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The Economic Future in Historical Perspective$

Paul A. David and Mark Thomas

Print publication date: 2006

Print ISBN-13: 9780197263471

Published to British Academy Scholarship Online: January 2012

DOI: 10.5871/bacad/9780197263471.001.0001

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Economic Welfare Measurements and Human Well-being

Economic Welfare Measurements and Human Well-being

Chapter:
(p.371) 12. Economic Welfare Measurements and Human Well-being
Source:
The Economic Future in Historical Perspective
Author(s):

Avner Offer

Publisher:
British Academy
DOI:10.5871/bacad/9780197263471.003.0013

Abstract and Keywords

This chapter focuses on alternative ways of measuring social welfare. These alternative measurements follow three approaches. The first involves extending the national accounts to incorporate non-market goods and services and to eliminate detrimental components. A second approach identifies social norms and evaluates their satisfaction through social indicators. The third approach involves the use of psychological indicators and attempts to reach directly into the experience of welfare using surveys of subjected well-being and research on the dynamics of hedonic experience.

Keywords:   social welfare, social norms, social indicators, psychological indicators, hedonic experience

Introduction

Richard Easterlin asked memorably, ‘Does Economic Growth Improve the Human Lot?’1 This chapter suggests that ‘it all depends—on history’. In 1948, a standard System of National Accounts (SNA) was adopted by the United Nations.2 Its broad and rapid acceptance facilitated international and inter-temporal comparisons, and generated a competitive preoccupation with economic growth, which continues among economists and economic historians to the present day. Extended into the past, it allowed the measurement of modern economic growth back to its beginnings.3 The primary purpose of the SNA was not to monitor human welfare, but to provide an efficient measure of cyclical changes in total economic activity. In that role it is an enduring success. Its persistence has some of the attributes of technological ‘lock-in’ and path-dependence. The same applies to its more problematic role as a welfare measure: during the 1950s and the 1960s, the output measure of GDP per head, or its annual rate of change, also became a normative benchmark for economic and even social performance, the higher the better.

The ‘golden age’ of 1950 to 1970 had barely taken off when the welfare value of economic growth began to be queried.4 Books like John K. Galbraith’s The Affluent Society, Vance O. Packard’s The Waste (p.372) Makers, David Riesman’s Abundance for What? and E.J. Mishan’s The Costs of Economic Growth sold well in the late 1950s and early 1960s. They were followed by the anti-materialist ‘counter-culture’ of the 1960s, and the anti-growth environmentalism of the 1970s. The discipline of economic history was also affected. In Britain, the ‘pessimists’ in the ‘standard of living’ debate argued that material improvement was compatible with a decline in well-being. In the United States, the debate on the economics of slavery suggested that efficiency was compatible with human degradation.

The debate on economic growth is usually regarded as an expression of conflicting values. But it might also be the case that the sources of human welfare are historically contingent. As the two decades of the post-war age (c. 1950–1970) came to an end, attention began to shift towards the costs of affluence, ecological, social and psychic. In the poorest of countries, priority was claimed for a set of basic needs over the sacrifices necessary for maximizing GDP. Hence, from the late 1960s onwards, the quest for alternatives to GDP as measures of welfare.

‘Alternative’ measurements of welfare have followed three approaches. The first involves ‘extending’ the national accounts, to incorporate non-market goods and services, and to eliminate detrimental components. A second approach identifies social norms, and evaluates their satisfaction by means of ‘social indicators’. A third approach has targeted mental states directly, with surveys of reported subjective well-being, and research on the dynamics of hedonic experience. Cumulatively, these three approaches suggest that the pursuit of welfare is not always satisfied by economic growth alone, and may require different measures at different times.

Extended Accounts

The micro-economic foundations of the SNA are insecure. The obstacles to the measurement of economic welfare at the micro level are formidable. Much of the difficulty arises from the problem of disaggregation from market prices and quantities to household and to individual consumption.5 Aggregating welfare upwards from individuals and households to the level of society is even less tractable. As (p.373) Amartya Sen puts it, ‘personal real income theory translates readily into the theory of real national income [only] if the nation is viewed as a person.’6 This ‘welfarist’ position, he says, is ‘not outrageously realistic’. Since the nation is not a single person, a higher level of GNP might fail to deliver more ‘welfare’, even in the narrow utilitarian sense.

In the face of such doubts, the pervasive use of GDP per head as a social welfare measure is a puzzle. The assumption that society is a unitary actor does help to side-step some intractable problems: the difficulty of making interpersonal and intertemporal comparisons of welfare, of taking account of inequality, of compensating losers for Pareto improvements, and of evading Arrow’s impossibility theorem. One explanation might be an assumption that underneath we are all pretty much the same, and share a repertoire of innate needs.7 When SNA is defended as a measure of welfare, it is on pragmatic grounds, by pointing to positive correlations, often implicit ones, with social indicators such as health, life expectation, and education.8 The unitary actor assumption also has a compelling appeal for international comparisons. And sometimes there is an a priori preference from doctrine or self-interest for market-friendly policies that can be justified as maximizing GDP.

Unlike the SNA, systems of ‘extended accounts’ are mostly designed to measure welfare. They start out with the SNA core, and make adjustments on consumption and capital accounts: they typically eliminate some commodities and services which are seen not as final goods in themselves, but as ‘regrettable necessities’. Finally, they impute a value to sources of welfare from outside the market. Early estimates were produced in the late 1960s, by Kendrick and Sametz.9 Nordhaus and Tobin’s ‘Measure of Economic Welfare’ (MEW) of 1972 was very influential.10 This measure eliminated ‘regrettables’, such as commuting, police, sanitation, road maintenance, defence and the (p.374) disamenities of urban life from total output. On the positive side, Nordhaus and Tobin imputed values for household production, and for time available for leisure.

