to curb pollution when transaction costs are high.
Yet another reason I discovered for the aversion to taking explicit account of the influence of context is that many economists feel that to do so would be to give weight to negative emotions such as envy and jealousy, which they feel merit no consideration in normative analysis. They reject models that incorporate context for the same reason they would reject models that give policy weight to the preferences of sadists.
Society does indeed have a legitimate interest in discouraging envy. We should continue to teach our children not to envy the good fortune of others. But the influence of context stems less from envy than from the fact that many important rewards depend on relative position. As I will explain in chapter 5, for example, the median household must keep pace with community spending on housing or else send its children to below-average schools.
Perhaps even more important, context is the very wellspring of the everyday quality judgments that drive consumer demand. That this point is not widely appreciated first became clear to me during a dinner conversation that took place before a lecture I gave at the University of Chicago several years ago. Three of us were waiting outside a restaurant when the fourth member of our dinner party pulled up behind the wheel of a brand new Lexus sedan. Once we were seated at our table, the Lexus owner’s first words to me were that he didn’t know or care what kinds of cars his neighbors and colleagues drove. As it happened, I had had numerous conversations with this gentleman over the years and found his statement completely credible.
I asked him why he had chosen the Lexus over the much cheaper, but equally reliable, Toyota sedan from the same manufacturer. He responded that it was the car’s quality that had attracted him—things like the look and feel of its interior materials, the sound its doors made on closing, and so on. He mentioned with special pride that the car’s engine was so quiet and vibration-free that the owner’s manual posted warnings in red letters against attempting to start the car while its engine was already running.
I then asked him what car he had been driving before trading up. I forget what he said, but for the sake of discussion suppose that it was a five-year-old Saab. I asked him how he thought people would have reacted to his Saab if it had been possible to transport it back to the year 1935 in a time capsule. He answered without hesitation that anyone from that era would have been extremely impressed. They would have found the car’s acceleration and handling spectacular; its interior materials would have amazed them; and its engine would have seemed unbelievably quiet and vibration-free. His own evaluations of his former car were of course strikingly different on each dimension.
We then discussed what a formal mathematical model of the demand for automobile quality might look like, quickly agreeing that any reasonable one would incorporate an explicit comparison of the car’s features with the corresponding features of other cars in the same local environment. Cars whose features scored positively in such comparisons would be seen as having high quality, for which consumers would be willing to pay a premium.
Such a model would be essentially identical to one based on a desire, not to own quality for its own sake, but rather to outdo, or avoid being outdone by, one’s friends and neighbors. Yet the subjective impressions conveyed by these two descriptions could hardly be more different. To demand quality for its own sake is to be a discerning buyer. But to wish to outdo one’s friends and neighbors is to be a boor, a social moron. To be sure, there are people whose aim is to flaunt their superiority over others. But most of us do our best to avoid such people, and the fact that we succeed most of the time suggests that they are relatively rare.
I noticed that on the heels of this discussion, everyone at the table suddenly took much more interest in talking about the kinds of behavior that are driven by contextual concerns. It was fine to talk about behaviors that result from context-dependent perceptions of quality, but not at all palatable to speak of behaviors that result from envy or a desire to outdo others.
In sum, if relative deprivation is really about context, which shapes perceptions of quality, which in turn drive demand, then it is not a peripheral concept. It applies to virtually every good, including basic goods like food. When a couple goes out to dinner for their anniversary, for example, the thought of feeling superior to their friends and neighbors probably never enters their minds. Their goal is just to share a memorable meal. But a memorable meal is a quintessentially relative concept. It is one that stands out from other meals.
With my dinner conversation in Chicago still fresh in memory, I was careful to emphasize, both during my Wildavsky Lecture and in the roundtable discussion the following day, that concerns about context and relative position have little to do with envy of the rich or a desire to keep up with them. Middle-class families don’t look to Donald Trump and worry about what he is spending his money on. Likewise, it’s totally irrelevant to most in the middle class that Bill Gates has a 40,000-square-foot mansion on the shore of Lake Washington.
The existence of such houses nonetheless affects the spending behavior of people in the middle. It does so through a chain of local comparisons. To begin with, there are people in Bill Gates’s league who are influenced by the fact that he built such a house. Indeed, others who live on Lake Washington now have houses even larger than his. Some have 50,000 square feet of living space, some have 60,000, and at least one has 70,000. And just below these people on the economic ladder, there are others for whom these large houses do matter.
For some, they matter because of envy, to be sure. But others are influenced even if they feel no envy. The mere presence of the larger mansions, for example, may shift some people’s perceptions about how big a house one can build without seeming overly ostentatious. Or it may change the way people entertain, making dinner parties for thirty-six guests the norm, rather than parties for twenty-four. Or perhaps because their larger mansions make it possible to do so, those at the top of the economic ladder may begin hosting their daughters’ wedding receptions in their homes, rather than in hotels or country clubs. Or perhaps people build bigger houses simply because the larger houses of others make their own houses seem small. In each of these instances, we need not invoke envy to explain people’s behavior.
The simple point is that local context matters for a host of reasons, most of which have nothing to do with envy or a desire to feel superior to others. Viewing the phenomenon of relative deprivation in terms of such feelings has consigned it to the periphery. This, I will argue, has been a grand mistake, one that has seriously undermined our ability to reach sensible judgments about economic policy.
CHAPTER ONE
Introduction
Many years ago, I attended a lecture by a philosopher who began his talk with a thought experiment. For me as a listener, that approach worked so well that in the years since I have tried to employ it myself at every opportunity. A recent conversation with a neuroscientist friend shed some light on why this device is often so effective. Different parts of the brain, it seems, specialize in thinking about different things. When we are confronted with a question in a Different domain, blood flows to the relevant part of the brain, priming it to think more effectively about the related ideas to follow.
So I want to begin by asking you to conduct not one but two thought experiments. Each is addressed to that part of your brain that thinks—and, more important, that cares, in the most deeply personal way—about inequality. Try as best you can to imagine that you are actually confronting the hypothetical choices I am about to describe.
In each case, you must choose between two worlds that are identical in every respect except one. The first choice is between World A, in which you will live in a 4,000-square-foot house and others will live in 6,000-square-foot houses; and World B, in which you will live in a 3,000-square-foot house and others in 2,000-square-foot houses. Once you choose, your position on the local housing scale will persist.
According to the standard neoclassical
