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Wednesday, October 31, 2007

A Monetary Value for Almost Anything

Andrew Oswald and Nattavudh Powdthavee explain how to assess the value of losses from bereavement of loved ones, and more generally how to put "values on all sorts of things that we care for":

A New Approach to Awarding Compensations in Courts, by Andrew Oswald and Nattavudh Powdthavee, Vox EU: Economists are known to be able to put a monetary value to anything. For instance, the contingent valuation method – a survey-based method which asks individuals “how much compensation would you demand for the destruction of X” or “how much are you willing to pay to preserve X” – has been used to calculate the monetary valuations for many of the non-marketable resources that come without immediate price-tags attached. For example, the contingent valuation approach has been used in the literature to calculate the willingness to pay for contaminated residential property[1] and the willingness to pay to prevent oil spill[2].

So the question is: can judges use the same method to assign pecuniary amounts to be awarded to tort victims in situations that do not appear to have any intrinsically financial aspect such as losses from bereavement of loved ones?

Yes, at least in principle. Although we imagine that answering questions like “what number of euros would compensate you for the death of your daughter” is likely to be hard for everyone, and morally offensive to many. As a result, most judges are left to their own devices to award compensation packages they think would make sense in court, and they do so by using the rule of thumb that have no conceptual foundations that are based on solid, scientific findings. This often leads to judges awarding financial settlements that can seem so small in real life compared to the shock a loss of loved one can bring. For example, the Fatal Accident Act 1976 provides a lump-sum at currently £10,000 damages for bereavement (that is, approximately €14,000), which is available only to the husband or the wife of the deceased and not to the children for a loss of a parent. In today’s term, this makes up only around 3% of the lifetime income for a successful white-collar worker.

From a scientific point of view, this raises a question of whether we can develop a systematic method to calculate a reasonable compensation package that would reflect as close to the genuine damages generated by bereavement as possible.

Our approach to answering this question focuses on the use of surveys of happiness to estimate a compensation that would ceteris paribus make up for the average well-being gap between those who had experienced the loss of loved ones and the rest of the sampled population. In other words, our approach involves empirically tracing out a form of an indifference curve between money and bereavement[3].

Many economists would shudder at the thought of using happiness surveys in economic analysis, let alone anything scientifically useful. Yet studies in psychology have shown self-report well-being data to be of some significant validity and a good proxy for the individual’s utility[4]. Further, the structure of happiness regression equations -- regressions with a measure of subjective well-being as the dependent variable -- has been shown to have a consistent pattern in many countries around the world. For example, we have found important life events, such as marriage, unemployment, having children, and higher incomes, to have the same qualitative influences – in terms of signs and statistical significances – on individual’s happiness in the USA[5], Europe[6], South America[7], and South Africa[8].

For our empirical analysis, we use two different measures of subjective well-being – a seven-point-scale life satisfaction (1 = very dissatisfied … 7 = very satisfied) and a twelve-point-scale record of a person’s mental health status in the general health questionnaire (GHQ) – in the long-run British Household Panel Survey (BHPS) carried out annually by the University of Essex, UK. The BHPS is a nationally representative sample of households, which contains over 10,000 adult individuals, conducted between September and Christmas of each year from 1991. Respondents are interviewed in successive waves about their socio-economic status, attitudes, and their subjective well-being. Since its inception, BHPS has remained representative of Britain’s population.

Using the two measures of subjective well-being, we are able to estimate how much happiness can be gained on average by a higher income of X thousand euros, and how much happiness is lost by the death of loved ones. We then calculate the ratio of the two, which will give us a statistical measure of a marginal rate of substitution between the pleasure of money and the pain from the death of a loved one.

Our results may seem hard to predict by any judge’s standard. Figure 1 shows that there a significant variation in the compensation valuation between our loved ones. Losing a partner is extremely damaging to subjective well-being and requires on average a compensation package of £114,000 (€160,000) in real income to make the person feels indifferent about the situation. Death of a child, on the other hand, is equivalent to an additional income of £89,000 (€125,000) a year. The loss of a sibling has one of the smallest compensation packages at around £16,000 (€22,000).

Figure 1: Death and the Calculation of Compensatory Damages for Bereavement

Vox1

Policy Implications

Many of the valuable things in our life – love, friends, health – come without price-tags attached. Our approach of estimating happiness equations is not limited only to valuing bereavements and, therefore, gives us a way of putting  or even on what politicians make speeches about. Using this method, we can now put actual scientific numbers on their intuitive assessments.

Footnotes

1 Simmons, R.A., and Winson-Geideman, K. (2005). Determining market perceptions of residential property buyers using contingent valuation surveys, Journal of Real Estate Research, 27(2), 193-220.

2 Carson, R.T., Mitchell, R.C., Hanemann, M., Kopp, R.J., Presser, S., and Rudd, P.A. (2003). Contingent valuation and lost passive use: Damages from the Exxon Valdez oil spill, Environmental and Resource Economics, 25(3), 257-286.

3 Oswald, A.J., and Powdthavee, N. (2007). Death, Happiness Equations, and the Calculation of Compensatory Damages. Journal of Legal Studies, forthcoming.

4 See, for example, Diener, E., Suh, E.M., Lucas, R.E., and Smith, H.L. (1999). Subjective Well-Being: Three Decades of Progress. Psychological Bulletin, 125(2), 276-302.

5 Blanchflower, D.G., and Oswald, A.J. (2004). Well-being Over Time in Britain and in the USA, Journal of Public Economics, 88, 1359-1386.

6 Alesina, A., Di Tella, R., MacCulloch, R. (2004). Inequality and Happiness: Are Europeans and Americans Different?, Journal of Public Economics, 88, 2009-2034.

7 Graham, C., and Pettinato, S. (2002). Happiness and Hardship: Opportunity and Insecurity in New Market Economies. Brookings Institution Press, Washington D.C.

8 Powdthavee, N. (2005). Unhappiness and Crime: Evidence from South Africa, Economica, 72, 531-547.

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