FALLING BEHINDHow Rising Inequality Harms the

Middle Class

Robert H. Frank

Cornell University

Adam Smith’s invisible hand:

Self-interested demands will result in a socially efficient allocation.

Charles Darwin: Traits are selected because of their impact on the reproductive fitness of individuals, not groups.

Traits that benefit individuals often work to the disadvantage of groups.

Why do male elephant seals weigh five times as much as females?

The exception that “proves” the rule:Very little sexual dimorphism in

monogamous species.

Gaining access to mates

= a positional good

Minimizing the risk of death from predators

= a nonpositional good

The Conflict Between Individual and Group

Positional goodsNonpositional goods

Bombs

Toasters=

Robert H. Frank. “The Demand for Unobservable and Other Nonpositional Goods.” American Economic Review, 75, March, 1985, pp. 101-116.

Positional Externalities Are Pervasive

In a poor country, a man proves to his wife that he loves her by giving her a rose. In a rich country he must give a dozen roses.

Richard Layard

Cycles of Fashion

Tattooing and piercing

Forms of Discourse:

Individual vs. Collective Incentives

Excessive formalism in economics

The holder [of a CAB certificate] may continue to serve regularly any point named herein through the airport last regularly used by the holder to serve such point prior to the effective date of the certificate. Upon compliance with such procedures relating thereto as may be prescribed by the Board, the holder may, in addition to the services hereinabove expressly prescribed, regularly serve a point named herein through any airport convenient thereto.

Bureaucratic Language

“I propose to embrace tactical strategies in moving in disruption of the dichotomy, as crucial to an epistemology of resistance/liberation. To do so is to give uptake to the disaggregation of collectivity concomitant with social fragmentation and to theorize the navigation of its perils without giving uptake to its logic…”

Maria Lugones, “Tactical Strategies of the Streetwalker”

Discourse in the Humanities

If you were society’s median earner, which option would you prefer?

1) You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

2) You save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests?

Launching your children successfully in life

= positional good

Maintaining a comfortable standard of living in retirement

= nonpositional good

Expenditure Cascades

• Top earners spend more because they have more money.

• And so on all the way down the income ladder.

• That, in turn, shifts the frame of reference for those next below.

• This shifts frame of reference for those just below them, who also spend more.

The cost of sending a child to a school of average quality is linked to the price of the average house in the community.

Median size of a newly constructed house:

1980: less than 1600 square feet

2004: more than 2100 square feet

Viking Professional, $5,000.

1989 Sunbeam, $90

Gas Grills Then and Now

Talos Outdoor Cooking Suite, $35,000.

Evidence for Expenditure Cascade Hypothesis

In 100 most populous U.S. counties, those that experienced highest growth in income inequality also experienced highest

Growth in long commute times

Growth in divorce rates

Growth in bankruptcy rates

Frank and Levine, 2006

In OECD, over time and across countries, higher 90/50 ratios are linked with longer hours of work

Bowles and Park, 2003

In 200 school districts, median home prices are higher in districts with higher income inequality

Ostvik-White, 2004

Proposed positional arms control agreement:

Raise tax rates on income and put additional revenues into retirement equity accounts for citizens.

If voters felt incapable of achieving their savings goals without the proposed law, on what grounds could a libertarian reasonably object?

Taxation as theft?

No taxes, no government.

No army.

Get invaded by some other country’s army.

Pay taxes to that country’s government.

The Libertarian Criterion:

Taxation and regulation are acceptable only if they are required to prevent citizens from harming others.

Driving 90 mph in school zones: not permitted

A necessary, not sufficient, condition.

Harming business rivals by cutting prices: permitted

The Libertarian Crybaby:

“You can’t tax or regulate me because that limits my freedom to do as I please.”

An effective advocate for liberty?

Ronald Coase, 1960. “The Problem of Social Cost”

Externalities are reciprocal:

Allowing pollution harms those downwind.

Forbidding pollution raises costs and prices.

Society’s interest lies in making total harm as small as possible.

When transaction costs are low, affected parties will negotiate efficient solutions privately.

Transaction costs often make private solutions impractical.

In such cases, policy should place the burden of adjustment on those who can accomplish it at the lowest cost.

Example: Smith objects to Jones wearing a purple shirt, the sight of which, Smith claims, causes him great distress.

Should the wearing of purple shirts be prohibited?

Impractical to pay Jones not to wear purple shirts.

“Get used to it, Smith! People have a right to wear whatever shirts they please!”

