The economics of happiness

The number of Americans who said, ‘yes, I am happy with my life’ peaked in 1956, but ever since then has fallen slowly but steadily. During this time our levels of world GDP per capita have increased dramatically, and according to the non-satiation principle of conventional microeconomics, our experience of higher utility means that should all be happier – yes?

We live in a finite world of perpetual economic growth. Levels of material wellbeing have never been so high. The walls between trading nations have been removed thanks to globalisation and technology. Why then does the economically paradoxical notion of ‘happy peasants and frustrated millionaires’ exist? Happiness economics takes a new approach to assessing welfare based on expansive notions of utility. Conventional economics has the aim of the efficient allocation of scarce resources to satisfy infinite needs. If increasing utility does not fundamentally achieve individual happiness, then what is the point of it all?

What did early economists and philosophers, ranging from Aristotle to Bentham, Mill, and Smith have in common? They incorporated the pursuit of happiness in their work, recognizing the importance of subjective wellbeing in their studies. Yet as economics grew more rigorous and quantitative, excessively frugal definitions of welfare took hold. Utility was taken to depend only on income as mediated by individual choices or preferences within a rational individual’s monetary budget constraint. Economists now realise that conventional notions of economic happiness, as defined by utility, have been largely replaced by more expansive notions of welfare, albeit more complicated – interdependent utility functions including health, marital and employment status and civic trust.

Microeconometric happiness equations have the standard form:

Wit = α + βxit + εit

• W is the reported wellbeing of individual i at time t, x is a variety of known variables including socio-demographic, economic and cultural characteristics.
• βx takes into account the measurable components of happiness, such as income, education and marital and employment status.
• The error term captures the unobserved characteristics and measurement errors.

These regressions typically yield lower R-Squared values than economists are used to, reflecting the higher extent to which our emotions and other components of true wellbeing are driving the results.

The Easterlin paradox is similar to the idea of diminishing marginal returns, stating that income can only increase up to a point where it no longer contributes to increased happiness. Wealthier people are, on average, happier than poor people. However, happiness studies struggle to find a significant correlation between an increase in average levels of GDP per capita and average happiness levels. Obviously, income matters to the achievement of happiness – deprivation of basic needs and extreme poverty contribute significantly to unhappiness. But after the basic needs are met, and we add in other factors such as rising aspirations, political stability and relative income levels, happiness and income don’t display a statistically significant positive relationship.

If anything, happiness research has found that high levels of income drive excessive consumption and other perverse economic behaviors, all of which may not contribute to happiness.

The study of happiness economics has opened up a new world, where increased sophistication of econometric techniques and accuracy of data can put economists in a better position to assess welfare based on psychological needs, rather than just quantitative figures rigorous in their belief that ‘more is more’.

If economics, at its fundamental core, is about satisfying our unlimited needs and wants and doing so does not make each  and every one of us happy, what is the point of it all?

References

1. Graham, Carol. “The economics of happiness.” World Economics 6, no. 3 (2005): 41-55.
2. The Economics of Happiness, Documentary, directed by Steven Gorelick, Helena Norberg-Hodge (2011; Australia, The International Society for Ecology and Culture).