What does economics tell us about making New Year's resolutions?

Opportunity cost was the first thing that came to mind the other day after the thought occurred that I should perhaps consider making a New Year’s resolution. That was probably because I just happened to be paying attention on the day the concept of opportunity cost was explained when I was at university many years ago. 

Opportunity cost is just a label. If you haven’t had the benefit of studying economics you might still be aware that the time and effort you spend making resolutions and trying to keep them could possibly be spent doing something more enjoyable. You may also be aware that there are emotional costs associated with making resolutions and then failing to keep them.

On the other hand, by now some of you will be thinking that opportunity costs are just excuses for inaction. You might want to urge me to consider the potential satisfaction of making resolutions that might enable me to become a healthier or better person.

That is why my mind now turns to the law of diminishing marginal utility. That law says, more or less, that as you obtain more of any good, the additional happiness you obtain from each additional unit tends to diminish. Every wine drinker should know that a larger increment of happiness is likely to be obtained from the first glass of wine than from the second, and a larger increment of happiness from the second than from the third, and so on. If the truth of that observation is not obvious to you on New Year’s eve, it might well become very obvious on New Year’s day.

It seems to me that the law of diminishing marginal utility applies to New Year’s resolutions in much the same way as to other goods. For example, a person who swears a great deal might gain some satisfaction if she can refrain from using foul language in the presence of children. The further increment she obtains from refraining from swearing in front of people whom she knows to be disgusted by the behaviour, might be somewhat smaller. The increments in satisfaction could be expected to become progressively smaller as she adds further classes of people or situations.

All this brings to mind the image of a scissors diagram, regarded as a thing of great beauty by many economists of my vintage. The downward sloping line in the diagram below represents the declining marginal utility of resolutions and the upward sloping lines represent the rising marginal cost of resolutions (expressed in utility terms). If you are having difficulty viewing the quantity of resolutions as a homogenous good, think of the horizontal axis as measuring the extent to which you might consider reducing your use of a particular swear word over the next year. 

I have drawn two cost curves in the diagram to illustrate how the optimal investment in resolutions would change if it became less costly to make and keep resolutions. The initial optimum is at point A, where our subject makes a relatively small investment in New Year’s resolutions. If it became less costly to make resolutions, the optimum would move to point B. At that point she would make more resolutions - and her total utility would be higher.

So, what does economics have to tell us about how to reduce the costs associated with New Year’s resolutions? An obvious place to look is behavioral economics. It is not difficult to find articles on the internet suggesting how we can use behavioral economics to help us to stick to our resolutions. Much of the underlying research is more in the field of psychology than economics, such as the work of Roy Baumeister on willpower (which I discussed here).

In my view the area of economics that has most potential to help us to understand and reduce the costs associated with making and keeping resolutions is ‘identity economics’. The key idea of identity economics – as explained in a book of that name by George Akerlof and Rachel Kranton - is that individuals gain satisfaction when their actions conform to the norms and ideals of their identity. In the way Kranton and Akerlof develop the concept, identity is determined to a large extent by the groups to which individuals belong. 

However, when you think about your own identity, as an autonomous individual, you are free to think of it as being defined by the qualities you value most highly - or identify with. (There is some relevant discussion in a recent post in which I reviewed Russ Harris’s book, The Happiness Trap.) Recent research by Anthony Burrow and Nathan Spreng, which suggests that having a purpose in life tends to impede impulsivity, points to the potential benefits of keeping in mind the qualities we value most highly.

This brings to mind the potential to draw a possibilities diagram showing trade-offs between some of the things I value. On one axis is excellence and on the other axis is tranquility. I will leave it to your imagination.

Postscript

On reflection, it doesn’t seem to make much sense to think in terms of trade-offs between excellence and tranquility. It might make more sense to think in terms of a trade-off between satisfaction with professional achievement and satisfaction with relationships, as shown below. An investment in emotional health might expand the possibilities available.

How can we avoid the happiness trap?

The idea that pursuit of happiness can be futile has been around for thousands of years. In my last post, I discussed J S Mill’s contribution in the 19^th Century. In this post I will discuss the contribution made by Russ Harris in The Happiness Trap: Stop struggling, start living, which was first published in 2007. This book is based on Acceptance and Commitment Therapy (ACT) developed by Steven Hayes.

Russ Harris suggests that many people are caught in a happiness trap, which is based on four myths:

1. Happiness is the natural state for all human beings;
2. If you’re not happy, you’re defective;
3. To create a better life, we must get rid of negative feelings; and
4. You should be able to control what you think and feel.

It would be easy for me to become side-tracked into a discussion of how prevalent the happiness trap might be. The survey evidence suggests to me that in high income countries most people are actually fairly happy, but the picture that emerges does differ depending on the way happiness is measured. For example, at a national level high levels of positive emotion are not always accompanied by low levels of negative emotion. It is also possible for a substantial proportion of the population to experience chronic anxiety and depression at some time during their lives, despite the sustained existence of relatively high average happiness levels.

The important points are that too many people are falling into the trap of struggling to get rid of negative feelings and of attempting to control what they think and feel. I don’t think it is a myth that happiness is the natural state for most humans to be in: a majority of humans seem to have an inbuilt optimism bias. Nevertheless, there are times when it is natural, healthy and appropriate for humans to have negative thoughts and feelings. We cannot avoid having negative thoughts and feelings, but we can exercise a great deal of control over our responses to thoughts and feelings.

Harris argues that happiness has two very different meanings. The first refers to a feeling: a sense of pleasure, gladness or gratification. The second refers to a rich, full and meaningful life. The happiness trap is associated with craving the first form of happiness. If we seek to live a full and meaningful life at various times we can expect to experience the full range of human emotions, including sadness, fear and anger.

The author writes:

“The reality is, life involves pain. There is no getting away from it. As human beings we are all faced with the fact that sooner or later we will grow infirm, get sick and die. …”

But he provides grounds for hope:

“The good news is that, although we can’t avoid such pain, we can learn to handle it much better – to make room for it, rise above it and create a life worth living”.

