We studied whether relative income has an impact on subjective well-being among extremely poor people. Contrary to the findings in developed countries, where relative income has shown a significant and negative impact on subjective well-being, we cannot reject the hypothesis that relative income has no impact on subjective well-being in rural areas of northern Ethiopia.absolute income, relative income, subjective well-being

Akay, Alpaslan

Martinsson, Peter

English

Research Papers in Economics

IZA DP No. 3812
Does Relative Income Matter for the Very Poor?
Evidence from Rural Ethiopia
Alpaslan Akay
Peter Martinsson
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Forschungsinstitut
zur Zukunft der Arbeit
Institute for the Study
of Labor
November 2008 
Does Relative Income Matter 
for the Very Poor? 
Evidence from Rural Ethiopia 
 
 
Alpaslan Akay 
University of Gothenburg 
and IZA  
 
Peter Martinsson 
University of Gothenburg 
 
 
 
 
Discussion Paper No. 3812 
November 2008 
 
 
 
IZA 
 
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Germany   
 
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available directly from the author. IZA Discussion Paper No. 3812 
November 2008 
 
 
 
 
 
 
 
 
 
 
 
 
ABSTRACT 
 
Does Relative Income Matter for the Very Poor? 
Evidence from Rural Ethiopia
*
 
We studied whether relative income has an impact on subjective well-being among extremely 
poor people. Contrary to the findings in developed countries, where relative income has 
shown a significant and negative impact on subjective well-being, we cannot reject the 
hypothesis that relative income has no impact on subjective well-being in rural areas of 
northern Ethiopia. 
 
 
JEL Classification:  D10, I31, I32 
  
Keywords:  absolute income, relative income, subjective well-being 
 
 
Corresponding author: 
 
Alpaslan Akay  
IZA 
P.O. Box 7240 
53072 Bonn 
Germany 
E-mail: akay@iza.org       
 
                
 
                                                 
* We are grateful to Haileselassie Medhin for helpful comments. Financial support from the Swedish 
Agency for International Development Cooperation (Sida) to the Environmental Economics Unit at 
University of Gothenburg is gratefully acknowledged.    
 
1. Introduction 
 
The observation that people are not only concerned with their own income but also with their 
own income relative to others has been discussed by scholars from Adam Smith to Karl Marx. 
Recent evidence from the subjective well-being literature, which utilizes subjective well-being 
(also referred to as “satisfaction with life” or “happiness”) as a proxy for utility, does show that 
the income of others affects our own subjective well-being (see, e.g., a summary of the literature 
in Clark et al. 2008). Another branch of the literature on “relative positions” has applied stated 
preference studies to explicitly test both for relative concerns on income as well as on other 
domains in life, such as days of vacation and value of a car, with the overall finding that people 
do have relative concerns (e.g., Alpizar et al., 2005; Johansson-Stenman et al., 2002; Solnick and 
Hemenway, 1998). The implications of relative concerns are lowered utility from a unit of 
income as well as engagement in activities for the reason to increase one’s relative position, i.e. 
conspicuous consumption.  
 
One of the main catalysts for the research on relative income is the Easterlin paradox (Easterlin, 
1974, 1995). Richard Easterlin noted that despite sharp rises in income per capita in many of the 
Western countries after World War II, the average subjective well-being remained fairly constant 
over the same period of time. However, cross-sectional data showed a positive correlation 
between income and subjective well-being. Clark et al. (2008) discussed the relationship between 
different cross-section data sets and argued that the lower the absolute level of income in a cross-
2    
sectional data set, the higher the positive correlation between subjective well-being and own 
absolute income. In other words, relative income is more important for subjective well-being 
among people in richer countries than in poorer countries. The empirical evidence supporting 
this observation on this issue stems from research in wealthier countries, where the empirical 
results show that relative income has a negative and significant impact on subjective well-being. 
However, there is a lack of empirical evidence from poorer countries with exception of the 
application by Knight et al. (2007) to rural China, where they found that the self-reported 
relation between own household income and village average had a positive and significant 
impact on subjective well-being. In a similar vein as Clark et al. (2008), Frey and Stutzer (2002) 
argued that when absolute income is above some subsistence level, then other factors, such as 
relative income, start to influence subjective well-being.  
 
