Happiness, Deprivation and the Alter Ego · Background Happiness, utility and income The Easterlin paradox Relative income A few stylized facts 1 Income matters but: 2 Decreasing

Happiness, Deprivation and the Alter Ego

Paolo Verme

Department of Economics ‘S. Cognetti de Martiis’, University of Torino

July 2010

Paolo Verme Happiness, Deprivation and the Alter Ego

Background

Happiness, utility and income

The Easterlin paradox

Relative income

A few stylized facts

1 Income matters but:2 Decreasing marginal returns for states and people3 Relative income and the reference group4 Aspirations and Expectations


This paper

How do people evaluate income? The income utility function

The role of relative deprivation and income inequality

The ‘Alter Ego’ model of income utility

An empirical application of the model with CHER data

Value added1 Comprehensive framework2 Income satisfaction Vs. Life satisfaction3 Personal income Vs. GDP per capita4 Richer data set5 Econometric issues


Theory

Smith, Marx and relativity

Stouffer et al. (1948) and the American Soldier. Theimportance of relative deprivation

Davis (1959) relative deprivation and the reference group.Within (fairness) and between (social distance: relativesubordination and relative superiority) comparisons

Leibeinstein (1962) theory of democracy. Pure Paretocomparisons (only income), Share of the pie comparisons(only rank) and Compromise Pareto comparison (both).

Runciman (1966) theory of social justice. Relative deprivationwhen someone: 1) Does not have X ; 2) Sees some otherperson or persons as having X ; 3) Wants X and 4) Sees it asfeasible to have X .


Theory (cont...)

Gurr (1968) theory of deprivation and civil strife. Distancebetween expectations and capabilities is relative deprivation

Karapetoff (1903) progress curve. Expectations and the roleof speed of change in shaping expectations

Davies (1962) theory of revolutions. Revolutions occur duringpost-growth recessions. Growth creates expectations andrecessions crash these expectations

Hirschman and Rothtschild (1973) tunnel effect. The role ofincome mobility and inequality in the short and long-term


Ingredients

Absolute income

Relative income

Absolute changes in income

Marginal changes in income

Income inequality

Rank

Aspirations and Expectations

Relative income deprivation

The reference group


Measuring Relative Deprivation

Yitzhaki (1979), Berrebi and Silber (1985), Chakravarty(1995): Measuring relative deprivation. Lack of feelings andlack of selection mechanism of the reference group

Festinger (1954), Nagel (1974) and Panning (1983): Thetendency of two individuals to compare their own wealth withthat of the other varies inversely with the difference in theirwealth. Selection mechanism.

Clark and Oswald (1996), Verme and Izem (2008), Silber andVerme (2009), Verme (forthcoming). Relative deprivationwith selection of the reference group based on income(absolute), predicted incomes (expected) and rank (relative)


Happiness and income models

Clark et al. (2008)

Ui ,t = U(u1(Yi ,t), u2(Yi ,t/Y ∗t )) (1)

where: i=individual; t= present time; Y = income; Y ∗=Relativeincome (where relative income can be interpreted as one own pastincome or a “moment” income of the reference group).


An alternative value model of income


The ‘Alter Ego’ model

Ui ,t = U(ue(Yi ,T ), ua(Y ∗t )) (2)

where:Ui ,t = Individual utility at the present time;Yi ,T = Individual income through time with T = (t − 1, t, t + 1)1;Y ∗t = Income of a reference group at the present time;ue(.) = Evaluation function of the ‘Ego’ system andua(.) = Evaluation function of the ‘Alter’ system.

Note: Utility=Happiness=Income satisfaction. We consider bothindividual income and GDP per capita.

1For simplicity, we model the past as t − 1 and the future as t + 1.Paolo Verme Happiness, Deprivation and the Alter Ego

The ‘Ego’ value system

UEi ,t = U(Yi ,t−1,Yi ,t ,E (Yi ,t+1)) (3)

E (Yi ,t+1) = f (∆Yi ,t ,∆Y ∗t ,∆GDP/capt) (4)

E (Yi ,t+1) = Yi ,t(1 + (((∆Yi ,t + ∆Y ∗t + ∆GDP/capt)/3)) (5)

UEi ,t = U(Yi ,t ,E (Yi ,t+1)) (6)


The ‘Alter’ value system

UAi ,t = U(Yi ,t ,Y

∗t , ri ,t) (7)

RD = [...1/n...]′G [...si ...]− [...1/n...]′G [...wi ...] (8)

where: [...1/n...]′ is the row vector of population weights; G = isthe ‘G’ matrix as defined in Silber1994 - A square matrix with all‘0’ along the diagonal, all ‘1’ above the diagonal and all ‘-1’ belowthe diagonal; [...si ...] is the column vector of shares of incomesorted in descending order of incomes and [...wi ...] is the columnvector of shares of predicted incomes sorted in descending order ofincomes. Thus, the observed utility of the ‘Alter’ system is reducedto:

UAi ,t = U(RDIi ,t) (9)

Thus, we capture income, the reference group, rank and incomeexpectations into one measure and avoid collinearity problems inempirical applications.


Observed utility in an ‘Alter Ego’ framework

Aggregating the ‘Ego’ and ‘Alter’ systems we obtain the observedincome utility function:

Ui ,t = U(Yi ,t ,E (Yi ,t+1),RDIi ,t ,Zi ,t) (10)

where Ui ,t is the observed satisfaction with income and Zi ,t is avector of variables controlling for other non-income factorsaffecting satisfaction with income.Our purpose is now to measure the elasticity of income satisfactionto changes in the factors of the utility function.


Data and Sample

Consortium of Household Panels for European Socio-economicResearch (CHER).

Collection of panel survey data sets whose variables have beenharmonized into a consistent data set

19 panel studies carried out between 1990 and 2001 andtotaling over 1.2 millions individual observations

Individuals in age 30-50 with a declared working time of atleast 15 hours per week and with positive incomes.

Only panel observations in 2nd+ years

193,000 observations, 94 country/year points

Thanks to CEPS/INSTEAD Luxembourg for finance and data


Empirical specification

Si ,t = α + β1(ln(Yi ,t)) + β2(ln(E (Yi ,t+1))) + β3(ln(RDIi ,t))+γ1(Xi ,t) + γ2(Cc) + γ3(Tt) + ηi ,t

(11)

Pooled world sample

Dep.Var.: Satisfaction with income (5 steps)

Income: Annual real income in USD PPP equivalent

Key Vars: Income, expected income and relative deprivation

Controls: Age, Gender, Education, Marital status, Householdsize, Professional status (self-employment and stateemployment)

Estimator: Ordered logit model, robust standard errors,country and year fixed effects


Results 1 - Linearity


Results 2 - Collinearity


Results 3 - Income Expectations by Quantile


Conclusion

The ‘Alter Ego’ system as an alternative model of incomeutility

Expected income and relative deprivation as core concepts forthe ‘Ego’ and ‘Alter’ systems

Absolute income sits at the cross-section between the ‘Ego’and ‘Alter’ systems, both theoretically and empirically. Mostimportant predictor of income satisfaction

Once we control for absolute income, the relation betweenincome satisfaction and expected income becomes complex toassess, non linear and overall rather weak

Relative deprivation critical in reducing significantlysatisfaction with income in line with relative income theories

The ‘Alter’ value system (the comparison with others)dominates the ‘Ego’ value system (the comparison withoneself) in explaining satisfaction with income


Documents

Happiness, Deprivation and the Alter Ego · Background Happiness, utility and income The Easterlin paradox Relative income A few stylized facts 1 Income matters but: 2 Decreasing