Saturday, June 20, 2009

Do people make good choices between income and leisure?

“What are the applied implications of our findings? In the work area we suggest that a balance between hours of work, social time and leisure will produce the highest well-being, whereas even work that is enjoyable will produce less well-being if carried out for too many hours. Conversely, it would be an error to assume that people would be happiest if all their time were spent in pleasurable leisure activities. ... At the policy level an implication is that too many work hours, without sufficient free time or vacation, will prove less rewarding for most people” (Diener, Weiting Ng and Will Tov, 2008, ‘Balance in life and declining marginal utility of diverse resources’, Applied Research Quality Life).

This quote is from the conclusions of an article which assesses how average happiness levels differ with differing amounts of time spent in various ways (free time, with family and friends, and commuting) as well as with income levels. The findings seem to confirm the predictions of standard economic thinking in this area i.e. as our consumption of any good (including non-market goods such as leisure) rises the marginal utility of adding an additional unit of the good tends to decline.

What does the article tell us about marginal utility? The part of the study that seems most informative uses data from the Gallup World Poll, a representative sample of people almost covering about 95 percent of the world. As its main measure of happiness the study uses affect balance, which measures relative experience of positive feelings (enjoyment, and smiling and laughing) and negative feelings (depression, anger, sadness and worry) for the previous day.

The results suggest that the marginal utility of “free time” and “time with family and friends” is quite high for the first few hours of each activity (in the time category zero to four hours) and then declines to around zero. The marginal utility of additional income rises steeply for incomes up to around $US 40, 000 and then increases moderately, if at all. (The ladder of life indicator shows a similar pattern, but with the marginal utility of income remaining positive at high income levels).

How much additional income would a person need to earn to compensate for the loss of utility associated with the sacrifice of an hour of free time or an hour with family or friends. My rough calculation suggests that the hourly rate of pay required would be around $28 for a person with an income of around $20, 000 per year. (The loss in utility for sacrifice of an hour of leisure equals 0.075. Income on the preceding day would have needed to rise by $28 in order to raise utility by 0.075.)

For people with higher incomes, the hourly wage rate needed to compensate for the loss of an hour of leisure time would be very much higher. At first sight it might appear that with incomes in excess of around $60,000 the hourly rate of pay required to compensate for sacrifice of an hour of leisure would be huge. We need to remember, however, that some of the people earning this additional income might be saving it to spend at times of their lives when their earning capacity is diminished and the marginal utility of additional income is much higher. There are also some people who enjoy their work so much that they would not require any compensation for sacrificing an hour of free time. More research is required before we will have a good understanding of why people make the choices they make between income and leisure.

The quote at the beginning of this article suggests that the choice that individuals make between income and leisure is a government policy issue. Why should it be? The weight of evidence suggests that when governments attempt to regulate how people live their lives they tend to make people more miserable rather than happier. As I see it, the main benefit of research of this kind is that the findings may help individuals to improve their own well-being and that of their families by enabling them to make better choices.

Tuesday, June 16, 2009

Can we use dollars to compare how much various life events affect well-being?

The life events I propose to discuss here are things like major improvements or worsening in financial situation, getting married or divorced, having a child, serious personal injury, death of a spouse, being made redundant and change of residence. I will focus on subjective well-being, as measured by surveys which ask people for a numerical rating of their satisfaction with life.

One way to compare the impact of life events on well-being is to calculate what change in income would have an equivalent impact after controlling for other factors. Some readers might recall research findings for the U.S. and Britain which suggested that the increased income equivalent of a lasting marriage is around $100,000 and an increase in income of around $60,000 would be required to compensate for the loss in well-being associated with becoming unemployed. (These numbers come from some pioneering research by David Blanchflower and Andrew Oswald published in 2000.)

There are several problems with the methodology of this early research which tend to overstate the income changes equivalent to life events. First, the methodology is based on estimates of the (small) impact that higher incomes have on current well-being without taking account of the impact of higher incomes on future well-being. Higher incomes enable the wealth accumulation (and the redistributions through tax and welfare systems) that make it possible for people to maintain their well-being during periods when earning potential is diminished (e.g. during retirement) or when they incur heavy costs or heavy costs are incurred on their behalf (e.g. education and medical expenses).

