Blogs | February 10, 2014

“You’re one of the luckiest people who ever lived. Why not celebrate?”

Britons in 2014 had lower real incomes than in 2007, due to wage pressures and high inflation. Americans had lower incomes that year than in 1999. But never mind the politics of this; think about the psychology.

In the UK and the USA, there was a sense of weakness and decline relative to fast-growing China – expressed when a Chinese newspaper described the United Kingdom as “no longer any kind of big country". Yet both nations were still vastly better off than China; UK real incomes per person were four times those of China’s. And yet Brits and Americans didn’t think “we’re massively richer than the Chinese, so we should be happy.”

Compared with last year, I’m not as well off
Instead, people typically compare their incomes to those of a few years ago, and feel bad. Nothing has changed in the 238 years since Adam Smith wrote: “The progressive state is in reality the cheerful and the hearty state. The stationary is dull; the declining, melancholy.” This highlights an important fact. When we think about our incomes, what matters are frames. If our frame of reference were Chinese incomes, we’d consider ourselves blessed. Instead, our frame is the income of our recent selves, which depresses us.

Compared with my colleague…
Our past selves, though, are not the only point of reference. We also compare our incomes to those of our friends, colleagues and neighbours, and feel worse off if they are lower. In terms of making us happy, “it is not the absolute level of income that matters most, but rather one’s position relative to other individuals” says Bruno Frey of the University of Zurich. It’s a cliché in investment banking that people will be unhappy with even a mega-million bonus if the person on the next desk gets a bit more. But investment bankers aren’t really much different from the rest of us.

Such comparisons don’t just make those on below-average incomes unhappy. They can also cause us to spend more when those around us do. This can get us into more debt than we’d otherwise want, as we try to “keep up with the Joneses”. What’s more, income comparisons can erode social capital. In a study of 26 countries, economists at the University of St Gallen found that people whose incomes were below average were less likely to trust others and less likely to have confidence in their countries’ political and legal systems.

Is there hope for me yet?
Comparisons, though, are not always objectionable. Some people feel happier when they compare their incomes to richer people's. Andrew Clark at the Paris School of Economics has found this to be the case for people whose incomes are rising. And Felix FitzRoy at the University of St Andrews has found that although older Germans feel worse if their income is below that of their peers, younger ones feel better. There’s a simple reason for this. Youngsters, or people with rising incomes, look at those on higher incomes than themselves and think “I could be earning that soon”, and so feel hopeful. Older ones, however, see higher incomes and think “that’s what I could have had”, and so feel regret and remorse.

Compared to our ancestors, we are very lucky
Herein, though, lies some reasons for hope. We might be able to train ourselves to reduce the bad feelings we have from comparing ourselves to others. First, remember that bygones are bygones. We’ve all missed opportunities in the past. Unless you can invent time travel, there’s no point dwelling on them. Second, change your reference group. Compared to the vast majority of humans who ever lived, anyone reading this piece is incredibly well-off. If you were born in a western nation in the late 20th century, you’re one of the luckiest people who ever lived. Why not celebrate this?

Third, remember the salience heuristic: we see others’ wealth, but not its downside. Our neighbour’s brand new BMW is obvious. But we don’t see him lying awake at night worrying about debt, or the misery he feels working long hours in a lousy job. This bias can lead us to needless envy.

Finally, remember the words of John Stuart Mill over 150 years ago. Flat incomes, he wrote, imply "no stationary state of human improvement. There would be as much scope as ever for all kinds of mental culture, and moral and social progress; as much room for improving the art of living, and much more likelihood of its being improved, when minds ceased to be engrossed by the art of getting on.” Maybe we should think less about how to earn more - and more about how to live better.

Personal financeEmotionHappinessPsychology

Chris Dillow
Chris Dillow

Investors Chronicle writer and economist