Master thesis

My master thesis, entitled "Happiness and Economics: Enriching economic theory with empirical psychology", was submitted to Maastricht University on Sep. 27, 2001.

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About my thesis “Happiness and Economics”

“Happiness and Economics” investigates the relationship between choice, material welfare, and happiness. Empirical evidence on subjective well-being is analyzed and set against economic theory. It appears that strong a priori assumptions limit the economic science in its ability to provide substantive explanations of human behavior. As a consequence, economics has lost sight of its original concern for genuine well-being. Instead, economists take delight in the internal consistency and analytical versatility of their theoretical models.

Themes discussed in “Happiness and Economics” include

  • rational behavior: freedom of will vs. determinism (ch. 1, part 1)
  • the moral dimension to Pareto efficiency (ibid.)
  • subjectivity vs. objectivity in scientific research (ch. 1, part 2)
  • validity of happiness surveys (ibid.)
  • cardinality and interpersonal comparability of utility (ch. 1)
  • the nature of happiness (ch. 2, part 2)
  • economics and (lack of) empiricism (ch. 1 and 3)
  • the potential harms and benefits of economic growth (ch. 3)
  • the relation between money and happiness (ch. 2 and 3)
  • implications for economic theory and policy (ch. 3)
  • cultural relativism with respect to happiness (ch. 2 and 3).

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Excerpts

select a topic from this list

introduction
the economic conception of behavior
subjectivity and scientific rigor
happiness and life circumstances
income and happiness
happiness as a judgment
individual rationality can be socially wasteful
happiness research thwarts the rationale for social discounting
the scope of happiness research
the procedure can matter more than the outcome
conclusion

[page numbers refer to the print version]

introduction

“Despite decades of economic growth and unparalleled technological progress, it seems that people in the wealthy countries have done badly in transforming material affluence into freedom from economic cares and into agreeable lives. While there can be little doubt that in many respects life in the industrialized countries is better today than in 1928, it appears surprising that the economic problem is far from being solved. Material affluence—American per capita income rose by 277%, i.e., almost four-fold, between 1913 and 1989 (Maddison 1991)—it seems, has done little to bring real improvements in well-being. More than half of Americans (since 1973, when the series starts) agree with the statement that “the lot of the average man is getting worse”, and the share of people agreeing has been rising after 1981 (until 1994 where the series stops) to reach almost two thirds (Lane 2000b: 27-8). Indeed, as will be shown later, self-reported life satisfaction in the U.S. has, if anything, shown a downward trend after World War II while it did not show any clear trend for the industrialized world as a whole.” (Introduction, p. 5)

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the economic conception of behavior

“The behavioral theory that has been developed within economics has not been inspired by psychological research or any other sort of empirically qualified concepts. Rather, it relies primarily on a priori axioms that derive their appeal from their theoretical properties. In particular, economics has adopted a conception of behavior that is largely identical with the Hobbesian doctrine of psychological hedonism that states that nature endowed the human mind with but a single motivation which is the attainment of pleasure. Even ostensibly altruistic acts are deemed to be motivated by the ensuing pleasure one experiences. Thus Thomas Hobbes (1588-1679) is said to have explained, after giving alms to a beggar outside St. Paul’s Cathedral, that he gave the money because it pleased him to see the poor man pleased.

There has certainly not been a lack of criticism of the Hobbesian view, but as long as the scientific community does not agree on ways to observe human motivation (and even introspection seems to be a questionable standard), every complete account of human motivation must remain beyond falsification. Consequently, that also means that psychological hedonism cannot be a scientific theory by the well-known criteria established by Karl Popper (1959/1934).” (chapter 1, p. 7)

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“When now the rational behavior hypothesis is merged with the utility maximization axiom, the economic conception of human behavior is complete. Consistent with the terminology used thus far, this conception of behavior will be called the rational utility maximization hypothesis (RUMH for brevity; panel V in fig. 2). To summarize briefly, the RUMH contains the axioms and hypotheses that

  1. Ultimately, an individual’s values boil down to one summum bonum which is called, by convention, utility.
  2. Motives completely determine behavior.
  3. Utility maximization is the only motive.
  4. People make reasonably precise predictions of the consequences of their choices.