So, how does the book suggest we go about creating lives that are worth living?  As I read it, the book does this by suggesting ways in which we can exercise and develop our personal powers (or capabilities) in relation to thoughts, sensations, values and goals. The underlying idea seems to be that if we manage to cope with unhelpful thoughts and unpleasant feelings, identify and endorse the values we want to guide us, set sensible goals for ourselves, act purposefully and engage fully in what we are doing, we will end up with lives that are worth living. That makes a lot of sense to me.

The approach suggested for coping with unhelpful thoughts or stories is to defuse them. The simplest technique suggested is to give yourself some distance from the thought by observing, “I am having the thought that …”. Many other techniques of defusion are suggested. One I particularly like is to thank my mind for the unhelpful advice it is giving me, and then ignore it.

The approach suggested for coping with unpleasant feelings and sensations is expansion -  that means making room for them rather than struggling with them. The three basic steps of expansion are: to observe the feelings and sensations in your body; breath into them; and let them come and go, or just stay there. If that sounds like Vipassana meditation, there are probably good reasons for that.

On the basis of my personal experience (as a consumer of self-help advice rather than a professional) I have doubts about the author’s recommendation to focus on the most uncomfortable sensation first. Acceptance of unpleasant sensations seems easier in the context of scanning my whole body, noticing and accepting all the sensations. Nevertheless, I particularly liked this comment:

“As you practice this technique one of two things will happen: either your feelings will change or they won’t. It doesn’t matter either way, because this technique is not about changing your feelings – it is about accepting them”. 

Russ Harris is of course not the first person to argue that we need to be guided by our values – our deepest desires relating to how we want to be and what we stand for – in order to have a rich full and meaningful life. For example, Aristotle emphasized the importance of values to individual flourishing, and Ayn Rand had John Galt develop a cogent argument leading to a definition of happiness as “that state of consciousness which proceeds from the achievement of one’s values” (Atlas Shrugged, p 1014). Harris underlines the importance of values by referring to Viktor Frankl’s observation that the prisoners who survived in Auschwitz were often not the physically fittest, but those who were most connected with something they valued such as a loving relationship with their children.

Harris suggests that people identify their values in all domains of their lives: family, marriage, friendships, employment, personal development, recreation and leisure, spirituality, community, environment, health etc. Many of the questions involve asking what sort of person we want to be and what qualities we want to bring to our experiences.

The next step is to set goals and action plans relating to our values for each domain of our lives. When reading about it, the process seemed as though it might be just as boring as corporate planning, but that need not be so. Findings of recent neural research (by Christopher Cascio and colleagues at the University of Pennsylvania) indicate that a focus on things we value in life -  referred to as self-affirmation – is associated with greater activation in parts of the brain that are known to be involved in expecting and receiving reward (the ventral striatum and the ventral medial prefrontal cortex).  A focus on what is most valued in a future context also involves more neural activity in areas associated with thinking about the self (the medial prefrontal cortex and posterior cingulate cortex).

It is worth remembering that the point of acting in accordance with our values is about the quality of our journeys through life rather than about reaching ultimate destinations.  As Russ Harris puts it:

“When we move in a valued direction, every moment of our journey becomes meaningful”.

I have written enough to provide a few hints about the contents of the book. My one criticism of the book (as a consumer of self-help products) is its failure to recognize that some cognitive approaches, e.g. Neuro-Semantics, can help people to adopt the frames of mind that they value, without having to engage in a struggle against negative thinking. Leaving that aside, in my view, this book has great value in helping readers to work out what they have to accept in life, what they can hope to change, and what commitments they have to make to make their lives more meaningful.

Why should we expect a close association between autonomy, realism and happiness in a worthwhile life?

Winton's amateurish artwork

Neera Badhwar writes:

“The main argument of my book can be stated in the following five propositions:

(i)    Well-being as the HPG (highest prudential good) consists of happiness in an objectively worthwhile life;

(ii)   Someone who leads such a life must be characteristically autonomous and reality-orientated, that is, disposed to think for herself and seek truth or understanding about important aspects of her own life and human life in general, and disposed to act on her understanding when circumstances permit;

(iii)   To the extent that someone with these traits succeeds in achieving understanding and acting on it when circumstances permit, she is realistic.

(iv)   To the extent that she is realistic, she is virtuous.

(v)     Hence, well-being as the HPG requires virtue”. 

"Wellbeing:Happiness in a Worthwhile Life", 2014.

I don’t have many problems with the first three propositions. Those propositions have been briefly discussed in my last two posts: “Is human well-being subjective or objective?” and “Is there a close relationship between autonomy and realism?” It is important to be clear that a realistic orientation is consistent with optimistic (hopeful) appraisals of future opportunities. Indeed, healthy human functioning seems to be characterized by realistic optimism. I will write something about that in my next post.

Coming back to the line of argument in Neera Badhwar's book, it was not immediately obvious to me why a person who is autonomous and realistic should be expected to be virtuous (point iv). Examples readily come to mind of situations where ‘being realistic’ appears to involve compromises in which virtue is sacrificed for pragmatic reasons. I will try to explain, briefly, how the author reaches the conclusion that virtue is positively related to realism.

The author accepts Aristotle’s view of virtue as an integrated intellectual-emotional disposition to think, feel, and act “at the right times, about the right things, towards the right people, for the right end, and in the right way”, and to take pleasure in so doing. Her focus is on the cardinal virtues of justice, honesty, courage, integrity, kindness, and the virtues that are partly constitutive of these virtues: practical wisdom, and regard for self and others.

In Chapter 4 she suggests:

“To the extent that an autonomous/ reality-oriented person achieves understanding of the true and the good, and acquires the disposition to deliberate, feel, and act accordingly, he is realistic and morally virtuous” (p. 108).

After reading that chapter I was left feeling sceptical about the line of argument developed. That surprised me because I have previously responded positively to other attempts to link well-being with virtues. (For example, see my previous comments on the views of Martin Seligman about cultivation of signature virtues.) As I see it the problem is that it is necessary to have or acquire a disposition to cultivate the virtues - as well as a somewhat optimistic disposition - before it is possible for the chemistry of autonomy and reality-orientation to produce happiness in a worthwhile life.

