Erzo Luttmer wrote an acclaimed paper in 2005 called 'Neighbors as Negatives: Relative Earnings and Well-being' in the Quarterly Journal of Economics.  He defends the stance that our neighbours affect our happiness because they are the reference group to whom we compare ourselves, and therefore they are the people we believe ourselves either inferior or superior to (subconciously or not).  Everyone, it seems, wants to be above average to be happy.

Luttmer mans the bulwarks of the 'positional' happiness theory with his phenomenal statistical rigour and his methodical and exhaustive explanations.  I will present some of his findings here and leave you to read the paper if it excites you.

Findings

1. Neighbours income has a negative effect on reported subjective well-being controlling for a host of potential confounds.
2. Particularly, people reference neighbours with similar levels of eduction: the happiness of a person with a degree decreases if they have a neighbour with a degree who earns more than they do. Similar effects occur for those with high school education only.
   
3. The negative effects are more pronounced for people who associate more with their neighbours.
4. Individuals living in richer areas report lower happiness on average.
5. But, absolute income levels remain pertinent - if your income and the average income of your neighbourhood increase by the same percentages you would be happier. 

Potential confounds
Consider the following arguments:

1. Definitions of happiness change - this can be dismissed because the frequency of arguments between spouses about finance increases as a consequence of neighbour's income increasing, but other types of disagreements did not increase in frequency.  Were it simply about definitions of happiness then this would not occur.
2. Individual opinions change over time - this is discounted because the data are panel data (cross-sections over time) and Luttmer includes 'individual fixed effects', i.e. he includes variables which check whether an individual's opinions remain constant over time given other factors.  They do and the reports on subjective well-being are not responsive to such concerns.
   
3. Omitted individual characteristics drive the results - this is dismissed because of a measure of depression.  Arguably, increases in a neighbour's income could affect well-being without altering depression-related variables.  Such is the case, neighbours' earnings generally do not affect depression, with one caveat: those who are farthest from being depressed are slightly more likely to be a bit depressed when neighbours' income increase.
4. A third argument might consider the role of health, but there was no relationship in the data between neighbours' income and reported health outcomes. 

Underlying mechanisms
General finding: satisfaction increases with increases in own earnings, but decreases with increases in neighbours' earnings. However, neighbours' earnings increases satisfaction with the neighbourhood generally (i.e. I like living there because I am in a 'good' neighbourhood), but increases in neihbours' income makes satisfaction with leisure decrease. 

Neighbours' income could affect aspirations, but financial worries (about whether family income will be enough to cover bills and food) do not increase with neighbours' income - i.e. the reference points don't increase in this data, contrary to Stutzer's paper that I reported on previously. 

However, friendships and social capital could be deteriorating as a consequence of keeping up with the Joneses. I quote from the text:

People appear to be giving up leisure, to allow their friendships to suffer, and to work more, perhaps in an attempt to mimic the material livings standards of their neighbours. (985)

This is consistent with arguments that people overestimate the value of consumption (and immediate consumption particularly), and do not take into account the long term effects of deterioration in friendships, family ties and other social capital (more on this soon). 

I found this paper well structured, rigorously defended and strongly posed. 
It was a pleasure to read and consider. I will have to read more on the topic before I am convinced though that there are not complementary causes through aspirations à la Stutzer.

Post Script
I found the following finding interesting. Jews and the non-religious are significantly less happy.  Baptists are the most happy.  No significant effects hold for other Christians.

Today I comment on a chapter by Stefano Bartolini in the Handbook of the Economics of Happiness.  He discusses the role of economic growth in our understanding of subjective well-being and particularly the role that money plays for happiness. He considers trends in expectations about leisure and money, trends in saving and in labour markets. He explains some of the reasons behind these trends.

Historic Trends
During the 70s economists were debating the coming 'leisure society' with predictions that work hours would decrease to 15 hours per week in the UK because of how society and production were flourishing. 

This society has obviously not been realised.  Furthermore, economists thought growth would release workers from the need to save to insure against economic shocks.  Interest in 'money' was expected to decline.  Though mass poverty in the US, UK and EU has been eradicated, we still obsess over money.

