The Economics of Happiness

1. The Economics of Happiness A Tool for Measuring Well Being and Public Opinion: A Summary for the IADB Workshop on Quality of Life in Latin America December 8, 2006 Carol Graham Economic Studies Program, The Brookings Institution/ School of Public Policy, The University of Maryland

2. Why Happiness Economics? • New method combining tools and methods of economists with those typically used by psychologists • Method captures broader elements of welfare than do income data alone • Method is uniquely well suited for analyzing questions where revealed preferences do not provide answers, for example the welfare effects of institutional arrangements individuals are powerless to change (like inequality or macroeconomic volatility) and/or behaviors that are driven by norms or by addiction and self control problems (alcohol and drug abuse, smoking, obesity) • While economists traditionally have shied away from reliance on surveys (e.g. what people say rather than what they do), there is increasing usage of data on reported well being (happiness): • a) consistent patterns in the determinants of well being across large N samples across countries and across time • b: econometric innovations help account for error and bias in survey data (AND with the error that exists in all kinds of data!!)

3. Why Not Use Happiness Surveys • Biases in the way people answer surveys (question ordering/random events) • Adaptation – at individual and country levels • a) individual level: some psychologists believe that people ALWAYS adapt to their set point, even after extreme events like divorce or spinal cord injuries; THUS if a poor peasant, who has adapted to his/her condition reports he/she is happy, what can development economists do with this information? • b) country level: Easterlin paradox - average happiness levels have not increased as rich countries get richer and make improvements in other areas such as health, education; BUT……………… • how long does it take individuals to adapt to these extreme changes? Equilibrium could be a LONG time away…..Do we not care about several years of very low well being levels caused by certain phenomena? • most relevant information is about individual well being; country level averages do not tell us much and it is difficult to control for error/cultural traits, etc. Do we really care if Nigerians are happier than Ghanaians just because they have a tendency to respond in a more cheerful manner? • WITHIN countries, wealthier, healthier, and more educated people are happier than poorer, less healthy, and less educated ones and have more time to enjoy those lives

4. How Can This Approach Help Us Better Understand Well Being in Latin America? • Major discrepancies between positive assessments of the benefits of globalization for the poor and for poor countries by economists, and the more negative assessments of the typical lay person on the street; same goes for assessments of reform in Latin America • In some contexts, these assessments are positive; in others they are very negative and are even associated with widespread public frustration, political protest, and civic unrest • Our research – based on well being surveys of thousands of individuals in developing countries world-wide (RESEARCH BEGAN IN LATIN AMERICA) finds that – counter to the received wisdom - public frustration is NOT most evident among the poor, but rather among upwardly mobile, low and middle income individuals • Frustration is associated with mobility, inequality, and insecurity – e.g. with dynamic trends - rather than with static poverty • Our approach is based on analyzing the dynamics of poverty and inequality, rather than using the usual static measures and focus on equilibrium • It is also based on comparing perceptions of well being to objective, income-based measures

5. Data for Latin America • Conducted annually (1997-2005) by the Latinobarómetro organization, a non-profit corporation based in Chile and directed by Marta Lagos (www.latinobarometro.org) • Survey consists of approximately 1000 interviews in each of 18 countries in Latin America (Dominican Rep added in 2004) • Conducted annually by a prestigious research firm in each country, and are nationally representative except for Chile, Colombia, and Paraguay (less than full coverage/logistical constraints) • Survey is comparable to the Eurobarometer survey for European countries in design and focus • First survey 1995 in 8 countries, with grant from the European Community and now comes from multiple sources. Access to the data is by purchase, with a 4 year lag in public release. Graham has worked with the survey team for years and assisted with fund raising, and therefore has access to the data. Aim is for full public funding and access by end 1996. • Region-wide data complemented by in-depth surveys of mobility and perceived well being in Peru and Russia by Graham et al. (2002, 2004)

6. Happiness in Latin America:Age Pattern Conforms!

7. Happiness In Latin America:Most Other Variables Conform to Patterns for the U.S. and Europe

8. Support for Markets and Democracy in Latin America: Insights from Research by Graham and Sukhtankar, 1994 • DOES CRISIS REDUCE SUPPORT FOR DEMOCRACY? • “Crisis” countries defined as those where economic growth was negative between 2001 and 2002. There may be better definitions, but this was the most parsimonious • How did support for democracy and markets fare during the 2001-2002 economic crisis in the region? • Did support fall dramatically in the crisis countries? • Did crisis affect happiness/well being?