The problem is resolved in a later chapter. In Chapter 6 Neera Badhwar observes that nature has endowed humans with positive self- and other-regarding natural virtues and that in their early moral development people tend to acquire emotional dispositions to tell the truth, risk danger, help and empathize. She notes that the idea that well-tempered emotions are necessary for characteristically making the right choices is now widely recognized in philosophical literature and supported by psychological and neurological research.

The author argues that virtue and well-being both involve emotional, deliberative and evaluative dispositions. She notes that the cultivations of those dispositions is “to a significant extent up to us”. She adds:

“Furthermore, the integration of emotional dispositions with intellectual (especially deliberative) dispositions that is required by virtue, makes virtue highly conducive to happiness, since a common source of unhappiness is conflict between our emotions and evaluations. Indeed, since the virtuous agent necessarily takes pleasure or joy in acting virtuously, virtuous activity is inherently productive of some happiness. It also promotes happiness insofar as the achievement of worthwhile goals is a source of happiness, and virtuous activity enables the virtuous agent to achieve them” (p 152-3).

The way the author summarised her argument at the beginning of the book seems to me to have been unnecessarily provocative. After reading the book as a whole, however, I doubt whether many people would have fundamental objections to the idea that an objectively worthwhile life requires virtue and that cultivation of virtue requires autonomy and reality orientation. Indeed, if we accept that widespread regard for the traditional virtues must have evolved because practice of those moral intuitions served the individual and collective interests of humans, it would be strange if individuals who endorse and cultivate those virtues in their own lives did not obtain happiness from seeking to make their lives worthwhile.

In my view Neera Badhwar has presented strong reasons in support of the view that the chances for an individual to achieve happiness in an objectively worthwhile life depend heavily on the extent to which her/his life is characterized by autonomy and reality-orientation. 

Is there a close relationship between autonomy and realism?

Is this an empirical question or a conceptual question?

If it is viewed as an empirical question the obvious way to answer it would be to define autonomy, define realism and then test for an empirical relationship. I have made a quick attempt to do that in the chart below, using the excellent data analysis facility of the World Values Survey. The autonomy index used is the sub-index constructed by Christian Welzel for his emancipative values index.  Welzel’s approach is based on survey respondents’ views of desirable child qualities: an emphasis on independence and imagination is considered to be positive in terms of the value placed on autonomy whereas an emphasis on obedience is considered to be negative. The realism indicator I used is based on responses to the statement: “We depend too much on science and not enough on faith”. The data shown are from an Australian survey conducted in 2012.

The chart seems to show that people who place high value on autonomy tend to be more realistic. However, this is a fairly frivolous piece of research. Questions can be raised about the relevance of an Australian survey to people in other countries, the small size of the sample etc. More importantly, for present purposes, the plausibility of the depicted relationship depends on the validity of the indicators of autonomy and realism used in the chart.

The empirical approach to answering the question cannot avoid conceptual issues relating to selection of appropriate indicators. Perhaps the question should be viewed as entirely conceptual.

In Well-being: Happiness in a worthwhile life, Neera Badhwar presents a philosophical argument that autonomy and reality-orientation are two facets of the same character trait. (In my last post I discussed another issue arising from this book, the question of whether human well-being should be viewed as objective or subjective.)

In brief, the argument is as follows. An autonomous person is self-governing. When we live autonomously, we “play an active role in shaping our individual selves, instead of slavishly following others, or surrendering direction of our lives to our fantasies, illusions, momentary urges or inertia”. Autonomous individuals have minds of their own – they rely on their own epistemic powers to form judgements about important issues, including the issue of how far they can rely on their own judgement. They are goal-directed and have a reliable self in charge - they not so self-confident as to be self-deluded. In order to have a reliable self in charge a person has to be reality-oriented. Autonomous individuals also accept responsibility for their actions, and in order to do that they must be reality oriented.

The difference between autonomy and reality-orientation lies only in their focus:

“The focus of reality-orientation is gaining the truth about, or understanding of, important things and responding accordingly, while that of autonomy is living by one’s own judgements and decisions”.

Much of Neera Badhwar’s discussion of the relationship between autonomy and realism is taken up with defence of her view against various possible criticisms. I found her discussion of claims that realism is bad for people to be particularly interesting. (The relevant chapter is based on a previously published article.)

The author concedes that when facts are devastating we might be better off remaining ignorant of them – some happiness based on ignorance is better than total misery based on knowledge. However, she is critical of empirical research which purports to show that holding positive illusions about oneself tends to promote happiness. She points to many problems with the research leading to these claims. She also implies that it is not possible to draw useful conclusions from the research findings, even if they are accepted at face value.  People who have positive illusions about their abilities could also be expected to have positive illusions about their happiness:

“the emotions and evaluations that express or constitute their illusions about their abilities, achievements, and future prospects … together entail a sense of meaning and enjoyment of life. … It follows then that insofar as happiness consists of these unwarranted evaluations and emotions, the connection between happiness and illusions is a conceptual, and not a causal, one”.

I have to think more about what means in relation to neural research findings which suggest that it is normal for humans to have an inbuilt optimistic bias. When I look around me most of the people I see seem to have both a realistic orientation and tendency to look on the bright side of life. 

The author makes clear that she is not opposed to optimism. She recognizes that self-fulfilling attitudes, whether positive or negative, are a pervasive aspect of human psychology. The point she is making is that realistic optimism about oneself and one’s future beats unrealistic optimism – and thus recognizes that it is possible to have a realistic basis for optimism (as I have previously argued on this blog).

Neera Badhwar notes that Abraham Maslow and Carl Rogers, leaders of the human potential movement, viewed realism as central to mental health and well-being. She notes that in Rogers' view the fully functioning individual is open to experience, distorting neither his perceptions of the world to fit his conception of himself, nor his conception of himself to fit his perceptions of the world. I find this particularly interesting in the light of Rogers’ use of Alfred Korzybski’s notion that “the map is not the territory”. Carl Rogers recognized that our maps do not serve us well if they are not realistic.

Is work-life balance a big problem in Australia?

There was a time, not long ago, that I avoided using the term “work-life balance” on the grounds that work is a normal part of life. Writing about work-life balance makes about as much sense as writing about sleep-life balance. But here I am now, writing about work-life balance! Never mind, everyone knows that what I am actually writing about is the balance between work and other aspects of life, including leisure, spending time with family members, and sleeping.

