Robert J. Stonebraker, Winthrop University
The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop
University
It's All Relative
If winning isn't everything, why do they keep
score?
.....Vince Lombardi
As a young man I joined our church softball team. Early in the season, playing squads loaded with fleet teenagers and burly coal miners, we suffered several successive defeats. We played well, but our opponents played better. As the losses mounted, our spirits sank.
Finally, we met Curry Creek Presbyterian, a small rural church that fielded a team without fleet teenagers or burly miners. We smashed them. After five innings we had run up a lead of 30 runs and the game was called for darkness. More importantly, I hit my first home run. It was only an average fly ball, but it eluded the elderly woman playing left field and rolled to the fence as I chugged around the bases.
We didn't play particularly well that evening, and my "home run" was a routine out against another team. But we returned to our families with a victory under our belt and smiles on our faces. Thirty years later, I still remember the thrill of crossing home plate.
The Curry Creek players soon tired of continued annihilation and dropped out of the league. They found two other rural churches that played elderly women in the outfield, formed a new league, and spent many evenings enjoying friendly, more equally matched, games of softball. With Curry Creek out of the league, my home run production plunged.
The key to victory often is not how well we perform in some absolute sense; it's whether we can drub our opponent. We may hold our heads high after a well‑played loss, but we'd rather win. We have an inherent distaste for being at the bottom of the barrel, no matter how nice a barrel it may be.
Relative vs. absolute
This drive to win, to be "number one," seems hard‑wired into our behavioral circuits. Biologically, that's not surprising. After all, relative and not absolute performance determines which species win the Darwinian struggle for survival. The slow‑afoot can survive and prosper as long as predators and prey are even slower. Competitive economic survival depends on the same relative success. I can produce a lousy pizza, but if it is the best pizza on the market, I will still flourish.
Apply this same concern with relative standing to income. First, imagine opening your pay envelope and finding a $20 bonus. How do you feel? Next, imagine finding that your co‑workers received $500 bonuses. Now how do you feel? Your absolute income is up. You have an extra $20. Theoretically, you should be happier. Are you? Which is more important, the value of the $20 or your wrath at getting less than the others?
Economists teach that happiness depends upon the quantities of goods consumed. Of course, common sense suggests that what others consume might also matter. I can feel fortunate driving a run-down 1989 Plymouth in a developing country where cars are an unusual luxury. But if you make me drive that same Plymouth in a community where my neighbors are driving late-model BMWs, I will sulk. The Plymouth might be an effective status symbol in Bangladesh, but not in Palm Springs.
Economist Robert Frank argues that our obsession with winning and with our relative standing in the community (what he calls local status) profoundly affects economic behavior1. Frank suggests that status, like any other scarce commodity, has a demand, a supply, and an equilibrium price. Those who most value the status of being "top dog" will compete for the spot and drive up its price.
Who supplies this status? According to Frank it is the losers. After all, we cannot continue to win unless we can find others who are willing to lose. We cannot be the biggest fish in our pond unless the smaller fish agree not to leave. Remember, no one wants to lose; no one wants to be the smallest fish. If we are always at the bottom of our barrel, we are going to look for a new barrel. Like Curry Creek Presbyterian, we will want to change leagues (or ponds). If we want someone to hang around and play the patsy, we had better be prepared to pay.
Paying for status
The payments could be explicit -- we could have bribed Curry Creek to stay in the league, thus boosting our batting averages and keeping us out of the cellar. But the payments are typically disguised. As an example, consider how wages are set in a typical business.
Wage structures within firms are more egalitarian than labor economists might predict. In competitive markets a worker who is three times more productive than other workers should be paid three times as much. 2 Yet, this rarely happens. If you are employed, consider your co‑workers. Are they paid in strict accordance to their productivities? Or are some paid more than they are worth and others less?
Firms seldom base their pay rates exclusively on productivity. Many salaries, including those at my university, follow negotiated formulas based on education, experience, and seniority. In almost every firm there are significant productivity differences between workers earning the same wages. The least productive workers usually earn more than they are worth, while the most productive workers are paid less than their true value.
Why? Why would a firm pay an employee $50 if he were only worth $30? And why would an employee worth $100 stick around if she were paid only $80? In a competitive world she could find another employer willing to pay her the $100. Earlier economists assumed this meant that labor markets did not function competitively. But the differentials between pay and productivity might reflect the value of status in the firm's hierarchy.
Suppose the value of local status in a firm is $20. If so, those at the top can be paid $20 less than the value of their productivities. The employee worth $100 might willingly stay for an $80 wage if she can also enjoy $20 worth of local status. Similarly, the employee at the bottom may be worth only $30, but being at the bottom is no fun. To induce him to accept such an ignoble position, you might have to pay him more.
The $20 becomes a disguised bribe that those at the top of the heap must pay those at the bottom. Without such a bribe, those at the bottom -- like Curry Creek -- will change ponds. They will go to a smaller pond where they won't be stuck at the bottom of the hierarchy. The $20 is the compensation paid by those wanting to win to persuade others to be willing to lose.
Who will sell?
If some of us want to buy status, others must be willing to sell. We can create intriguing predictions about how the price of status will vary among people and organizations. Just as those who value status the most will be the buyers, those who value it the least will be the sellers. Who will these sellers be? Which people will willingly sacrifice local status? Quite likely, it will be those who enjoy status elsewhere.
For example, if you're the state racquetball champion you might be willing to accept a low-status job. You might be more willing to accept a position beneath mine at the office if you know that you can thrash me on the racquetball court. Similarly, my inability to match you at racquetball may make it more imperative that I rank above you at work. I might need high status at work to compensate for my low status at the racquetball club. In other words, those people who are "big fish" in their lives away from the job may be more likely to accede to being the "small fish" at work ‑‑ and vice versa.
Where opportunities for "off‑the-job" status are plentiful, it should be easy to find people willing to take low-status jobs. If so, the equilibrium price for status will be low. However, if opportunities to excel outside of work are scarce, the number of employees willing to accept low status jobs will drop. Without compensating status available elsewhere, it will be difficult and expensive for those at the top to induce others to accept the "small fish" roles. According to Frank, this explains why salary structures in the armed forces ‑‑ where military personnel are somewhat sequestered and have few off-the-job opportunities to excel ‑‑ are more egalitarian than those in the private sector.
This notion that status is an important economic commodity -- that we might care about our relative standing as much as our absolute standing -- is still controversial. But researchers in recent years have been developing an impressive array of supporting evidence. Even that economic sage Marge Simpson has jumped on the bandwagon. In one cartoon episode, her husband Homer laments, "I think we're the worst family in town." Marge replies, "Maybe we should move to a larger town."
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Notes:
1. Frank, Robert H., Choosing the Right Pond: Human Behavior and the Quest for Status, Oxford University Press, 1985. Much of this section is based upon Frank's work.
2. Traditional economic theory predicts that each worker in a competitive world will be paid the value of his/her marginal productivity. This equals the additional or marginal revenue that each worker creates for the firm. For example, if by hiring me firms can produce enough extra output to bring it $100 of new revenue, I will be paid $100. A firm would be foolish to pay me more and, in a competitive world, cannot get away with paying me less. If I am offered only $90, a competing firm, seeing my true $100 value, will offer me more.
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Testing Yourself
To test your understanding of the concepts in this reading, try answering the following:
1. Why might people care more about relative rather than absolute performance?
2. Use the concept of local status to explain why wage structures within firms are more egalitarian than labor economists might predict.
3. What types of people are most likely to be most willing to sacrifice local status for an appropriate price? Explain.