Our nominal income rises every year. But what about our real income – our “standard of living”? In order to answer that question, we have to accurately measure inflation. If we understate inflation, we’re getting richer at a slower pace than we think. If we overstate inflation, we’re getting richer at a faster pace than we think.
Most economists, sadly, just forget about the issue and pretend that standard measures of inflation are solid. Most specialists, however, have long believed that the standard CPI does indeed overstate inflation- and this consensus keeps getting stronger. CPI Bias is alive and well, so we’re materially much better off than we think. “There is no Great Stagnation” – say it non-ironically, as you should.
On reflection, however, there is a shocking implication. Happiness researchers – yes, even Justin Wolfers! – have almost uniformly found little effect of income on happiness. If official statistics understate real income growth, what should we conclude?
Simple: Income’s effect on happiness is even smaller than it looks! According to Winship, for example, U.S. real income from 1969-2012 plausibly rose not by 16% (the standard estimate) but 45%. Yet our happiness still barely budged.
How is this possible? The leading possibilities:
1. Hedonic adaptation. As Epicurus would predict, human beings quickly psychologically adapt to greater riches. The more you have, the more you take for granted.
2. Relative income. Another possibility is that human beings mostly care about how much they have compared to others. So it doesn’t really matter if the price index says we’re 45% richer or 16% richer; either way, what we really want is to be in the top 1%.
3. False consciousness. If you keep falsely telling people their income is stagnant, they’ll believe you and feel disappointed.
Where, though, does the truth lie?
The overwhelming factor, in my view, is hedonic adaptation. Materially, Americans are far better off than they were during my childhood in the 1980s. Yet hardly anyone appreciates the wonderful new and improved products they’ve received.*
The relative income story, in contrast, is frail indeed. Why? Because income has little effect on happiness even at a single point in time. As I explained in my discussion with Wolfers, his results imply that raising happiness by one standard deviation requires an increase in annual income of over $800,000. So stop conflating indifference with envy.
What about false consciousness? I doubt it’s a huge factor, because most of us lack the patience to heed so-called “opinion-makers.” The people too pragmatic, and the pundits are too boring. Still, I can easily believe that doomsayers make us feel 10% poorer than we really are. And in a well-functioning culture, I can easily believe that honest recognition of our good fortune could multiply this effect by negative one. In other words, a shift from our pessimistic narrative to an optimistic one would make us feel about 20% richer than we currently do. (Remember, though, how small a change in happiness that implies!)
At this point, I can picture Tyler Cowen remarking, “You’re a bigger pessimist than I am. According to you, we’re richer than we think, but riches don’t matter much for happiness, so who cares?” The whole point of optimism, though, is to say, “You may not be happy, but you should be.” If you want to meme that as, “Optimism is pessimism about the dangers of pessimism,” so be it.
* Aside: Thank you, oh great producers, for the wonderful new and improved products I have received at your hands. For verily you have redeemed my adulthood from the gray bleakness of my youth, and blessed me with vibrant abundance.
READER COMMENTS
Roger McKinney
Sep 16 2019 at 2:25pm
An old sociology professor told me that happiness is relative to expectations. If your reality matches your expectations then you’re happy. But when things are good, people’s expectations outrun reality and they become unhappy. Revolts often happen in societies where things have been improving rapidly. Often the happiest people live where things are bad because their reality is better than they expected. That’s why Scandinavians are so happy, even though they commit suicide at high rates.
Jens
Sep 17 2019 at 11:22am
Scandinavians don’t commit suicide at high rates. Suicide rate in Finland is slightly higher than in the US, Norway and Sweden markedly below. Finland had a problem in the past, but that’s mostly gone. Btw Peoples reality in Scandinavia is very good, probably the best on this planet and revolts rarely happen in societies where have been improving rapidly. But yes, you posted something incoherent and pejorative and mentioned Scandinavia in that context.
Philo
Sep 16 2019 at 3:23pm
Evidently happiness is not as important as most people, and many moral philosophers, think. The Utilitarian “Greatest Happiness” principle should really be about “Greatest Well-Being.” We now have more well-being than people had in the past, and this is what makes the present times so good. The fact that we have little or no excess happiness does not at all detract from this goodness.
