspect to make the right choices. Consequently, they might want to rely on "signaling mechanisms".
For instance, consider an investor who has to choose between two candidates for doing business with. The investor would like to know which is the candidate with higher business skills. But the talents are not observable. The investor might have access to their resumes, recommendation letters, education, and other signals associated with business skills, but he cannot see the business talents of the individuals.
Nevertheless, the wealth of individuals may be a very good signal for business skills, since the most talented businessmen (by definition) are expected to have made more money. However, there are many problems to show that information directly (e.g. credibility, security, availability, tax evasion). Instead of showing his bank account, the individual can simply go to the meeting in a car of U$D 200,000. As a consequence, he will "signal" his income and get the deal.
My argument "against" the redistribution of income is now very clear. The accumulation of capital has an informational role: signaling the industrial virtue of individuals. The redistribution of income clouds the distinction between talented an untalented businessmen in the same way than the redistribution of scientific achievements (if they were fungible and transferable) between scholars would cloud the distinction between clever and inept researchers.
The argument can be extended to a wide variety of situations. The redistribution by the state degenerates the signaling of income whenever income can be a signal for talent. A painter might find optimal to rent a very expensive gallery in order to signal the (high) prices of her paintings. Then, for the otherwise uninformed buyers it will be very easy to know which are the most appropriate paintings for them.
Some parents may find useful to send their kids to an expensive school in order to show to the other parents that their kids come from a safe and sound environment as well. In spite of the absence of a "formal" market for choosing friends for their kids', the parents can still influence considerably that choice.
I try to find the root of the conspicuous behavior: envy (or ambition, avarice, etc.) may not be the innate expression of a perverse human feature (as usually suggested), but an optimal behavior designed by nature thorough social and biological evolution for solving an informational problem (as in the mechanism introduced above).
Brosnan et al. (2003) found strong evidence that monkeys have developed relative concerns through evolution. ¿Would it be odd to think that the same could have happened to human beings? Therefore, envy should not be seen as a negative aspect of human nature, but as a spontaneous arrangement of Nature for the creation of incentives towards competition, which allows for the identification of human virtue and thus to a proper allocation of non-market goods.
In Pérez Truglia (2007) I studied this phenomenon quantitatively based on data for 10,000 respondents in Russia for 2000-2002. The statistical analysis gave considerable support to the predictions of the theoretical model: expenditures inequality within the reference group does increase individual happiness. Moreover, the evidence presented by several papers seems to be consistent with my conjecture.
Since I do not want to hurt sensibilities, I explicitly recognize that my claim goes below the primordial problem of poverty. I do not believe that people without access to the basic goods and services worry about status goods. As well, I explicitly affirm that the redistribution of income is vital for the development of poor economies, as long as it can guarantee a floor of opportunities for the disadvantaged (provided that the mechanism for redistribution relies in a democratic procedure and that its scope of action has been properly limited).
Conspicuous consumption is the natural and efficient response to the absence of certain markets. Hence, some portion of the observed income inequality is endogenous, the desired product of the decision of every person within the society. People need such level of inequality to allow for the signaling of income through conspicuous consumption. That portion of inequality is known as "manufactured inequality".
Both the theoretical and empirical findings suggest, for example, that the government of the United States should not worry about the rise in income inequality experimented in the last decades. The redistribution of income by the state would be not only inefficient, but it would also disappear in the short run, since the individuals would find optimal to be involved in riskier activities to recover the (optimal) previous level of inequality.
About the Author
Ricardo Nicolás Pérez Truglia coursed his M.A. and B.A. in Economics at the Universidad de San Andrés (Argentina), where he currently holds a Teaching Assistant position. He also held research positions at different organizations, such as the Center for Financial Stability and the Buenos Aires Stock Exchange. He has shown a profound interest towards the understanding of political realms in developing countries. Ricardo is a Fulbright Scholar and member of the Argentinean Association of Political Economics. For further details visit his personal web site: www.ricardotruglia.com.ar
References
Brosnan, S.F. and De Waal, F.B. (2003), "Monkeys reject unequal pay" – Nature, No. 425, pp. 297-299.
Glazer, Amihai and Konrad, Kai A. (1996), "A Signaling Explanation for Charity" - The American Economic Review, Vol. 86, No. 4, Sep. 1996.
Pérez Truglia, Ricardo Nicolás (2007), "Can a rise in income inequality improve welfare?" - Working Paper, Universidad de San Andrés.
Pérez Truglia, Ricardo Nicolás (2006), "¿Cola de león o cabeza de ratón? El impacto de la distribución del ingreso en el aporte marginal del ingreso a la felicidad subjetiva" - Annals of the Asociación Argentina de Economía Política, XLI Annual Meeting.