Rethinking the Relative Income Hypothesis

Abstract

This paper focuses on the understanding of the eect of relative income on health. Traditionally, relative income was expected to have a negative association with individual health by means of negative psychological eects. However, the empirical evidence is not conclusive. In order to explain the results disparity in previous literature, I use new evidence regarding the eect of income comparisons within a reference group on well-being. Using German Socio-Economic Panel data (SOEP), I analyse whether income comparisons aect health through psychological well-being in dierent directions, depending whether the comparisons are upwards or downwards, and not only through relative deprivation, as it was suggested initially. In addition, income endogeneity, due to omitted variables, have been tackled considering unobserved heterogeneity after a POLS transformation. The results show that relative income is more important for health than absolut income. The association between \upwards comparisons and health is positive, being negative the eect of \downwards comparisons.