The industrial transition - the move from agriculture to manufacturing - saw savings rise to a stable and high level.  In post-industrial countries the labour supply went through dramatic changes: from a working day of less than 8 hours to work days of 10, 12, and 14 during and after the industrial revolution.  The reversion to 8 hour working days (though many still work more than that) took some time.  Industrialisation also saw increases in urbanization.  Post-industrial societies also seem geared towards producing goods, rather than leisure. Finally, work hours in post-industrial countries seem to be increasing once more. 
Explanations
The question thus becomes, with these patterns, what is making people unhappy? If people are unhappy, why do they not realise it and change their behaviour? Consider the following explanations: 

1. Set point theory: With this theory, individual propensity to happiness is a personal trait of largely genetic origin and influeced by personality.  Happiness is thus a randomly distributed trait in the population and unaffected by external factors.  But, if this is the case, then why do we see increases (EU) or decreases (US, UK) in 'happiness' keeping the gene pool relatively constant?
2. Decreasing marginal utility of money: Basic idea: a progressive saturation of needs by material goods - as you get more money it is worth relatively less to you.  Consistent with relatively affluent societies having sated basic needs.
   
3. Adaptation (Hedonic Treadmill): Main idea here is that people adapt to a consumption level and then require more consumption to feel satisfied.  Aspirations play a role in this (consider yesterday's post).  The argument is that humans evolved adaptability to deal with poor circumstances, but this same adaptability makes us dissatisfied with high levels of absolute wealth and consumption.
   
4. Relative Position: Relative position in society, or in a community, is relevant to individual happiness and satisfaction.  If relative position counts, then an increase in income for all people in society will not improve subjective well-being because each person's position remains the same.
   

1-3 fall into the 'Money Can't Buy Happiness' class of explanations.  However, a problem arises.  I quote extensively from the text:

If people realize that their happiness depends on, say, personal traits, or that adapataion will sooner or later annul the advantages of an increase in income, or that money cannot satisfy needs that are essential, [then] they will react by reducing their efforts aimed at making money. In short, if money cannot buy happines, the labor supply and the saving rate will be highly responsive to variations in labor productivity and wealth. (Bartolini, 2007, 343)

But, as Bartolini notes, this does not occur.  The opposite occurs.  Thus, to predict the patterns of consumption that we see in reality, theories 1-3 need an additional theory about the failure of rationality, i.e. an explanation for why people don't realise that they are unhappy and adjust their behaviour accordingly. 

4 means money can buy happiness, but only relative to other the position of other people. It does not require additional assumptions about failures of rationality.  Moreover, with the increases in inequality concurrent with the increases in GDP growth that occurred in much of the Anglo-Saxon world this theory offers strong predictions that are verified by reality.

Endogenous Growth
Growth theory should explain the trends in labour supply, productivity and leisure.  But, many growth models take the labour supply as given (they assume a working population 'N' and put it into a mathematical model).  This therefore assumes that all increases in labour will be dedicated to production.  But what about increasing leisure? What makes leisure so bad that we don't include it in our growth models? Well, it turns out that if you include labour-leisure decisions as endogenous variables - variables to be determined within the model, rather than taken as given - then the conclusion that economies can perpetually grow disappears.  Including leisure decisions results in decreases in accumulation (people save less), and increases in leisure time (people work less).  People do indeed seem to have saved less in Anglo-Saxon capitalist societies of late, but they have increased their work hours, not decreased them.  This leaves much to explain.

However, if we incorporate a 'micro assumption' about relative position as a motivating factor, then the incessant need to compete and accumulate could drive perpetual growth while also maintaining a population that, on average, reports levels of happiness that do not seem commensurate with its levels of absolute wealth.

Policy Solutions
Let us assume that the subjective well-being of its populace is important to the state. What should it do to deal with the problem of low levels of happiness?  Bartolini proposes three classes of solutions.

1. Fiscal Solutions: Income taxes and wealth taxes close the gaps.
   
2. Redistributive Solutions: Inequality increases positional competition - trampling on your neighbours to get to the top. Reducing inequality would reduce this competition.
   
3. Social Solutions: Reduce opportunities for positional competition for 'intrinsically zero sum games'.  
   

Now, I am not certain about all of these solutions.  For fiscal solutions I think consumption should be taxed, not necessarily income or wealth.  Why? People try to 'signal' wealth, either proper signaling or false signaling, by conspicuous consumption.  The problem, however, is that at the high end of the income scale no (feasible) amount of consumption taxes would result in certain people choosing not to purchase that Maserati, or that ostentatious mansion, nor do they refuse to have their wealth published in magazines and newspapers. I think that there are viable redistributive and social solutions, but I reserve those discussions for later.

None of this, in my view, requires that we get rid of capitalism, as some people argue.  Capitalism has allowed the contexts in which people compete positionally to proliferate and diversify: when once you would have to fit a fairly strict 'norm' to be happy, capitalist democracies sustain a plethora of new areas in which people can become important to grow and flourish.  There are lots more castles of which you can become the king or queen (or intergender ruler if you prefer).  Think about games from chess, to poker, to MMORPGs; about music, from hip-hoppers, rappers, goths, punks and emos; about sports from football, to rugby, running, cycling, field athletics.  All of these allow people a place in which to exploit positional joy. 

