The Economics of Happiness

The Economics of Happiness

By: Vikas Shah, Originally Published at AllAboutAlpha.com

Factory farming is a brutal endeavour.  In this environment, chickens (and other animals) are given a variety of feeds and chemicals (stimuli) designed to make them grow as big as possible as fast as possible and hence maximise output.  In truth, factory farms probably will output more product than their organic counterparts, but in the process the animals are kept in horrendous conditions where the combination of feeds and supplements bloats them so fast, that often their growth outpaces their body’s ability to cope resulting in broken bones.

We may squirm at this example; but it’s precisely what the macro-level policies around economic development (particularly in the rich nations) have been designed to do.  The post-war era(s) created a world in need of growth; and in some cases, growth at any cost.   A significant piece of research highlights what is now known as the Easterlin Paradox, which shows that the vast economic growth in the rich nations since the second world war has failed to make people any happier.   A study published on October 30th 2014 by the Pew Research Centre in Washington DC (perhaps the largest such study of its kind) also found that people in emerging markets are within a whisker of expressing the same level of satisfaction as people of the rich countries.

The Stiglitz-Sen-Fitoussi commission has also led a movement of change after concluding (in 2009) that indicators of subjective well-being hold the promise of delivering better measures of the quality of life, it’s determinants, and hence- the well being of an overall economy.

To learn more about happiness in economies, I spoke to Richard A. Easterlin, University Professor and Professor of Economics, University of Southern California. Professor Easterlin is a member of the National Academy of Sciences and the American Academy of Arts and Sciences, Distinguished Fellow of the American Economic Association, Fellow of the Econometric Society, a former Guggenheim Fellow, and past president of the Population Association of America, Economic History Association, and Western Economic Association International.

Q: How did GDP and GNP become the accepted measures of economic performance?

[Prof Easterlin] This goes back to the studies of economic development that my mentor Simon Kuznets won the Nobel Prize for.  He developed national income measures which were then taken-up by the UN and governments as the accepted measure of economic performance.  The standardisation of this measure by the UK was ultimately what engendered it’s adoption as the criteria of economic success.

Q: How effective are GDP and GNP at measuring economic performance?

[Prof Easterlin] GDP and GNP measure an economy’s output in a fairly comprehensive way.  They’re good for analysing economic fluctuations, but they’re not so good at measuring the long-term performance of the economy as they involve various conventions; for example, GDP includes all government spending- Kuznets (who developed the measure) was highly skeptical about the assertion that all government spending contributed to people’s economic well-being.   He wanted the measure of output to be more relevant to people’s well-being and he lost-out on this argument to the UN and partner economies of the USA.  GDP and GNP shouldn’t be scrapped, they’re of value, but they don’t even give us an indication of economic well-being let alone individual well-being

Q: What is happiness as it relates to economies?

[Prof Easterlin] Happiness is the way each individual defines it for himself in a survey. People are simply asked how happy or satisfied they are overall! On the face of it, since each individual is free to have their own concept of happiness, you would think it would be very difficult to put these responses together and get an aggregate measure- however, when you look at what people say about the sources of their well-being, the concerns that people have are very similar.

All over the world, people spend their time trying to make living, trying to raise their families, taking care of health-problems and do work they find interesting and rewarding.  When you recognise the objectives of people largely the same around the world, it becomes possible to measure it.

Happiness is a measure that reflects the success with which people achieve their personal objectives of living levels, happy and healthy families and satisfying work.

When you put the responses of a happiness survey together for any given country, you start to see patterns that are very consistent from one country to another, around the world.

For example, those who are unemployed consistently show up as less-happy.  Those who are in broken marriages show up as quite less-happy as those who are in marriages or who have partners.  When I studied China for example, the output measure (GDP) has gone up dramatically over the past few decades.  When you look at life-satisfaction however, unemployment has gone up and the social safety net has been removed.  Happiness measures tell you more about what’s happening to people’s lives than any output measure.

Q: Can happiness measures inform economic, social and investment policy?

[Prof Easterlin] Unemployment is a good example.  It’s clear that government policies that are directed to reducing unemployment are policies that will make people feel better and will make them happier.  Research has shown that when you compare the effect of a 1% change in unemployment rate and 1% change in the inflation rate; a 1% increase in unemployment has a bigger impact on people’s happiness than a 1% increase in inflation.  This shows how important unemployment objectives are vis-a-vis price objectives.

Health measures show a systematic and strong relationship to happiness.  People with poorer health are less happy; this suggests that policies that deal with the health concerns of people, will improve their happiness.

Happiness research can inform public policy, and help people be better-off!

Q: Would happiness led measures change the global balance of power?

[Prof Easterlin] If you look at the countries in the world that are leading in their levels of reported happiness, it’s countries such as the Nordics- Denmark virtually always comes out on top.  In the LDC world it’s Costa Rica, a country which back in the 1950’s decided not to have a national army!  The countries where people are happiest are ones which are much more domestically oriented and not seeking world-power.   I speak out on this question with great trepidation, as it’s more in the realm of political science than economics.

 How does this impact policy makers, investors and risk-managers?

The short-termism and bluntness of current output measures of economic (and corporate) performance mask the fact that their very pursuit may be damaging the economy (or company) that is being built.  Policy makers have tended to support industries that contribute wealth and economic growth at the cost of killing those that create employment and long-term sustainability, and corporations have been forced to take decisions in-line with this.

For those at the investment-end of the market, understanding subjective measures of well-being can give important insights into the long-term attractiveness of an investment, and for risk-managers- understanding the impact on subjective well-being of a firm (or nation’s) decision can provide indications of the potential right-tail risks that could emerge during the lifespan of the position.

For policy-makers however, understanding measures of subjective well-being is central to building growth strategies that empower economies, regions and cities.

About the Author

Professor Vikas S. Shah is an award winning entrepreneur, strategist and educator who has built businesses in diverse sectors around the world for almost 20 years. He is also a consultant and advisor to numerous entrepreneurs, business and organisations globally.

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