Subjective Economic Reality

Why economists need surveys even when they have huge datasets, how people’s perceptions of the economy correlate with reality, and whether they are subject to change: Econs.online publishes excerpts from the lecture that Stefanie Stantcheva, Professor of Economics at Harvard University, gave on October as a part of the NES Public Lecture series.

– We use large scale social economic surveys and experiments, trying to see how people reason, how they fancy themselves in the society, how they perceive and understand social and policy issues, and how they form their views and attitudes. The surveys are extremely important because they show things that we cannot see in traditional data, no matter how complete or good it is. At some point, our standard methods that we use in economics, such as inferring preferences from observed behaviour, are no longer sufficient. Our goal is to try and see the invisible. Back in the day, surveys used to measure income level or transfers, but now we can get this information directly from administrative data, tax status, security data, or firms. However, there are still intangible things, which cannot be seen, even when using enlarged datasets, and modern surveys and experiments allow us to get into people’s minds.

Beliefs about unequal opportunities

– Our joint research with my Harvard colleague Alberto Alesina, who unfortunately passed away this year, and Edoardo Teso from Northwestern University, is about intergenerational mobility and beliefs that people have about it. We conducted surveys in the USA, UK, France, Italy, and Sweden. We started by defining stereotypes that Americans and Europeans have.

We tend to think that Americans believe that the economic system is fair, that they believe in the American dream, meaning that everyone can make it if they work hard enough, and poverty is due to one’s inability to take advantage of opportunities. By contrast, Europeans are often perceived to think that the system is unfair, that wealth is due to one’s family history and heritage, and that if people are poor, to a large extent, it is because society is unable to help them. The World Values Survey, a big international survey, also shows that 70% of Americans versus only 35% of Europeans believe that if you work hard, you can climb the social ladder. There’s new data that shows that reality is not in line with these perceptions.

We tried to understand what people really think about intergenerational mobility in their country: what, in their opinion, it takes to climb the social ladder, whether they see the economic policy as fair, what the role of effort versus the role of luck is in making it, and what measures can reduce inequality of opportunity and income.

It turned out, for instance, that Americans overestimate the probability of the American dream coming true, i.e. of making it from the bottom to the top. Our respondents think that the chances are around 12%, while in fact, the chances of moving from the bottom to the top are only 7.8%, as data shows. On the other hand, Europeans are more pessimistic, while the probability of realising the American dream in Western Europe is higher than in the USA, at about 11%. At the same time, Americans living in states with the lowest actual mobility overperceive it the most: in some states perceived chances are twice as high than reality. On the other hand, people living in states where the mobility level is above average, underperceive it slightly or overperceive it much less.

This raises the question about what actually shapes people’s views on mobility that are so not in line with reality. Our research has shown that one of the biggest predictors is political affiliation. Left-wingers, both in the US and in Europe, tend to be much more pessimistic about intergenerational mobility; right-wingers tend to believe in equal opportunities and self-made men and women.

‘Polarisation of reality’

– People’s perception of mobility influences their views on redistribution. The more pessimistic people are about making it from the bottom to the top, the more they support an increased tax rate on high incomes, and increased social benefits, etc. Optimists showed the opposite trend. If you try to shift people’s views on intergenerational mobility by for instance showing them pessimistic information about mobility, they become more supportive of redistribution, even if this only begins during the experiment.

Another research project is about how people understand a particular type of distribution policy. We were trying to see what mental models people use to think about tax policy, what exactly they know about it, and how they reason. That is very important to understand in order to see how fair the tax system is, who pays the most in taxes, and who benefits the most.

It turned out that what people actually pay the most attention to when thinking about tax policy and what will ultimately shape support for taxes or not is tax fairness and who benefits from redistribution. At the same time, the efficiency of the tax system is far less important.

However, surveys have shown that ‘fairness is in the eye of the beholder’ and to a great extent, political affiliation defines the way people perceive tax policy. There are large divergences between left and right-wingers, although fairness of the tax system is very important to both groups, albeit in different ways. For instance, right-wingers tend to be more cautious about public spending, while left-wingers think more about redistribution and inequality. This polarisation of reality that people with different political views experience persists even when it comes to factual knowledge of the tax system: they give different answers to questions like ‘What is the tax rate? Who pays how many taxes?’ etc., although this information can be easily accessed through the Internet. Thus, supporters of opposing political parties live in different economic realities.

From an economist’s point of view, the most crucial misalignment between people’s views and reality is the misperception of the way the economy and economic policy work. It is necessary that people be well-informed and understand what consequences different policies will have. This involves education about economics earlier: currently, most people only get this if they go to university, and that is not the vast majority of people. Economic issues affect everyone’s daily lives.

People need tools to see what’s in their best interest and what is going to happen to the economy in general if they support this or that economic policy. Education reform takes time, but we already can provide them with useful information. The most important thing is that it be diffused by a non-partisan organisation, and this is the part where academic economists conducting independent research should play their role.