Extended accounting of this and similar kinds has continued into the 1980s and the 1990s, and has included estimates for the United States, Britain, Europe and Australia. 11 Some of these contained retrospective historical accounts, going back to 1950 for Britain, 1869 for the United States, and all the way to 1788 for Australia.12 These indices indicate that extended welfare has been positively correlated with GNP over the long run, though the actual growth rates have differed.13

The most compelling implication is that more welfare is derived from non-market than from market activities. Typically the imputed value of leisure equals or exceeds the value of GDP, and household production adds another 25 to 45 per cent. About two-thirds of output arise outside the market. This salience of non-commodities casts doubt on the welfarist assumption that all well-being can be priced. Leisure and housework dominate the index, and are relatively slow to change. Hence, the summary indicators are not much use for monitoring cyclical fluctuations.

Extended accounting relies heavily on the allocation of time. There is also a strand of research which takes time-use as the measure of welfare. This lends itself both to micro and to macro applications.14 Gershuny and colleagues have been attempting to devise an encompassing system of accounting based on time use, with a wide international coverage, and going back to the early 1960s.15

The concept of sustainable consumption goes back to Hicks, who defined it as the maximum value of consumption which would leave the individual afterwards as well-off as before.16 In their study of 1972, Nordhaus and Tobin attempted to estimate ‘sustainable’ welfare, which they took as consumption plus net investment.17 They acknowledged the need to take account of the depletion of non-renewable natural (p.375) resources. This had been anticipated by Kapp in 1950, and several estimates were produced during the 1970s.18 Weitzman provided theoretical underpinning: national product net of asset depletion also described the discounted sustainable productive potential of the economy.19 A more normative and radical approach was pioneered by Zolotas in 1981. He incorporated pollution and natural resource depletion into a set of extended accounts for the United States for the period 1950 to 1975, and also imputed shadow costs to some social detriments.20 His index of the economic aspects of welfare (EAW) rose progressively more slowly than GNP, and he envisaged a time, a generation hence, when an increment of GNP would produce no welfare at all. He argued that this was a systemic feature: ‘beyond a certain point, economic growth may cease to promote social welfare. In fact, it would appear that, when an industrial society reaches an advanced state of affluence, the rate of increase in social welfare drops below the rate of economic growth, and tends ultimately to become negative.’21

Concern over inequality has motivated a good deal of the effort to devise measures of welfare.22 Atkinson’s influential index provided a measure for evaluating the effect of income inequality on welfare, which could be adjusted to the amount of inequality tolerated (or desired).23 This has been applied to extended accounts by Beckerman, Crafts, and Jackson et al.24

After a hiatus in the 1980s, Daly and Cobb continued to develop the Zolotas model: they incorporated inequality (based on Gini coefficients) into a new measure, the Index of Sustainable Economic Welfare (ISEW).25 This had the effect of depressing the index: inequality has worsened since the 1970s, and it offset the benefits of economic growth.26 The principle of ‘sustainability’ in the rubric referred primarily (p.376) to the depletion of non-renewable resources. Daly and Cobb also removed the imputation for leisure time, on the grounds that it dominated the index and was conceptually unsound. It was this item mainly that had tended to offset the increase in inequality in less radical accounting exercises.27 While GNP continued to grow, the American ISEW declined overall by about 25 per cent between the 1975 and 1990, and the British one by almost 50 per cent during the same period.28 Later versions (Figure 1) show smaller declines. The innovation has caught on, and ISEW measures are available for Australia, Austria, Chile, Germany, Italy, the Netherlands, Sweden, the UK and the USA.29 All except Italy record ISEW growth until the 1970s, with stagnation or decline afterwards. ISEW is explicitly normative, where SNA is only so implicitly. An American variant, the ‘Genuine Progress Indicator’, is bolder still, and introduces imputations for divorce and crime.30 For all their defects, these measures are effective ways of articulating a normative position on economic change.

Economic Welfare Measurements and Human Well-being

Figure 1. GNP and index of sustainable economic welfare (ISEW), USA 1950-c. 1995.

(p.377) If we are to think of society as a unitary actor, then according to the ISEW, the growth in economic activity since the mid–1970s has been producing a reduction in aggregate welfare. Since the 1970s, from this perspective, the pursuit of further growth has been irrational. It is only myopia and habit which allow it to continue in the face of negative welfare returns. The problems of aggregation should be borne in mind, and the imputation of environmental depletion is open to criticism. For Britain, however, the inflection point remains even without this imputation.

Extended accounting is approaching official recognition. Following two decades of research and consultation, in its last revision of the SNA, the United Nations introduced guidelines for an optional set of ‘satellite’ environmental accounts, designed to integrate with the main core SNA.31 ‘Sustainability’ has become a normative public policy objective in the UK.32 This perspective of diminishing returns to economic growth is also captured in a different research programme, the measurement of normative social indicators.