The objective of this paper is to test whether relative income matters for very poor people by 
using a novel data set collected in rural areas of northern Ethiopia in 2004–2005. Ethiopia was 
ranked in the top five poorest countries in the world, based on adjusted gross national purchasing 
power parity income per capita and almost 40 percent of households are living under poverty line 
(World Bank, 2004).1 The overall results of our paper, based on different definitions of reference 
groups, suggest that the relative income does not affect subjective well-being among the very 
poor people in northern Ethiopia.  
                                                 
1 Using international US$, where one dollar has the same purchasing power as US$ 1 in the United States, 
Ethiopia’s gross per capita income is only 1.7% of the gross per capital income in the United States (World Bank, 
2004). 
3    
2.  Modeling Relative Income in Northern Ethiopia 
 
To test if relative income has an impact on subjective well-being requires that the group of 
people to whom one compares oneself is defined. Different reference groups have been assumed 
in the empirical literature:  McBride (2001) used age as the reference group and geographical 
area was used, for example, by Blanchflower and Oswald (2004) and Luttmer (2005). In an 
ambitious paper, Ferrer-i-Carbonell (2005) tested different combinations of gender, age, and 
education as reference groups.  
 
We used data from the third round of an extensive household survey (“Sustainable Land Use in 
the Ethiopian Highlands”), which was conducted in 2004-2005. The survey covered 1,753 
randomly chosen households within clusters of 2 zones, 6 districts, 14 sub-districts, and 196 
local communities.2 The data are comprehensive in terms of socio-demographic and economic 
variables, such as age, marital and health status, educational attainments, and agricultural 
practice. Income was the key variable in our analyses of its impact on subjective well-being. We 
used household income per capita, which was calculated as the sum of sale of crops, off-farm 
income, sale of livestock products, oxen rental, tree sales, honey sales, gifts, and farm wages 
divided by the number of household members.  
 
                                                 
2 Ethiopia consists of 11 regional states, which are divided into sub-regions called zones; the zones are divided into 
districts (woreda); the districts are divided into sub-districts (kebele); which are in turn constructed of local 
communities, called got (singular = got; plural = gotoch). 
4    
In this paper, we followed the Ferrer-i-Carbonell (2005) approach by testing several possible 
combinations of reference groups, both on their own as well as in combinations. We defined the 
reference groups as related to age, size of land holdings, and geographical area. Age of the 
individuals was classified into 10 groups, starting from age 25 to 85, 
as ;   (average age was 50.29, with standard deviation 15.24). 
Land size of the households was measured in hectares and classified into seven groups:   
(the 
average size of land was 0.22 hectares with standard deviation 0.25). We used two different 
geographical areas as reference groups:  (1) sub-district and (2) local community.  
} 5 40 5 20 { z age z i + < ≤ + 9 ,... 0 = ∀z
{ 0;0.1 0.1( 1), 0,1,2;0.3 0.5;0.5 0.7; 0.7} ii i i i land z land z z land land land =< ≤ + = < ≤ < ≤ >
 
Subjective well-being is measured on a discrete scale by asking, “in general, how satisfied are 
you with the way you live?” with five possible response categories ranging from very unhappy to 
very happy. (The number of individuals that self-reported to be happy or very happy was low 
and therefore these two categories were merged.) Due to non-responses and missing values, we 
used 1,463 individuals in our analyses. The distribution of happiness was very unhappy (11.3 
percent), unhappy (56.4 percent), neither happy nor unhappy (24.9 percent), and happy or very 
happy (7.4 percent).  
5    
We tested for the impact of relative income on subjective well-being by using the following 
ordered probit model approach:3  
                                  ,  i k i
r
i j relative i absolute i x y y SWB ε α γ β β + + ′ + + = − ) log( ) log( ,
*
where   is the self-reported subjective well-being of individual i reported on an ordinal 
scale;  is absolute income of individual i;   is the average income of the reference group j, 
defined as 
i SWB
i y
r
i j y − ,
∑ = − − =
1 , ) ) 1 ( 1 (
s s j i j y N y
−1 j N r  (where  is the number of individuals who are in jth 
reference group); 
j N
absolute β  and  relative β  are the estimated parameters for the absolute and relative 
income;   is a vector of socio-demographic characteristics, such as age, sex, marital and health 
status, main occupation, and literacy; 
i x
γ  is a vector of estimated parameters of the socio-
demographic variables;  k α  is the sub-district level fixed-effects to capture unobservable regional 
differences;4 and  i ε  is the error terms which are assumed as normally distributed with zero mean 
and unit variance due to identification. We expected that absolute income would have a positive 
impact on subjective well-being ( 0 > absolute β ) and that relative income would have a negative 
impact ( 0 < relative β ) if it affected subjective well-being. It is the sign, magnitude, and statistical 
significance level of the relative income parameter which is of main interest in this paper.  
                                                 