According to the OECD’s Better Life index, work-life balance in Australia is among the worst in the OECD. Australia’s ranking on this criterion is even below that of the United States. The indicators used by the OECD to assess work-life balance are the percentage of employees working very long hours, and time devoted to leisure and personal care. Australia’s ranking is 30/36 on both those indicators.

Do those indicators accurately reflect the impact of hours of work on the well-being of individuals? In order to answer that question it makes sense to look at the way hours of work impact on life satisfaction and other measures of emotional health. The fact that people are working long hours does not necessarily mean that they are irrational, or even that they are choosing to sacrifice some life satisfaction in order to achieve other objectives that are more important to them. They might just like working.

A few years ago, in an update of one of my more popular posts - entitled “How much does over-work affect happiness?” -  I ended up suggesting (not surprisingly) that life satisfaction data might help to answer that question. Since then I have wondered from time to time why I had not seen any studies using Australian survey data to shed light on the issue. I obviously hadn’t looked!

An article by Mark Wooden, Diana Warren and Robert Drago entitled “Working time mismatch and subjective well-being”, published in 2009, uses HILDA panel survey data to examine the relationship between working hours and levels of work and job satisfaction in Australia. The authors found that neither job satisfaction nor life satisfaction varied much with number of hours worked when the number of hours worked was consistent with the preferences of individual workers. That suggests the OECDs work-life balance indicators are not particularly relevant to the well-being of Australian workers.

Wooden et. al. found that the mismatch between the preferred working hours of individuals and their actual working hours has a significant impact on job satisfaction and life satisfaction. Both underemployment and overemployment have similar negative impacts on job satisfaction, but overemployment has larger negative impacts on life satisfaction than does underemployment. The authors suggest that although the absolute impacts on subjective well-being appear small, “the measured impact of overemployment should be viewed as important”, relative to “quite serious events, such as the onset of severe illness or injury”.

More recent research by Natalie Skinner and Barbara Pocock published in the latest Australian Work and Life Index (AWALI 2014) makes use of a flourishing index (the Huppert and So index discussed in my last post) encompassing characteristics of positive mental health such as optimism, resilience and competence. The survey results suggest that the rate of flourishing among Australian workers is higher than that for European workers. The difference is particularly marked for women workers, with 41% estimated to be flourishing in Australia, compared with only 33% in EU countries. I wonder how that can be explained.

The authors also found that rates of flourishing do not vary with length of work hours, but do vary according to whether working hours fit with the preferences of individual workers. The results are depicted in the chart below.

The rates of flourishing are much lower among women who would prefer more work than among the other categories. (The authors also found that working unsocial hours (weekends, evenings/nights) was associated with lower rates of flourishing for men.)

In order to show that mismatch between actual and preferred hours of work is a big problem in Australia it would be necessary to show that working hour mismatches tend to persist over time. In fact, research by Robert Breunig, Xiaodong Gong and Gordon Leslie using the HILDA data base suggests that most working hour mismatch problems are resolved within one year. Full-time workers who prefer to work less are the only group for which this is not true – the persistence of mismatches is just over 50 percent for this group, but declines in a predictable way over longer time periods. The evidence suggests that workers often resolve mismatches when they change employers.

My conclusion is that people who argue that work-life balance is a big problem for the well-being of Australians have been talking through their hats.

Do major cities create unhappy Australians?

Sydney's eastern suburbs

“Major cities create unhappy Australians”. That headline jumped out at me when I was doing an internet search recently. The source was The Melbourne Newsroom – a media unit at the University of Melbourne. The news release tells us that Australians who live in rural locations or towns of less than 1,000 residents “have significantly higher life satisfaction than those living in major cities”. (Major cities have more than 100,000 residents.)

The news release is linked to a recent publication based on the highly regarded HILDA survey undertaken by Melbourne University. The survey results suggest a boost to average life satisfaction (on the 11 point scale from 0 to 10) of 0.127 points for females and 0.108 points for males from living in a rural location or town rather than a major city. That might seem small, but it appears to imply that living in a major city has an adverse impact on life satisfaction of similar magnitude to being unemployed or divorced.

The authors of the HILDA publication conclude:

“other things being equal, the major cities are the least desirable places to live”.

The qualification in that statement is important. The authors go on to point out that the undesirability of living in cities is somewhat counteracted by the fact that the major cities contain areas of greatest socio-economic advantage.  Life satisfaction is influenced by the effects of the relative socio-economic advantage or disadvantage of the area in which an individual lives.

The main reason I was sceptical when I read the headline “Major cities create unhappy Australians” was because earlier in the day I had read a paper by Arthur Grimes and Marc Reinhardt which found that the differences between life satisfaction in rural and urban areas in other high-income OECD countries disappeared in a model controlling for other variables. The other variables controlled for were own income and reference income (mean income within a country of individuals of the same gender, age and employment status).

A study examining differences between life satisfaction of rural and urban residents of Victoria, undertaken a decade ago by Dianne Vella-Brodrick et al, also found that the significance of rurality disappeared when other variables were controlled for. The other variables in the model included satisfaction with community and perceived level of satisfaction with distance from services.

In a post I wrote on this blog a few years ago I considered the differences at a regional level between the stories told by a range of wellbeing indicators in Victoria. The (rural) local government areas (LGAs) with higher average subjective well-being (SWB) also tended to have higher ratings in terms of satisfaction with being part of the community, social support (ability to get help from friends), citizen engagement (e.g. attending town meetings, writing to politicians), safety (e.g. feeling safe walking in the local area at night) and volunteering. However, those LGAs tended to have lower household income, lower satisfaction with work-life balance and less acceptance of diverse cultures. The latter variables tended to have higher values in Melbourne and in LGAs close to Melbourne.

Do those results suggest major cities create unhappy Australians? I don’t think so. As discussed in a more recent post, major cities in Australia are ranked among the most liveable in the world. People who choose to live in major cities may well do so for good reasons, in full knowledge that they are making choices that are likely to reduce their life satisfaction. Life satisfaction is important, but it is not the only argument in individuals’ utility functions. For example, it can be rational for people to sacrifice some life satisfaction now to obtain more life satisfaction later (e.g. by accumulating wealth to fund their retirement in a more pleasant location). There is also some evidence that many people are prepared to sacrifice their own happiness in making location choices in order to provide better opportunities for their children.