Social Indicators

An abiding idea is that access to certain goods constitutes a precondition of welfare. Early examples in Britain were the Poor Law, compulsory primary education, and B.S. Rowntree’s ‘Poverty Line’ of 1901. In the 1960s and early 1970s this approach re-emerged as the ‘social indicators’ movement. This was also inspired by the idea that real welfare was not captured by the SNA indicators.33 Typically the goods in question consisted of nutrition, housing, education, health and life expectations, environmental quality, crime, and poverty levels. They might also include such objectives as the freedoms of movement, expression and political organization. Implicit in social indicators is some notion of adequacy: there is too little of some things, such as nutrition, housing or education; or too much of others, such as poverty, inequality or crime. Social indicators are rarely scaled in the metric of money, or set within an accounting framework.

(p.378) By the early 1970s, several leading countries and international bodies had published one-off or serial collections of social indicators.34 This enterprise has not abated. Social indicators relied implicitly on a social-democratic consensus, with an egalitarian bias and a quest for social inclusion, as in the Scandinavian ‘level of living’ surveys.35 But there was a lag between impulse and execution, and by the time social indicators were delivered, the impetus of social democracy was spent. Priorities for social expenditure had already been set in the ‘golden age’ period of expansion and the 1970s were a period of fiscal retrenchment. Social consensus swung away from equality and towards competition, from the left towards the right. The absence of a coherent accounting framework was another disadvantage.

In developing countries, deprivation was not relative but absolute. In the 1970s a ‘basic needs’ movement identified a bundle of goods that might claim priority over economic growth.36 Morris argued that if encompassing was beyond reach, there was a virtue in parsimony. He introduced an unweighted ‘Physical Quality of Life Index’ (PQLI), made up of infant mortality, literacy and life expectation at age one, as a single measure of welfare.37 Economic historians adopted the same principle by taking anthropometric measures, primarily heights, as a welfare index.38

What followed shows how social indicators not only depend on norms, but can also help to create them. The focus on basic needs came into conflict in the 1980s with the World Bank/IMF ‘structural adjustment’ policy, and with the increasing market orientation within development economics. The results of these programmes have been mixed, but the impression was that costs fell often disproportionately on the poor. In the late 1980s, dissatisfaction with the ‘structural adjustment’ programme inspired the creation of a new social indicator, the Human Development Index (HDI).39 This is made up of income per head, life expectation at birth, and an education indicator, expressed in a single figure between 0 and 1. It has gained wide acceptance, and may have played some role in the partial retreat of the World Bank (p.379) and its acknowledgment of poverty as a policy objective.40 Morris’s updated index of 1996, which covered a longer time-span, also exposed the ambiguity of the links between growth and welfare.41

It is interesting to compare HDI and GNP with Sen’s ‘capabilities’ approach, which has attracted a great deal of discussion. Sen moved from an axiomatic ‘welfarist’ position to the view that income alone does not satisfactorily capture welfare. In keeping with liberal values, he has not privileged any particular good. Even under indigence it was necessary to respect individual priorities.42 Well-being constitutes having the ‘capabilities’ to achieve valuable ‘functionings’. Both of these categories extend beyond the purely economic. Sen has not embodied his approach in any metrics, but it has influenced the Human Development Index. ‘Alternative’ approaches, especially Sen’s capability/functioning approach, and the various ‘sustainability’ measures are congruent to some extent with non-utilitarian ethical frame-works— Eastern, Jewish, Greek, Christian, ‘Enlightenment’, Romantic—which teach that acquisitiveness may be self-defeating, and which highlight other welfare criteria: virtue, stoicism, altruism, approbation, self-realization.

The most compelling justification for the SNA as a measure of welfare is its correlation with social indicators which enjoy normative consensus as ‘good things’. Hence, it is instructive to test the claims that this correlation exists. What such tests indicate is that the correlation is strong under conditions of indigence, but loses its power at surprisingly low levels of real income. In Figure 2, three such indicators are plotted against income per head. These are Morris’s Physical Quality of Life Index (3 indicators), Estes’ Index of Social Progress (36 indicators in 10 subgroups), and Slottje’s Multidimensional Quality of Life Index.43 All three suggest a strong diminution of welfare returns to income at around $2500–3000 US in 1981 prices. A logarithmic curve provides the best fit. The HDI already incorporates such a turning point in its premises, by including income per head in its arguments, with a diminishing return to incomes higher than the whole-sample average.

(p.380)

Economic Welfare Measurements and Human Well-being

Figure 2. Social indicators and income per head, 1981, 1983. Selected countries.

(p.381)

Table 1. Measures of the relation of welfare to income per head, c.1870–1973.

Welfare units per 1990 dollar of GDP per head, 1870–1973

 

UK

USA

France

Germany

1870

1.2

1.8

2.2

2.0

1913

1.0

1.0

1.5

1.2

1950

0.9

0.7

1.1

1.5

1973

0.6

0.5

0.5

0.5

HDI* per 1990 dollar of GDP per head, 1870–1973

 

UK

USA

France

Germany

1870

1.1

1.5

1.7

1.7

1913

1.0

0.9

1.3

1.2

1950

0.9

0.7

1.1

1.4

1973

0.6

0.5

0.6

0.6

Income Elasticity of Welfare Index

 

UK

USA

France

Germany

1870–1913

0.5

0.3

0.4

0.3

1913–1950

0.7

0.3

0.2

0.9

1950–1973

0.3

0.1

0.1

0.1

Income Elasticity of HDI*

 

UK

USA

France

Germany

1870–1913

0.7

0.4

0.6

0.5

1913–1950

0.8

0.6

0.6

2.2

1950–1973

0.3

0.3

0.3

0.2

Notes: Welfare index is made up of (% school enrolment+life expectation) 2. HDI* is the Human Development Index, with the income element untruncated. Index units multiplied by 100. The indices are bounded variables but are well short of the maxima even in 1973.

