Economics Review Questions

[Lyric Maro]

Iwant to begin by thanking the Board of Trustees of the University of South Carolina, President Pastides, and this year's graduates for the great honor of addressing this commencement ceremony. Although I was born just across the border in Augusta, Georgia, I considered South Carolina my home from early childhood until I married and took my first academic job after graduate school. During most of that time, my family lived in Dillon, a couple of hours' drive from here. I have had several occasions to visit Dillon and other places in the Carolinas since I got into government work, and I am both amazed and proud about the remarkable economic and social progress that has occurred since I grew up here. South Carolina, like America, is always reinventing itself, despite new and, it sometimes seems, ever more difficult challenges.

I always find it difficult to choose a topic for a commencement talk. I am an economist, but my experience has been that people in a celebratory frame of mind are usually not that interested in an economics lecture. (I can't quite understand why not.) Instead, they are generally looking for something more personal and inspirational. So I thought I would split the difference between an economics lecture and inspirational remarks and speak briefly about what economics and social science more generally have to say about personal happiness, and what those ideas imply both for economic policymaking and the choices each of you will make as you leave college for other pursuits.

Why talk about happiness? Well, it's right there in the mission statement of the United States, the Declaration of Independence: The inalienable rights of Americans are "Life, Liberty and the pursuit of Happiness." If Thomas Jefferson thought it was important to facilitate the pursuit of happiness, maybe we should think a bit about what that means in practice.

In exploring the question, researchers have distinguished between two related, but different, concepts--"happiness" and "life satisfaction." They use "happiness" to mean a short-term state of mind that may depend on a person's temperament, but also on external factors, such as whether it is a sunny or rainy day. They use "life satisfaction" to refer to a longer-term state of contentment and well-being.1 The relationship between life satisfaction and happiness, and the factors contributing to each, is not always straightforward. I'll come back to this issue later.

As you might guess, when thinking about the sources of psychological well-being, economists have tended to focus on the material things of life. This proclivity is why economic policymakers often emphasize the promotion of economic growth. The richer a country is, the higher the material standard of living of its average person. What applies to a country applies to individuals: Higher income equals a higher standard of living, which most people desire.

This traditional economist's perspective on happiness is not as narrow and Scrooge-y as you might think at first. If I were to ask you what you value in life besides goods and services--a nice car or house, for example--you might begin with, say, your health. Well, richer countries have more resources to devote to medical care, to good nutrition and sanitation, and to workplace safety, and for these and other reasons rich countries have higher life expectancies, lower infant mortality rates, and generally better health indicators than poor countries. Likewise, as the United States has grown richer over time, longevity and other measures of health have improved.

Another thing that most people value is a clean environment. Air and water quality are not included in the broadest measure of economic activity emphasized in government statistics, the gross domestic product (GDP), although some economists have worked on ways to do so. But again, rich countries have more resources to devote to maintaining a clean environment and do tend to have better air and water quality than poor and middle-income countries, notwithstanding the fact that rich countries by definition produce more goods and services. Rich countries also generally provide people more leisure time, less physically exhausting and more interesting work, higher education levels, greater ability to travel, and more funding for arts and culture.2 Again, these linkages, together with the benefits of enjoying a wide variety of goods and services, are the reason that economic policymakers--at the behest of the public--usually put heavy emphasis on job creation and growth. Along with price stability, maximum employment is one of the Congress's two mandated objectives for the Federal Reserve. And, indeed, economists researching happiness and life satisfaction have found that both inflation and unemployment detract from happiness, consistent with the focus on these macroeconomic conditions in the mandate of the Federal Reserve.3

Even though I hope I have persuaded you that purely economic measures of personal well-being are not as narrow as sometimes thought, I have so far dodged the key questions: Ultimately, what makes us happy? What makes our lives satisfying in the long run? And, more subtly, how is the state of mind we call happiness, at least as social scientists define the term, related to our long-run life satisfaction? We can look inward for answers, but, at least for someone trained as a social scientist, the most direct way to tackle the question is just to go out and ask people--lots of people. In fact, psychologists for some time have been running surveys in which they have asked thousands of randomly selected people in countries all around the world to rate their own happiness or life satisfaction, and recently economists have gotten into the act. There is now a field of study, complete with doctoral dissertations and professorships, called "the economics of happiness." The idea is that by measuring the self-reported happiness of people around the world, and then correlating those results with economic, social, and personal characteristics and behavior, we can learn directly what factors contribute to happiness.

The results of these studies are quite interesting. One finding is that most people consider themselves to be reasonably happy, despite the undeniable hardships that many people face. Asked a question like, "Taken altogether, how would you say things are these days--would you say you are very happy, pretty happy, or not too happy?", about 90 percent of respondents in the United States reply that they are very happy or pretty happy, a relatively high percentage.4 Perhaps people don't want to admit to survey-takers that they are unhappy, but the explanation preferred by most researchers is that human beings are intrinsically very adaptable and are able to find satisfaction in their lives even in very difficult circumstances.

Another area of this research bears directly on what I said earlier about the relationship between income and happiness. Some years ago the economist Richard Easterlin showed that, just as would be expected, wealthier people in any given country are more likely to tell a survey-taker that they are happy with their lives than are poorer people in the same country. However, Easterlin also found two other things that don't fit so well with the economic perspective. First, he found that as countries get richer, beyond the level where basic needs such as food and shelter are met, people don't report being any happier. For example, although today most Americans surveyed will tell you they are happy with their lives, the fraction of those who say that they are happy is not any higher than it was 40 years ago, when average incomes in the United States were considerably lower and few could even imagine developments like mobile phones or the Internet. Second, he found that--again, once you get above a basic sustenance level--on average, people in rich countries don't report being all that much happier than people in lower-income countries. The finding that people in rich countries don't report much greater happiness than those in lower-income countries--even though, in any given country, the rich say they are happier than the poor do--is called the Easterlin paradox, after its discoverer.5

Now, research in social science is hardly ever the final word, and a large body of more recent research has contested Easterlin's results, finding that people in rich countries may, on average, be happier or more satisfied after all. But this research still suggests that the increase in happiness flowing from greater wealth is moderate. For example, reported levels of life satisfaction among Americans are similar to reported levels among Costa Ricans, who have about one-quarter the per capita income.6 So I am going to continue under the assumption that, although wealth and income do contribute to happiness and life satisfaction, other factors must also be very important.7 Or, as your parents always said, money doesn't buy happiness. Well, an economist might reply, at least not by itself.

What could explain Easterlin's finding that, beyond a certain point, wealth and income don't buy happiness? Easterlin's own view, taking an economic perspective, is that people's happiness depends less on their absolute wealth than on their wealth compared with others around them. If I live in a country in which most people have only one cow, and I have three cows, then I will have lots of social status and self-esteem and will thus feel happy. But if everyone around me has a luxury car, and I am hung up on status, I won't feel very special unless I have both a luxury car and an SUV. This relative-wealth hypothesis can explain why rich people are happier than poor people in the same country, but also why people in richer countries are not on average much happier than people in poorer countries. It's the big fish in a little pond phenomenon.

There is certainly something to this explanation. "Rich" is a relative term. When I was a kid, having a color television was a major status symbol. Now, most households have color TVs, often more than one. Your sense of how well off you are economically depends a great deal on your expectations and aspirations, which in turn are largely formed by the community in which you live.

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