3 Alternatively, the distance between own income and the income of the reference group, i.e.,  , 
could be used. This implies, then, that  i i . In this 
specification, the sign of the relative income is expected to be positive. The larger the distance, the richer the 
individual relative to the reference group, the happier is the individual. (See for instance, Clark et al., 2008; 
Blanchflower and Oswald, 2004.)   
) log( ) log(
r
j i y y −
r
j relative i relative absolute i x y y h ε γ β β β + ′ + − + = ) log( ) log( ) (
*
4 Sub-district (kebele)-level fixed effects are not controlled for in the models using sub-district level as reference 
groups.  
6    
3.  Results 
 
Table 1 presents how absolute and relative income affect subjective well-being in eight different 
cases based on reference groups defined by using different combinations of age, size of land 
holdings, and geographical area (sub-district and local community).5 As a comparison case, we 
also ran a model without relative income (presented in the second column), with the expected 
positive and significant effect of absolute income on subjective well-being, which is in line with 
the literature. The next two columns report the results for the geographical reference groups and 
the estimations show a positive and significant impact of absolute income and an insignificant 
effect of relative income on subjective well-being. The next two columns use age-peers and land 
size separately. Again, only the absolute income has significant impact on subjective well-being. 
The second part of the table presents the results when combining the reference group sub-district 
and local community levels with the age-peers and land size, respectively. The unanimous 
conclusion is that relative income is not a significant determinant of subjective well-being.6   
4.  Discussion  
 
This paper investigated whether relative income matters for the very poor. We tested this 
hypothesis for individuals living in rural areas of northern Ethiopia, which is one of the poorest 
                                                 
5 Full estimation results are not reported here, but are available upon request.  
6 We also estimated the models with different groupings of age and land size, and the results were robust to 
grouping.  
7    
regions in the world. We found that the impact of relative income on subjective well-being is 
small in magnitude and also insignificant. This is in line with the predictions by Clark et al. 
(2008), who hypothesized that the impact of relative income on subjective well-being within a 
country will decrease as one moves from richer to poorer countries. This result leads to many 
important implications in the development research, especially in reducing poverty and income 
inequality, and designing redistributive policies as discussed by Luttmer (2005) and Fafchamps 
and Shilpi (2008). The policy implication is to focus on reduction of absolute poverty. However, 
in less poor countries, the policy should also consider income inequality, but identification of the 
threshold level where relative income will begin to affect subjective well-being is an important 
area for future research.  
References 
 
Alpizar, F.,   F. Carlsson, and O. Johansson-Stenman. 2005. “How Much Do We Care about 
Absolute versus Relative Income and Consumption? Journal of Economic Behavior and 
Organization 56: 405–421. 
Blanchflower, D.G., and A.J. Oswald.2004. “Well-Being over Time in Britain and the United 
States,” Journal of Public Economics 88: 1359–86. 
Clark, A.E., P. Frijters, and M.A. Shields. 2008. “Relative Income, Happiness, and Utility:  An 
Explanation for the Easterlin Paradox and Other Puzzles,” Journal of Economic 
Literature 46: 95–144.  
Easterlin, R. 1974. “Does Economic Growth Improve the Human Lot? Some Empirical 
Evidence.” In Nations and Households in Economic Growth, edited by P.A. David and 
M.W. Reder. New York:  Academic Press.  
Easterlin, R. 1995. “Will Raising the Incomes of All Increase the Happiness of All?” Journal of 
Economic Behavior and Organization 27: 35–47. 
8  
 
 
 