Source: Calculated from Crafts, ‘Human Development Index’.

A visual examination of the figures indicates that some countries achieve very high levels of welfare indicators on very low incomes, and that others persist in low welfare indicators on high incomes. These three exercises in social indicators research echo the extended accounts findings of a curvilinear relation between income and welfare.

These data are cross-sections at one point in time. Similar patterns also appear to obtain over the long term. The contribution of economic growth to welfare may have been underestimated for the earlier (p.382) periods of economic development, as has been noted by Crafts.44 A corollary is that its contribution to welfare may be overestimated for the period of affluence. This is suggested by some very crude measures in Table 1. This table takes two measures of welfare, (a) an ad hoc welfare index made up of percentage school enrolment and life expectation,45 and (b) the Human Development Index. For both measures, the corresponding purchasing power of a 1990 dollar and the income elasticity (in 1990 dollars) are calculated. In the four countries measured, there is a downwards trend in the welfare purchasing power of income over time, although the income elasticity of welfare tends to peak in the inter-war years. In brief, then, dollars deliver diminishing returns in simple welfare measures over time, as well as in the cross-section.

It could be argued that the simple development indices are misleading, in that the measures used are exhausted under affluence. Measures like HDI and PQLI are oriented strongly towards the priorities of indigence. The most extensive social indicators study so far puts this possibility to the test.46 Easterly used a panel dataset of 81 indicators covering up to four time periods (1960, 1970, 1980 and 1990), in seven domains.47 Each of these indicators was regressed on income per head, with fixed time effects. The criterion for robustness was an impact on the quality of life indicator that was significant, positive and more important than exogenous shifts. Exogenous shifts capture the effect of global socio-economic progress which may arise from the diffusion of knowledge or of norms. Three methods were used. In the first, all data were pooled, and only time effects were included in the regression. Thirty-two out of eighty-one indicators passed this test. When country fixed effects were added, the number of robust indicators fell to 10. With a first-differences IV estimator to establish causal effects, only 6 indicators survived out of 69. Three variables alone passed all three tests: calories per head, protein per head, and telephones per head. The first two, however, are known to be problematic (p.383) once adequacy has been reached.48 This comprehensive study confirms that the relationship of well-being and income per head is weak, both in cross-section and over time.

Association between health outcomes and economic status has long been observed within countries.49 It is not entirely clear how much ill-being arises simply from material deprivation, and how much from the psychic costs of exclusion. There are good descriptive indicators of inequality, such as the Poverty Line, the Lorenz Curve, the Gini Coefficient, Atkinson’s index and Pareto’s alpha. What is lacking are standard, simple, social indicators of the consequences of inequality for affluent societies, an index of deprivation and detriment similar perhaps to the PQLI or HID. Such indices are currently under construction.50 It is also possible, of course, that causation is not exclusively from low status/income to poor health, but also the other way round, from poor health to low status/income.

The HDI has the prestige of UN approval, is widely used and quoted, and has also been used retrospectively for historical evaluation.51 The United Nations has now also laid down a standard for a 15–item ‘minimum national social data set’.52 But unlike HDI or PQLI, the components do not lend themselves to aggregation, indexation or a focal-point summary figure. These indicators are oriented towards development. They are essentially catch-up indices, calibrated to current best practice. They fail to address the original impulse of the social indicators movement, which was finding a way of measuring welfare in affluent societies; not only the welfare of the poor in those societies, but also of those who are working, healthy, and reasonably well-off. How does economic growth affect such people, and is it worth the cost?

(p.384) Psychological Indicators

Economic resources are not final goods, but intermediate ones. Pigou conceded that ‘welfare consists of states of consciousness only and not material things’, and Irving Fisher wrote, ‘human beings are ever striving to control the stream of their psychic life by appropriating and utilizing the materials and forces of nature’.53 From this viewpoint, to understand the economy, more needs to be known about the mind. Psychological approaches attempt to reach directly into the experience of welfare. They test the validity of the national accounting measure of welfare in two ways: ‘static’ measures estimate the correlation between SNA goods and psychological indicators of well-being. ‘Dynamic’ approaches probe deeper into the hedonics of satisfaction.54

Like ‘human development’, the static ‘happiness’ approach has also produced a measurement standard. This constitutes survey data on responses to a simple question about current subjective well-being on a bounded ordinal scale (1–3, 1–5, 1–7 or 1–10). One variant is the following survey question: ‘Taking one thing with another, how would you describe your feeling today? Very satisfied, quite satisfied or not so satisfied?’ The response to questions of this kind is known as ‘Subjective Well-being’ (SWB). The stock of surveys of this kind is very large. Some time series go back as far as the 1940s.55 The indicator is crude, but this is not necessarily a defect. It has a defensible empirical validity.56 A common theme in this literature is that levels of reported well-being are remarkably high in affluent societies. Those describing themselves as unhappy or very unhappy are typically fewer than 15 per cent.57

Richard Easterlin was originally impressed by an apparent lack of relation between country income levels and SWB.58 This was challenged by Veenhoven, who identified a curvilinear relation, rather like the social indicators in Figure 2.59 A recent comparison of countries was carried out by Diener et al. (Figure 3a).60 They found that SWB (p.385) rose moderately but significantly with income, with a large variance, of which 37 per cent was explained. Subsequent analysis of the same data indicated an inflection point at the 75th percentile: above that level, income did not provide any increment to subjective well-being.61 But cross-sections do not establish convergence over time. In fact, for the United States, France and Japan, SWB changed hardly at all since 1946, over a period in which real incomes per head have more than doubled (Figure 3b).62

Economic Welfare Measurements and Human Well-being

Figure 3. Subjective well-being, income and time. Selected countries.

