Editors’ Summary

The Brookings Panel on Economic Activity held its eighty-fifth conference in Washington, D.C., on April 10 and 11, 2008. For this conference—our first as editors of the journal—we selected papers on a range of topics central to macroeconomics and economic policy: the relationship between economic growth and people’s subjective well-being; the effect of international trade on wages; the appropriate role of policies designed to strengthen local economies; macroeconomic crises and asset pricing; the impact of political constraints on the success of economic policy reform; and the behavior of financial markets during the approach of world wars. This issue of the Brookings Papers on Economic Activity presents the six papers from the conference, comments by the formal discussants, and synopses of the discussions of the papers by conference participants.

In the first paper, Betsey Stevenson and Justin Wolfers examine the effect of income on subjective well-being. More than thirty years ago, Richard Easterlin compiled empirical evidence suggesting that an increase in a country’s average income did not increase the average level of happiness among its citizens. This “Easterlin paradox” cast doubt on the desirability of public policy focused on increasing material standards of living. However, Stevenson and Wolfers argue that the data available for assessing the link between income and happiness were quite limited for many years, and that the apparent lack of a robust link led some observers to “confound the absence of evidence of such a link with evidence of its absence.”

Today, data on income and self-reported satisfaction are available for a broad array of countries at all levels of development over a number of decades. Using an extensive collection of these new datasets, Stevenson and Wolfers estimate that income has a significant positive effect on subjective well-being. Moreover, the magnitude of the estimated income-happiness gradient is similar across countries, among people of different income levels within countries at a point in time, and within countries as their average income changes over time. In particular, the authors find no evidence of a satiation point beyond which higher income does not raise well-being.

These results show that absolute levels of income have important effects on well-being. However, the authors acknowledge that relative incomes may matter as well: Because their estimates of the income-happiness gradient are imprecise, one cannot rule out either that the within-country effect of income is smaller than the cross-country effect (which might be attributable to relative-income effects) or that these two effects are identical (which would speak against a role for relative income). The authors also note one striking exception to the pattern they observe: Americans have experienced virtually no increase in happiness during the past thirty-five years despite ongoing increases in average income.

In the second paper, Paul Krugman returns to a question that he and others studied in the 1990s: How does international trade affect the wages of less skilled workers in the United States? Textbook analysis predicts that increased trade with countries that have large quantities of unskilled labor should reduce the relative price of goods whose production uses unskilled labor intensively, and that this reduction in relative price should reduce the relative wages of less skilled workers in the United States. The key question is whether this effect is quantitatively important, and the answer given by several studies in the 1990s was that U.S. trade with developing countries was having only a modest effect on U.S. income inequality.

Krugman explains, however, that the magnitude and nature of trade have changed considerably since these earlier estimates were made. Imports from developing countries have roughly doubled as a share of U.S. GDP since the early 1990s. Moreover, the developing countries that account for most of the recent expansion in U.S. trade have substantially lower wages, relative to U.S. wages, than did the developing countries that were the focus of the previous literature. Therefore, the effect of trade on income inequality is potentially much larger today.

Examining the data, Krugman documents a marked increase in imports of products that are traditionally skill intensive, such as computers and...