Are there good reasons why income comparisons can influence happiness?

One of the findings of happiness research is that when people are asked how satisfied they are with life as a whole their answers often depend partly on comparisons of their income levels with those of other people. Thus, for example, some people whose income level has risen may report that their life satisfaction has gone down if their incomes have not kept pace with the growth in average incomes in the community in which they live.

Many of us tend to assume that those who allow interpersonal income comparisons to influence how they feel must be either be feeling envious or gaining pleasure from others being less fortunate than themselves. Either way, the most obvious solution is for them to get over comparing themselves to others.

However, there are some good reasons why people compare their incomes with those of others when considering how satisfied they are with their own lives. Consider an imaginary person who responds to the life satisfaction question by considering how her (his) life is unfolding compared with her expectations. She had clear expectations about some important aspects of what life might hold – for example, she knows what she expected married life would be like and whether it is turning out to be as she had expected. At the same time, although she had no idea what rate of increase in income she could expect to receive, she nevertheless has a strong view that her income has not increased in line with her expectations. She has come to this view because at an earlier stage of her career she had good reason to expect that her income would rise at about the same rate as the average incomes of the people she was working with at that time. The fact that her income has not kept pace with the average rate of increase in the incomes of her former work colleagues does not make her feel envious of them. She just feels disappointed that she has not been able to live up to her own expectations in this regard.

In this example the individual is using a comparison with incomes of a specific reference group merely as a source of information. There is research evidence that in some countries this information effect is positive and dominates any negative comparison effect. Research by Claudia Senik suggests that in transition countries (Russia, Hungary, Poland and three Baltic countries) the life satisfaction of individuals rises when the income of their reference group -people with the same skills and occupation - increases (see here). Her explanation is that in these countries people consider that their own future prospects to be better when the income of their professional peers rises. By contrast, in EU countries increases in incomes of the reference group tend to reduce life satisfaction - people tend to assess how well they are doing relative to their reference group. The difference seems to stem from the greater income volatility and uncertainty of the transition countries.

The important point is that when people use income comparisons in assessing how satisfied they feel we should not assume that they perceive themselves to be involved in some kind of rat race. They may merely be using comparisons to consider their own expectations.

What should we make of survey results showing no increase in happiness as income rises?

The issue I want to address is whether survey results showing little or no increase in happiness as incomes rise in high income countries mean that further economic growth is not worth having in those countries. I will assume that the observation of no increase in happiness as incomes rise cannot be attributed to factors such as changes in income distribution. (For a reference discussing this possibility with regard to the U.S. see here.)

First we should clarify the relationship between increases in income and increase in happiness in economic terms. It seems to me that in terms of economic theory what a person would be doing in comparing his happiness at different times would be analogous to calculating the change in value of his/her assets by discounting the future flows of income they are expected to produce. In computing his happiness level this person would ignore the past and just consider the expected future flows of goods of all kinds and the satisfaction that he/she and his/her family will derive from them.

How relevant are the happiness and satisfaction concepts measured in surveys to this concept of happiness as the discounted present value of the future? If surveys can be viewed as akin to barometers which measure how people are feeling about the direction of events affecting their well-being, they have some relevance. But if incomes just keep rising as expected, people will not necessarily record higher levels of satisfaction.

The economic concept of happiness as the discounted present value of the future seems somewhat at odds with prevailing psychological theory relating to subjective well-being – although a reconciliation may be possible. The set-point model, which is pivotal in the field of subjective well-being (SWB), suggests that while people may initially react strongly to events affecting them, their SWB subsequently returns to a stable level (set point) determined by their personality predispositions.

In its original form the set-point model implied that no matter what benefits an increased flow of goods and services may provide to individuals in helping them to achieve their goals, it will not result in any long-term improvement in measured SWB. This view has been modified in the light of evidence that set points can change as a result of a variety of factors, including widowhood and unemployment. A recent study by Frank Fujita and Ed Diener using panel data for Germany covering 17 years of life satisfaction judgements showed that almost 9 percent of respondents changed 3 or more scale units (on a 10 point scale) from the first five year average to the final five year average. Nevertheless, the majority of respondents showed long term stability in life satisfaction between the beginning and end of this period ( ‘Life satisfaction set point: stability and change’, Journal of Personality and Social Psychology, 88 (1), 2005).

