Other people's money makes us do strange things. A friend buys a new car, so we start daydreaming about one, too. The neighbors build an addition, so we start mulling the second mortgage that could finance a similar sunroom, because suddenly the house feels too small. We want what they have — to keep up with the Joneses.
Thanks to this impulse, economists worry that greater income inequality may get less wealthy people into trouble. If the neighbors around you start making — and conspicuously spending — a lot more than you do, your efforts to keep up could land you in serious debt. In fact, during periods of widening income inequality like the 1920s and the run-up to the housing bubble in the United States, when a larger share of income went to families at the top, just about everyone else was busy amassing debt.
This is a tricky thing to prove, though: that widening inequality causes financial problems for people not at the top. But recent research from the Federal Reserve Bank of Philadelphia offers fascinating evidence that this does really happen. The authors, Sumit Agarwal, Vyacheslav Mikhed and Barry Scholnick, looked at sudden and very local shocks in inequality — when individual households in Canada won the lottery. The bigger their lottery winnings, the study found, the more likely their neighbors were to file for bankruptcy.
We've all heard of lottery winners going bankrupt. But here the researchers were more interested in the effect of all this cash on the people who watched those winnings turn into nicer cars or home improvements. Canadian postal codes contain, on average, just 13 households, allowing the researchers to track thousands of lottery winners and their very immediate neighbors over time. They found that a $1,000 increase (in Canadian dollars) in lottery prize money caused a 2.4 percent rise in bankruptcies among those immediate neighbors over the next two years.
The balance sheets that bankruptcy filers must submit also show that people who lived near big lottery winners had larger holdings of visible assets like cars, motorcycles and houses, suggesting that their conspicuous consumption may have been what got them into trouble. The larger the lottery winnings, the higher the value of housing and vehicle assets for the bankrupt neighbors.
These effects were also stronger in lower-income neighborhoods and places that had wider inequality to start with. And the study implies that the original lottery prizes wouldn't have the same effect if winners were using the money in less visible ways, like to pay off loans or pad their savings.
The researchers removed payouts larger than $150,000 from their dataset, and so the sums of money they're talking about here aren't Mega-Millions-like mind-boggling. The likelihood of a person filing for bankruptcy is also small to begin with, so while these higher odds are significant, they don't mean that people are filing for bankruptcy left and right.
Given that the rich and non-rich seldom live right next to each other — and that income segregation between them is growing in the United States — it's hard to say what these findings might mean for middle- and lower-income households that aren't in eyeshot of a one-percenter's new Tesla. But the results are in line with the wider worries that more inequality might also mean more financial distress.
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