Should self-funded retirees be concerned that interest rates on term deposits have declined?

Some readers will wonder why I am bothering to ask this question. It appears to be fairly obvious that people who are relying on interest on term deposits to fund their retirement must have greater difficult in surviving without drawing upon their capital when interest rates are as low as they are now.

However, it is by no means clear that the relevant interest rate is lower now than it has been over most of the last 15 years or so.

So, what is the relevant interest rate? First, nominal interest rates should be adjusted for taxation since the interest income that people are able to spend is the amount left after tax has been paid.

Second, it is also necessary to take inflation into account in the calculation. Inflation tends to deplete the purchasing power of the amount deposited, so some part of the after-tax interest has to be saved in order to prevent the real value of the nest egg from being depleted. Retirees who do not take inflation into account in their calculations are suffering from money illusion - an affliction that enables them to spend their children’s inheritances without feeling any guilt until they realize how much the real value of those sums have depleted.

So, if a retiree is intent on preserving the real value of her capital, the amount of interest income available to be spent is real after-tax interest. You might well ask why a retiree would want to preserve the real value of her capital. That is a very good question. If she has saved the funds to spend during retirement, it does not make any sense for her to be obsessed with the idea of living on interest and preserving capital. The important point is that awareness of the real after-tax interest rate might help her to avoid depleting the real value of her savings more rapidly than she intended.

The chart below shows trends in Australian interest rates on one year bank term deposits, after-tax interest rates on those deposits assuming a marginal tax rate of 30%, and real after-tax interest rates (deducting the CPI inflation rate for the previous 12 months). The data used in the chart is sourced from the Reserve Bank of Australia.

From the chart it looks to me as though it is about 15 years since retirees have been able to spend any of their interest income from term deposits without depleting the real value of their savings. 

It is easy enough to understand that some elderly people might suffer from money illusion and consider it to be sinful to deviate from time-honoured prudential rules about living off nominal interest. One would hope that professionals in the investment advice industry would encourage such people to modify their views somewhat to take account of tax and inflation.

However, some senior people in the investment advice industry have been encouraging the view that low interest rates have reduced the real spending power of retirees. For example, Jeremy Cooper, chairman of retirement income at Challenger Ltd, and the man who chaired the 2010 review of the superannuation system, has been reported in The Australian as saying:

 “Back when bank deposit rates were around 6 and 7 per cent there was no great problem with self-funded retirees relying on bank interest”.

In the same article, Jeff Rogers, chief investment officer of IPAC funds at AMP Capital, made a similar point. He is reported as saying bank deposit rates “will now adjust to just below 3 per cent, so with core inflation at around 2.4 per cent your real spending power is very small” in a self-funded retirement and warns that even if interest rates do start moving up again, “they won’t be going back up any time soon to the level that provided bank interest of 6 to 7 per cent’’. (Article by Andrew Main, ‘Risk rules for retirees reliant on bank interest’, May 6, 2015.)

It looks to me as though the after-tax real rate was close to zero when bank deposit rates were around 6 or 7 per cent, just as it is now.

If your satisfaction with life is adversely affected by regret, what should you do about it?

The purpose of feelings of regret is presumably to help us to make better choices. That suggests that the best way to deal with regret is to make sure we make better choices in future. But regret can also put people into a frame of mind where they make poor choices and find it difficult to enjoy of life.

Regret does not feature prominently in conventional economic theory, even though everyone knows that sensible people take into account the potential for regret when they make decisions.  I suppose that is because Max U, the rational economic man of economic theory, does not let potential for regret prevent him from seeking to maximize utility. Even when economists allow for the possibility that Max might feel losses from the status quo to a greater extent than gains (as in prospect theory), the potential for disappointment and regret still does not come into consideration in the choices he makes.

It is normal for humans to feel disappointment when outcomes are worse than expected – for example when an investment fails even though we have good reasons to expect it to succeed. We feel regret about the opportunities we have foregone in making such investments. Regret is likely to be particularly intense if you mortgage your home to fund an unsuccessful investment.

It usually makes sense for people to take account of the potential for regret in making choices. It is also possible, however, for regret to lead people to make poor choices – choices they later regret. For example, when share prices slump, people who are unduly influenced by regret about the losses they have experienced may decide precipitously to reallocate funds to less risky investments, and later regret that they have sold at the bottom of the market. Alternatively, they may gamble to recover past losses (for example, by buying more shares) and come to regret that choice if the market falls even further. Some economic studies, for example theoretical and experimental work by Philip Strack and Paul Viefers, illustrates the potential for regret to influence decisions in this way.

There is some evidence that regret can have a large impact on life satisfaction. The results of a recent study by Olivia Pethel and Yiewei Chen seem particularly interesting, since these authors use a measure of the intensity of regret, in addition to indicators of negative decision outcomes and the tendency of people to feel regret. The study focuses on mature adults, people over age 35, who are old enough to have had opportunities to make decisions which they might regret. The findings of the study should probably be viewed with caution because of the small size of the sample (119 adults) sex composition (71% female) and the potential for bias in the informal sample selection process that was used.

The regret intensity variable used in the study was constructed by asking people how much they regretted having made wrong choices in various aspects of their life on a 5 point scale (1 = no regret; 5 = very strongly regret) and averaging across the scores. The results of the regression analysis suggest that “very strongly regretting” a wide range of choices in life would be likely to have a large impact on life satisfaction – reducing it by about 1.6 points on the 7 point scale used in the study.

The authors suggest that people who have lower levels of regret intensity may have developed effective emotional regulation strategies in dealing with life regrets. Unfortunately the study does not directly test the use of regulation strategies.  However, the regression results support previous findings that cognitive reappraisal - use of emotion regulation strategies that change the way situations that elicit negative emotions are viewed - has a positive impact on life satisfaction.

I will resist the temptation to conclude that everyone should be taught the bygones principle - much loved by economists - that decisions should focus only on future costs and benefits, leaving aside regrets about the past. In my experience, the bygones principle is much easier to apply to public policy than to one's private life. 