It seems to me that these changes in set-points may correspond to the kinds of changes a forward looking person might calculate in his/her happiness stocks when life does not turn out as expected. For example, people who suffer large losses on the share market often tend to become more pessimistic about the future and discount future earnings more heavily as result - and this pessimism may also be reflected in a decline in their happiness assessments. Similarly a period of unemployment may cause a person to be more pessimistic in valuing his/her human capital and this will be reflected in a decline in happiness assessments.

To sum up, it does not seem to me that there are strong grounds in terms of set-point theory to expect avowed happiness to continue to increase in high income countries in which economic growth has come to be expected as a normal part of life. However, the discounted present value of the future could be expected to continue to rise under those circumstances. In other words, a future in which incomes continued to rise could be expected to be valued more highly than one in which incomes were stationary.

Those who argue that economic growth is not worth having when it has little or no effect on set point levels might change their view if they considered whether they would also be prepared to argue against other things, for example marriage, on the same grounds.

Would you rather be a rich person in a poor country or a poor person in a rich country?

A few months ago, Dani Rodrik asked readers of his blog the old question: “Would you rather be poor in a rich country, or rich in a poor country?”
He added the following specifications:
Assume you care only about your own consumption
Define poor and rich as someone who is the in the bottom or top decile of a country
Define poor and rich country analogously as a country in the bottom or top decile of the distribution of per-capita incomes across countries.
Some time later he told readers that the correct answer is that a poor person in a rich country is three times better off than a rich person in a poor country. He used average incomes in each decile (for 2004 PPP adjusted) to assess whether people would be better off. So far so good.

However, Rodrik received several comments along the following lines:
Though monetarily a poor person in a rich country might be better off, this says nothing about the actual welfare of this person. There are numerous studies showing that happiness is directly correlated to relative income.

Those comments may seem fair enough. But are they supported by what people say about how satisfied they are with their lives?

In order to test this I have used data on percentages of lower, middle and upper income groups who are satisfied with life as a whole for 66 countries. The data was sourced from surveys conducted over the period 1999 - 2002. (See: Ronald Inglehart et al, Human Beliefs and Values, Siglo XXI Editores, Mexico, 2004, A 170.)

Observations for each country were ranked according to average income as a percentage of U.S. levels in 2000. The relevant averages for each quintile of countries are presented in the table below. (There are 14 countries represented in the first quintile and 13 in each of the others. Australia is in the fifth quintile and New Zealand is in the fourth quintile.)

The data in the table suggest that, despite status considerations, the probability of a lower income person in a high-income country being happy is about 60 percent greater than the probability an upper income person in a low-income country being happy (100x(71.3 - 44.6)/44.6 = 60). Rodrik’s answer is still correct, although the margin is smaller under the assumptions of the calculation that I have made.

Another interesting point suggested by the data in the table is that it matters a great deal more whether you are rich or poor if you happen to live in a low-income country - where incomes of the poor are more likely to be close to subsistence levels . In low-income countries (first quintile) the probability of an upper income person being happy is about 66 percent greater than the probability of a lower income person being happy (100x(44.6 – 26.9)/26.9 = 66). By contrast, the corresponding figure for high-income countries (fifth quintile) is about 23 percent.

How does probability of happiness vary with income level?

It has often been observed that cross-country comparisons show a strong positive relationship between average income levels and average happiness levels up to about 50 percent of U.S. income, with no clear relationship after that.

However, a different picture emerges when we group countries according to income levels and look at percentages of people who claim to be satisfied with life as a whole. I have used data on percentages of lower, middle and upper income groups who are satisfied with life as a whole for 66 countries. The data was sourced from surveys conducted over the period 1999 - 2002. (See: Ronald Inglehart et al, Human Beliefs and Values, Siglo XXI Editores, Mexico, 2004, A 170.) Observations for each country were ranked according to average income as a percentage of U.S. levels in 2000.