Second, the methodology focused on the impact of being in a particular state (e.g. married or unmarried) rather than on the duration or timing of the effects that life events have on well-being. Life events typically have large impacts on life satisfaction for only a relatively short period.

Third, the methodology was unable to distinguish causation. For example, it was unable to assess whether married people are happier than unmarried people because marriage tends to make people happy or because happy people are more likely to get married.

Research in this area has progressed a great deal in recent years, with the use of ongoing surveys that enable changes in the well-being of the same sample of people to be linked over time to life events. The HILDA survey (Australian data) shows that the events with the greatest positive effect on life satisfaction for both males and females included a major financial improvement in the past three months, having been married in the last three months and birth of a child (less than nine months ago). The events with greatest negative effect on life satisfaction included being detained in jail, a major financial worsening at any time in the last year, a recent separation from a spouse or partner and recent death of a relative or family member.

A recent paper by Paul Frijters, David Johnston and Michael Shields estimates the one-off windfall improvement in finances needed to compensate for various life events (‘Happiness dynamics with quarterly life event data’, DP 3604, IZA, July 2008). The windfall approach seems preferable because a comparison of the effects on current well-being of different life events avoids the conceptual and measurement problems of attempting to compare the effects of life events with the effects of differences in income levels.

The authors obtained the following estimates of compensating windfall financial gains for various life events:

Death of spouse/ child: + $178, 300
Serious personal injury or illness: + $ 59,200
Change of residence: - $ 53,000
Birth or adoption of child: - $ 18,300
Marriage - $ 16,500
Separation from spouse or partner: +$ 14,900
Fired or made redundant: + $ 6,900
Victim of property crime: +$ 2,700

(Currency: Australian dollars; $A1 = about $US 0.80. Assumed discount rate = 5% ) .

I should note that these compensating windfall estimates are additive. For example, a person who is fired might become separated from his or her spouse and experience a major financial worsening at the same time.

It seems to me that the magnitude of these estimated compensating windfalls generally make a lot more sense than do the much larger estimates of income-equivalents of life events. Nevertheless, I feel uneasy about the idea that the life satisfaction of people who suffer the death of a spouse or child would be unaffected, on average, if they received a windfall gain of around $A 178,300 at the same time. Can any amount of monetary compensation actually be sufficient to enable life satisfaction to remain unaffected while a person is mourning the loss of a loved one?

Saturday, June 13, 2009

Do well-being surveys measure utility?

Economists often think of utility and well-being as the same thing. If a person chooses to buy an additional unit of good A rather than an additional unit of good B, they tend to assert that this “revealed preference” shows that the marginal utility provided by good A exceeds that provided by good B. If asked to explain what this means in simple terms an economist might say that the additional unit of good A increases the person’s well-being by more than an additional unit of good B.

At this point some readers will immediately want to bring in complications like the possibility of irrational behaviour. A branch of economics (behavioral economics) explores this possibility, but I want to put this possibility aside for the moment.

The question I want to focus on is whether well-being surveys that are conducted by asking people questions relating to their personal well-being are measuring the well-being or utility referred to by economists. Some economists assume that it is, but I think they are mistaken.

What is it that the surveys actually measure? They measure a variety of different things. Most commonly they measure happiness or satisfaction with life by asking people to provide numerical evaluations in response to a single question. Some more complex surveys (e.g. the ACQOL survey) measure perceptions of the quality of life by asking questions about satisfaction with various aspects of life such as standard of living, achievements, relationships and health. Others ( e.g. nef’s “National accounts of wellbeing”) incorporate a framework of questions relating to life evaluations, emotional well-being, vitality, resilience and self-esteem, and feelings of autonomy and competence etc.

I think it is fair to say, however, that the surveys measure how people feel about their current lives. (Some do include questions about future security but when this averaged with other factors most weight is given to how people feel about their current lives.) For the purposes of this discussion let us call this “current well-being” and assume that the surveys measure it accurately.

At this point the economists reading this will immediately recognize that the surveys cannot be measuring utility because people often make trade-offs between their current well-being and future well-being. This is most obvious in savings decisions where current consumption may be sacrificed to enable a higher consumption levels to be enjoyed in future. It also occurs, for example, when people decide to put up with working long hours or spending a lot of time commuting in order to make their families more financially secure.

