Monday, March 31, 2014

Consumption Contagion and Income Inequality

The trends of rising income inequality and the declining national savings rate since the early 1980s may be related, according to a paper by Marianne Bertrand and Adair Morse. The authors find that higher levels of visible consumption by increasingly better-off households at the top of the income distribution induces consumers in the lower parts of the income distribution to spend a higher share of their disposable income. From "Consumption Contagion: Does the Consumption of the Rich Drive the Consumption of the Less Rich?":
"Our empirical strategy exploits variation across geographic markets and over time to identify the effect of expenditures by the rich on that of the non-rich. We ask whether, everything else held constant, higher levels of consumption by the rich living in a household’s relevant market (which we define to be either a state or an MSA in a given year) predicts a higher propensity to consume out of disposable income for the non-rich household. After establishing that such vertical consumption correlations occur, we then explore possible mechanisms. Our results are most consistent with the view that visible increased consumption by the rich induces status-seeking or status-maintaining consumption by the less rich."
Bertrand and Morse define the rich households in each state as those with above the 80th percentile of income in that state. Their baseline regression shows that a 1 percent increase in consumption (excluding housing) among the rich in a particular state translates into a 0.07 percent increase in consumption among the less-rich. They find no evidence that this could be explained by the permanent income hypothesis; rising consumption by the rich in a particular state is not predictive of faster future income growth by the state's less-rich. Thus, they conclude that "Our preferred explanation for the vertical consumption spillovers we observed in our basic results is that low and middle income households witness the higher consumption levels by the rich and are tempted to also consume more."

To test this explanation further, they use data from the Consumer Expenditure Survey and use the Ori Heffetz (2011) index to rank goods into seven categories of increasing visibility. Highly visible consumption items include cars, clothing (except underwear!), shoes, and cigarettes; minimally visible consumption items include health or legal accounting services and, yes, underwear. They replicate the analysis by goods category, and find strongest effects in the most visible consumption categories, consistent with a "consumption contagion" explanation.

As another test, they replicate the analysis using Census Metropolitan Statistical Areas (MSAs) instead of states. They use a measure of community segregation, indicating how closely the rich live to the less-rich in each MSA. In MSAs where the rich and less-rich live closer together, there is more consumption contagion.

Overall, the authors estimate that the savings rate of median-income households would be one to two percentage points higher in the absence of this "consumption contagion" effect. This is non-trivial but also not huge. What is most important is the empirical support of a particular type of departure from the Permanent Income Hypothesis. Many types of departures have been hypothesized, but quantifying their relative importance and carefully tracing out their implications for macro models is an ongoing task.

7 comments:

  1. This is one of those things that ordinary people experience every day that economists verify is true. I myself know I am a victim of this -- I can't really afford a tablet but that's what people richer than me seem to be buying, so I put a tablet on my credit card. Or I feel compelled to do that anyway.

    Seeing them on TV and in friends' and family's homes is like a trigger.

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  2. I suggest you look at contradictory evidence in the paper by Yuri Gorodnichenko, 'Does Greater Inequality Lead to More Household Borrowing? New Evidence from Household Data', just presented in a London Business School seminar. Should be available at Berkeley!

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  3. I think our inequality problem would begin to be solved if we raised the minimum wage by one dollar every year.

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  4. Richard, yes, I looked at that paper yesterday after someone mentioned it to me on twitter. John Mondragon, one of the coauthors, told me "We expected debt was financing consumption but found no. leaves room for labor supply, liquid wealth, informal debt." So the two papers aren't necessarily contradictory, as one focuses on consumption and the other on debt, but it is an interesting contrast.

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  5. Veblen would not have been surprised...

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  6. Or see the paper in the first issue of the Review of Behavioral Economics (ROBE) by Robert Frank, Adam Seth Levine, and Oege Dijk entitled "Expenditure Cascades." It already has a Wikipedia entry and basically makes the same argument.

    Barkley Roser

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Comments appreciated!