TCS Daily

Can Money Buy Happiness?

By Arnold Kling - April 4, 2003 12:00 AM

Many years ago, some friends of mine who were taking a class from popular Swarthmore economics professor Bernard Saffran thought that it would be amusing to ask him if money could buy happiness. Bernie's answer was, "Yes, to a first approximation."

This is not a frivolous issue. Many people instinctively distrust or dislike economics. However, once you concede that people with higher incomes are better off than people with lower incomes, you have conceded home field advantage to the economists. To the socialists, we can demonstrate that free markets, capital accumulation, strong property rights, and governments that serve the people rather than oppress them are factors that lead to higher incomes. To the environmentalists, we can show that the keys to environmental sustainability are substitution and technological change, not anti-capitalist primitivism.

A Basic Challenge

Recently, the Co-Director of the Centre for Economic Performance at the London School of Economics Richard Layard spelled out a fundamental challenge to mainstream economics. He argues that higher incomes do not lead to greater happiness. This in turn threatens much of the conventional wisdom among economists concerning policy issues.
To an economist, it is literally axiomatic that if people pursue higher incomes, then higher incomes make them happier. We do not believe that people do things that are contrary to their interests.

Layard argues instead that people pursue higher incomes even though collectively it is not in their interest to do so. He says that people are deluded into pursuing higher incomes by distortions in perception.

"First, I compare what I have with what I have become used to (through a process of habituation). As I ratchet up my standards, this reduces the enjoyment I get from any given standard of living. Second, I compare what I have with what other people have (through a process of rivalry). If others get better off, I need more in order to feel as good as before. So, we have two mechanisms which help to explain why all our efforts to become richer are so largely self-defeating in terms of the overall happiness of society."

According to Layard, we are on a happiness treadmill. Once we get used to air conditioning, having air conditioning no longer makes us happy. Once we get used to surfing the Internet, surfing the Internet no longer makes us happy. Once we get used to living longer because of modern medicine, our greater lifespan no longer makes us happy.

Furthermore, according to Layard, being aware of other people with higher incomes makes us unhappy. Lowering other people's incomes would make us just as happy as raising our own. He concludes that "in an efficient economy, there will be substantial levels of corrective taxation."

The Evidence

Layard's analytical edifice rests on an empirical foundation of survey evidence known as "happiness research." Psychologists will ask people questions such as "would you rather earn $50,000 in a world where others earn half that or earn $100,000 in a world where others earn double that?" The responses are used as indicators of whether people value relative or absolute income. Layard reports that these surveys indicate that most people would prefer higher relative income to higher absolute income.

Economists tend to distrust survey research. We believe that people indicate their desires by how they behave--we call this "revealed preference." For example, we rarely see affluent people move into poor neighborhoods in order to enjoy higher relative incomes. We often see immigrants come to the United States knowing that they will be relatively poor. Thus, their behavior appears to suggest that people value absolute income rather than relative income. Given a conflict between surveys and behavior, economists tend to view the survey results as unreliable.

Layard defends survey research on happiness, arguing that people have shown an ability to self-report happiness accurately. He reports on results showing that people's answers to questions about whether they are feeling happy are correlated with increased activity in certain parts of the brain. Therefore, something "real" is going on when people say that they are happy.

However, the fact that people can report their own happiness correctly does not mean that they can correctly articulate what makes them happy. Going from the fact that brain activity changes when people say that they are happy to the conclusion that surveys can correctly identify the causes of happiness is not a valid logical leap.

More important, the fact that subjective happiness and measurable brain activity are correlated does not imply that we can make a meaningful comparison between the happiness reported by one person and the happiness reported by another person. In particular, if I do a survey and find that two people with incomes of $20,000 and $40,000 report happiness of X and Y, I cannot draw any conclusion based on the relative values of X and Y. Even if we are talking about one person, and X and Y represent their reports at two different points in their lives, it is not clear that we can make a meaningful comparison between X and Y. Thus, it is unlikely that survey research can shed light on the effect on happiness of a change in income from $20,000 to $40,000.

What Is Socially Constructed?

Layard writes that "My main message will be that happiness depends on a lot more than your purchasing power. It depends on your tastes, which you acquire from your environment - and on the whole social context in which you live." He is saying that you cannot trust people's behavior as an indicator of their preferences, because their tastes may be socially constructed.

However, if tastes are socially constructed, then it seems to me that social context is at least as likely to affect survey research as it is to affect behavior. For example, Layard reports that marriage increases happiness, based on survey research. Even if we overlook the issue that interpersonal and intertemporal comparisons of subjective happiness have not been demonstrated to be meaningful, it could easily be that the difference in reported happiness reflects respondents' views of how they are expected to feel about being single or married.

As an economist, I do not worry about whether tastes are innate or acquired. I am pretty sure that I was not born with an innate taste for reading. However, reading presumably satisfies an innate desire, so that I have acquired a taste for reading. Does it matter how I acquired that taste? The fact is, I buy books and I spend time reading them. Often, I read books that make me unhappy. Yet I feel that they worth reading.

A Failure

Overall, the more one compares Layard's survey-centric "happiness research" to the traditional approach of revealed preference, the more one appreciates the latter. One can make better predictions and arrive at more robust policy conclusions by watching what people do, not what they say.

For some perspective on Layard's work, consider that in the world of cutting-edge technology businesses, every new company thinks that it has a revolutionary idea that will turn the market inside out. Over 90 percent of such start-ups fail.

Richard Layard is not the first academic revolutionary to claim the ability to turn the world of economics inside out. Like a Silicon Valley entrepreneur, he should not be faulted for trying. But my judgment is that he has failed.

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