I will also resist the temptation to conclude that people who are allowing regrets to interfere with their enjoyment of life should learn cognitive reappraisal skills. It would be easy to draw upon my own personal experience to suggest ways people might be able to acquire such skills, but at this stage I can't cite reliable studies testing what works and what doesn't work.

Does it make sense to think of trade-offs between life satisfaction and wealth?

Before you answer the question, I would like you to conduct a couple of thought experiments.

The first step is to answer the following question:

All things considered, how satisfied are you with your life these days? Please give your answer as a number between 1 and 10, with a rating of 1 is you are dissatisfied and 10 if you are satisfied.

That is a standard question that has been asked by happiness researchers. Now we come to the thought experiments.

Thought experiment 1:

Imagine that your circumstances suddenly change so that it becomes possible for you to increase your peronal life satisfaction rating by 25% if you are prepared to sacrifice some wealth. What is the maximum amount of wealth that you would be prepared to sacrifice in order to achieve an improvement of 25% in your life satisfaction rating?

Don’t worry if the 25% improvement would take you beyond the top of the rating scale. For the purpose of this exercise it is deemed to be possible to increase your life satisfaction beyond the end of the scale e.g. from 10 to 12.5. That makes sense because people who are completely satisfied with their lives sometimes find that their lives get even better.

Thought experiment 2:

Now imagine a different scenario. Your circumstances change so that it becomes possible for you to increase you wealth by 25% if you are prepared to sacrifice some personal life satisfaction. How much life satisfaction would you be prepared to sacrifice in order to achieve a 25% increase in wealth?

My guess is that in answering the first question there are not many people who would be prepared to sacrifice all their wealth to obtain a 25% increase in life satisfaction. In relation to the second question I don’t think there would be many people who would be unwilling to sacrifice any life satisfaction (if only for a limited period) in order to obtain a 25% increase in wealth. Those are just my guesses. If large numbers of people tell me that I am wrong, I will have to admit that I have made a mistake.

What is the point of this exercise?  Some economists have been prepared to assume that the sole aim of individuals is to maximize life satisfaction as measured in social surveys. That might seem to be a reasonable assumption until you think of the implications. If your sole aim is to maximize personal life satisfaction it would be irrational not to sacrifice all your wealth in order to obtain greater life satisfaction, if that possibility became available. Similarly, it would be irrational to sacrifice any life satisfaction under any circumstances to obtain greater wealth.

If the choices that people make imply that they do not aim to maximize life satisfaction, that doesn’t mean that they are irrational. It just means that there are some things more important to them than life satisfaction, including some things that money can buy.

What could be more important to people than life satisfaction? Some clues are offered by research, discussed here a couple ofmonths ago, which asks people to choose between hypothetical situations with different ratings of life satisfaction and other well-being indicators. 

The people surveyed indicated a stronger preference for options offering high overall well-being to you and your family than for life satisfaction. Other well-being indicators ranked above life satisfaction included personal health, being a good, moral person and living according to personal values, the quality of family relationships, financial security, your mental health and emotional stability, a sense of security about life and the future, having many options and possibilities in life and freedom to choose among them and a sense that your life is meaningful and has value.

What is missing from "Mind,Society and Behavior"?

There is no prize for any reader who suggests that there is a “u” missing from “behavior”.

Mind, Society and Behavior is the title of World Development Report 2015, recently published by the World Bank. The title of the report is intended to capture

“the idea that paying attention to how humans think (the processes of mind) and how history and context shape thinking (the influence of society) can improve the design and implementation of development policies and interventions that target human choice and action (behaviour)".

The main point that the report seems to be making is that policy outcomes depend on psychological and social influences as well as economic incentives.

The report argues that it is important to take account of three different kinds of thinking:

• Automatic thinking causes us to simplify problems and base decisions on associations that automatically come to mind. This means that policy outcomes can depend heavily on the framing of choices (the way information is provided) and default options.
• Social thinking causes behaviour to be influenced by social preferences, networks, identities and norms. These influences can lead societies into self-reinforcing patterns of behaviour, which may be highly desirable (e.g. norms of loan repayment) or undesirable (e.g. a culture of corruption).
• Thinking with mental models involves concepts, stories and views of how the world works which influence our understanding of what is possible, what is right and what governments should do. An example cited in the report is that people from disadvantaged groups can have mental models that cause them to under-estimate their own abilities.

The report draws upon a substantial amount of research which establishes the relevance of these different types of thinking to policy issues. I am probably more familiar than most readers would be with the underlying research in psychology, behavioural economic and institutional economics that is referred to in this report. However, it was interesting to see how the authors were able to draw on an impressive array of relevant research related to poverty, child development, household finance, productivity, health and climate change.

Anyone with an interest in economic development is likely to find the overview of the report interesting and easy to read. I read the whole report, but it took a long time because I kept finding more interesting things to do. The report seems to have been prepared by bureaucrats to be read by bureaucrats. As I was reading, I could not help thinking that while psychology and sociology do influence behaviour, we should not overlook the importance of pecuniary incentives. I find this kind of report easier to read when I am being paid.

I found the tone of the report to be slightly irritating, but I suppose it is difficult not to appear to have superior wisdom when discussing biases in decision-making of ordinary people. The tone in the rest of the report is balanced somewhat by a chapter which discusses the biases of development professionals in the World Bank. The chapter notes, among other things, that predictions by development professionals grossly understated the extent to which poor people in selected developing countries perceive themselves to be in control of their own lives and grossly overstated the extent to which these people perceive themselves to be helpless in dealing with life’s problems.

There is a major omission in this report, in my view. Any discussion of the influence of cognitive bias in decision-making on economic development should take into account the influence of bias in the mental models on economic development policies. There is no discussion of the deficiencies mental models that led to trade protectionism, widespread public ownership of business enterprises in many countries or the over-emphasis on the role of savings and capital investment in economic development. And there is no discussion of institutional arrangements for policy development that might help prevent biased views of how the economic growth process works from continuing to have a huge adverse impact on government policies in many parts of the world.

This report makes a useful contribution, but it could have been a lot better.

Why am I interested in happiness research?