As a consequence, and this is the most important result of this analysis, the RUMH states that people reasonably well maximize their experienced utility. [...]

The exclusion of a free will therefore leads to a loss of distinction between values and motives and necessarily implies hypothesis 3. This is a striking result worth to appreciate for a moment. As soon as behavior is assumed to be determined, the utility maximization axiom follows necessarily, unless gross inconsistencies are committed. The single assumption of given values, or, in economic terminology, of a connected preference map leads to the result that all behavior can be interpreted as motivated by utility maximization. Put differently, the entire idea of utility maximization follows rather automatically once a free will is excluded.” (chapter 1, pp. 12)

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subjectivity and scientific rigor

“Thus, subjectivity is not a weakness per se. On the contrary, when we are concerned with theories concerning the human mind, we cannot do without subjectivity. And when economics wants to give substantive explanations of behavior, it must be concerned with the human mind, not only in normative economics but also in its positive branch as far as it is concerned with choice. Objectivity might often be of instrumental value in order to elucidate partial relationships and mechanisms, but it is no compelling criterion. Rather, the ultimate criterion has to be the relevance to the problem at hand and the scientific rigor. Scientific rigor, in turn, is not dependent on objectivity and precision, but primarily requires concreteness to warrant falsifiability.” (chapter 1, p. 22)

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happiness and life circumstances

“If we step back from single correlates, it appears that “hard” (i.e., readily measurable) objective life circumstances as a whole account only for a small proportion of the observed variance in SWB, and that the large untraceable proportion of variance among individuals must be attributed to other than these factors. Taking all their demographic factors together, Campbell, Converse, and Rodgers (1976) could explain not even 20% of the variance in SWB (reported by Ed Diener and Lucas 1999). Andrews and Withey (1976: 141) could not explain more than 11% in any of their data sets when they included six demographic variables simultaneously (family life cycle stage, family income, age, education, race, sex), and none of these predictors alone could explain more than 6% of the variance. These low values suggest that “there is no reason to expect strong relationships between the objective conditions of life and subjective assessments of well-being under most circumstances” (Schwarz and Strack 1999: 79).” (chapter 2, p. 33)

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income and happiness

“The above presentation of income correlates with SWB can be summarized by three stylized facts.

  1. At one point in time, within a given country, the poor report lower SWB than the non-poor.

  2. Over time, within a given country whose per capita income exceeds some threshold income, SWB does not rise as per capita income rises.

  3. Across countries, happiness correlates positively with per capita income, but the relationship is weak to nonexistent among the richer countries. [...]

The first and second stylized facts suggest that there is a considerable relative aspect to the SWB-income relationship: people derive satisfaction of earning an income that is high with respect to the country’s current average income, but apart from this relative effect the level of income has no bearing on happiness as long as it exceeds some threshold income. This observation has become generalized as the relative income hypothesis.” (chapter 2, p. 36)

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“In even the poorest countries the consumption patterns of the world’s wealthiest societies are represented, in particular in the cities, via television, tourism, advertising, and through the emulation of Western life styles by the local upper classes. Lauterbach (1972), for example, observed that in Latin America the exposure to the consumption patterns of the affluent countries gives rise to “‘premature’ consumer aspirations” and to “an ever-growing pressure on the Latin American consumer, even the one with little discretionary purchasing power, in the direction of emulating the consumption preferences and habits of consumers in industrialized countries” (ibid.: 276).” (chapter 2, p. 42)

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“However, taking into account all the evidence considered so far, a preliminary conclusion on the relationship between income and SWB shall be drawn.