World Bank. 2004. World Development Indicators. Washington, DC:  World Bank.  
Solnick, S.J., and D. Hemenway. 1998. “Is More Always Better? A Survey on Positional 
Concerns,” Journal of Economic Behavior and Organization 37: 373–83. 
McBride, M. 2001. “Relative-Income Effects on Subjective Well-Being in the Cross Section,” 
Journal of Economic Behavior and Organization 45: 251–78. 
Luttmer, E.F.P. 2005. “Neighbors as Negatives:  Relative Earnings and Well-Being,” The 
Quarterly Journal of Economics 120: 963–1002.  
Knight, J., L. Song, and R. Gunatilaka. 2007. “Subjective Well-Being and Its Determinants in 
Rural China.” Discussion Paper 334, Department of Economics. Oxford:  Oxford 
University.  
Johansson-Stenman, O., F. Carlsson, and D. Daruvala. 2002. “Measuring Future Grandparents’ 
Preferences for Equality and Relative Standing,” Economic Journal 112, 362–83.  
Ferrer-i-Carbonell, A. 2005. “Income and Well-Being:  An Empirical Analysis of the 
Comparison Income Effect,” Journal of Public Economics 89: 997–1019. 
Fafchamps, M., and F. Shilpi. 2008. “Subjective Welfare, Isolation, and Relative Consumption,” 
Journal of Development Economics 86: 43–60.  
Frey, B.S., and A. Stutzer. 2002. “What Can Economists Learn from Happiness?” Journal of 
Economic Literature 40: 402 –435.   
 
9 
    
 
 
Table 1.  Estimation Results from Different Reference Groups 
 
  Benchmark 
model 
Geographical area 
reference groups 
Socio-demographic and economic 
reference groups  Composed reference groups 
 
 
 
Sub-district 
level 
Local 
community 
level 
Age      Land size
Sub-district 
and age 
Sub-district 
and 
land size 
Local 
community 
and age 
Local 
community 
and 
land size 
Without socio-demographic and economic variables 
Absolute income 
0.184* 
(0.043) 
0.168* 
(0.041) 
0.211* 
(0.050) 
0.184* 
(0.037) 
0.183* 
(0.044) 
0.167* 
(0.039) 
0.168* 
(0.036) 
0.232* 
(0.054) 
0.216* 
(0.051) 
Relative income  - 
0.001 
(0.092) 
0.030 
(0.083) 
0.054 
(0.152) 
0.006 
(0.070) 
-0.004 
(0.055) 
0.003 
(0.029) 
-0.041 
(0.046) 
-0.010 
(0.040) 
With socio-demographic and economic variables 
Absolute income 
0.195* 
(0.049) 
0.171* 
(0.046) 
0.220* 
(0.058) 
0.194* 
(0.049) 
0.195* 
(0.050) 
0.173* 
(0.044) 
0.169* 
(0.042) 
0.250* 
(0.064) 
0.229* 
(0.059) 
Relative income  - 
-0.029 
(0.100) 
-0.001 
(0.090) 
-0.087 
(0.155) 
-0.026 
(0.076) 
-0.030 
(0.057) 
-0.015 
(0.032) 
-0.058 
(0.048) 
-0.035 
(0.043) 
N        1483  1483  1061  1483 1483 1483  1483  1061  1061
Notes: We control for many socio-demographic and economic variables:  age, age-squared, female household head, marital status, health status, literacy, occupation, number of relatives inside and 
outside the local community; type of house, characteristics of the house, household size.(*) The variable is significant at the 1% level. Robust standard errors are in parentheses. Models which do not 
include kebele reference groups include kebele level fixed-effects. The average number of households in our survey from a sub-district was 123 (the minimum and maximum are 106 and 187, 
respectively). The “neighborhood” concept is narrowed to local community level and the average income in these micro regions is used as the income of reference group. Local communities are not 
official administrative units, but are the micro living units in which individuals have daily interaction. A local community with less than 20 surveyed households was excluded. As a result, 68 local 
communities were included in the analysis (the minimum and maximum are 20 and 40 households, respectively) with 1061 households. 
 
10 

Does Economic Growth Improve the Human Lot? Some Empirical Evidence.”

How Much Do We Care about Absolute versus Relative Income and Consumption?

Income and Well-Being: An Empirical Analysis of the Comparison Income Effect,”

Is More Always Better? A Survey on

Measuring Future Grandparents’ Preferences for Equality and Relative Standing,”

Neighbors as Negatives: Relative Earnings and

Relative Income, Happiness, and Utility: An Explanation for the Easterlin Paradox and Other Puzzles,”

Does Relative Income Matter for the Very Poor? Evidence from Rural Ethiopia

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