“THOMAS GRADGRIND, sir. A man of realities. A man of facts and calculations. A man who proceeds upon the principle that two and two are four, and nothing over, and who is not to be talked into allowing for anything over. Thomas Gradgrind, sir - peremptorily Thomas - Thomas Gradgrind. With a rule and a pair of scales, and the multiplication table always in his pocket, sir, ready to weigh and measure any parcel of human nature, and tell you exactly what it comes to. It is a mere question of figures, a case of simple arithmetic. You might hope to get some other nonsensical belief into the head of George Gradgrind, or Augustus Gradgrind, or John Gradgrind, or Joseph Gradgrind (all supposititious, non-existent persons), but into the head of Thomas Gradgrind - no, sir!

In such terms Mr. Gradgrind always mentally introduced himself, whether to his private circle of acquaintance, or to the public in general.” Charles Dickens, Hard Times, Chapter2.

I'm not like that. However, an interest in happiness research may seem to many people to imply an obsession with measuring, calculating and attempting to understand things that are not meant to be understood. 

Perhaps trying to understand what makes people happy is a bit like trying to understand why jokes are funny. It isn’t obvious that an understanding of what makes jokes funny would be much help to anyone in telling jokes, or how an understanding of what makes people happy would help anyone to become happier.

It is fairly easy to explain how I came to be interested in happiness research, so I will begin by writing about that. In my work as an economist I spent more than a few decades considering what government policies were likely to advance the well-being of the people in the countries where I have lived and worked (mainly Australia and New Zealand. It seemed fairly obvious that the vast majority of Australians and New Zealanders wanted higher incomes, so it was reasonable to assume that would improve their well-being. If someone questioned whether higher incomes would make people any happier, my defence was that economists should be in the business of making it possible for people to have happier lives rather than advising them how to spend their money.

At the same time, I could not help becoming interested in the puzzle of why happiness surveys showed little or no increase in average happiness ratings in high income countries over several decades while average income levels rose substantially. This is of course Easterlin’s puzzle - named after the economist Richard Easterlin.

I stopped being puzzled once I understood that happiness surveys measure emotional well-being - a component of well-being rather than the whole package. There is no reason to expect the value that people place on physical health, education, housing and safety, among other things, to be fully reflected in measures of emotional well-being. 

Emotional well-being is strongly related to self-esteem, optimism and the feeling of being in control of one’s life – none of which would be expected to be strongly influenced by further increases in incomes in high-income countries.

It is true, of course, that when people see higher incomes as the pathway to emotional bliss they are unlikely to be satisfied with one pot of gold - even if they find the end of a rainbow. But most people seem to make sensible choices. They might seek a higher income if that is necessary to pursue objectives that they consider to be worthwhile. For many people, higher incomes are incidental to career objectives. There is no reason to expect people to stop trying to achieve more in life just because they are satisfied with their current standard of living.

It seems to me that if we are interested in measuring well-being, then the survey measures of happiness are just one of the items we should look at. I favour the approach taken by the OECD in its Better Life Index.

However, an indicator approach doesn’t give economists a value-free measure of well-being. It leaves open the question of what weights should be given to the various component indexes. The OECD leaves the value judgement in the hands of the users of its index. That is more appropriate than having researchers assign weights, but it would be good to see how weights might need to differ to reflects the different values of people in different parts of the world. In my view the Better Life Index should be accompanied by illustrative weights derived from a values survey.

So, one of the reasons why I am interested in happiness research is apparent from what I have written. Happiness research is relevant to measurement of human well-being and that is relevant to economic policy.

I am particularly interested in the relationship between freedom and flourishing. Do government restrictions on individual freedom – in the wars against drug taking, smoking, alcohol, obesity, overwork etc. - actually have the desired effect of enabling people to have happier lives? I don’t think so. The policies adopted by governments seem designed to make people less happy in an attempt to get them to adopt healthier lifestyles, but I don’t know where to find the evidence to prove it.

In any case, that is only part of the story. My interest in happiness research is not always closely related to government policy. Some of my recent posts have taken me into the relationship between life satisfaction and the incidence of negative emotional experience. I am not sure why I am interested in such matters. Nevertheless, it seems more satisfying than spending my time trying to understand what makes jokes funny.

Do realistic optimists have more successful lives?

I think realistic optimists probably do have more successful lives than optimists and pessimists, but unfortunately I cannot claim that I have a particularly strong basis for that view.

A couple of months ago I notice a story by Tia Ghose on Huffington Post reporting on research findings by Sophia Chou of the National Taiwan University. The research apparently suggests that realistic optimists – people who combine the positive outlook of optimists with the clear-eyed perspective of pessimists – get the best of both worlds. Their realism enables them to perform better at work because they don’t delude themselves that they can do well without working hard. Their optimism enables them to avoid getting bogged down by unhappiness.

I was particularly interested because of something I wrote on this blog a couple of years ago entitled: Why can’t we have a realistic basis for optimism? My consideration was prompted by a discussion by Martin Seligman of issues relating to possible circumstances where expectations may influence reality.

After reading the article by Tia Ghose, I decided to go looking for the relevant paper by Sophia Chou, which was presented at the American Psychological Association in Hawaii earlier this year. I haven’t been able to find a copy of the paper on the internet. I could write to the author and ask for a copy, but I don’t think I will bother. My qualifications are in economics, so I have reason to be pessimistic about my ability to judge the quality of the research behind these findings.

Sophia Chou’s research findings seem to me to make a lot of sense, but I guess a realistic optimist would wait for her paper to be published in a peer reviewed journal before getting excited about them.

Why was Northern Ireland a highlight of our tour of the British Isles?

There were many highlights of our recent tour of Britain and Ireland, but the visit to Northern Ireland will stick in my memory. Before we went there I knew that it was now a safe place for tourists to visit, but I had not grasped how much the conditions of life of the people who live there have improved since the Good Friday agreement was signed 15 years ago.

My first surprise was that crossing the border from the Republic to Northern Ireland was less noticeable than crossing from England to Wales. If we had not been told to look out for a change in the colour of the lines marking the edge of the road, we would not have known that our bus had crossed the border between the Republic of Ireland and the United Kingdom.

As expected, you don’t have to drive far in Northern Ireland before seeing evidence of division, with some communities displaying the Union Jack and others displaying the flag of the Republic. There are also plenty of murals, like this one, to let you know the feelings of the local communities.

