Keeping Up with the Neighbours: Envy as a Driver of Economic Growth

© iStock

Classical economic theory assumes that economic agents are entirely self-interested and rational in their pursuit of material well-being, and that they are not affected by external factors. As a result, externalities are not considered in any way when constructing economic models. Nevertheless, some sociologists argue for a revision of modern economic theory to incorporate the ethical dimensions of economic agents' behaviour. Kirill Borissov, Professor of the Faculty of Economics at the European University in St Petersburg, spoke at the XXIV Yasin (April) International Academic Conference and shared his observations from creating his own economic model incorporating the factor of envy.  

'It's natural to assume that an individual's level of patience may depend on their level of envy. For example, if an individual's neighbours display a high level of consumption and are buying new phones or cars, the individual may feel compelled to increase their own consumption and buy new things, regardless of the expense, in order to keep up with their neighbours,' explains Borissov. His paper, entitled 'Growth and Distribution in Models with Envy', discusses an approach to rationalising the relative income hypothesis by incorporating envy into consumers' utility functions.

Kirill Borissov

The permanent income hypothesis in macroeconomics proposed by American economist Milton Friedman suggests that as income increases, people should save more. Although the hypothesis holds true at the individual level, it can create a misleading picture when applied to a larger scale, such as when making comparisons between countries. According to Friedman's hypothesis, if a country becomes wealthier, it should save more. However, in reality, this is often not the case.

Also relevant is the Solow model of exogenous economic growth based on the neoclassical production function and the exogenous savings rate. This model assumes that the savings rate remains constant. However, this assumption contradicts the permanent income hypothesis and the Keynesian approach, which suggests that savings determine the size of investments, rather than the other way around. 'If individuals save more as their income and wealth increase, then economic growth should result in a higher average savings rate,' Borissov observes. 'In reality, however, the average savings rate tends to remain relatively constant despite the growth of income in society.' James Duesenberry, an American Keynesian economist, proposed an explanation for this paradox in his relative income hypothesis.

According to Borissov, Duesenberry argued that poverty is relative, and that people make decisions about savings based not on their absolute level of income, but on their relative position in society and on the property ladder.

Economist Robert Frank, professor at Cornell University's Graduate School of Management, believes that a successful theory should account for three key facts:

• as national income grows over time, the average savings rate should remain relatively constant
• consumption should be more stable than income
• people with higher incomes should save more

'However, Duesenberry's theory has been criticised for its lack of microfoundations, sociological and psychological underpinnings,' notes Borissov, who has proposed a model in which an individual's degree of patience may be influenced by the level of envy, and individuals differ only in their initial level of savings. 

It turns out that the level of envy can be calculated. In Borissov’s model, which employs the standard Cobb-Douglas production function with competitive markets, total production is dependent on the inputs of labour and capital. A distinctive aspect of the model is its consumption function, in which an individual's consumption is calculated as the difference between their theoretical consumption and the average consumption within their generation, multiplied by the envy coefficient. The model assumes, according to Borissov, that an individual's enjoyment from consumption is not based on the absolute level of their consumption, but rather on how this level relates to the average consumption within their generation. This, indeed, is a mathematical expression of envy. 

In an economy with envy, there are two equilibrium types: an egalitarian equilibrium with a fair distribution of wealth, and multiple two-class stationary equilibria, similar to the Schlicht-Bourguignon model (an endogenous growth model where the consumption function plays a significant role in wealth redistribution in a society having two groups of equilibria. The model predicts the existence of multiple stationary equilibria, including one with a Pareto-dominant single group—Ed).

'If the parameter responsible for envy is not very high, then the incomes of consumers tend to be levelled over time,' says Borissov. 'However, if the envy parameter exceeds a certain threshold value, the society will become polarised.' The economy will then converge to a stationary equilibrium in which the population is divided into two classes: the poor and the rich, and the division between them will depend on the initial distribution of wealth. The consumers who had the highest initial savings will be the only ones who become rich. Borissov's model demonstrates how envy can contribute to an increase in inequality.

One interesting modification considered in the model is the robotisation of society. Borissov has observed that regardless of the level of envy in society, robotisation will result in a continuously growing economy, while wages will remain stagnant. 'Even if robotisation starts in an egalitarian mode, it will eventually lead to a regime of growing inequality, where all benefits of growth will go to the wealthy,' Borissov concludes.

Author: Kamila Rafibekova, Research Assistant, HSE Laboratory for Economic Journalism