What Can Economists Learn from Happiness Research?

HAPPINESS IS generally considered an ultimate goal of life; virtually everybody wants to be happy. The United States Declaration of Independence of 1776 takes it as a self-evident truth that the "pursuit of happiness" is an "unalienable right," comparable to life and liberty. It follows that economics is-or should be-about individual happiness; in particular, how do economic growth, unemployment and inflation, and institutional factors such as governance affect individual well-being? In addition to this intrinsic interest, there are important reasons for economists to consider happiness research. The first is economic policy. At the microlevel, it is often impossible to make a Pareto-improving proposal, because a social action entails costs for some individuals. Hence an evaluation of the net effects, in terms of individual utilities, is needed. On an aggregate level, economic policy must deal with trade-offs, especially those between unemployment and inflation. Data for twelve European countries for the period 1975-91 show that a 1-percentage-point increase in the unemployment rate is marginally compensated for by a 1.7percentage-point decrease in inflation (Rafael Di Tella, Robert MacCulloch, and Andrew Oswald 2001). This result significantly deviates from the "misery index" that, for lack of information, has simply been defined as the sum of the percent unemployment rate and the percent annual inflation rate. Another trade-off that can be calculated on the basis of estimated happiness functions is the compensating variation for being unemployed rather than holding a job. For the same European countries referred to above, a move from the lowest income quartile to the highest income quartile would not be enough to offset the adverse effect of unemployment, suggesting that unemployed people suffer high non-pecuniary costs. Happiness research can thus usefully inform economic policy decisions. Another reason why happiness is of relevance to economists is the effect of institutional conditions such as the quality of governance and the size of social capital on individual well-being. Research for 49 countries in the 1980s and 1990s suggests that there are substantial well-being benefits from factors such as improved accountability, effectiveness and stability of government, the rule of law, and control of corruption. The data show that the effects flowing directly from the quality of 1 University of Zurich, Institute for Empirical Research in Economics. We wish to thank a large number of scholars and three referees for their detailed comments on this and previous versions of the paper.