Happiness and Economics: How the Economy and Institutions Affect Human Well-Being

CHAPTER 10 Happiness Inspires Economics

Chapter 10 HAPPINESS INSPIRES ECONOMICS 10.1 Introduction The research on happiness presented in this book inspires economics in several ways:  The extent to which people are happy or unhappy is an essential quality of the economy and society. The state of the economy strongly affects people’s happiness. But even more important, in the long run, is whether the constitution favors or hinders the pursuit of happiness (section 10.2).  The results of happiness research tell economic policymakers which factors tend to raise or diminish people’s well-being. The temptation to maximize the happiness functions econometrically identified is, however, mistaken. Rather, institutional (or constitutional ) rules promising higher happiness are to be recommended (section 10.3).  Happiness research inspires economic research by extending the realm of measurement in an important way and by providing new answers to burning questions concerning the welfare effects of income, unemployment, and inflation (section 10.4).  The systematic study of happiness by economists is only in its initial stages. Many important issues are unresolved and may serve to inspire future economic research (section 10.5). 10.2 Happiness in the Economy and Society 10.2.1 Happiness as a Final Goal “For most people, happiness is the main, if not the only, ultimate objective of life” (Ng 1996, p. 1). Happiness, or subjective well-being, 172 CHAPTER 10 is measured by representative surveys. Nevertheless, standard economic theory clings to an “objectivist” position based on observable choices made by individuals. Individual utility depends only on tangible factors (goods and services), is inferred from revealed behavior (or preferences), and is in turn used to explain the choices made. This seemingly modern view is influenced by the positivist movement. It rejects subjectivist experience (for example, as captured in surveys) as being unscientific because it is not objectively observable. It is assumed that the choices made provide all the information required to infer the utility of outcomes. Moreover, the axiomatic revealed preference approach is applied not only to derive individual utility, but also to measure social welfare. To do so, social welfare comparison is based on the consumption behavior of households. This positivist view is still dominant in economics. Sen (1986, p. 18) observes that “The popularity of this view in economics may be due to a mixture of an obsessive concern with observability and a peculiar belief that choice


is the only human aspect that can be observed.” Its dominance is also reflected in the contents of microeconomic textbooks . However, not all contemporary economists subscribe to this view. Numerous scholars have challenged standard economic theory from different angles. (a) There are numerous examples of nonobjectivist theoretical analyses in economics. They incorporate emotions (e.g., Elster 1998), such as regret (e.g., Bell 1982), self-signaling (self-esteem), goal completion, mastery, and meaning (Loewenstein 1999), and status (e.g., Frank 1985a,b), as well as even broader considerations beyond the normal use of utility (e.g., Sen’s 1982 “entitlements”). (b) Standard theory assumes independent utilities, although interdependent utilities fit particular observed behavior much better (e.g., Clark and Oswald 1998). More importantly, interdependent utilities question traditional welfare propositions (e.g., Boskin and Sheshinski 1978, Holländer 2001). (c) By focusing on the value of outcomes rather than on observed decisions, various types of utility can usefully be distinguished (Kahneman, Wakker, and Sarin 1997). Predicted utility “refers to beliefs about the experienced utility of outcomes,” remembered utility “is inferred from a subject’s retrospective reports of the total pleasure or displeasure associated with past outcomes,” and HAPPINESS INSPIRES ECONOMICS 173 instant utility measures “hedonic and affective experience, which can be derived from immediate reports of current subjective experience or from physiological indices” (pp. 376f). The differences between these evoke a number of positive questions that have not yet been answered in a satisfactory way—for example, “How is the remembered utility of extended outcomes determined?” (p. 378). These hedonistic concepts are based on an old tradition. The initiators of the modern analysis of decision making (Bernoulli and Bentham) understood utility as satisfaction, referring to the hedonic quality in terms of pleasure and pain. (d) The previous remarks reveal that the position of psychologists has differed markedly from the economic position. Psychologists value subjective experience as an important source of information about individual utility. They are less convinced that choices are always rational (see the vast literature on anomalies in decision making...