Social Comparisons and Inequality Perception in Homophilic Networks

Permanent Project Team: Daniel Mayerhoffer and Jan Schulz

Across income groups and countries, the public perception of economic inequality and many other macroeconomic variables is spectacularly wrong. These misperceptions have far-reaching consequences, as it is perceived inequality, not actual inequality informing redistributive preferences and hence voting behaviour. The prevalence of this phenomenon independent of social class and welfare regime suggests the existence of a common mechanism behind public perceptions that has not yet been fully accounted for. The same holds for perceptions of gender and racial wage gaps. We identify social comparions within localised neighbourhoods as a potential mechanisms. Moreover, these social comparisons may cause individuals with lower income to consume more than they would otherwise and hence contribute to expenditure cascades.

Our project aims to reconcile these phenomena by offering a mechanism of homophilic linkage based on income. This homophily means that individuals retrieve information from a limited sample which is biased towards less inequality.

Method

The proposed theory of inequality perception bases on a random geometric graph type network. Individuals form this network by a weighted draw of link neighbours whereby the weights decrease in the income difference between drawer and potential drawee. We analytically evaluate this network and also simulate it in an agent-based model to closely track the mechanisms at work.

Jan Schulz, Daniel Mayerhoffer and Anna Gebhard (OVGU Magdeburg)

This paper introduces and analyses the basic mechanism of homophilic linkage and the resulting random geometric graph type network as well as its implications for general perceptions of societal inequality. The generating mechanism can simultaneously replicate all stylised facts that the literature has identified on how inequality perceptions respond to actual inequality and how biases vary systematically along the income distribution. The mechanism also produces social networks that exhibit salient features of real-world networks; namely, they cannot be statistically distinguished from small-world networks, testifying to the robustness of our approach. Our results, therefore, suggest that homophilic segregation is a promising candidate to explain inequality perceptions with strong implications for theories of consumption and voting behaviour.

Click here to access the working paper.

Jan Schulz and Daniel Mayerhoffer

We extend our model to incorporate individuals from an underprivileged and a privileged group in order to study the perception of wage gaps. This extension shows that the combination of homophilic graph formation and estimation based on locally limited knowledge can replicate both the underestimation of the gender or racial wage gap that empirical studies find and also the well-documented fact that the underprivileged perceive the wage gap to be higher on average and with less bias. In contrast to this qualitative replication, we also demonstrate that the effect of homophilic graph formation is quantitatively too strong for a recent Israeli sample on perceived gender wage gaps. We propose a simple remedy, where agents estimate using a composite signal based on local and global information. Our calibration suggests that women place much more weight on the (correct) global signal than men, in line with the intuition that people who are adversely affected by a wage gap are more interested in global information about the issue. Our findings thus suggest that (educational) interventions about the global state of gender equality are much more likely to succeed than information treatments about inequality and that these interventions should target the privileged.

Jan Schulz and Daniel Mayerhoffer

The nexus between debt and inequality has attracted considerable scholarly attention in the wake of the global financial crisis. One prominent candidate to explain the striking co-evolution of income inequality and private debt in this period has been the theory of upward-looking consumption externalities leading to expenditure cascades. Building on income-based homophily, we propose a parsimonious model of upward-looking consumption at the micro level mediated by perception networks with empirically plausible topologies. This allows us to make sense of the ambiguous empirical literature on the relevance of this channel. Up to our knowledge, our approach is the first to make the reference group to which conspicuous consumption relates explicit. Our model, based purely on current income, replicates the major stylised facts regarding micro consumption behaviour and is thus observationally equivalent to the workhorse permanent income hypothesis, without facing its dual problem of `excess smoothness' and `excess sensitivity'. We also demonstrate that the network topology and segregation have a significant effect on consumption patterns which has so far been neglected.

Click hereto access the working paper.

Jan Schulz and Daniel Mayerhoffer

This subproject investigates voting behaviour in light of economic inequality using the concept of homophily. It builds on two established assumptions: a) perceptions of one’s own economic status impact preferences for redistribution; b) one’s decision whether to vote depends on how strong their preferences in the issue are and how likely they deem their vote to make a difference, i.e. how they expect others to vote. In our model, agents form their preferences about redistribution as well as their expectations over others’ voting behaviour based on their local perception in the homophilic network. This approach allows us to replicate the stylized empirical facts regarding voting behaviour concerning issues of redistribution.