A priori, there can be no doubt that for very low levels of income there will be a positive and causal influence of income on SWB that does not depend on the income of any other individual. Once a certain threshold income is reached, however, a nation’s average SWB does not respond to increases in income while the SWB of any individual tends to increase with relative income. Despite the positive cross-national correlation between income and SWB, there seems to be no substantial causal relationship among these two variables. Rather, the correlation seems to be primarily, if not exclusively, due to a third influence, that of individualism (and perhaps additional cultural attributes). One effect of individualism is to fuel competition which results in economic efficiency and, therefore, in material prosperity. A second effect is that individualism places priority on intrinsic desires which are characterized by a high “happiness payoff”. At the same time, it assigns a more important role to happiness as a constituent of the good life.” (chapter 2, p. 44)

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happiness as a judgment

“Very generally, a judgment can be understood as an evaluation of a state against a counterfactual standard of what ought to be. This standard, which I will call the counterfactual frame of reference, will be influenced basically by two hypothetical considerations: by the perceived likelihood of alternative states (likelihood counterfactuals) and by normative considerations of what ought to be the case (normative counterfactuals; Kahneman and Miller’s [1986] norm theory takes the same perspective). [...]

The entire question of SWB, and consequently the very idea of the good society, appears in a paradigmatically different light if it is not understood as maximizing the availability of resources that meet given needs, but as the satisfaction of legitimate expectations in which the active and sensible examination of the expectations themselves has at least as large a role to play as the means to satisfy them. Csikszentmihalyi, renowned for his seminal research on truly gratifying experiences he called “flow”, expressed in one sentence all the difference such a perspective makes: “Happiness is not something that happens to people but something that they make happen” (Csikszentmihalyi 1999).” (chapter 2, pp. 46)

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individual rationality can be socially wasteful

“To the individual, the desire for positional goods, or for status itself, is an aspiration not categorically different from the desire for a nice house or good health. From the viewpoint of society, however, the satisfaction of positional aspirations is a zero-sum game without a net benefit: the gain of one is, by definition, the loss of another. Only to the degree that those with above-average aspirations “purchase” high positions from those with below-average aspirations (e.g., as in the case of within-firm status-salary bargains; see chapter two, p. 39) a net social gain is possible. Once the distribution of positions has exhausted such potential gains, however, and in the majority of settings where prohibitive transaction costs prevent such gains altogether, the individually rational pursuit of status will lead to a waste of resources from a social perspective.” (chapter 3, p. 52)

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happiness research thwarts the rationale for social discounting

“In this context it should be noted that a major argument for the economic practice of discounting future outcomes would not be valid in a SWB perspective. If wealth is understood in terms of goods, discounting over generations can be justified on the grounds that the discount rate reflects the potential increase in real wealth. For example, at a social discount rate of three percent and assuming no inflation, environmental damage one hundred years hence of $1 million will have a net present value of $52,033. If avoiding the damage requires an investment today of more than this amount, such an investment will be inefficient because investing it elsewhere will lead to a benefit that will in one hundred years exceed the cost of the environmental degradation, leaving a net benefit to society. However, the analysis will be invalid in terms of SWB. The failure of SWB, in the wealthy countries, to rise over time despite economic growth undermines the very rationale for intergenerational discounting. No purely quantitative method will provide an appropriate criterion for long-term tradeoffs between different forms of investment.” (chapter 3, p. 62)

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the scope of happiness research

“It should be clear therefore that the goal of happiness research cannot be to provide the ultimate criterion for the good life and the good society. Rather, its goal has to be understood as contributing to a better understanding of one, perhaps the most important, aspect of individual and social welfare. Given that happiness is one among several values people hold, measuring SWB can help identify those factors that add to happiness—and those that do not. Perhaps its greatest value lies in testing and correcting intuitive theories of what affects SWB.“ (chapter 3, p. 62)

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the procedure can matter more than the outcome

