Economics of Happiness

Table of Contents

List of Tables and Figures

Chapter 1: Introduction

Chapter 2: Happiness
2.1 Terms and definitions
2.2 Measuring well-being
2.3 Issues with measuring well-being
2.4 Determinants of subjective well-being

Chapter 3: Beyond GDP
3.1 Overview
3.2 Flaws of GDP
3.3 Defence of GDP as a measure of well-being

Chapter 4: Easterlin Paradox revised
4.1 Original Easterlin Paradox
4.2 Hagerty and Veenhoven critique
4.3 Stevenson and Wolfers critique

Chapter 5: Conclusions

Appendices

Bibliography

List of Tables and Figures

Chapter 2: Happiness

Figure 2.1 Instant utility while hand is put in cold water for 60 or 90 seconds

Figure 2.2 The change in reported life satisfaction following a life-changing event

Figure 2.3 Life satisfaction in different countries

Figure 2.4 Changes in happiness, before and after life-changing events

Table 2.1 The Day Reconstruction method

Appendices

Appendix 1: Diminishing marginal utility of income for US, 1994

Appendix 2: Happiness and Real Income per Capita in the US

Appendix 3: Life Satisfaction and Real GDP per Capita

Appendix 4: Change in Life Satisfaction and Economic Growth (Stevenson and Wolfers)

Appendix 5: Change in Life Satisfaction and Economic Growth (Easterlin)

Abstract

The purpose of this dissertation is to analyse and compare scientific research in the economics of happiness. This study field has expanded significantly over the last forty years and some wider conclusions needs to be made.

This literature review looks in great detail at all concepts behind happiness and subjective well being, provides deeper understanding of GDP as a measure of welfare with issues around it and finally analyses ‘Easterlin Paradox’ and its updates.

Acknowledgements

I am grateful to my supervisor, Mr. Stewart Dunlop, whose expertise, understanding, generous guidance and support made it possible for me to work on a topic that was of great interest to me.

I would also like to thank Dr Alex Dickson and Dr Rodolphe Desbordes, who have kindly provided me with information that was essential for the completion of this work. I also wish to thank all my teachers throughout my academic study years.

Chapter 1: Introduction

Happiness might be an ultimate goal of life. Virtually everyone wants their life to be meaningful and pleasant. Even the United States Declaration of Independence declare that ‘pursuit of happiness’ is an every man’s right, next to life and liberty. The reason economists care about individual happiness is that they care about the standard of living. The ‘father of modern economics’ Adam Smith expressed that “no society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable”.

On a daily basis, politicians and journalists give out a clear message. It is that better economic performance leads to greater well-being for a nation and this idea is rarely questioned publicly. Individuals feel that if their employees raised their income, it would make them happier and assume it would be about the same for countries worldwide. However, recent and ongoing scientific research challenges these ideas and suggests that economic progress buys only a small amount of well-being.

The purpose of this dissertation is to analyse existing literature on the economics of happiness and to explore how research findings could be implemented in the real world. Chapter 2 examines all the concepts behind happiness - various terms and definitions, ways to measure happiness within a country and number of issues surrounding it and the actual determinants of happiness. Chapter 3 will detail the current issues of the GDP as a measure of welfare. Finally, Chapter 4 will examine the ‘Easterlin Paradox’ in great detail and controversies surrounding it.

Chapter 2: Happiness

2.1 Terms and definitions

Although economic research on happiness has been conducted for nearly half a century, there is a lack of clear definition of what happiness actually is. Happiness can mean pleasure, positive emotions, meaningful life or even freedom from suffering. Following Easterlin (2005a, p.29), many researchers put the terms “well-being, utility, happiness, life satisfaction, and welfare to be interchangeable”. However, these terms are not synonymous and can cause conflicting empirical results, when measured on one scale questionnaires. For example, if you would ask someone whether they are ‘happy’, they are more likely to provide a result that reflects temporary emotional responses, while asking to rate their overall life satisfaction would give a longer-term life experience. Bjørnskov (2008) study found that the correlation between self-reported ‘happiness’ and self-reported ‘life satisfaction’ in the World Values Survey is surprisingly low (ρ = 0.44).

