Date: Monday 10 June, 2013
Location: PG Hub 7, Senate House
Topic: Happiness Economics: Key findings from several decades of happiness research and their implication for economics
Speaker: Katharina Allinger

In my research lounge talk I attempted to discuss a variety of interesting findings from the research on “happiness economics” *. I chose an interactive format where we tried to use common sense and economic intuition to approach questions and answers from the field of happiness economics. For this reason I want to thank all of my amazing colleagues for their participation and, as usual, very insightful comments. This article cannot possibly reflect all the issues we touched upon which is why I focus on two topics instead: the relationship between income and happiness and happiness equations.

Income and Happiness
What economists ultimately care about is welfare and not GDP, but GDP and welfare maximization have often been equated in the public debate. Whether GDP and well-being are indeed necessarily positively related has been questioned on various accounts and happiness research has made important contributions to the discussion. One of the earliest academic contributions in the field was a book chapter written by Richard Easterlin in 1974.

What Easterlin discovered was that when you looked at time series data for the United States, GDP per capita in the period of analysis had increased rapidly, but there had been no increase in life-satisfaction over the same time period. If you believed that GDP growth was sufficient for increasing life satisfaction, then the logical conclusion was to name the finding “Easterlin paradox”. As usual, when conventional wisdom gets challenged, people reacted strongly to the findings and tried to prove them wrong. Almost 30 years later, the consensus among economists is that Easterlin’s results are robust and indeed, do not only apply to the United States, but to some other developed countries as well. His findings have been confirmed and extended in numerous studies. On the other hand, there are also some stylized facts on the impact of income on happiness: Individual-based cross-country studies, experimental evidence and macro studies largely show a positive correlation between measures of happiness and income.

So how can we reconcile the Easterlin Paradox that shows no increase in happiness combined with large increases in GDP over time with these stylized facts that suggest that GDP does lead to higher happiness? Many researchers have attempted to answer this question and found two main explanations: social comparison and adaptation. The former refers to the fact that for individuals it does not only matter what they have, it also matters what others – our reference groups – have. An impressive amount of studies has focused on different reference groups and in many studies the effects on happiness of a personal income increase are exactly neutralized if the income of the reference group also increases by the same amount. In addition, there is a certain adaptation effect, meaning that a one-off increase in income may only increase happiness temporarily. Studies have shown that income’s long-run effect is only 40% of it’s short-run effect. **

If we wanted to translate these findings into economic intuition we could say that increasing income for an individual has two effects: a consumption effect and a status effect. When we assume that happiness rises with income we normally invoke the idea of a positive but decreasing marginal utility of consumption. Therefore in developed countries the additional benefit from more income and consumption may become relatively small. On the other hand, if the income of the reference group is held constant, the individual gets a happiness boost because its relative income rises: we can call this a status effect. If we assume that status is not a zero-sum game, then we can, for example, hypothesize that increasing income inequality might have negative effects on happiness even though it might raise average income. There are certainly many different combinations of consumption and status effects that can lead on aggregate to very different effects of an increase in average income on average happiness.

Happiness Equations
Most of the second half of our discussion was then devoted to another interesting question. Obviously, income is not the only factor that causes people to be happy (or in this case maybe better: content with their lives). After some brain storming we were able to use common sense to figure out the main determinants of happiness and stumbled upon one important distinction: the difference between “being happy in the moment”, which could be triggered by eating chocolate, and “being generally happy with one’s life”. This distinction is mainly one between “affective” and “evaluative” measures which have yielded different results in empirical studies. While every study follows a slightly different approach and focuses on different measures we could generally say that the factors that are most important for evaluative happiness are: income, employment (unemployed, employed, housewife, job satisfaction, …), family (marital status, children, …), community and friends, subjective health, freedom and religion (which has yielded ambiguous results in empirical studies).

In addition to these “happiness equations” that try to explain the variation in happiness through different individual variables, a number of authors, e.g. Helliwell, have argued that we need to include societal variables as well in our happiness equations and that including purely individual determinants without societal controls leads to confounding results. For this reason many studies in recent years have attempted to distinguish between individual and national determinants of well-being.

Footnotes:
* To avoid confusion I subsequently use the term happiness even though it is generally assumed that happiness is a more „affective“, short-run measure while subjective well-being is a more „evaluative“ and long-run measure and that both are strongly linked but not identical.
** If one cares to dig a little deeper into the literature on happiness, we can find that what happiness economists have proven with the means of elaborate econometrics, Bernard Mandeville already discussed as early as 1705 in his book „Fable of the Bees“.