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INCREASING INEQUALITY MAKES EVERYONE FEEL WORSE: Evidence from Germany

  • Published Date: March 2016

Income inequality makes people less happy across society. That is the central finding of research by Johannes Eigner, to be presented at the Royal Economic Society's annual conference in Brighton in March 2016.

His study analyses data from the German Socio-Economic Panel, which has tracked over 12,000 households across the country from 1984 to 2012. The analysis finds that people report themselves as less happy when the income gap between the richest and poorest increases, suggesting that Germans generally dislike income inequality regardless of whether they win or lose from it.

For example, even if someone’s income rose by €1000, they would not become any happier if people who are richer also became better off by this amount. This could explain why life satisfaction measures do not show people to be happier when their country’s GDP increases.

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The life satisfaction of individuals appears to be influenced by the distribution of wealth in their peer group and the society as a whole. More precisely, the respondents in the German Socio-Economic Panel (SOEP), a repeated survey of more than 12,000 representative households across the whole of Germany over the period 1984 to 2012, report significantly lower happiness scores when the income distance to richer and poorer individuals increases.

This result suggests that Germans are on average averse to both disadvantageous and advantageous income inequality and have inequity averse preferences. A policy-maker interested in improving the average life satisfaction should aim at reducing income inequality.

The measures of income inequality used in the study are calculated at the individual level with respect to six different peer group specifications. The results are robust to estimation methodology, over years, and for both income and expenditure as proxy for unobservable wealth. Including other measures of inequity in the regression confirms the outcome. The magnitude of the marginal effect of income inequality varies across specifications, but can be as large as the marginal effect of income.

For example, even if an individual saw her income rise by €1000, her happiness would not be predicted to rise if at the same time the incomes of the people richer than her also rose by the same amount. Aversion to income inequality could explain why average life satisfaction measures within a country do not increase with GDP.

Empirical and in particular experimental studies commonly find that individuals care not only for their own level of income or consumption but also about its relative size compared with the levels of a peer group.

The peer groups are usually defined according to visible characteristics such as occupation, age, education, and can also relate to all individuals in the sample/experiment. Surprisingly, empirical and experimental findings are not in agreement on the way human wellbeing is affected by the wealth of others.

A robust result in non-competitive game-theoretic experiments is that individuals on average express altruistic preferences. This finding is generally not confirmed by empirical studies. Common inequity measures such as the Gini coefficient cannot be robustly linked to wellbeing and studies report either positive, negative or no significant influence. But the negative impact of relative income on well-being is a robust result in the empirical comparison income literature.

Assume advantageous as well as disadvantageous income inequality affects wellbeing of the average individual in some way. Without making further assumptions on the nature of these preferences, this study shows that accounting only for relative income in a regression on subjective well-being could lead to biased results. The direction of the bias depends on the true nature of preferences.

The goal of this research is to evaluate empirically whether relative income and the relative position in the income distribution or inequity aversion and social preferences are better suited in describing the preferences of the average individual. The author proposes a simple test for the relevance of relative income and social preferences for subjective wellbeing.

ENDS


How does the wealth of others affect our life satisfaction? Some evidence for altruism and inequity aversion
Contact details:
Johannes Eigner
j.f.eigner@sms.ed.ac.uk
The University of Edinburgh, School of Economics, 30 Buccleuch Place, EH8 9JY, Edinburgh, UK