There are a lot of opposing theories in psychological studies of happiness as well. The biggest tension lies between J. Bentham’s ‘hedonic’ idea of happiness, where happiness is the result of avoiding pain and seeking pleasure, and Aristotle’s ‘eudaimonic’ approach, where happiness arises from emphasis on non-material pursuits such as genuine interpersonal relationships and intrinsic motivations (Nussbaum, 2005). The only term that can capture both the ‘hedonic’ and ‘eudaimonic’ ideas of happiness and overall assessment of people’s life is called Subjective Well-Being (Sumner, 1996). One of the lead researchers in the field of happiness, Ed Diener (2004), proposes SWB hierarchical model which includes components such as: (i) pleasant emotions (love, happiness, satisfaction); (ii) unpleasant emotions (stress, irritation, anger); (iii) global life judgement (success, fulfilment); and (iv) domain satisfaction (leisure, health, work, marriage). Thus, both ‘happiness’ and ‘life satisfaction’ are components of SWB and will be used in further discussions about happiness.

2.2 Measuring well-being

An increasing number of investigations and researches are measuring national well-being, as well as specific groups, such as lottery winners, students or single parents. To be accurate there were more than 100 papers analysed on self-reported life satisfaction from 2001 to 2005, up from just four in 1991-1995, according to tabulation of EconLit. Majority of these studies revolve around a one time questionnaire, but more and more reports of well-being have a follow-up studies or being repeated over a period of time, like once a year. Going beyond GDP and measuring national well-being is important and will lead to:

- better knowledge of policy impacts on national happiness levels;
- better allocation of public resources;
- sound information on the best places to live in, career path to choose from, based on the well-being information for particular area/organisation;
- comparisons between how different sub-groups of society are doing (students, professionals, unemployed, single parents);
- assessment of the performance of government;
- comparisons between countries.

The most simple way of measuring people’s happiness is to ask them how much they enjoy their life as a whole (Frey and Stutzer, 2002). As an example, global network of social scientists, called The World Values Survey, analyses SWB with a following question:

“All things considered, how satisfied are you with your life as a whole these days? Using this card on which 1 means you are ‘completely dissatisfied’ and 10 means you are ‘completely satisfied’ where would you put your satisfaction with your life as a whole?”;

while Eurobarometer, public opinion survey conducted regularly on behalf of the European Commission since 1973, asks:

“On the whole, are you very satisfied, fairly satisfied, not very satisfied, or not at all satisfied with the life you lead?”.

However, after establishing the “Measuring National Well-being Programme” in 2012, U.K. Office for National Statistics (ONS) developed possibly the best questionnaire to analyse determinants of subjective well-being (Halliwell, Layard and Sachs, 2012). It brings up a balanced approach of life evaluation with positive and negative effects, as recommended by the Stiglitz-Sen-Fitoussi (2009) report. Additional question was added to see whether people feel that their everyday activities were worthwhile, which satisfies the eudaimonic perspective. The experimental questionnaire looked as follows:

- Overall, how satisfied are you with your life nowadays? (evaluative);
- Overall, to what extent do you feel the things you do in your life are worthwhile? (eudaimonic);
- Overall, how happy did you feel yesterday? (experience - positive affect);
- Overall, how anxious did you feel yesterday? (experience - negative affect); (All asked using a 0 to 10 scale where 0 is “not at all” and 10 is “completely”).

2.3 Issues with measuring well-being

2.3.1 Mood and socially constructed perceptions

Although there are number of varied and strong surveys that could potentially measure true life satisfaction scores, numerous pertinent issues arise that put the reliability of the surveyed data into question. Schwarz and Clore (1983) believe that answers to these surveys are not true reflections of people’s happiness and results can be affected by current mood or the frame of the question. They conducted an experiment where random half of those surveyed found a dime on the copy machine before filling out the questionnaire. Those who ‘luckily’ found the dime significantly raised satisfaction with life scores, which is clearly not an income effect. Their other research proved that life satisfaction can be strongly influenced by the weather (higher scores on sunny days), however it is important to note that if individuals were clearly asked about the weather beforehand - it did not influence the satisfaction scores. Skidelsky (2012) brings similar approach and states that survey results can be influenced not only by the mood, but also by socially constructed perceptions as well. For example, Americans are generally really positive and if they were asked how they are doing - chances are they would respond “great, thanks”. If Russians were asked the same question, they would typically shrug and say “normalno”, meaning it could always be worse.

