Income and Happiness

Why Happiness Levels Have Not Grown

It is predicted that there is a positive relationship between income and happiness. In other words, happiness levels are expected to increase as income increases.

Two Key Facts:

1. Rich people, on average, are happier than poorer ones.
2. Over time, however, advanced countries have not grown happier as they experience higher income levels.

Table 1

Happiness in the US by income

The rich people are happier than the poorer ones, but there is no drastic change in the numbers between 1975 and 1998. These results are a standard pattern for all countries and they would be the same even if we compared two different countries at the same time (1 being more advanced/ richer than the other).

What’s the problem?

Individually as one gets richer, he/ she becomes happier. However, when the whole society becomes richer, nobody seems to be happier. Happiness is not increasing because people are not comparing their income with a norm. As income increases this norm increases as a result of habituation and rivalry.

Habituation

In order to be successful one must be able to adapt. This can be both a positive and negative attribute. Examples of this include a person who experiences an injury and two people who are recently married.

Relating this to income: When our income and living standards increase, we experience joy and happiness. However, we will get used to this level (adapt to it) and it will make little difference. It is important to note that it is still very difficult to change and go back to our original standard. In other words, people measure their success and “norm” level to where they have recently obtained. Psychologists call this the ‘hedonic treadmill.’ People try to rise up a level, but in the future they consider that level as the bottom. Essentially, habituation is exactly like an addiction, where people always need a higher income level and a higher standard of living in order to be happy. No matter what level a person is at, he strives to get to a higher level.

In order to become happier and raise living standards, people over-invest in material goods (cars, clothes, houses, etc). Problems arise when one cannot predict how they might get used to and bored of their possessions. To alleviate their boredom they work more instead of taking leisure time in order to gain more income so they can buy more goods. Thus, people are over-investing in acquiring goods (working more instead of leisure) and so they are nor increasing their level of happiness. Richard Layard, suggests that an increase in that taxation on spending will reduce the amount of conspicuous spending, and thus increase happiness.

Rivalry

Layard starts out with the following example:

Which would you prefer? (prices are the same)

1. You get $50,000 a year and others get half
2. You get $100,000 a year and others get more than double that

In a recent study, the majority selected the first option over the second. The participants would prefer to be poorer as long as their position compared to others was greater. People care about their own income and living standard as well as that of others. When comparing these, people look towards their own personal “reference group” (neighbors, coworkers, etc) instead of people on a higher tier (celebrities). In an attempt to calm this rivalry, the best solution is to keep salaries a secret. Competition occurs because people are concerned with their relative income and not its absolute value.

Implications on society are massive if people solely cared about their relative income. This is because even economic growth would not be able to increase happiness if one keeps the same reference group. If a growth occurred everyone would experience a growth in income and thus relatively speaking they would be in the same place, and happiness would not increase.

Layard also asks:

Which would you prefer?

1. You have 2 weeks vacation, and others have half that
2. You have 4 weeks vacation, and others have double that

Only 20% chose the option A, therefore showing that people are not rivalrous when dealing with leisure. The results show that people would prefer longer leisure time, hence happiness will only increase if leisure time increases.

Policy Suggestion

Happiness increases in the short- run for individuals, but that change is not evident on a larger scale. People are conflicted with the decision of working more, or committing more time to leisure activities. Through habituation, one concludes to work more in order to increase income levels so that they can raise their living standard. Rivalry, on the other hand, tells people to work more while also increasing leisure time. Through rivalry, people compare their income levels with others in their reference group, therefore they will work longer hours in an attempt to gain higher wages so that they can dominate the competition. However, in his second example Layard states that people are NOT rivalrous in regard to vacation time, thus noting that people are looking to maximize leisure time. Happiness cannot increase due to these factors because people are conflicted in what to choose, and the opportunity costs that they incur, negatively affect their happiness.

In order to increase happiness, Layard suggests an increase in taxes. He equates habituation with a smoking addiction. To decrease the levels of consumption of cigarettes, the government increased taxes on them. So, he suggests an increase in the levels of taxes on spending, in an attempt to decrease conspicuous consumption due to habituation. For rivalrous activity, he suggests an increase in income taxes so that people will decrease the numbers of hours they work.

Happiness will increase in the long run when people realize their personal utility maximizing balance of work and leisure.

Source

Layard, Richard. Lecture 2 Income and Happiness: Rethinking Economic Policy. 27 February 2003.