Economists still probably learn at an early stage of their study of the subject how to picture these kinds of choices in their minds, but for the benefit of anyone else who might be reading this I will draw a relevant diagram below. Readers who prefer stories to diagrams might prefer to read an earlier post, entitled “Do good decisions always make us happy?”. For the benefit of any readers who might find an appeal to authority more persuasive I should also mention that Gary Becker and Luis Rayo have suggested that the happiness measured in surveys can be viewed as “a commodity in the utility function in the same way that owning a car and being healthy are” (comment on Stevenson/Wolfers paper, Brookings Papers, Spring 2008: 89).

The possibilities curve in this diagram (shown in red) encompasses the various combinations of “current well-being” and “security” that are attainable by the decision-maker. It can easily be seen that points on this curve are superior to all attainable points closer to the origin.

The indifference curves (shown in blue) reflect the preferences of the decision-maker between current well-being and security. The decision-maker is indifferent between the combinations of “current well-being” and “security” on particular curves. She maximizes her utility at the point of tangency between the possibilities curve and the highest attainable indifference curve.

The point I am trying to make is that as a result of the decision-maker’s preferences she views point A, where current wellbeing is at a maximum, as inferior to point B, the point at which utility is maximized.

The obvious implication is that it is foolish to rush into policy recommendations based solely on consideration of how people can improve their well-being as measured in surveys. If happiness surveys suggest that people are behaving in ways that are contrary to measured well-being we should ask ourselves whether we have an adequate understanding of what is motivating their behavior, rather than assuming that it is a result of ignorance (an information problem) or human frailty (predictable irrationality).

Thursday, June 11, 2009

Should governments collect subjective well-being data?

The idea of governments collecting data on our subjective well-being might seem slightly Orwellian to many people. It could bring to mind images of officials from the government statistics office knocking at your front door and telling you that they are from the government and they have come to help you by collecting information about what is going on in your mind.

However I don’t think anyone needs to worry a great deal about the implications for their personal liberty of proposals for government collection of subjective well-being data, such as in the recently published book, “Well-being for Public Policy” by Ed Diener, Richard Lucas, Ulrich Schimmack and John Helliwell. As discussed in an earlier post, such data would be unlikely to increase the influence that paternalistic interventionists may have on the policy making process.

The important issue is whether the collection of this additional information is warranted in terms of its potential contribution to discussion of policy issues.

In their concluding chapter the authors ask themselves whether enough is known about subjective well-being for government agencies “to initiate systematic programs for measuring it”. This is how they summarise their reasons for answering “yes”:
“The measures are sufficient to reveal some of the groups in society that are suffering, and they also tell us which groups are thriving. The measures already provide strong clues about the characteristics of nations that lead to the experience of a satisfying life for citizens, along with those that predict the opposite. The measures give clear clues about the activities and circumstances that tend to lead to ill-being and well-being. And when national accounts of well-being are instituted our understanding of these issues will only grow.”

Do we really need systematic programs for collection of information on subjective well-being to tell us about such matters? The measures of subjective well-being generally tend to confirm what we know already from information on incomes and other objective indicators of the quality of life. It seems to me that the important issue is whether collection of more data on subjective well-being would add reliable information that is not available from other sources.

The book discusses the potential contributions of subjective well-being measures in providing new information that could be relevant to discussion of policy issues relating to externalities, non-market goods, taxation, setting fines and compensation for lost welfare. Some specific examples caught my eye. It is possible that information on the extent of misery caused by different diseases could result in better allocation of public funds for medical research (p 134). Some research findings suggest that effects of airport noise on well-being of people in affected areas may currently be under-stated by its effects on residential land values (p 147). Subjective well-being information may help in assessing the value of public facilities such as parks to residents of cities who have access to such facilities (p 155).

The critical issue in considering the contribution that subjective well-being data can make to public discussion is whether this information is reliable (yields consistent results) and valid (actually measures well-being). My assessment of the relevant literature (in my draft paper on Gross National Happiness) is somewhat less optimistic than the view presented in this book. Despite all the noise in this data, however, I think the authors may be correct that enough randomness washes out in large samples to make the responses to single item questions sufficiently reliable for the purpose of creating national indicators (p74). Multiple item questionnaires such as those suggested by Ed Diener and Robert Biswas-Diener to measure “psychological wealth” (in their recent book, “Happiness”) could provide much more reliable information.

