Frey, B. S., & Stutzer, A. (2002). The economics of happiness. World economics, 3(1), 1-17.

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Happiness is not identical to utility, but it well reflects people’s satisfaction with life. For many purposes, it can be considered a useful approximation to utility. This allows us to empirically study problems that so far could only be analysed on an abstract theoretical level.

Happiness research adds a considerable number of new insights to well-known theoretical propositions. This has been shown with the example of how unemployment, income and inflation affect reported individual well-being.

Effects of unemployment

Economists’ views about the costs of unemployment differ. According to the ‘new classical macroeconomics’, unemployment is voluntary. People choose to go out of employment because they find the burden of work and the wage paid unattractive compared to being unemployed and getting unemployment benefits. In contrast, there are a lot of economists who take unemployment to be an unfortunate event, to be avoided as much as possible. To become unemployed is considered to be burdensome and, above all, involuntary. Happiness research is consistent with this latter view and suggests that unemployment strongly reduces subjective well-being, both personally experienced and for society as a whole.

Effects of income

Most economists take it as a matter of course that higher income leads to higher happiness. A higher income expands individuals’ and countries’ opportunity set, i.e. more goods and services can be consumed. The few people not interested in more commodities need not consume them; they are free to dispose of any unwanted surplus costlessly. It therefore seems obvious that income and happiness go together.

The empirical research on happiness evidence both supports and contradicts this generally held idea. In line with common thinking, it is found that at a particular point in time, and within a particular country, higher income is associated with higher individual happiness. In contrast, higher per capita income in society seems not to raise reported satisfaction with life in rich western countries. Even at an income level half that of the US, there are only small effects of higher average income on subjective well-being. This can be attributed to the rise in aspiration levels going with increases in income.

Effects of inflation

The econometric analysis of happiness data allows us to go beyond the a priori notions of theoretical economics, based on the distinction between anticipated and unanticipated inflation. Adjustment is the more costly, the higher is the variability in aggregate inflation and in relative prices caused by an increase in inflation. People must invest a lot of effort to inform themselves about, and insulate themselves from, the expected price increases. They may make many different errors, for instance underestimating the extent of future inflation, or how a particular price changes in comparison with other prices.

The welfare costs of rising prices have previously been measured by computing the appropriate area under the money demand curve. Based on this method, the cost of 10% annual inflation has been calculated to be between 0.3% and 0.45% of national income (Fischer, 1981; Lucas, 1981). This is very little and suggests that an anti-inflationary policy is rarely worth the cost it entails in terms of additional unemployment and real income loss. In contrast, happiness research finds that inflation systematically and sizeably lowers reported individual well-being.

Effects of democracy

The consequences of democratic rules have mainly been analysed in economics with regard to their effects on economic growth. Data on subjective well-being allow us to look at the interaction between democracy and happiness. The extent to which a constitution is democratic and allows its citizens to make decisions according to their own preferences can be captured by various measures. It is found that increased possibilities to directly participate in public decision-making via popular referenda and a decentralised state significantly contribute to happiness.

The insights gained about happiness are in many respects useful for economic policy undertaken by governments. Two examples suffice to illustrate the point:

  • Welfare policy is faced with the question of to what extent people with low incomes can be helped by financial support. If low income is due to unemployment, the research results suggest that not much is achieved by providing the person with a higher income. Rather, the policy should be directed towards providing the person with appropriate job opportunities.
  • Tax policy must consider to what extent various income groups are affected. Is it possible to achieve social goals by redistributing income, or are the negative effects on subjective well-being prohibitive?

The discussion in this paper intends to show that the happiness research in which economists have recently become engaged constitutes an important advance over previous economics. This research is only in its initial stages, and much still awaits analysis. For instance, most happiness studies consider developed economies. Additional empirical studies devoted to developing economies could broaden the picture and qualify previous findings. It has sometimes been claimed that comparisons of happiness between countries make little sense because of cultural differences. While differences between cultures are important, they are often exaggerated. Culture may, to some extent, affect what factors influence happiness but, as shown in various studies, there are universal factors determining subjective well-being, and it may also be argued—as Ng (2001b) does—that happiness as an ultimate goal in life is independent of culture.