But, at the same time, other resources that sustain happiness and satisfaction have begun to die out and these other things - social capital and the environment - will be the focus of later posts. 

Post Script
Bartolini also comments extensively on negative endogenous growth in the chapter, I am reserving that for another post as I think it warrants its own discussion (and me reading one of the papers on the topic, rather than just a few paragraphs). 

Alois Stutzer's paper 'The role of income aspirations in individual happiness' forms the basis for my commentary today.  Stutzer's research  provides a few specific messages:

1. People experience lower subjective well-being when they have higher income aspirations, controlling for their income level. 
   
2. People adapt to their income levels and adjust their aspirations upwards according to their new, higher levels of income.
   
3. The average income of an individual's community affects that individuals aspirations contingent on them interacting with their community, say by visiting neighbours.
   
4. Controlling for endogeneity and for time, a gap between aspirations and reality has a negative correlation with reported subjective well-being.
   

Now, let me try to interpret. Stutzer's main hypothesis is that individuals do not obey utility functions of the type I mentioned in the last post, instead they obtain utility, and thus well-being, through relative assessments of their income, of their position in society.  This draws on a long history in economics from Marx (1849), to Veblen (1899), to Duesenberry (1949) to Frank (1985): their basic message is that aspirations tend to be above the current level.  Wealthy people therefore impose a negative externality on poor people (because the poor aspire to riches), but not the converse (the rich do not aspire to poverty). 

On adaptation, the idea progresses as follows: individuals achieve a certain level of utility become accustomed to it (adapt) and aspirations kick in making them relatively less happy with their position than they were when they first obtained it.  When the gap between aspirations and reality widens, people become less happy (or more unhappy). 

Stetzer's research involves panel data on Swiss households from 1997, 1999 and 2000.  Because he has panel data (i.e. repeated cross-sections with the same households) he can get rid of confounds, such as whether income is constant over time, or whether individual or household reported levels of wellbeing remain constant over time. The survey respondents were also asked what level of income they thought would be good or bad in their circumstances, as well as the monthly income they would require to maintain a standard of living where their needs were reduced and they did not run into debt.  These variables were used to measure understandings of context and aspiration, i.e. the extent to which living in a specific community at a given level of income affected the reported incomes for these questions of 'good', 'bad', and 'sufficient'.

First, couples are, as elsewhere, happier on average than singles.  Couples with young children or grown children or also happier than their single counterparts.  Second, happiness seems U-shaped in age: the general rule is that subjective wellbeing is at its lowest ebb somewhere in your 40s, but then it increases again. Third, foreigners, people with poor health, and the unemployed are substantially less happy on average.  Fourth, household income has an unambiguous positive effect on happiness, but aspirations counteract this positive effect.  What this means is that if people did not have such crazy aspirations, they would be quite happy with the level that they had already obtained.  The pattern of aspire, obtain, adapt, aspire continues.  Let me quote from the article at this juncture:

People experience lower wellbeing when they have higher income aspirations, given their income level. A doubling of the aspiration level, measured by the income that is evaluated as 'sufficient', reduces reported life satisfaction on average by o.266 points. (Stetzer, 2004, 96)

This is a substantial effect, if you consider that there are only ten points on the satisfaction index. 

When looking at the effects on aspirations several factors affect whether aspirations increase or decrease.  Couples have much higher income aspirations than singles.  Those who have previously had lower incomes have lower income aspirations (I tell myself, therefore, that experience the relative low income of being a student is a good thing).  More education correlates with higher income aspirations (oh well...), as does being a foreigner, and being self-employed.  This 'foreigner' aspiration could also explain why foreigners are relatively less happy - they expect higher income, but for some reason do not obtain it, and thus are less happy with the status quo. 

Stetzer's results support the hypothesis that aspirations have a negative impact on subjective well-being, or satisfaction.  For some people the effect might counteract completely the positive impacts from having a higher income.  Stetzer's evidence offers crucial support for the notion that we experience satisfaction, wellbeing, and therefore utility in a relative and not in an absolute manner.  The evidence for this continues to mount - the days of absolute utility functions cannot be maintained for much longer.  That said, I think that the basic notion of a utility function in absolute levels up to some level for the 'necessaries' in Adam Smith's words is probably accurate. Recall though, that for Smith, also have a contingent and culturally embedded meaning:

By necessaries I understand not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without. (Wealth of Nations, Book V: II).