Smith complains that Jones’s larger house reduces his welfare.

“Get used to it, Smith! Jones has a right to build whatever size house he chooses.”

Analysis-free response:

Defending any right entails benefits and costs.

Free speech: The First Amendment protects most forms of expression, even those that cause intensely painful effects on others.

But when the cost of speaking freely is sufficiently high, we prohibit speech.

Yelling “Fire!” in a crowded theater.

Wearing purple shirts is permitted because people who are offended by them can adapt more easily than those who are told they can’t dress as they please.

Which party can avoid harm at least cost in the case of positional externalities?

Proponent of the agreement:Save too little and suffer diminished living standard in retirement (or send your child to a bad school in a dangerous neighborhood).

Opponent of the agreement: Live in a smaller house than you would have chosen.

Why have economists been so slow to take positional concerns seriously?

James Duesenberry’s Relative Income Hypothesis:

The poor save at lower rates than the rich because they are more frequently exposed to consumption standards higher than they can comfortably afford.

Milton Friedman’s Permanent Income Hypothesis:

“Rich and poor save at the same rate.”

John Maynard Keynes:

“Economic Possibilities for our Grandchildren,” 1930:

How will they fill their days once productivity advances make it possible to meet their economic needs by working only a few hours a week?

“Now it is true that the needs of human beings may seem to be insatiable. But they fall into two classes—those needs which are absolute in the sense that we feel them whatever the situation of our fellow human beings may be, and those which are relative in the sense that we feel them only if their satisfaction lifts us above, makes us feel superior to, our fellows.”

“But this is not so true of the absolute needs—a point may soon be reached, much sooner perhaps than we are all aware of, when these needs are satisfied in the sense that we prefer to devote our further energies to non-economic purposes.”

“Needs of the second class, those which satisfy the desire for superiority, may indeed be insatiable; for the higher the general level, the higher still are they.”

Context and the demand for quality

A memorable meal

An effective interview suit

A suitable gift

Regulations as Data

Why do hockey players vote in secret ballots for helmet rules, even though they choose not to wear helmets when there is no rule?

Rules Governing Duels

Mandatory Kindergarten Start Dates

2) You work in a risky job at $1200 a week, and your children attend a school whose students score in the 50th percentile on those tests?

Safety Regulation

In the abstract, you value safety at $300/wk.Which option would you prefer?

1) You work in a safe job at $1000 a week, and your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

Which option would you prefer?

1) You save enough to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

2) You save too little to support a comfortable standard of living in retirement, but your children attend a school whose students score in the 50th percentile on those tests?

Mandatory Savings Programs

Which option would you prefer?

1) You work 40 hours a week, and your children attend a school whose students score in the 20th percentile on standardized tests in reading and math; or

2) You work 60 hours a week, and your children attend a school whose students score in the 50th percentile on those tests?

Limitations on Work Hours

Why do predominantly male legislatures enact statutes prohibiting polygamy?

Positional externalities are no different from other externalities.

The Progressive Consumption Tax

Consumption + Savings = Income

Consumption = Income – Savings

Taxable consumption = Income – Savings – standard deduction

Taxable Consumption Marginal Tax Rate

0 - $39,999 20 percent

$40,000 - $49,999 22 percent

$50,000 - $59,999 24 percent

$60,000 - $69,999 26 percent

$70,000 - $79,999 28 percent

$80,000 - $89,999 30 percent

$90,000 - $99,999 32 percent

$100,000 - $129,999 34 percent

$130,000 - $159,999 38 percent

$160,000 - $189,999 42 percent

$190,000 - $219,999 46 percent

$220,000 - $249,999 50 percent

Taxable Consumption Marginal Tax Rate

$250,000 - $499,000 60 percent

$500,000 - $999,999 80 percent

$1,000,000-$1,999,999 100 percent

$2,000,000-$3,999,999 150 percent

$4,000,000+ 200 percent

Income Savings Taxable Consumption

Tax

$30,000 $1500 0 0

$50,000 $3000 $14,167 $2833

$100,000 $10,000 $49,836 $10,164

$150,000 $20,000 $81,538 $18,462

$200,000 $40,000 $104,328 $25,672

$500,000 $120,000 $258,000 $92,000

$1,000,000 $300,000 $458,000 $212,000

$1,500,000 $470,000 $646,000 $354,000

$2,500,000 $800,000 $1,029,900 $667,100

$3,500,000 $1,200,000 $1,316,400 $953,600

$20,000,000 $10,000,000 $4,444,267 $5,525,733