The Economics of Happiness

Image: flickr.com/liafeatherbrain
Image: flickr.com/liafeatherbrain

In life there is no truer or widely shared goal than to achieve happiness. Yet the most ubiquitous measure of economic performance – Gross Domestic Product – completely ignores happiness and wellbeing. To quote Senator Robert F. Kennedy, “it measures everything, except that which makes life worthwhile.” So why, you might be asking, have those flint-hearted economists ignored happiness in favour of more indirect measures of wellbeing, such as income and consumption? Well, for a start happiness is unobservable and intangible – because you can’t see it or touch it, measuring a person’s level of happiness is rather difficult. Another reason is that happiness is inherently subjective – we all have a different perspective of how happy we are so it’s hard to find a uniform measure.

the most ubiquitous measure of economic performance completely ignores happiness and wellbeing

However, despite all of the difficulties in measuring happiness, several studies have attempted to do just that. Some of what they have discovered will come as no surprise: a higher level of income is associated with a higher level of happiness. Yet that’s only true up to a point. It appears that once we reach a certain level of income, money stops making us happier. Research by the New Economics Foundation has found that while Britain has become significantly wealthier since the 1970s, people don’t seem to have gotten much happier.

uk-gdp-per-capita-and-life-satisfaction

And it’s not just the grumpy Brits who haven’t become happier as they’ve gotten richer. This phenomenon, known as the Easterlin Paradox, also seems to occur on the other side of the Atlantic. The economist who discovered it, Richard Easterlin, demonstrated in 1974 that the average level of happiness among Americans had remained roughly the same from 1946-1970, despite the fact that per capita income had doubled.

The Easterlin Paradox does not only occur as countries get richer over time, but it also appears when we compare income and happiness of different countries at a single point in time. A poll conducted in 2014 by the Pew Research Centre found that while people in richer countries do tend to be happier, the relationship becomes far weaker once income exceeds a certain threshold – around $20,000 per annum. For example, 60% of respondents in Germany (GDP per capita of around $40,000) reported being very happy with their lot in life compared with only 34% in Bangladesh (GDP per capita of roughly $2,000). But if we compare a middle income country with a rich one, the differences are far less stark: in the USA (GDP per capita of approximately $53,000), 65% of respondents reported being very happy with their lives; this is roughly the same level of happiness as in Argentina, where 66% of respondents reported a high life satisfaction, yet per capita GDP is only about $19,000 – or roughly 1/3 of that in America.

However, how much you earn does still matter – and so does how much your neighbour earns. A paper by economists David Blanchflower and Andrew Oswald found that as income levels increase, the relationship between money and happiness becomes stronger. In other words, while income matters for wellbeing, what’s really important is how rich people are relative to their peers. This makes sense. We humans are creatures of comparison, so earning a nice fat bonus one year and buying a new BMW with it would be rather less sweet if you saw a shiny new Lambourghini parked on your neighbour’s drive.

while people in richer countries do tend to be happier, the relationship becomes far weaker once income exceeds a certain threshold

So what other factors determine life satisfaction? Age certainly seems to have an influence, but the relationship is rather interesting: people tend to be happiest when they are young and when they are old; life satisfaction is at its lowest point during middle-age. In a more recent paper, Messrs Blanchflower and Oswald investigate this “U-shaped” relationship between age and happiness and they’ve come up with three main explanations. The first is that individuals learn to adapt to their strengths and weaknesses, so give up on their aspirations in middle-age. The second is that there is a selection effect – happy people tend to be healthier and hence live longer. And the third is that as people see their friends die in old age, they learn to be content with what they have. Other important factors in determining happiness are employment and marital status. Unsurprisingly, unemployment has a hugely detrimental effect on happiness, although the effect is much stronger among men. Marriage also makes people happier – except in this case it’s women who feel the effect more strongly.

By now I’m sure you’re thoroughly convinced that Bobby Kennedy got it right about GDP – it’s a useless measure of wellbeing because, even though money makes us happier, we care more about our wealth relative to other people, and besides, there’s more to happiness than just money. However, that assessment would miss the point of GDP. GDP is not a measure of human wellbeing; it’s a measure of economic output. Therefore, it’s better to think of GDP as a component of human wellbeing. As we’ve seen, higher incomes do make people happier, if only up to a certain threshold of around $20,000 per annum – enough to secure a decent standard of living. Moreover, a higher GDP per capita is a proxy for all other sorts of improvements in people’s lives that do make us happier: lower infant mortality, higher life expectancies and higher consumption. So, while it may be true that GDP measures everything except that which makes life worth living, it also measures a lot of things that make the lives we live possible in the first place.

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