The results are shown below. The average percentages for countries in the 5th quintile (average income of 76 percent of the U.S. level in 2000) who are satisfied with life as a whole is considerably higher than for the 4th quintile (average income of 46 percent of the U.S. level).

Does income inequality lead to happiness inequality?

It seems reasonable to expect that the difference between the probability of happiness of people on upper incomes and those on lower incomes would depend on the degree of income inequality in the country in which they live.

This proposition can be tested simply by calculating the gap between the percentage of upper and lower income people who claim to be satisfied with life in each of a large number of countries and then ranking them by the gini coefficient (or some other measure of income inequality) and calculating gap averages for groups of countries. I have used data on percentages of lower, middle and upper income groups who are satisfied with life as a whole for 66 countries. The data was sourced from surveys conducted over the period 1999 - 2002 (see Ronald Inglehart et al, Human Beliefs and Values, Siglo XXI Editores, Mexico, 2004, A 170).

The results are shown below.




If income inequality causes happiness inequality we should expect to see lower average gaps between happiness of people on upper and lower income in countries with relatively low levels of income inequality. That is not what the chart shows.

Similar results have been found in a study by Jan Ott. In a study covering 64 countries this researcher found that inequality of income tends to go together with higher levels of happiness and more inequality of happiness. The correlations are not substantial, but the result challenges conventional wisdom. (See: ‘Level and inequality of happiness in nations’, Journal of Happiness Studies, 2005, p 408-9).

Is anything left of the Easterlin paradox?

Richard Easterlin proposed in 1974 that there is no link between the level of economic development of a society and the overall happiness of its members: “raising the incomes of all does not increase the happiness of all”. There were two legs to Easterlin’s paradox. The first was his claim that subjective well-being is generally no higher in high income countries than in low income countries. The second was his observation that average levels of happiness do not appear to rise through time as societies become richer.

The first claim was always dubious and it has become more obvious that it is wrong as comparable data has been collected for a broader range of countries. Recent cross-section studies provide strong evidence that average levels of subjective well-being are higher in high income countries than in low income countries. Furthermore, there is no evidence of a satiation point beyond which wealthier countries have no further increases in subjective well-being. (For a recent discussion on the Freakonomics blog, click here.)

The second claim was based on time series data of happiness for the United States, Europe and Japan since the 1950s. The data for Japan was of particular concern. If rapid economic growth brought no improvement in avowed well-being to the people of Japan during the period from the 1950s to the end of the 1980s, did we have sufficient reason to believe that rapid growth in other low and medium income countries would result in improvements in well-being?

A recent study by Betsey Stevenson and Justin Wolfers (Economic growth and subjective well-being: reassessing the Easterlin paradox, shows convincingly that the apparent failure of subjective well-being to rise with increasing wealth in Japan can be attributed to changes in the questions asked in surveys. Within periods when the same questions were asked subjective well-being rose strongly as incomes rose.

The authors update Easterlin’s original study of trends in life satisfaction in Europe and conclude that the addition of data for more recent years and show that, although there are exceptions, life satisfaction has typically risen in those countries as income has risen.

Stevenson and Wolfers also conduct an analysis of U.S. data which suggests that the failure of happiness to rise with income in the U.S may have something to do with incomes of lower-income groups not rising as rapidly as high income groups. It seems to me that these findings might be difficult to reconcile with the findings of other research which suggests no relationship between income inequality and happiness inequality. (For example, see here.)

The authors acknowledge that their findings still admit a role for income comparisons in shaping subjective well-being. It seems to me that this is important because there is strong evidence that satisfaction with life depend on income aspirations – a moving target involving income comparisons - as well as on absolute income levels. In my view Steven Pinker made a good point when he suggested that humans nature enables us to calibrate our pursuit of happiness by what we can aspire to attain so that we can avoid fretting about not having things that are out of our reach (“How the Mind Works”, 1997, p 390).