I am reminded by this how the nature of happiness, of satisfaction, of subjective wellbeing generally, and, of course, of utility, are deeply embedded in culture, in community, and in the point in time at which we experience a given act of consumption. Aspiration and adaptation are evidently part of human behaviour, be they learnt or biological, but they seem also to be the enemies of our own satisfaction.

My recent course on sustainable development included a module on the growing literature of happiness economics.  It was included in a sustainable development course because of the trends that are observed in the 'happiness economics' literature regarding dissatisfaction with GDP as an index of human welfare and thus GDP growth as a measure of a society's advancement.  I will attempt to deal with some of the questions that we covered in our class as prep for my exam next week. I am particularly interested to find data on this for South Africa as I believe we could find some interesting patterns in South Africa (more on which later, but mostly relating to South African economic inequality and its effects on happiness).

I want to clear a couple of areas of scepticism and introduce some of the 'problems' in Economics and why there are problems with economic methods and their relationship with happiness. In my second post I'll get onto the first paper about aspirations and happiness. 

First a definition.  Subjective wellbeing is normally measured using an index of either 1 to 5 or 1 to 10 points.  The questions range from asking about 'happiness' to 'satisfaction'.  Thus a 1 generally corresponds to completely dissatisfied or completely unhappy, and a 10 corresponds to completely satisfied or completely happy. It's called 'subjective' wellbeing because survey respondents are asked their opinion on their own levels of happiness, or wellbeing, i.e. currently we have no 'objective' method to measure happiness.

Second, to clear some questions about cultural differences and comparisons across countries I believe it is arbitrary to state (as we see in the media so regularly) that Country X is happier than Country Y.  There may be all kinds of cultural factors, say reservedness, which affect how people report happiness, or more accurately 'subjective wellbeing'.  However, it is completely acceptable to compare trends across countries, for example to state that subjective wellbeing in America and the United Kingdom has decreased dramatically over the past 30 years, whereas in Europe subjective wellbeing has either increased or remained constant over the same period.  Why do we accept the trend comparisons and not the absolute comparisons? To compare absolute levels between countries lacks nuance and does not take account of factors endemic to that country, say British reservedness (as I mentioned above).  Comparing within country trends however assumes that something like culture remains constant within a country, so, holding British reservedness constant over the past 30 years, why has their subjective wellbeing decreased, while in the same period subjective wellbeing in Denmark has increased? That comparison is legitimate and allows us to explore the factors that affect each country.  Note too that average economic growth in the US and UK has exceeded that of Europe on average, which leaves us with the happiness paradox - more growth (i.e. objectively more stuff), but people are less happy. 

Third, I want to annunciate the problem clearly (and somewhat technically).  In basic economics individuals get something called 'utility' derived from acts of consumption where consumption can include eating food, seeing a movie, taking an airplane flight, or purchasing insurance. From this we can derive what we call a utility function - a mathematical representation of peoples' utility that contains information on what they consume. 

A utility function looks like this: U = f(x) where x can be a 'vector' (read as a list) of goods that a person consumes, the basic idea being here that if you choose, say, to eat a banana then you have derived utility from doing so, similarly for buying a chair, watching a movie, and so on. 

Now, the problem arrives.  If we can say that utility should correlate with subjective wellbeing or happiness (if it isn't then many people are uncertain what it really measures), then having more money on average should make people happier. They can consume more because money is instrumental to consuming more.  By this reasoning people in the US and the UK should have been getting happier over time, and we could probably even say that they should have been getting happier more quickly than people in countries that were not growing as quickly.  But, the opposite is true! Brits and Americans have become unhappier over time.  The graph adjacent depicts US happiness and US GDP per capita over a period of 50 years (one of my prof's slides).  The trend is similar (though not quite as dire) for the UK.  It is quite dissimilar for the most of the EU - Italy, France, Germany, Denmark, Sweden and the Netherlands. 

I will address some of the reasons why we observe this happiness paradox in my next few posts, some of the motivations will deal with flaws in the utility function (it only measures absolute gains, not relative gains and losses, or gains and losses relative to some group), to the problem of 'negative endogenous growth' (not as difficult to consider as it sounds), the degeneration of social capital, and I will offer some stylised facts that may offer some insight.  I will also try to read some of the literature on developing countries, specifically I have found one paper on subjective wellbeing in South Africa from data in 1993 and I will comment on that when I have the time. 

