Papers of the Day: Money and Methods

Money Does Matter! Evidence from Increasing Real Incomes and Life Satisfaction in East Germany Following Reunification by Paul Frijters, John P. Haisken-DeNew and Michael A. Shields, American Economic Review, Vol. 94, No. 3, June 2004

ABSTRACT. In this paper we investigate how life satisfaction (or happiness) is affected by a substantial increase in real income. Our context is East Germany in the decade following reunification, and we implement a new fixed-effect estimator for ordinal life satisfaction and develop a decomposition approach that accounts for new entrants and panel attrition. Using data from the German Socio-Economic Panel we find that average life satisfaction in East Germany increased by around 20% between 1991 and 2001, leading to a clear convergence with West Germany. Importantly, increased real household incomes in East Germany accounted for around 35-40% of this increase, which corresponds to the economists’ view that money surely matters.

The great thing about this paper is not that it tells us that money matters, but that it is better statistics, doing something to take into account individual fixed effects.

I also highly recommend Frijter’s and Ferrer-Carbonell’s paper comparing various statistical methods for analyzing happiness data. The thing that really sticks out in their comparisons is that methods that take into account individual differences, like personality, produce quite different, but more likely accurate, results. “We call for more research into the determinants of the personality traits making up these fixed effects.” Me too! It’s also fun to note that the various methods disagreed a lot about whether kids were good or bad for self-reported happiness. Almost every method shows that money is good for SWB, by the way, albeit weakly so (better than being married, or having kids, not as good as being healthy.)

I liked the concluding thought in the methodology paper:

Finally, a note on the unimportance of income for happiness. The coefficient of 0.11 of log-income in the OLS individual fixed-effect model, implies that an individual would need an income increase of over 800000% to achieve an increase of one for general satisfaction on a (0,10) scale. This in itself raises the question of why individuals expend so much effort on obtaining more income to the extent that most economists since Jevons (1871) have taken this as the main human motivation. The psychologists Brickman and Cambell (1971) long ago answered this question by proposing that humans can be on an ‘hedonic treadmill’ in which they are constantly chasing objectives that cease to be satisfying once reached. This often repeated argument would fit the finding that average satisfaction hardly increases in countries where incomes increase (Diener and Suh, 1999; Kenny, 1999), but it would seem to need a high degree of imperfect forecasting and self-delusion on the side of individuals to be true. Is there perhaps more to individual choice than happiness?

Now, as you know, I think the self-report data is quite unlikely to accurately track individual or average increases in objective well-being, so I think the correlation between the self-report and income understates the correlation between real well-being and income. That said, I like their concluding thought. Even if folks do have some problems with forecasting how they will feel, surely you’d need to be pretty silly to have the experience of something failing to satisfy you hedonically over and over again and yet keep doing it because you’re looking for hedonic satisfaction. Donald Davidson would not accept this! The best explanation is that people keep doing it because they’re looking for something else.

[Cross-posted from Happiness and Public Policy.]