Sources:

(a) Diener et al., “Factors Predicting”, Table 1, p. 856.

(b) Diener and Suh, ‘Measuring Quality of Life’, Table 1, p. 211.

This result has been confirmed by surveys of SWB at the individual level. SWB has been correlated with an array of socio-economic determinants and domains. This approach was first applied in cross-section on an American national sample in the early 1970s.63 The predictive power of each individual determinant of global well-being was low, and even all of them together accounted for only about half of the variance. Income on its own counted little for happiness, and the relation is again curvilinear: the effect is stronger at lower incomes. The positive effect of income is stronger in cross-section than over time. A large longitudinal study in the United States found a very modest relation of income to well-being (r=0.12), with a curvilinear form, flattening out at (p.386) about $6000–8000 (1971 to 1975).64 Interestingly, a rise of income over time for particular individuals produced no improvement at all in well-being. Among the determinants of SWB, the quality of relationships, of leisure and of work experience counted considerably more for aggregate well-being than income and consumption measures.65 Materialism, a preoccupation with economic well-being, was negatively correlated with SWB, and especially so in those who believe that more money would make one happier.66

Table 2. Happiness in the United States (ordered probit), 1972–1994. Dependent variable = Reported Happiness on a three-point scale. N = 26,668.

Variable

Coeff.

Std.error

Unemployed

−0.379

0.041

Self-employed

0.074

0.023

Male

−0.125

0.016

Age

−0.021

0.003

Age squared

2.77E-04

3.00E-05

Education: High school

0.091

0.019

      Associate/Junior college

0.123

0.04

      Bachelor’s

0.172

0.027

      Graduate

0.188

0.035

Marital status: Married

0.38

0.026

                        Divorced

−0.085

0.032

                        Separated

−0.241

0.046

                        Widowed

−0.191

0.037

No. of children: 1

−0.112

0.025

                           2

−0.074

0.024

                           3 or more

−0.119

0.024

Income quartiles: Second

0.161

0.022

                            Third

0.279

0.023

                            Fourth (highest)

0.398

0.025

Retired

0.036

0.031

School

0.176

0.055

At home

0.005

0.023

Other

−0.227

0.067

Source: Di Telia et al., ‘Macroeconomics of Happiness’, Table 3, p. 20.

(p.387) The determinants of SWB have more recently been investigated on very large samples over time, in both the United States and in Europe.67 The findings are consistent with previous ones. They show little variation of SWB over time. Absolute income counts for little but relative income (that is position in the ladder of earnings) has significant influence on well-being, from the second quartile upwards. Misery, that is strong negative divergences from the reference case (white, married, female, employed), is caused primarily by three conditions: non-white race, unemployment and non-marriage. There are also a number of consistent but weaker effects, such as age (U-shaped). Gender makes no difference. In the European sample there are also very strong country effects. The magnitude of the coefficients is remarkably similar from one large sample to another, which indicates that however crude SWB is as a measure of well-being, its components are surprisingly robust. Table 2 is typical.

The positive cross-sectional correlation of income and SWB within countries has long suggested a link from static to dynamic approaches, and to the ‘relative income hypothesis’, which states that what counts is not absolute income, but relativities.68 From this point of view, even a large rise in income will leave no impact on well-being, if distribution is unchanged. For example, the large rise in American, French and Japanese incomes since the war has hardly changed their SWB scores (Figure 3b). The reason for this, it is argued, is that as incomes increase, so do consumption norms.69 Consumers become habituated to new levels of consumption. Scitovsky reviewed psychological research on arousal and habituation to probe the dynamics of diminishing returns,70 and questioned whether American acquisitiveness was in fact increasing welfare. The Dutch ‘Leyden Approach’ to welfare research has also found that the welfare increment declines substantially as income increases. Earning norms drift up with income, though not all the way. A more vivid metaphor, which applies to all three measurement approaches to welfare, is the ‘hedonic treadmill’: income has to rise in order to sustain satisfaction at a constant level.71

(p.388) The World Values Survey permits a cross-sectional test of the importance of the effect on subjective well-being of relative and absolute income. Figure 3 indicates that in the cross-section absolute income is quite highly correlated with subjective well-being scores. But the same dataset also makes it possible to distinguish whether it is relative or absolute income that produces well-being.

The three waves of this survey (in the early 1980s, and early and mid–1990s, covering forty-six countries in all) record both relative and absolute income levels. The effect of income on subjective well-being was analysed in regressions with a very large sample of 87,806 observations, which included a maximum of 38 variables (some of them sub-categories). It was found that both absolute and relative income delivered strongly diminishing returns of well-being. Taking relative incomes first, for an individual to move from the fourth to the fifth income decile raised well-being by 0.11 units, but from the ninth to the tenth, only 0.02 units, although in absolute terms the latter was the much larger increase. Comparing absolute income internationally, a 10 per cent increase in per capita incomes at half the US level would increase average individual well-being by only 0.0003 of the same units, while net gains became zero before US levels were achieved.72

The low responsiveness of well-being to income under affluence may arise because people are simply born happy or unhappy, and most are happy already. Longitudinal studies indicate that personality is a strong predictor of SWB.73 One review concludes that happiness is more a trait than a state.74 A study of separated identical twins suggests that neither social and economic status, educational attainment, family income, marital status nor religious commitment could account for more than three per cent of the variance in ‘happiness’. About half the variance was associated with genetic variation. Subsequent re-testing suggested that about 80 per cent of the stable element in well-being was heritable.75