I think the authors make a fairly strong case that the surveys are measuring an aspect of well-being although I think it is an over-statement to claim that “the measures behave as they would be expected to behave given widely accepted ideas about what well-being is” (p 93). For example, the measures show a decline in well-being when people have children, despite the widely accepted idea that having children has something to do with well-being.

There is a risk that subjective well-being measures will cloud public discussion of policies rather than shed additional light on relevant issues if they come to be viewed as definitive measures of overall well-being. In interpreting these measures it is important to bear in mind that it is quite possible for people to make rational decisions to sacrifice some of their current satisfaction with life, in order to improve their own future well-being or that of their families.

Tuesday, June 9, 2009

Are "policy makers" responsible for our happiness?

“Societies need subjective indicators of well-being to aid policy makers and ordinary citizens in making decisions.” This is the opening line of the recently published book, “Well-being for Public Policy” by Ed Diener, Richard Lucas, Ulrich Schimmack and John Helliwell. The first three authors are psychologists (Diener has played a leading role in the field of happiness research) and Helliwell is an economist.

The final sentence of the first paragraph explains: “Overall, accounts of subjective indicators of well-being will help policy makers make wiser decisions regarding policy alternatives and help citizens be better educated about the choices that affect their lives”.

I am in favour of research to enable people to become better informed about the choices that affect their lives. I hope that what the authors mean by “help citizens to be better educated” doesn’t involve anything more sinister than publication of research findings.

While reading the book I became irritated by what seems to me to be a naive view it presents of the policy making process. Although the nature of policy making is largely incidental to the purpose of the book, I will devote the remained of this comment to policy making. I promise to focus on the substance of the book in a later post.

According to the “public interest” view presented in the book, public policies are made by “policy makers” who would make wise decisions if only they knew what policies would improve the well-being of citizens. In reality, however, the policy making process is a messy business which involves politicians seeking votes and hoping to further their careers, civil servants seeking to expand and protect empires, voters who have little interest in most policy issues and even less incentive to understand likely consequences of the proposals being considered, interest groups seeking to further the interests of the people they represent and electoral rules that may give disproportionate power to particular groups. The process also attracts ideologues of various kinds who wish to advance their particular views of the good society.

In my view, rather than attempting to persuade us that more information on the subjective well-being of citizens would help some hypothetical “policy maker” to make better decisions, it would have been better if the authors had sought to persuade us that this information would enable policy processes to produce better outcomes.

Would this have made any difference to the book? Although the basic arguments about the validity of subjective well-being measures and their potential usefulness would have been unchanged, I think this change of focus would have made some difference. In particular, it seems to me is that the authors would have had less difficulty convincing readers that they “do not advocate the idea that governments should intervene strongly to move society towards a primary goal of increased well-being” (p209). When most of the book seems to be devoted to telling “policy makers” how they can use subjective information to improve the well-being of citizens it is natural enough to expect readers to be concerned that some “policy makers” might act paternalistically in using this information. Some readers might not be entirely reassured that paternalistic “policy makers” would have regard to the findings of happiness research which show that humans tend to feel most satisfied when they perceive that they have freedom to choose how to live their lives.

The problem of how paternalistic interventionists might like to use research findings is placed in perspective once it is recognized that competing interests are involved in policy-making through discussions in a range of different forums. These discussions are about various things, but the matters discussed by vast majority of participants usually relate in some way to the effects of different policies on the well-being of people.

The important issue is whether measures of subjective well-being can make useful contributions to the discussion of policy issues.

Monday, June 8, 2009

What are the rules of the game of human flourishing?

Human flourishing, it seems to me, is a game that can only be played by people who are free to decide how they will live their lives and willing to accept the consequences of their decisions. There is no limit to the number of players. The game becomes more enjoyable as the number of players increases.

The aim of the game is for each player to "flourish". The game differs from most other games played by humans because the number of points scored by any one player does not necessarily diminish the number of points that can be scored by other players. Players may score additional points by helping other players.

