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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 economic model of choice, which holds that utility depends on the absolute amount of consumption, the uniquely correct choice is World A. For if absolute house size is all that matters, A is indeed a better world for all, since everyone has a larger house there than the largest house in World B. The important thing, though, is to focus on how you would feel in the two worlds.

In fact, most people say they would pick B, where their absolute house size is smaller but their relative house size is larger. Even those who say they would pick A seem to recognize why someone might be more satisfied with a 3,000-square-foot house in B than with a substantially larger house in A. If that is true for you as well, then you accept the main premise required for the arguments I will present.

In the second thought experiment, your choice is between World C, in which you would have four weeks a year of vacation time and others would have six weeks; and World D, in which you would have two weeks of vacation and others one week. This time most people pick C, choosing greater absolute vacation time at the expense of lower relative vacation time.

I use the term positional good to denote goods for which the link between context and evaluation is strongest and the term nonpositional good to denote those for which this link is weakest.¹ In terms of the two thought experiments, housing is thus a positional good, vacation time a nonpositional good. The point is not that absolute house size and relative vacation time are of no concern. Rather, it is that positional concerns weigh more heavily in the first domain than in the second.

The argument I will advance in this book can be reduced to four simple propositions.

1 People care about relative consumption more in some domains than in others. Or, to put this proposition in more neutral language, context matters more in some domains than in others. The two thought experiments just discussed illustrate this proposition. Although context matters for evaluations of both housing and leisure time, it matters more for evaluations of housing.

2 Concerns about relative consumption lead to “positional arms races,” or expenditure arms races focused on positional goods. In the context of the two thought experiments, this proposition says that individuals will work longer hours to earn the money that will enable them to buy larger houses, expecting to enjoy the additional satisfaction inherent in owning a relatively large house.

3 Positional arms races divert resources from nonpositional goods, causing large welfare losses. When people contemplate working longer hours to buy larger houses, they anticipate additional satisfaction not only from having a larger house in absolute terms, but also from having a larger house in relative terms. For the move to appear attractive, the anticipated sum of these two gains must outweigh the loss in satisfaction associated with having fewer hours of leisure. When all make the same move in tandem, however, the distribution of relative house size remains essentially as before. So no one experiences the anticipated increase in relative house size. When the dust settles, people discover that the gain in absolute house size alone was insufficient to compensate for the leisure that had to be sacrificed to get it. Yet failure to buy a larger house when others do is not an attractive option for the individual, either. As in the familiar stadium metaphor, all stand to get a better view, but when all stand no one sees better than when all were seated.Because proposition 3 contradicts standard assertions about efficient resource allocation in competitive markets, the impulse of many economists will be to reject it. Yet its logic is precisely the same as the logic that governs the analogous, and completely uncontroversial, claim regarding military arms races. People in every nation want both a high material standard of living and protection from aggression from other nations. To protect against aggression, resources must be diverted from other forms of consumption into military armaments. Relative expenditures clearly matter more in the armaments domain than in the consumption domain. After all, a nation that spends less than its rivals on armaments puts its political independence at risk, whereas one that spends less than its rivals on consumption risks only a reduction in relative living standards. In short, military arms races result because most people believe that being less well armed than one’s rivals is more costly than having fewer flat-panel television sets. By the same token, positional arms races result because consumption evaluations are more sensitive to context in some domains than in others.

4 For middle-class families, the losses from positional arms races have been made worse by rising inequality. As I will presently discuss, most of the income gains in the United States during the past several decades have gone to people at the top of the income distribution. Not surprisingly, their higher incomes have led these people to build larger houses. There is little evidence that middle-class families envy the good fortune of the wealthy. Yet through a chain of indirect effects I will describe, the larger houses at the top have led families in the middle to spend sharply higher fractions of their incomes on housing, in the process forcing them to curtail other important categories of spending.

Our task in the pages ahead will be to examine these propositions in greater detail. But before taking up the question of whether rising inequality harms the middle class, I will first examine the extent to which inequalities in income and wealth have, in fact, been rising.