Culture provides another element of stability. Affluent industrial societies with similar levels of income per head report very different levels of subjective well-being, with a gradient coming down from the Nordic countries, which have very high levels, the English-speaking (p.389) countries at an intermediate level, the Catholic middle and south of Europe lower still, and Japan lowest of all.76 Inglehart regards this gradient as representing an adaptation or adjustment to affluence. He classifies societies on two value orientation dimensions, the pursuit of economic security and deference to traditional authority. As societies become more affluent, they move gradually away from both. This implies that the experience of affluence reduces concerns about economic security, and that culture adapts, albeit slowly, to changes in economic endowment.77

In affluent societies, culture appears to affect SWB more strongly than income. Japan and Australia had comparable incomes per head in the early 1990s but Australia scored an SWB of 1.02 (mean of 60 countries at 0), with Japan at the other end of the affluent country distribution, at —.86. Once controlled for ‘individualism’, the correlation of income and SWB disappeared.78 This suggests that the hedonic ideal of individual welfare, utility or happiness might be an ethnocentric cultural construct that is peculiarly Nordic, Anglo-Saxon or Protestant. European surveys of SWB over time have produced very large country coefficients.79 The long-term persistence of SWB scores in particular countries even brings to mind the idea of ‘national character’.

An early inspiration of the social indicators movement was the 1960s ‘rediscovery of poverty’, which redefined it as a relative rather than absolute form of deprivation. Easterlin has hypothesized that expectations are formed by comparisons with parents, and that demographic cycles mean that (in the United States, at least, since World War II) different cohorts have different expectations.80 Satisfaction has moved pro-cyclically for young adults, with those of the ‘golden age’ exceeding their own modest expectations, while the successor ‘baby boom’ having its higher expectations disappointed. A related perspective is Inglehart’s long-standing study of ‘post-materialism’. The argument here is that the post-war cohorts have shifted their preferences from economic to non-economic rewards, as a result of their experience of economic security.81

(p.390) A different psychological approach is to investigate the hedonic dynamics of satisfaction. In welfare economics, it is assumed axiomatically that the consumer is well-informed, self-aware, consistent and acquisitive. These assumptions are necessary if ‘revealed preference’ is to equal welfare.82 Other approaches do not have such confidence in the cognitive abilities of the consumer. That individual choice might fail to maximize welfare is an old but neglected theme in welfare discourse. The Victorians distinguished between the deserving poor, who had suffered from adversity, and the feckless and undeserving, who had brought about their own misfortune. B.S. Rowntree made a distinction between ‘primary poverty’, which was caused by the shortfall of subsistence resources, and ‘secondary poverty’, caused by impulsive consumption and poor resource management.83 This is brought out by the difference between a ‘social indicator’ poverty line, which focuses on normative consumption, and a money metric one, which merely measures access to resources. Economists committed to rational choice might regard ‘secondary poverty’ as reflecting legitimate lifestyle choices.84

Empirical research into the determinants of choice queries the empirical validity of the axioms of rationality. This is not very damaging to SNA welfare measures, since, as we have seen, their micro-foundations are already insecure. These lines of research have not so far provided direct measures of the validity of welfare aggregation, but rather implicitly query the premises of consumer sovereignty. This effort has highlighted a sequence of systematic and recurrent deviations from normative optimizing choice behaviour.85 The most robust ones appear to be asymmetric valuation of gains and losses, and the ‘endowment effect’ by which goods increase their value once they have entered into possession. If correct, these findings cast further doubt on the possibility of compensating losers, and on the notion of ‘opportunity cost’. Research in the hedonics of satisfaction continues. It stresses that satisfaction depends on habituation, anchoring, contrast and temporal effects; that the experience of satisfaction varies with time, and changes between decision, experience and retrospection.86

(p.391) Under affluence, SWB appears buoyant and quite stable, and responds quite sluggishly to economic indicators, both stagnation and growth. It is poorly correlated with income in affluent societies, and highly correlated in poor countries, confirming the diminishing returns to income detected in social indicators research.87 Both extended accounting and static psychological indicators suggest that well-being is derived to a great extent outside the market, from human relations in the workplace, the family, and from other forms of attachment. The psychic payoff of rising absolute income is small, but gains from relative income are considerable. There are high levels of satisfaction with stable attributes such as personality, gender and nationality. Stability and habituation appear to promote well-being.

This also suggests that novelty may undermine it. New rewards are compelling, while their costs are not yet known. Economic competition is driven by novelty and innovation, which stimulate myopic rather than informed choices. In the absence of prior experience, new forms of stimulation are highly compelling. Innovation devalues existing prudential conventions and norms, and is to that extent destructive of existing psychic and social capital. Diener found that SWB is inversely related to the pace of economic growth.88 Cheap alcohol, drugs, tobacco and fast food are all innovations which it has taken society decades to adjust to and cope with.