9. Satisfaction with and Support for Market Policies

10. Preference for Democracy

11. Satisfaction with Democracy

12. Conclusions from Research on Markets and Democracy • Crisis, rather surprisingly, seems to increase support for markets and democracy as systems, although satisfaction with how these policies are working in the crisis countries has fallen at the same time • Both happiness and satisfaction with these policies were higher than average in the crisis countries before the onset, and then fell markedly to average or below average levels after (happiness and satisfaction with markets and democracy are correlated, not surprisingly) • There is no evidence of a “growth” premium; support for democracy does not seem greater when countries are growing more. Higher levels of growth may raise expectations at the country level as well, and respondents expect more from these systems. • In contrast, in crisis countries, they seem to appreciate the importance of the survival of the systems as expectations about performance adjust downwards

13. Inequality and Happiness in Latin America: Insights from Graham and Felton, 2006 • The effect of inequality on individual welfare remains a debated question in economics. A common explanation for these mixed findings is that in Europe and the U.S., inequality can be a signal of income mobility and opportunity as much as it is a signal of injustice. • Paper explores the effects of relative income differences, as well as of inequality more broadly defined, on well being in Latin America, the region with the highest inequality in the world. • Also analyzed trends in respondents’ perceptions of inequality, rank, and opportunity as a means to gauge the effects of broader, non-income definitions of inequality on well being. • Explored role of inequality and perceived inequality in mediating the effects of unemployment on well being.

14. Effects of Average Country Level vs. Relative Individual Wealth

15. An Illustration of the Importance of the Relative Wealth Effect on Happiness, Based on Chile and Honduras

16. Summary of Inequality Findings • Large and consistent effects of relative income differences on well being; Average country and city-size wealth, holding individual incomes constant, had no significant effects on well being, with the exception of in the smaller, poorer cities; Suggests that inequality or relative position matters more in Latin America than it does in other places, such as Europe and the United States. • Back of the envelope calculation suggests that inequality in the region makes those in the highest quintiles 5% happier than the average and those in the poorest quintile 3% less happy, regardless of differences in average or individual wealth levels within and across these groups. • Common explanation for these mixed findings on effects of inequality on welfare in the Europe and the U.S. is that inequality can be a signal of mobility and opportunity as much as it is a signal of injustice. In Latin America, a region where the gaps between the poor and the wealthy are larger and more persistent, inequality seems to be a signal of persistent advantage for the very wealthy and persistent disadvantage for the poor.

17. Summary of Inequality Findings Cont. • Also analyzed trends in respondents’ perceptions of inequality, rank, and opportunity as a means to gauge the effects of broader, non-income definitions of inequality on well being. Relative differences in these realms may be more important than income-based differences to well being. • These concerns varied according to reference norms and were greater among those respondents in places where there is higher average wealth and with greater variance in levels (and probably more information and awareness), as in big cities.

18. Questions for further research by Graham et al, based on Latino and Other Regional Surveys • The links between inequality and discount rates – e.g. the willingness of the poor to invest and save when inequality is high and persistent • Linkages between inequality and political attitudes • Links between norms, expectations, and discount rates pertaining to public health investments; initial work exploring variance in obesity rates across socioeconomic cohorts in the U.S. and Russia • Variance in the determinants of optimism and well being in Latin America and Africa (based on Afrobarometro). Initial findings (Graham and Hoover, 2006) suggest that optimism for the future is correlated with extreme poverty in Africa, while, in contrast, in Latin America, the U.S., and Russia, it is correlated with higher levels of income and education

19. Questions for the IPES to Explore Via Happiness Surveys: A Laundry List • The welfare effects of inequality – including its effects on savings, investment (financial and in children’s education), and on support for reform are still not fully understood. • Gender, ethnic, and other aspects of inequality in the region are recognized as important; surveys can help measure their welfare implications and their possible effects on the behaviors listed above. They can also help assess their relative importance compared to other variables, such as employment status. Happiness surveys can help us assess the relative importance that the region’s citizens attach to various macro and institutional arrangements, such as inflation versus unemployment, and democracy and participatory politics at various levels (central versus local). • Job security and job quality are hugely important questions for the region, both in terms of competitiveness and support for reform. • Achieving higher quality and higher levels of education for more people are linked to the above topics. Well being surveys can shed light on the perceived returns to education investments in the region

20. Sources • Carol Graham and Stefano Pettinato, Happiness and Hardship: Opportunity and Insecurity in New Market Economies (Washington, D.C.: The Brookings Institution Press, 2002). • Carol Graham and Sandip Sukhtankar, “Does Economic Crisis Reduce Support for Markets and Democracy in Latin America? Some Evidence for Surveys of Public Opinion and Well Being”, Journal of Latin American Studies, April 2004. • Carol Graham et al., “Does Happiness Pay? Some Initial Evidence from Panel Data for Russia”, Journal of Economic Behavior and Organization, Vol. 55, 2004. • Carol Graham and Andrew Felton, “Inequality and Happiness: Some Insights from Latin America”, Journal of Economic Inequality, January 2006. • Andrew Felton and Carol Graham, “Variance in Obesity Across Countries and Cohorts: A Norms-Based Explanation using Happiness Surveys”, CSED Working Paper #42, The Brookings Institution, September 2005; www.brookings.edu/es/dynamics/papers • Carol Graham and Matthew Hoover, “Poverty and Optimism in Africa: A Survival Strategy in a Context of Incomplete Markets?” Mimeo, The Brookings Institution, June 2006.