Evidence for relative concern

On the one hand, there is limited evidence about the relationship between income mobility and relative income concern. Piketty (1998) suggests there is indirect evidence about status motives based on social preferences for redistribution and beliefs about the origins of income inequality. Hoff and Pandey (2004) carried out an experiment in Northern India, in which they find that lower-caste children’s cognitive tasks are unrelated to their social position. They have the same results as their high-caste counterparts when their caste identity is not publicly known, but obtain worse results once their status caste is known.

The authors interpret this result as children reducing their effort when they believe that they could be discriminated against. Similar conclusions are reported by Afridi et al.

(2015) for China’s Hukou System. Fehr et al. (2011) found that willingness to punish social violations is lower among members of lowstatus caste than among highstatus caste. They argue that this behavior could affect income mobility. Fehr and Hoff (2011) review evidence about the influence of society on individual preferences and explore the potential consequences on the persistence of inequality between social groups.

On the other hand, there is growing evidence that supports the fact that economic behav-ior could be affected by interpersonal comparisons and the esteem of others. Therefore

one central issue is that the behavior of individuals is often motivated by relative concern (Rabin, 1998; 2002). Heffetz and Frank (2011) review anecdotal, experimental and sur-vey evidence, which shows that social status affects individual behavior. From economics there are at least four areas of empirical research that account for the importance of rela-tive position in economic decisions. First, there is the literature on happiness or more in general, the empirical literature on subjective well-being measures. This literature stud-ies how individuals’ relative position and the environment where individuals live could affect their level of satisfaction or their economic aspirations (Clark, et al. 2009a, 2009b, Stutzer, A., 2004, Ferrer-i-Carbonell, 2005; Vendrik and Woltjer, 2007). Most of these studies highlight the opportunities provided by these types of variables for a better un-derstanding of economic behavior.⁵ Second, there is literature that measures the effect of relative position on “objective” output as consumption (Charles et al., 2009; Kaus, 2013;

Brown, et al., 2010). These studies confirm the effect of reference groups on the con-sumption of visible goods, which crowds out other investments. Third, there are valuable research contributions in experimental economics which confirm that there are significant income comparison effects (Kanheman and Tversky, 1979, Galanter 1990; McBride,2010;

Fliessbach et al., 2007; Alpizar, et al. 2005; Johansson - Stenman et al., 2002). Finally, there is empirical literature on how social status, relative situation and the visibility of decisions affect behavior and achievements (Ball and Eckel,1996; 1998, Ball et al., 2001;

Rege and Telle, 2004; Ariely et al. 2009, Hoff and Pandey 2004).

Furthermore, empirical findings about relative concern allow us to formalize how refer-ence group income affects an agent’s utility. Evidrefer-ence confirms the relevance of relative concern with respect to a reference point: mean dependence model.⁶ Furthermore, Ferrer

5There is a debate in economics on the consistency of self-reported measures with “utility” and with observed choice behavior (Clark et al. 2008, Kahneman and Krueger, 2006, Ferrer-i-Carbonell, 2011).

6Hopkins (2008) distinguishes two families of relative concern models. On the one hand, he identifies mean dependence modelswhere relative concern is defined as the difference between own performance and the reference level (Boskin and Sheshinski,1978; Abel,1990; Harbaugh,1996, Clark and Oswald,

i Carbonell (2005), McBride (2001), Di Tella et al., (2010) Vendrik and Wotjer (2007) found evidence on asymmetry of comparisons and loss aversion. Vendrik and Woltjer (2007) relate these empirical findings with the prospect theory developed by Kahneman and Tversky (1979). According to Tversky and Kahneman (1991), reference group in-come provides a natural reference point for inin-come comparison. prospect theory suggests that welfare depends more on deviations from a reference level than on absolute levels.

Negative changes generate a higher impact on utility than positive changes of the same magnitude (loss aversion), and preferences could be convex in the loss area (principle of diminishing sensitivity).⁷

Hopkins (2008) identifies a set of models and reviews evidence that supports relative concern based on three behavioral foundations: envy, pride (also named competitiveness) or compassion. According to the envy effect, the utility of an agent declines when an increase in the income of people richer than them occurs (namely ^∂U_∂dy^(.)R > 0if y^RG > y, whereU(.) is the utility function,y^RGandyare reference group income and agent’s income respectively and y^R = y−y^RG). Duesenberry (1949) argues that poorer individuals are negatively influenced by the income of their richer peers, while the opposite is not true (^∂U(.)_∂y^R > 0if y^RG > y, ^∂U(.)_∂y^R = 0 if y^RG < y ). However, the pride effect (also named competitiveness) suggests that the utility of an agent decreases with any improvement in the income of others (^∂U(.)_∂yR >0). Secondly, some authors assume that agents are better off when there is an improvement in the income of those agents below them (“compassion effect” (^∂U(.)_∂yR <0 if y^RG< y).⁸

These behavioral foundations based on relative comparison are related with social

pref-1996;1998, Futagamia and Shibata,1998; Ferrer-i-Carbonell, 2005; Card et al., 2012; Van Praag 2011).

On the other hand, an alternative specification considers relative concern based on income rank (Layard, 1980; Frank, 1985 and Robson, 1992; Clark et al. 2009a; 2009b). In the next section we use the mean dependence models, because seem useful to model the role of reference group as a benchmark.

7This theory also suggests that individuals make decisions based on subjective probability assessments.

8There are models that combine these effects on the basis of different functional forms using reference-dependence model or ranking concern.

erences, which supports some of the presented assumptions (Hopkins, 2008; Fehr and Schmidt, 2003; Heffetz and Frank, 2011).⁹ The original model of Fehr and Schmidt (1999) assumes that agents dislike others having more (envy effect) but low income for others reduces their utility (compassion effect). Alesina and Giuliano (2010) discuss the “ incen-tive effects” of inequality aversion. They suggest that inequality generates incentives to work hard for most people below the top of the income distribution of the group.

The above findings provide some central issues for relative concern modelization. In sum, most of the studies assume ^∂U_∂y^(.)R >0 when y^R < 0 and there is a consensus on the asymmetry in the income comparison with respect to reference income. In general, models assume the standard assumption of diminishing marginal utility of relative income when y^RG< y(^∂_∂^22U(.)_y^R <0). However, there is less agreement on the sign of the second derivative with respect to relative income for those individuals with relative deprivation. Vendrik and Woltjer (2007) argue that the objective function could be convex or concave in relative income, for agents with relative deprivation. On the one hand, the standard assumption of the diminishing marginal utility of income in neoclassical theory suggests concavity of the objective function in relative income (^∂_∂^22U(.)_y^R <0if y^RG> y). This effect would imply a rising marginal sensitivity to more negative values of relative income, which implies a

“positional self - encouraged agent” (chapter 1). On the other hand, in prospect theory it is plausible to argue that the utility function is convex, reflecting diminishing marginal sensitivity to larger deviations from the reference group income (^∂_∂²2^U(.)y^R > 0if y^RG > y).

This implies a “positional discouraged agent” (chapter 1).

Furthermore, these findings suggest the relevance of status in explaining income mobility and its effect on individual behavior and support the relevance of theoretical studies to explore the link between status and intergenerational mobility. The next chapter addresses

9In this model, agents dislike difference between their income and that the others. In general, that type of models do not consider relative care with respect a reference point. However different types of aversion models have been formulated, and some of them incorporate relative payoff, which could be adapted to be interpreted as reference point (Hopkins, 2008; Charness and Rabin, 2002).

this issue.