Take a look at this Scientific American Interview with Judith Rich Harris (author of The Nurture Assumption and No Two Alike). The central question of the interview is 'Do Parents Matter?' According to Harris's theory parents matter because of their genetic contribution to their children, which affects personality and physicality, and because of their role in nurturing specific behaviour patterns at home. But parents do not matter much for behaviour outside the home and thus for their behaviour at school, in the workplace and in social environments. For these environs it seems teachers and peers are more important than parents.  

This begs the question whether a parent can be 'better' by manipulating the external environment.  I would like to know whether proactive and interventionist parents affect the outcomes of their children by affecting the schools, playgroups and extracurricular activities with which their children are involved.  If, when I become a parent, the evidence indicates that the 'control' I have over the relative success of my child is affected greatly by peer effects, then I will probably be stricter and more interventionist about those peers and about my child's teacher.  So I will probably be one of those slightly neurotic parents championing my child's move from a worse teacher to a better teacher. I apologise to all school administrators in advance.

Research in economics on peer effects and neighbourhood effects reinforces Harris's conclusions.  I would recommend Stephen Durlauf on this topic, see this book chapter online where he discusses neighbourhood effects and 'classroom' effects as an example of neighbourhood effects.  Skip the technical stuff, it's not worthwhile for a non-economist, but some of the examples in the latter half of the paper are interesting for the layperson.

P.S. I apologise for the 'mater' matter play, I couldn't help myself.

In The Wealth of Nations Adam Smith argued that various institutions need to be in place before a commercial system will function well.  Moreover, these same arguments are applied to most forms of capitalist production and to most modern forms of market capitalism.  The conditions for capitalism's success include rule of law, well-defined property rights, and many others. These conditions have been elucidated by many researchers such as Douglas North and others.  The insight distils to the following: the rules for the game affect how the game is played.

Smith's insights are particularly relevant to the current world economy.  And they are relevant to a recent article by Johann Hari.  Hari reveals the tragedies resulting from a failure to uphold institutions - a capitalist system running amok - 'The Dark Side of Dubai'.  In it he depicts a world where workers are abused and treated as a slave class, nature deteriorates unchecked, the local populace and expats perpetuate the system by their complicity, debt default is punished with imprisonment, and the government quells dissent by confiscating passports and by summarily imprisoning offenders. 

Hari's tale takes particular significance in the current crisis where more and more debtors have defaulted, where workers are laid off but cannot travel, and where a government has myopically refused advice and seems set on repeating its mistakes.  Moderate Islam flourished in Dubai, but, because it had incurred such great debt, Dubai may kowtow to its more pious neighbour Abu Dhabi to relieve its debts and therefore renege on its moderate past and move towards greater fundamentalism and stricter Islamic practices.  It looks disastrous.  I hope it improves, both for the sake of moderate Islam and for the sake of the labourers (predominantly Indians and Sri Lankans) slaving for the edifice of this institutionally-unconstrained, monstrous capitalism.  Without the institutions Smith argued for in Wealth of Nations, without the sympathy and fellow-feeling in The Theory of Moral Sentiments, capitalism, the commercial system, looms terrifyingly. 

A question: Can we call it 'capitalism' when relevant institutions do not exist? What should we call it instead? What constitutes 'free trade'? Should things be left alone or not? (Let me remind any who happen to listen that Smith favoured neither laissez faire nor laissez passer cf. Kennedy, 2005: 185.)  A system like Dubai's without taxes, without support for workers and without any semblance of freedom of expression or other rights should not appear anywhere on our palette of solutions. 

I have had Anatole Kaletsky's article 'Goodbye Homo Economics' sitting in my opened tabs for a couple of weeks now.  I found his commentary germane, though not always accurate. First, I am regularly annoyed by people using the word 'economists' to denote macroeconomists, specifically of the theoretically and policy-oriented bent.  I am an economist, but I focus on microeconomic behaviour and evolutionary economics.  It annoyed me that Kaletsky subscribed to the current journalistic jihad against 'economists' when criticising macroeconomics.  Second, I think that Kaletsky should take a look at The Origins of Wealth by Eric Beinhocker.  Beinhocker argues that economics should be more incorporative of heterodox approaches, including those Kaletsky indicates, in addition to striving for an underlying method that is strictly scientific and statistical.  Consequently, macroeconomics may become more like meteorology, humbler about its predictions and couching them properly. Though unable to predict the magnitudes of all policies it would be scientifically rigorous.  I am not claiming this is what economics should become, rather that it is one path among many. Scientific rigour must remain crucial, in all likelihood this will require more sociology, psychology, neuroscience, history AND mathematics and statistics.  Mathematics and statistics won't be dropped because some nincompoops abused them, they will remain relevant.  (Photo appears in the Kaletsky article in Prospect Magazine)