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Saturday, March 08, 2008

Income and Happiness

How are income and happiness related?

Income and Happiness: An Imperfect Link, by Robert H. Frank, Economic View, NY Times: ...This week, Senator Byron Dorgan, Democrat of North Dakota, will ... hold a hearing exploring whether traditional economic measures like per-capita income accurately capture people’s sense of well-being.

This has long been a contested issue. ... The debate is not just of philosophical interest; it also has important policy implications. Recent research findings offer support for specific arguments on both sides. Mounting evidence suggests, however, that per-capita income is a less reliable measure of well-being when income inequality has been rising rapidly, as it has in recent decades. ...

[The problem is]... the assumption, traditional in economic models, that absolute income levels are the primary determinant of individual well-being.

This assumption is contradicted by consistent survey findings that when everyone’s income grows at about the same rate, average levels of happiness remain the same. Yet at any given moment, the pattern is that wealthy people are happier, on average, than poor people. Together, these findings suggest that relative income is a much better predictor of well-being than absolute income.

In the three decades after World War II, the relationship between well-being and income distribution was not a big issue, because incomes were growing at about the same rate for all income groups. Since the mid-1970s, however, income growth has been confined almost entirely to top earners. Changes in per-capita G.D.P., which track only changes in average income, are completely silent about the effects of this shift.

When measuring the economic welfare of the typical family, the natural focus is on median, or 50th percentile, family earnings. Per-capita G.D.P. has grown by more than 85 percent since 1973, while median family earnings have grown by less than one-fifth that amount. Changing patterns of income growth have thus caused per-capita G.D.P. growth to vastly overstate the increase in the typical family’s standard of living during the past three decades.

Some economists have advanced an even stronger claim — that there is no link, at least in developed countries, between absolute spending and well-being. Recent work suggests that this is especially true for spending categories in which the link between well-being and relative consumption is strongest. For instance, when the rich spend more on larger mansions..., the apparent effect is merely to redefine what counts as adequate.

Evidence also suggests that higher spending at the top instigates expenditure cascades that pressure middle-income families to spend in mutually offsetting ways. Thus, when all spend more on interview suits, the same jobs go to the same applicants as before.

Yet in many other categories, greater levels of absolute income clearly promote well-being, even in the richest societies. The economist Benjamin Friedman has found that higher rates of G.D.P. growth are associated with increased levels of social tolerance and public support for the economically disadvantaged. Richer countries also typically have cleaner environments and healthier populations than their poorer counterparts.

That per-capita G.D.P. is an imperfect index of economic welfare is not news. The lesson of recent work is that its weaknesses are more serious than we previously realized.

And it is an especially uninformative metric when income inequality has been rising sharply, as it has been in recent decades. A society that aspires to improve needs a better measure of what counts as progress.

This would be a good place to note this from Will Wilkinson:

Better to Be Richer, The Fly Bottle: I just ran across Angus Deaton’s latest summary of his happiness findings at the Gallup website:

As the graph indicates, life satisfaction is higher in countries with higher GDP per head. The slope is steepest among the poorest countries, where income gains are associated with the largest increases in life satisfaction, but it remains positive and substantial even among the rich countries; it is not true that there is some critical level of GDP per capita above which income has no further effect on life satisfaction. ...

Please share this fact with friends at your next cocktail party. Here’s the graph:

Deaton

Deaton conjectures that the consistent relationship between income and life satisfaction has to do with some kind of shared global standard for self-reporting — the Danes know how good they have it relative to the folks in Togo, and the folks in Togo know how bad they have it relative to Danes. I don’t know about that.

Here's more from Angus Deaton:

The link between money and contentment has been a question of considerable interest to researchers since Richard Easterlin noted in a seminal 1974 paper that average national happiness does not increase over long spans of time, despite large increases in per-capita income. ...

It is far from clear why questions of life satisfaction should be so closely related to national incomes. Much of the literature on the topic emphasizes the relative nature of such responses; when people answer such questions, they must surely assess their life satisfaction relative to some benchmark, such as their own life in the past, or the lives of those around them. Indeed, a recent study by Andrew Clark, Paul Frijters, and Michael Shields found that life satisfaction is sensitive to respondents' income relative to those with whom they most closely associate, which implies that there should be no relation between average national life satisfaction and national income, unless there is some other aspect of national income that raises everyone's life satisfaction together.

A simpler interpretation of the Gallup World Poll findings is that when asked to imagine the best and worst possible lives for themselves, points 10 and 0 on the scale, people use a global standard. Danes understand how bad life is in Togo and other poor places, and the Togolese, through television and newspapers, understand how good life is in Denmark or other high-income countries. ...

If this interpretation is correct, it would be an indication of how much the globalization of information has affected the perceptions of populations worldwide -- because the consistently high correlation between income and satisfaction could not have existed in its absence.

    Posted by on Saturday, March 8, 2008 at 03:50 PM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (69)

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