Conclusion

‘Alternative’ measures of welfare provide a great variety of indicators, in cross-section and over time, international, intra-national and individual. A common pattern emerges: the relation of economic welfare and welfare overall is historically contingent. They all suggest a curvilinear relationship between economic welfare and human welfare. Using extended accounting and social indicators, international comparisons suggest an historical cycle of two periods. In the first, economic growth provides high welfare payoffs, as basic deprivations are remedied and basic needs are satisfied. In the second phase, GDP goods provide diminishing, steady or even negative returns, depending on the measure used. This pattern can be fitted to different curvilinear curves. (p.392) A logistic curve model was first proposed by Xenophon Zolotas in 1981. He described three phases in the relation of income and welfare— of privation, steady improvements and declining ones, respectively.89 More graphic metaphors might be the economy of deprivation and the economy of satiation; or the economy of pain followed by the economy of pleasure. For social indicators the logarithmic curve relation of welfare to income provides a good fit. The three studies presented in Figure 2, as well as the HDI, all have in common the initial steep rise, followed by an increasingly flat trajectory.

Subjective individual welfare also follows a similar log-normal or power curve response to economic welfare.90 The cross-sectional international comparative relation of subjective well-being with income is positive, linear and fairly weak; it disappears when controlled for relative income. The temporal relation for individual countries is almost completely flat. This is consistent with low psychic welfare returns to rising economic growth, the classic ‘hedonic treadmill’.

If it is true that GDP goods and services have delivered and are delivering diminishing welfare returns, the question is: Why? It is premature to attempt to answer it here, but a few observations might be ventured. Both ecological and psychological approaches have one notion in common, namely that affluence produces congestion. In both cases, the affluent economy produces more than it can absorb. The ecology cannot absorb the extra energy, the extra traffic, the extra pollution, without incurring costs that equal or exceed the benefits. Likewise, the abundance of psychic reward under affluence leads to satiation and habituation. These are simple-minded metaphors that require much greater analysis and empirical study.

But policy cannot wait. Alternative accounting of welfare is pragmatically motivated, and even at this stage, it has some implications for policy:

  1. (a) In the most advanced economies, the increased supply of GDP goods and services is not the highest priority.

  2. (b) For policy to find a coherent focus, it requires a better understanding of hedonic dynamics.

(p.393) High levels of well-being are already pervasive, and it is manifestly difficult to improve them much further by raising incomes overall. What is needed is a more systematic targeting of ill-being, its determinants, and the economic costs of its amelioration, to make the reduction of ill-being the focus of international competition: of such things as life expectation, material deprivation, the prevalence of crime and the severity of punishment, ethnic, social and political exclusion and repression, family structure and breakdown, mental health, suicide, morbidity, education, quality of working life, job security, access to health care, urban congestion and sprawl, and perhaps also of the quality of personal and social interaction.91 It might be more useful to shift the focus of measurement from happiness to unhappiness. There is a view that ill-being does not belong on the same dimension as well-being.92 ‘Prospect theory’ argues that losses are more acutely experienced than gains. Unemployment and discrimination have a more powerful effect on well-being than material gains.93 It may be easier to reach consensus about welfare bads than about welfare goods.

This does not mean that GNP goods have lost their relevance permanently. A society dependent on exponential growth for a stable experience of well-being might suffer badly if growth is withdrawn. Many societies have yet to arrive at that state of abundance, and can still anticipate large welfare returns to growth, and a shift away from GDP goods towards leisure or short-term gratification might eventually return us to the economy of pain. Longer life expectation, high dependency rates and shorter working lives suggest that material scarcity could be a problem in the future as much as in the past. In other words, we should recognize the possibility that the determinants of human well-being are themselves historically contingent. How contingent? This is one of the challenges for economics and history in the twenty-first century.

(p.394) References

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Notes:

(1) Easterlin, ‘Economic Growth’.

(2) Studenski, Income of Nations.

(3) For example with great authority by Charles Feinstein for the UK.

(4) Kapp, Social Costs.

(5) Slesnick, ‘Empirical Approaches’.

(6) Sen, ‘Welfare’, p. 36.

(7) Stigler and Becker, ‘De Gustibus’, pp. 76–7; Diener and Suh, ‘Measuring Quality’, pp. 445–6.

(8) Abramovitz, ‘Retreat;’ Dasgupta, Inquiry; Olson and Landsberg, No-Growth Society; Lebergott, Pursuing Happiness; Beckerman, Defence.

(9) Kendrick, ‘Studies;’ Sametz, ‘Measurement’.

(10) Nordhaus and Tobin, ‘Is Growth Obsolete?’

(11) Kendrick, ‘Studies’; Zolotas, Economic Growth; Eisner, Total Incomes; Nordhaus, ‘Reflections’; Beckerman, ‘Comparable Growth’; Crafts, ‘Thatcher Experiment’; Snooks, Portrait.

(12) Crafts, ‘Thatcher Experiment’; Eisner, Total Incomes; Sametz, ‘Measurement’; Snooks, Portrait.

(13) Nordhaus, ‘Reflections’.

(14) Juster and Stafford, Time; Gershuny and Halpin, ‘Time Use’; Robinson and Godbey, Time for Life; Schor, Overworked American.

(15) Gershuny et al., ‘The Time Economy’.

(16) Hicks, Value, p. 172.

(17) Nordhaus and Tobin, ‘Is Growth Obsolete’?

(18) Kapp, Social Costs; Kneese, Economics; Drechsler, ‘Problems’; Meyer, ‘Greening’.

(19) Weitzman, ‘Welfare Significance’.

(20) Advertising, commuting, and ‘corrrective’ spending on health and education. Crime and divorce were also considered as bads, but kept out of the accounts.

(21) Zolotas, Economic Growth, p. 1.

(22) Another has been the measurement of household consumption; see Slesnick, ‘Empirical Approaches’.

(23) Atkinson, ‘Measurement’.