The value of hedonic adaptation lies in the motivational power of unhappiness. Happiness causes complacency and passivity, while unhappiness drives us to exert ourselves to improve our circumstances. Even though we are now very well off, we can make things even better by exerting ourselves; but we will do this only to the extent that we are unhappy–which we are (somewhat), thanks to hedonic adaptation.
Kevin Dick
Sep 16 2019 at 3:44pm
Hmmm. Let’s think a bit more about measurement error here.
As you point out, there’s significant measurement error of inflation over time.
But do you think happiness over time is measured with more or less error than inflation?
If you believe it’s more, than we really can’t say much at all.
Which from my read of the happiness literature seems like a reasonable belief.
nobody.really
Sep 16 2019 at 3:52pm
I also subscribe to the Hedonic adaptation hypothesis, which coincides with the “relative to expectations” hypothesis. To quote the joke-which-is-not-a-joke, the secret to a happy marriage is … low expectations.
Many stories begin with someone facing a crisis–at least, a crisis within their frame of reference–and the most feared outcome occurs. But as events unfold, with catastrophe upon catastrophe, a new frame of reference reveals “the most feared outcome” to be a trifle. Bilbo Baggins was dismayed to realize that he’d left his home without a proper handkerchief. What opinions would people draw about a man who didn’t have a proper handkerchief? What would the Sackville Baggins’ say? But by the time he found himself hundreds of miles from home, in a standoff with the only friends he had, surrounded by five warring armies, that whole handkerchief thing didn’t seem so pressing.
That said, what do we measure when we measure happiness? In Thinking Fast and Slow, Kahneman identifies two measures. You can ask people to rate their life on a 1-10 scale. This test seems to prompt people to reflect on their circumstances relative to their expectations. Yet this test is famously prone to influence by trivial matters. A pysch test showed that study subjects who had just found a dime on the copier would suddenly report that they were more content with their lives.
A second way to measure happiness is to enroll study participants to receive signals on their mobile phones and record on a 1-10 scale how happy they are at that moment. I have to suspect that a world in which fewer starving people are responding to the survey would produce a higher score, even if most people have reconciled themselves to the idea that they’re unlikely to starve.
Alfred Korzybski said, “God may forgive your sins, but your nervous system won’t.” Experiencing stress has real physiological consequences–consequences that to not disappear merely because the cause of the stress has. This suggests that if we live in objectively less stressful circumstances, we should see less adrenaline, noradrenaline and cortisol in the bloodstream, and less stress-related illness–even if we don’t acknowledge this fact on a happiness questionnaire. But perhaps hedonic adaptation means that we just adapt to our less stressful world and become stressed about ever more trivial things….
MarkW
Sep 16 2019 at 4:53pm
I’ve always thought that the obvious reason for ‘happiness stagnation’ is that it is invariably measured on a bounded scale that encourages relative rather than absolute thinking. And this is reinforced by relative questions that are guaranteed NOT to show increases over time with increasing incomes. This, for example, is from the ‘General Happiness Scale’:
If the world is getting better, lives are getting richer, healthier, and more interesting and people are generally enjoying life more, answers to this question still wouldn’t budge. Researchers have turned happiness into something that’s almost zero sum (encouraging you to rate yourself as happy only to the extent you’re outdoing your present-day peers in the ‘happiness race’).
robc
Sep 17 2019 at 11:09am
You mentioned this on a recent thread and it really resonated with me. This is the obvious problem comparing income to happiness as income is measured on an open ended scale and happiness is closed.
Here is an example. Lets say you score yourself an 8 out of 10 on happiness. Then you get a 26% raise. What if your happiness is exactly correlated with income? You cannot score yourself a 10.08, as that is out of bounds.
robc
Sep 17 2019 at 11:11am
I don’t know how to do it, but the happiness researchers need to create an open ended scale of happiness.
Then you would see things like average happiness in the 1600s was 4.7 and in the 1800s it was 11.6 and today it is 103.9. Or something like that.