2.3.2 Remembered utility

Another issue with measuring well-being is the way people feel about experiences in real- time can be different to to the way they remember it after they are over. That means that a distinction needs to be made between experienced utility and remembered utility. Cartwright (2011) defines experienced utility as the sum of instantaneous utilities (measures of pleasure or pain) over the duration of the event, while remembered utility as the utility a person thinks an event gave them. Body of evidence suggests that remembered utility is ‘path dependent’ - people do not perfectly remember experienced utility. It was illustrated with a study by Daniel Kahneman et al. (1993), where subjects were analysed experiencing and evaluating pain. Participants were asked to put their hand in cold water (14°C) for 60 seconds. After seven minutes, participants were asked to immerse their hand in cold water for 90 seconds (water was kept at 14°C for the first 60 seconds and increased to 15°C for the last 30 seconds). At the end of the experiment, individuals were asked to plot their level of discomfort during the tests, thus representing respondents’ remembered utility. Figure 2.1 shows the surprising results - although experienced utility was less for the 90-second than 60-second trial, because of extra 30 seconds of discomfort, 69 percent of participants

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Figure 2.1 Instant utility while hand is put in cold water for 60 or 90 seconds. Source: Kahneman et al. (1993).

noted they would prefer to repeat the 90-second trial. The study suggests that remembered utility depends both on the highest and/or lowest utility experienced, and the utility of the end can be described as peak-end evaluation. It can also be assumed that individuals forget lots of good/bad moments and remember an event based on only a few instances, process which is called duration neglect.

2.3.3 Happiness is relative

The idea that happiness is relative is as old as early Greek philosophers, in particular Epicures and the Stoics. In social psychology, Brickman, Coates and Janoff-Bulman (1978) compared the happiness of three sub-groups - randomly selected individuals, lottery winners and accident victims. The lottery winners had recently won up to $1 million and accident victims were quadriplegic and paraplegic. Figure 2.2 shows that there is very little difference in self-reported happiness.

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Figure 2.2 The change in reported life satisfaction following a life-changing event. Source: Brickman, Coates and Janoff-Bulman (1978).

Obviously, being in an accident has the biggest effect and lowers present happiness, but the future expectations are the same as lottery winners. Similarly, in economics research, R. Easterlin (1974) also supports the theory that happiness is relative. Although, Easterlin Paradox is going to be researched in more depth in further chapters, it is important to mention that happiness is reported to be as high in poor countries as it is in rich countries (for example, compare the United States with South Africa in figure 2.3).

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Figure 2.3 Life satisfaction in different countries. No apparent correlation between the average income in a country and satisfaction.

Source: World Values Survey 2005.

If happiness is relative, rivalry can become a strong motivation for well-being. In a fascinating economic behaviour survey, Solnick and Hemenway (1998) have asked University of Harvard graduates to choose between two alternative worlds to live in:

A: You earn $50 thousand a year, while other people get $25 thousand;

B: You earn $100 thousand a year, while other people get $250 thousand.

Results were striking - more than 50 percent chose the world A, meaning they would be willing to accept a fall in living standards if they would be in a more superior position within a society. This psychological mechanism leads to distorted incentives and reduces the power of economic growth to increase national well-being. The results got even more gripping, when graduates were offered another pair of imaginary worlds:

A: You can have 2 weeks of vacation, while others have 1 week;

B: You can have 4 weeks of vacation, while others have 8 weeks.

Interestingly only 20 percent of students chose the world A. To conclude, rivalry seems to be good-specific and is not crucial for leisure.

2.3.4 Adaptation and habituation

The last and probably one of the most important issues in measuring well-being is that big life changing events usually have a short-term effect on happiness. As seen previously in Figure 2.2, lottery winners became wealthier, but not much happier. Similarly, accident victims reported being less happy when asked, but their expectations on future events were a lot more positive. There is a lot research in literature that explains this rather constant level of average happiness with terms of adaptation and habituation. Clark et al. (2003, 2008) analysed data from Germany, which tracks the self-reported well-being during the years of 1984 to 1997. First five to seven years shows individuals’ baseline level of satisfaction and then leads up to the major life events, such as first-born child, disability or marriage. The graphed results can be seen in Figure 2.4.

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Figure 2.4 Changes in happiness, before and after life-changing events. Sources: Clark et al. (2003), Oswald and Powdthavee (2008).

The results illustrate that in terms of the birth of first child, marriage and cutbacks there is anticipation period, where happiness varies before the event. After the event, adaption can be seen for the birth of a child and marriage - happiness returns to the standard levels. In terms of disability, there may be readjustment period when the life satisfaction may not reach the previous levels, but individuals find new ways to fulfil their life (although it is not the case for unemployment). A possible explanation of these effects can be called aspiration treadmill (Kahneman, 2006), meaning that if people progressively adjust their desires to the utility they normally experience, eventually they will not report any higher life satisfaction. For example, lottery winners tend to buy new, expensive and luxurious goods, a lifestyle that you can quickly become accustomed to. Their aspirations adjust to this kind of behaviour and happiness levels returns to the norm.

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