“The way of thinking about economic policy should receive a different emphasis, away from the traditionally dominant concern for outcomes towards a concern for procedures. Solid evidence from laboratory and field experiments shows that procedural utility, i.e., considerations of procedural characteristics independent of the actual outcome, has a considerable and independent influence on individuals’ satisfaction (Folger 1986; Frey and Stutzer 1999b, 2001a; Tyler 1990). Just as Richard Layard is more annoyed by an identical noise at night if it is due to his neighbors than to the wind (see p. 47), people in general have been found to evaluate identical outcomes very differently on the basis of the circumstances and procedures that brought them about. For economic policy this means that the SWB of consumers, who are always also voters, workers, tax payers, and citizens, may depend more on the design of institutions and possibilities of participation than on consumption. These themes are rightly emphasized by Constitutional Political Economy. Swiss authors in particular—before the background of a long tradition of federal, participatory democracy, but also of Europe’s highest incomes—point to the benefits of federalism and direct democracy and provide econometric evidence that these are related to sound fiscal policies and, indeed, happiness (Frey and Stutzer 1999a, 1999b, 2001b). In turn, greater satisfaction with political institutions, and with life in general, may feed back to economic prosperity. A citizen who feels that she co-determines how much taxes she pays may be less likely to feel discouraged by a given marginal tax rate than one who feels taxes are imposed by an independent, anonymous authority.” (chapter 3, pp. 62)

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conclusion

“Economics should take advantage of more than forty years of empirical SWB research. The recognition that self-report measures are valid and reliable and that they correspond precisely to the subjective spirit of the psychological premises of economics would enrich the economic science in two ways: by substantiating the economic concept of utility and clarifying the limits of economics.

A substantiation of the economic utility concept would be a great progress for the economic science at large. It would render economic theory falsifiable and thereby add value to economics analyses because only falsifiability ultimately warrants a growth of knowledge (Popper 1959/1934). Theories based on unfalsifiable premises of what motivations underlie human behavior belong, in the sense of Popper, to the realm of metaphysics. Since their propositions cannot be refuted, they can also not be corroborated.

Making use of empirical methods to measure utility would enable economics to develop more substantive theories of how the behavior of individuals adds up to aggregate outcomes. The objection that the substantiation of the utility concept would overcharge economics with redundant details will be invalid. On the one hand, as has been indicated, taking SWB seriously will in many contexts lead to a substantial improvement of the explanatory potential of economics. It will therefore not be redundant but, on the contrary, indispensable. On the other hand, the current thin concept of utility will continue to be a powerful heuristic device that can inspire economists in their endeavor to explain economic phenomena. It will also be a useful empirical approximation of behavior in many more narrowly circumscribed contexts. [...]

The single most significant lesson of SWB research for economics is perhaps the recognition that negative externalities of individual choices are not the exception but the rule. As a consequence, the almost unconditional trust of many economists in the invisible hand is no longer justified, even though the concept itself will not become less valid. Putting the invisible hand in due perspective will reveal that there is a long way to go from individual choice to social welfare. Furthermore, it will necessitate a shift of emphasis from quantitative to qualitative wealth. Without institutional arrangements that restrict positional competition, a society is likely to spend too many resources on jewelry and advertising, to work too many hours, and to teach their children to take positional competition too seriously. An economy may produce quantitatively much in terms of goods, but in how far these goods translate into high well-being depends on how wisely a society sets the rules of the game and how it educates its children.

The pervasiveness of externalities also qualifies the Pareto criterion. Above all, it becomes apparent that the Pareto criterion derives its intuitive appeal from its supposed legitimacy. Its wide acceptance rests on the conviction that it tolerates the tolerable, namely personal tastes that do not unduly interfere with the liberty of others, and does not tolerate the intolerable, namely envy and other tastes that do interfere unduly with the liberty of others. Once it is recognized, however, that externalities are pervasive; that these externalities persist even in the absence of transaction costs; and that externalities from positional competition are not as easily labeled ‘legitimate’ or ‘illegitimate’ as conventional externalities (like industrial pollution), it becomes clear that the criterion of efficiency depends ultimately on which preferences and which degree of interference with the liberty of others are considered legitimate. In other words, it is ultimately absolute values, and not relative preferences, that define what is efficiency, individual well-being, and social welfare.” (conclusion, p. 66)

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© Johannes Hirata (last update: September 25, 2006)