However, people seem to be able to travel freely. Apparently it has become common for Protestants living in Northern Ireland to take a drive into the Republic. They have an incentive to do this because fuel is cheaper in the Republic. That is probably attributable to some kind of regulatory distortion, but it is nevertheless a hopeful sign when people put aside their prejudices to take advantage of economic opportunities.

Ronan McNamara, our local tour guide in Derry, or Londonderry (if you prefer), gave us a message of hope. He suggested that the vast majority of people in Northern Ireland now just want to get on with living their lives and leave sectarianism behind.

I was also surprised to learn that the unemployment rate in Northern Ireland is now below the average rate for the UK. (The unemployment rate for NI was 6.9% in June 2013, compared with 7.7% for the UK. The corresponding figure for the Republic was 13.5%, reflecting the uneven impact of the global financial crisis.)

We saw some symbols of hope in both Londonderry and Belfast.  The Peace Bridge is a cycle and footbridge across the River Foyle in Derry, which opened in June 2011, to improve access between the largely unionist 'Waterside' and the largely nationalist 'Cityside'.

The so called ‘peace walls’, built to separate the Protestant and Catholic communities in Belfast, are still very much in evidence and the gates are still closed at night. But the black cab drivers take tourists to see the murals on both sides of the walls. We were encouraged to add our messages to one of the walls.

I was impressed by the message left by Angus from Australia, last year.

The message I left would come as no surprise to regular readers of this blog.

Our trip to Northern Ireland has left me with a somewhat different perspective on the ‘troubles’ in Northern Ireland. I had to visit Belfast before I fully appreciated that the ‘troubles’ were the last smouldering embers of ongoing sectarian violence that has infected the British Isles since the dissolution of the monasteries during the reign of Henry VIII. It will help me to make the point if I present a couple more photos taken in Northern Ireland in historical context, relating to other things we saw as we travelled around the British Isles.  My efforts in doing this have been aided by the gruesome stories of warfare that our travel director, Paul Murphy (from Glasgow), told us as we travelled though the peaceful countryside of Britain and Ireland.

The ruins of Glastonbury Abbey are an appropriate place to begin. Before Glastonbury Abbey was closed by Henry VIII in 1539 it was one of the largest and most famous English monasteries. The dissolution of monasteries combined revenue-raising with religious persecution as buildings and other assets were seized by the Crown, to be sold off or leased, while monks and nuns were dispersed.

Now, fast forward to 1623 and the reign of James I. Although James was tolerant toward loyal Catholics, he decided that the best way to subordinate the people of Ulster (which was the last part of Ireland resisting British rule) was by colonising the area with Protestants from England and Scotland. Part of this colonisation involved building the heavily fortified city of Londonderry, so named because of investment from the City of London. The city walls are still intact despite the siege of 1689.

Before we can discuss the siege of Derry we need to skip past the English civil war, Oliver Cromwell’s suppression of the Royalists in Ireland, which led to confiscation of land owned by Catholics in Ireland, and the restoration of the monarchy which brought James II, a Catholic, to the throne. Although James II showed some degree of religious tolerance, influential members of Parliament became increasingly concerned about his religious beliefs and his close ties with France. So they brought about the Glorious Revolution of 1688, which involved Parliament inviting William of Orange to ascend the English throne as William III of England, jointly with his wife, Mary II of England.

I have previously suggested on this blog that the Glorious Revolution was an important milestone in replacing tyrannical government because it was followed by the Toleration Act of 1689, which gave formal recognition to religious pluralism and was an important step toward giving equal rights to followers of all religions. That is still my view, but some of my ancestors (those from Ireland) would have had some difficulty in accepting that the revolution brought about by William and Mary was glorious.

James II fled to Ireland and assembled his supporters to begin undoing the Protestant land settlement. In April 1689 he presented himself before the walls of Derry - and so the siege began. After 105 days, however, Williamite ships allowed supplies into the starving town. William of Orange subsequently met James at the Battle of the Boyne and defeated him. That is why we see William III portrayed prominently in this mural in a Protestant area of Belfast.

Our story continues as the Williamite forces went on to control Ireland, with the exception of Limerick, which they lay siege to. The Jacobite forces surrendered after the signing of the Treaty of Limerick, promising religious toleration among other things, on the Treaty Stone in the photo below.

That might have been a good place to end this story, but the Irish parliament, representing landowners who subscribed to the (Anglican) Church of Ireland, dishonoured the Treaty. While Catholics were not prevented from practicing their religion, a series of penal laws prevented them from owning land, practicing law, holding public office and bearing arms. Catholics and Calvinists were also required to pay tithes to support the Church of Ireland.

In 1745, on the other side of the Irish sea, the Jacobites led by Bonnie Prince Charlie attempted to take back the English throne. His army had some initial success, but he failed to obtain the English and French support needed to beat government forces. His army was massacred on the battlefield at Culloden, shown below.

In the aftermath of Culloden, the Scottish Highlands were disarmed, Gaelic was banned and the wearing of tartan was made a hanging offence for a time.

Discrimination against Catholics began to diminish from about 1760 onwards, in response to agrarian unrest in Ireland and the emergence of a reforming minority, urging greater respect for individual rights, among those in power in London. The process of granting equal rights to people of all religions occurred gradually in a series of steps and is still not complete. The Church of England still has links to the state and while citizens of the United Kingdom have freedom of religion, the sovereign does not have that freedom.

One of the things I think we can learn from the history of the British Isles is that freedom of religion and respect for individual rights emerged as a kind of stalemate from a long series of conflicts. Those in power gradually came to accept that it was counterproductive to try to force people to change their beliefs or to discriminate against them because of their beliefs. They came to accept that suppression just led to rebellion at a later stage.

When we travelled around the British Isles we saw a great deal of evidence that this was a very violent part of the world only a few hundred years ago. But without visiting Northern Ireland, this evidence would have seemed as though it had been planted for the benefit of tourists. Britain and Ireland are, for the most part, incredibly peaceful places where the vast majority of people are obviously willing to ‘live and let live’. It was good to learn that there are now strong grounds to hope that Northern Ireland will be able to stay on track to become as peaceful as the rest of Ireland and Britain.