New experimental research shows that individuals'' happiness depends as much on the incomes of people around them as on their own income. According to Olof Johansson-Stenman, Fredrik Carlsson and Dinky Daruvala, writing in the latest issue of the Economic Journal, people generally prefer more equal societies to less equal ones. But they also care as much about their relative income as their absolute income, with many people preferring a lower absolute income that is above average income to a higher absolute income that is below average.
The researchers analyse the answers to a survey in which respondents are invited to imagine choosing between two quantified scenarios of future societies on behalf of a future descendent:
''The average income in Society A is higher than in Society B, but the latter has a more equal income distribution. Which society would you choose?'' The results show that people generally prefer more equal societies to less equal ones – they are ''inequality averse''. Thus, individuals avoid the risk of extremely low future incomes, even if this means that their expected income is lower.
This preference is to be expected if the increase in well-being that an individual experiences is greater the lower their income. In fact, the study estimates that someone earning twice as much as another person would on average receive only about 20% of the enjoyment that the poorer person would get from an identical wage increase. But happiness may also be affected by an individual''s position on the income ladder, which can be tested by the following question:
''In Society A, the average income is £30,000 and your descendent earns £25,000. In Society B, the average income is £20,000 and your descendant earns £23,000. Which society would you choose?''
The choice between A and B is basically a trade-off between relative and absolute income. As many as 60% of the respondents chose society B, implying that most people are in fact quite concerned with their income relative to others. The research also shows that women and left-wing voters are both more ''inequality averse'' than other groups. What is more, these groups care more about their relative position on the income ladder, which, interestingly, is also the case for respondents with siblings, possibly implying that preferences for relative income, or status, are acquired in childhood.
If relative income is important, an increase in income for one person will mean a relative decrease in income for everyone else. And if the person who gets the income increase is sufficiently rich, the additional enjoyment he or she receives from the increase may be more than offset by the decreased enjoyment that everybody else feels due to their decreased relative income.
The researchers'' analysis of the experimental results show that an income increase for someone with a higher monthly income than £4,000 would decrease well-being in society as a whole, everything else being equal. Perhaps such welfare losses explain why some people get so upset about large wage increases for the rich.
These results run counter to economists'' typical assumption that an individual''s wellbeing depends on their own income and not on the level of income of people around them. They add to a growing body of evidence that people do care about how their income compares with that of others, as illustrated by the following Karl Marx quotation:
A house may be large or small; as long as the neighbouring houses are likewise small, it satisfies all social requirements for a residence. But let there arise next to the little house a palace, and the little house shrinks to a hut.
''Measuring Future Grandparents'' Preferences for Equality and Relative Standing'' by Olof Johansson-Stenman, Fredrik Carlsson and Dinky Daruvala is published in the April 2002 issue of the Economic Journal. The authors are at the University of Gothenburg, Sweden.