(24) Beckerman, ‘Comparable Growth’; Crafts, Economic Decline, pp. 58–60; Jackson, Economic Welfare.

(25) Daly and Cobb, Common Good.

(26) Crafts, Economic Decline, pp. 58–60.

(27) Daly and Cobb, Common Good, pp. 412–13; Crafts, Economic Decline, compare Table 4, p. 20 and Table 17, p. 59.

(28) Cobb et al., Progress Indicator, Jackson and Marks, ‘Economic Welfare’.

(29) Friends of the Earth, website.

(30) Cobb et al., Genuine Progress.

(31) Meyer, ‘Greening’.

(32) Great Britain, Department of Environment, Sustainable Development; and Sustainability Counts.

(33) Bauer, Social Indicators.

(34) Terleckyj, Quality of Life.

(35) Nordic Council, Living and Inequality.

(36) Miles, Human Development, pp. 153–6.

(37) Morris, Measuring the Condition.

(38) Floud et al., Nutritional Status; Fogel, ‘Economic Growth’. See also Floud, and Leunig and Voth, in this Volume.

(39) Desai, ‘Human Development’.

(40) World Bank, Poverty Reduction.

(41) Morris, ‘Measuring the Quality’.

(42) Sen, ‘Capability’.

(43) Morris, Measurement; Estes, Social Progress; Slottje, Quality of Life.

(44) Crafts, ‘Human Development Index’.

(45) A more reliable measure than notional literacy, which peaks early in the process of development.

(46) Easterly, ‘Life during Growth’.

(47) (1) rights and democracy (2) political stability and war (3) education (4) health (5) transport and communication (6) inequality, and (7) ‘bads’.

(48) Offer, ‘Body Weight’.

(49) Black et al., Black Report’, Marmot, ‘Social Differences;’ Smith, ‘Healthy Bodies;’ Wilkinson, ‘The Epidemiological Transition’.

(50) Index 99, ‘Final Consultation’.

(51) Costa and Steckel, ‘Trends in Health’; Crafts, Economic Decline and ‘Development Index’.

(52) UN, ‘Social Statistics’.

(53) Pigou, Economics of Welfare, p. 10; Fisher, Interest, p. 3.

(54) Kahneman et al., Hedonic Psychology.

(55) Veenhoven, Database.

(56) Veenhoven, ‘Satisfaction Research’; Diener and Suh, ‘Differences’.

(57) Veenhoven, ‘Study’, Table 2, p. 26.

(58) Easterlin, ‘Does Economic Growth?’

(59) Veenhoven, ‘Is Happiness Relative?’

(60) Diener et al., ‘Factors Predicting’.

(61) Diener and Suh, ‘Differences’, Fig. 22.1.

(62) Diener et al., ‘Income and Subjective Well-Being’; ‘Predicting Subjective Well-Being’; ‘Quality of Life’; Blanchflower and Oswald, ‘Well-Being’.

(63) Campbell et al., Quality.

(64) Diener et al., ‘Income and Subjective Well-Being’.

(65) Campbell et al., Quality, p. 80; Levy and Guttman, ‘Multivariate Structure’; Argyle, ‘Causes and Correlates’, pp. 356–9; Headey and Wearing, Understanding Happiness, pp. 78–9.

(66) Ahuvia and Friedman, ‘Macromarketing Model’, pp. 154, 161.

(67) Di Tella et al, ‘Macroeconomics of Happiness;’ Blanchflower and Oswald, ‘Well-Being’.

(68) Duesenberry, Consumer Behavior, Hirsch, Limits to Growth.

(69) Easterlin, ‘Raising the Incomes’.

(70) Scitovsky, Joyless Economy.

(71) Van Praag and Fritjers, ‘Measurement of Welfare’; Coleman et al., Social Standing, ch. 17; but see Diener et al., ‘Income and Subjective Well-Being’, ‘Predicting Subjective Well-Being’.

(72) Helliwell, How’s Life?’, pp. 15–16.

(73) Headey and Wearing, Understanding Happiness, pp. 84–5.

(74) Stones et al., ‘Happiness.’

(75) Lykken and Tellegen, ‘Happiness’; Stones et al., ‘Happiness’, p. 135.

(76) Inglehart et al., Human Values, Table V18.

(77) Inglehart, Modernization, ch. 3.

(78) Diener et al., ‘Factors Predicting’, pp. 860–2.

(79) Di Telia et al., ‘The Macroeconomics of Happiness.’

(80) Easterlin, Birth and Fortune.

(81) Inglehart, Modernization.

(82) Sen, ‘Income Comparisons’.

(83) Rowntree, Poverty, ch. 5.

(84) Hagenaars et al., ‘Patterns of Poverty’, p. 26.

(85) Rabin, ‘Psychology’.

(86) Kahneman, ‘Objective Happiness’, pp. 14–21.

(87) Veenhoven, ‘Satisfaction Research’, p. 25.

(88) Diener et al, ‘Income and Subjective Well-Being’; ‘Predicting Subjective Well-Being’.

(89) Zolotas, Economic Growth, Fig. 1, p. 16.

(90) Kahneman, ‘Objective Happiness’, p. 17; van Praag and Frijters, ‘Measurement’, pp. 419–20.

(91) Doyal and Gough, Human Need.

(92) Bradburn, Psychological Well-Being; Diener and Emmons, ‘Positive Affect’.

(93) Campbell et al, Quality, Fig. 2–5, pp. 52–3; Blanchflower and Oswald, ‘Well-Being’, p. 20.