Benjamin Cole
Sep 16 2019 at 8:37pm
The change in technology, most importantly the internet in the smartphone, make comparisons between different eras difficult.
Along the West Coast I would say living standards are lower than they were in the 1960s, due to the explosion in housing costs (which stems from property zoning).
People also drive sardine cans instead of high-finned extravaganzas and they sit in traffic for hours and more hours.
Young people used to move to Southern California to raise families. That never happens anymore.
In fact, the employee class in the US and in developed nations appears unable to reproduce itself. This leads to elite classes sacralizing immigration.
Brian
Sep 18 2019 at 7:07am
Lifetime average living standards are probably not lower because the West coast housing assets of the dying immediately become the assets of the living.
Weir
Sep 17 2019 at 7:00am
There’s a potential solution in the chorus to When You Wasn’t Famous:
When you’re a famous boy it gets really easy to get girls,
It’s all so easy you get a bit spoiled.
So when you try to pull a girl who is also famous too
It feels just like when you wasn’t famous.
Likewise in golf, the handicap. In diving, the degree of difficulty.
If making money is easy, make it challenging. Why not add a time limit?
A game consists of its rules. With the right rules it could be fun again.
Mark
Sep 17 2019 at 8:19am
I’m not following why income having little effect on happiness at a single point in time refutes the relative income hypothesis. The relative income hypothesis seems to be the strongest one for me because there are countries where people on average have very low incomes by US standards yet happiness is similar to or only a bit lower than US happiness. This seems explained by people comparing their incomes to a reference group. A minimum wage standard of living in the US is objectively an above-average standard of living for humans in the world (and way above average if you also count humans in the past), yet it feels poor because you’re comparing yourself to modern American neighbors.
Daniel Klein
Sep 17 2019 at 8:30am
I think MarkW’s point makes a fourth take on the matter.
If you asked Adam Smith: “Are you short, average, or tall?” He would have said “average.” If you ask me: “Are you short, average, or tall?” I would say “short.” But I, a “short” guy, am probably taller than Adam Smith was, an “average” guy.
Though we get taller, we remain on average only “average.”
nobody.really
Sep 17 2019 at 3:44pm
If you ask Hobbs to describe life in nature, he’d say, “nasty, brutish, and short.” Then again, Hobbs was nasty, brutish, and short.
(Just kidding; Hobbs was allegedly 6 ft tall. Haven’t heard about the nasty or brutish part, though…)
David
Sep 18 2019 at 1:09am
Have you considered the possibility that people usually prefer to spend money on things that don’t make them happy?
Brooklyn Boy
Sep 18 2019 at 8:26am
Where does the time spent working figure into this? Most people I know (in high tech) work insane hours, are always hooked in to their screens and almost never unplug and escape that treadmill completely. Companies like Google, Facebook and many other firms offer all sorts of inducements to stay at the office. While incomes may have risen 45%, the amount of time people are engaged in work in some form or other has also increased significantly. The balance of work and family is way out of kilter.
Jeff
Sep 18 2019 at 9:37am
Higher income and higher status get you more desirable mates and more opportunities to mate. The supply of highly-desired mates is limited and you compete for them, so it’s relative income and relative status that matter, not their absolute levels.
Tim
Sep 18 2019 at 11:30am
So here’s a way I think about this. I can get unlimited data at 4G speeds on my phone for ~$70/month. It is, of course, unthinkable to imagine how much this would have cost ten years ago (hundreds of dollars? thousands?). Furthermore, I can get an incredible, state of the art phone for $500-$1,000 which has features that are unthinkable in 2009. This is great! On the other hand, my cell phone bill is now probably twice or more what it was in 2009 and my cell phone costs 2-4x more. So I feel much worse off. I think this is true of many baseline services, for instance, housing: housing is much more expensive than it was many years ago, but houses are also bigger and fancier.
Larry
Sep 19 2019 at 2:01pm
GDP is so last century.
Shouldn’t we use something analogous to QALY but extended beyond health? We could think in terms of the number of QALYs delivered each year, or the % of QALYs versus the total.
Comments are closed.