Sep 29, 2011

GDP, Happiness and the Easterlin paradox

Some words for non-economists (and for economists) about why GDP is a great measure. It correlates with many different things, and it even gives us hints about happiness even though it is not designed to do that. Afterall economists have some reasons to focus on it.

Lets start with the controversial stuff.
The Eaterlin paradox.
Easterlin found that within a given country people with higher incomes are more likely to report being happy. However, in international comparisons the average reported level of happiness does not vary much with national income per person, at least for countries with income sufficient to meet basic needs. Similarly, although income per person rose steadily in the United States between 1946 and 1970, average reported happiness showed no long-term trend and declined between 1960 and 1970.

In Easterlin's words:
There is no significant relation between the growth rate of GDP per capita and the rate of improvement in subjective wellbeing or happiness.

Put is simple, people become happy if they are richer than others, not if they become richer and richer; i.e. relative income counts more than absolute income.
Is it a paradox?

For common sense not too much, but if you think that exchanging your life with that of your grandparents or with people of some poorer country should leave you neutral, it seems indeed paradoxical. On the contrary you could exchange your life with someone from a poor country, someone that is poorer than you, but that is one of the rich in its country and you might end up being happier. Would you do that? If you say no, then it is a paradox.
I wonder how happiness is then related with income distribution...
Are you wondering if this implies that is better being a top scorer player in a secondary league than a normal scorer in a top league? I don't know, perhaps...
But if it so, why should an above-average income person in a poor country migrate to a rich country if that will make him less happy? Or does he irrationally compare, before migrating, his expected income to his ex-neighbours in the poor countries?

However recently new research and new data seemed to have found an answer. And the answer seems to be that indeed there was no real paradox: while relative position remain important, GDP and happiness are correlated. Which seems to suggest that the Easterli paradox was a matter of bad data. It remains to find the exact causation...
I found a recent interesing debate between Daniel Gilbert, Robert H Frank and Justing Wolfers.

Wolfers thanks to its new data claims: "rich countries are overwhelmingly happier than poorer countries." That's what the new data shows and I guess we can take it as a fact.
However it does not mean that aboslute income is the only thing.

Frank points out that yet relative position matters. And not only it matters, our focus on relative position might even leave us worse off as a society (Darwin noticed it). If for an individual getting richer than his neighbours might be a good idea, making him happier, for the group as a whole that could turn into a rat race where anyone works too much, relative positions are unchanged and happiness is even less than before.
Frank even suggests that, this kind of behaviour being inefficient, it gives us a good rationale for progressive taxation on consumption, which then not only, as I see it, is ethically desirable, but can also be efficient.

So while the possibility described by Frank does not imply that we should all stop trying to be better than others, it does suggest that we better avoid push it too hard.
As usual, and economists should not forget that, Adam Smith already knew it (have a look at the "Theory of Moral Sentiments"): fair competition is often good, combat is always bad.
And I would add that competition with cooperation, i.e. sportmanship, is best.

Nothing I've written is really new. For instance in 2008 Justin Wolfers was commenting similar things:
There is no Easterlin Paradox.
The facts about income and happiness turn out to be much simpler than first realized:
1) Rich people are happier than poor people.
2) Richer countries are happier than poorer countries.
3) As countries get richer, they tend to get happier.
and he noticed that: is worth noting that a 10 percent rise in income in Burundi requires one-sixtieth as much income as a 10 percent rise in income in the U.S. Thus, even if the slope is three times as steep for rich countries as poor countries (as we estimate), this still means than an extra $100 has about a twenty-times-greater effect on happiness in Burundi than it would in the United States.
Comparisons like this make you think that foreign aid may not be such a bad idea.

The new availability of data seems to have made the paradox disappear.
But as you have seen there is still a debate on that. There is no certainty on many things, especially on the causality, but for sure the Happiness-GDP correlation is surprisingly strong. And this is per se very relevant as it means that all the talking we have being hearing about GDP as a useless measure, or not being a measure of what is really relevant in people life (by the way GDP has never meant to be a measure of happiness), is somehow irrelevant, at least on the practical side. Indeed if GDP and happiness are so correlated policy implications for growth etc. just fully apply to happyness, full stop. Interesting to know, intellectually appealing, but noting practically new. All the critiques to stardard economics have proven very weak.
Another nice graph from the Economist where we can appreciate what using a log scale means:

Jeffrey Sachs also has something to say about that, which seems more in line with Robert Frank:
First, we should not denigrate the value of economic progress. When people are hungry, deprived of basic needs such as clean water, health care, and education, and without meaningful employment, they suffer. Economic development that alleviates poverty is a vital step in boosting happiness.
As individuals, we are unhappy if we are denied our basic material needs, but we are also unhappy if the pursuit of higher incomes replaces our focus on family, friends, community, compassion, and maintaining internal balance.

And we arrive to an answer to what new data seems to show, especially to Stevenson and Wolfers.
In fact Easterlinf at al. have a paper called "The Happiness-Income Paradox Revisited":
The main problem with the Stevenson and Wolfers (S-W) analysis is that they, in fact, estimate a positive short-term relationship between life satisfaction and GDP, rather than the long-term relationship, which is nil. That life satisfaction and GDP tend to vary together in contractions and expansions has already been demonstrated for a group of developed countries (25), and microlevel evidence consistently shows that unemployment has one of the most negative impacts on happiness (4, 8, 10).

Also Kevin Quinn seems in line with Frank:
Readers of The Theory of Moral Sentiments will know that Adam Smith would not have been at all surprised by the paradox. On the contrary - remember his description of the poor man striving all his life to become rich who, when he finally succeeds, finds he is no happier than he began? But for Smith - and I agree - the paradox is in itself no critique of economic growth, as it has been wielded in contemporary debate: Smith thinks it a good thing (I'm paraphrasing, my TMS is in the office 20 miles down the road) that we Nature (I think it's capital N Nature, or it may be capital P Providence) deludes us in to thinking that more income will make us happier, because all this striving under this delusion has produced, well, Civilization! "Turned mighty ocean into a broad highway" and such - you know the passage. The larger point, though is this: why should happiness or utility be the desideratum of economic growth? Just as they had an objective, rather than a subjective, theory of value, The Classical economists generally, I suggest, had an objective rather than a subjective theory of well-being. In Senian terms, economic growth increases our capabilities. What we do with them is another thing. ...

So you can see that the issue is still open.
But one thing is key at this point, before we fall into a circular debate. Economists use to measure GDP, which represents the value of production. This is the amount of things of economic value that have been produced within the market. There are other things that have been produced that either have no economic value or have been produced outside the market. But still GDP, and its growth, is a rather good approximation of the level of activity of an economy.

The point is why do people bother producing things, or producing more and more things, even though they do not phisically need them? Why didn't we stopped our material prosperity at the levels of the 50's and started having more free time due to increased productivity? Instead we work more and produce more, may we are happier, maybe not. Why do people do that? Is it just a rat race? Perhaps in part it is, and we should take collective actions to regulate ourselves, which is what politics is meant to do, and it is terribly important to do that. But it is also because people want to improve their lives, and everyone is different. As long there will be a person who does not like so much his job, or that would like to have a job in a differet city. Or that would like to go to the restaurant one more time or to be able to have a room for his son...
As long as people will want something, they will try to get it and this energy is what ultimately generates both economic growth and happiness. As long as we do not forget our sportmanship.

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