The game commences when players agree to respect the lives and property of the other players. Each player inherits some cards and is dealt additional cards as the game progresses. Points scored depend also on the skills that the players develop as the game progresses and the opportunities available to them to benefit from cooperation with other players.

Players who trust each other can score many additional points by engaging in mutually beneficial voluntary cooperation. This cooperation can take a variety of forms including the formation of families and community groups which help people to live as they choose and to share gains and losses with relatives and friends. It also includes the creation of business ventures and the development of market institutions that enable players to benefit from specialisation and exchange.

Players can also score additional points by introducing new players. As well as providing additional opportunities for gains from trade this tends to reduce losses from theft by outsiders. The introduction of new players has some risks, however, because existing players do not know to what extent the new players can be trusted.

Players make up the rules of the game as they go along according to voting rules that they agree upon. Players usually make arrangements for provision of some public goods, including appointment of guardians who are permitted to use force to protect players from outsiders and cheaters. The appointment of guardians poses additional problems, however, in devising political rules that will discourage the guardians from plundering the players.

Unhappy players are permitted to voice their concerns and to form associations to lobby for changes to the rules. If players are unable to agree on rule changes, the political dice is rolled to determine the outcome.

Human flourishing is a relatively new game and is rarely played well. The biggest challenge for people who enjoy playing the game is to avoid rule changes that will convert it into a different game such as “serfdom” or “struggle for survival”.

Wednesday, June 3, 2009

To what extent are perceptions of freedom based on objective factors?

The Gallup World Poll has asked people in a large number of countries: “Are you satisfied or dissatisfied with your freedom to choose what you do with your life?” Recent research has shown that, even after controlling for other relevant variables, people tend to be more satisfied with their lives in countries in which a relatively high proportion of the population are satisfied with their freedom to choose. (See: John Helliwell, Christopher Barrington-Leigh, Anthony Harris and Haifang Huang, ‘International Evidence on the Social Context of Well-being’, Working paper 14720, NBER, 2009.)

This is hardly surprising. People who feel relatively satisfied with their lives could generally be expected to be satisfied with their freedom to choose what they do with their lives. Do the results have more profound implications? Is the proportion of people who are satisfied with their lives related to economic freedom (encompassing personal choice, voluntary exchange, freedom to enter and compete in markets and protection of persons and their property from aggression by others) and civil liberties? Alternatively, is satisfaction with freedom an emotional state that is unrelated to objective circumstances?

The Figure below has been obtained by matching the Gallup data on satisfaction with freedom with the Fraser Institute’s data on economic freedom and Freedom House’s data on civil liberties for 121 countries, and then ranking countries according to the percentage of people who are satisfied with their freedom to choose what to do with their lives. The results suggest that economic freedom and civil liberties tend to be substantially greater in countries where people are more satisfied with their freedom to choose.

Regression analysis suggests that economic freedom and civil liberties have a positive influence on the degree of satisfaction with freedom in different countries but only explain a modest proportion of the variation in this variable. In some countries (including China) the degree of satisfaction with freedom is much higher than predicted and in some countries (including Hungary) it is much lower than predicted.

In order to test whether there is a link between satisfaction with freedom and emotional states, another data set has been constructed which incorporates data on inner freedom (percentages who feel they have a great deal of choice and control over their lives) from the World Values Survey. Unfortunately the inner freedom data was collected for a smaller number of countries, so the matched data set only covers 70 countries. (Another problem with the inner freedom data is that it does not match very well in terms of the time at which it was collected. It was collected around 2000, substantially earlier than the other data.)

The second Figure, including inner freedom, provides a similar picture to the first one. Countries in which relatively high proportions are satisfied with the amount of freedom in their lives tend to have relatively high proportions who feel a great deal of inner freedom.

Inclusion of the additional variable in the regression analysis results in a substantial increase in the proportion of variation in the degree of satisfaction with freedom explained by the model, but reduces the coefficients on the other variables. This is not surprising in view of the apparent links between economic freedom and inner freedom discussed in an earlier post.

This simple analysis does not enable me to conclude to what extent perceptions of freedom are based on objective factors. The important point that emerges is that all four varieties of freedom tend to go together.