Over the past few decades our pursuit of economic growth has caused us to overlook the welfare and well-being of our people. It took no less than a major financial crisis for us to stop and think about our actions. The ever growing GDP numbers had put a sort of a veil on the real socio-economic reality. But this is not about what caused the crisis in the first place or the apathy of the intelligentsia instead about how we measure and value our progress today and in the future.
Angus Deaton in his book The Great Escape describes well-being as all things that make life good: this includes physical and psychological health, access to education, ability to participate in civil society democratically, and the rule of law. Today the major indicator welfare and well-being is the GDP and GDP per capita. By definition Gross Domestic Product or GDP is the sum total of the market value of all the goods and services produced in a country.
Before pointing to shortcomings of GDP as an indicator it must be made clear GDP and GDP per capita are good indicators, and there are studies that empirically show its positive relation with the increase in welfare in an economy. In fact, GDP per capita is highly positively correlated with indicators like the Human Development Index, which use measures like income, mortality, and literacy to measure well-being of a people. But the GDP tends to hide a lot of detail, hence distorting our picture of the reality.
Now let’s move on to a proposed solution to the problem that GDP poses. A new measure of welfare created by Pete Klenow of Stanford University, which combines indicators from household surveys. Klenow argues that economic growth comes at a cost not captured traditional measures of GDP. He formulates a new indicate that combine measures of consumption, leisure, and inequality. He then goes on to apply the this new index to a cross-section of countries and arrives at four key conclusions:
- As stated above GDP per capita is a good indicator of welfare, though it is important to address the difference between income and quality of life.
- Western Europe, even though behind the US in terms of GDP per capita it has similar living standards on account of higher leisure (lesser working hours) and lower inequality.
- Many developing countries are doing worse off than what their incomes indicated, this is due to extreme inequality in income as well as quality of life between the sections of society.
- Historically, the welfare indicator has grown much more than income i.e. the world has more improvements in quality of life than it has seen incomes grow over the past 30-50 years.
The paper points to another interesting pattern in countries that the authors term as ‘new Singapores’. They take the example of Singapore as a country with a very high income, but a lower measure of welfare. The situation arises because of reasons like longer working hours, and high savings, which in turn reduces consumption and leisure. Many emerging economies like China, Hong Kong, South Korea, Ireland, and India are predicted to have increase in incomes, but a fall in welfare. These examples point to trade off between growth in income versus growth in welfare.
These countries have the potential of becoming the engines of consumption growth outside of the Western world, where consumption and economies are stagnating. They will continue to be bastions of traditional economic growth for the decades to come. This optimism, however, should come with a warning: the above progress and growth is contingent upon many factors like sound policy making, climate change, adapting to changes in technology, and being able to leverage a young population.
Measuring Subjective Well Being
Moving on to the other aspect of well-being, which is the psychological and emotional well-being of a person. It directly relates to the ‘happiness’ a person experiences. Measuring ‘happiness’ has always been a controversial topic because of the very subjective nature of the topic. Any survey or measure of ‘happiness’ is always open to biases ranging from cultural to idiosyncrasies of the day. Warnings aside, let’s look at an index of perception of life developed by Alan Kreuger of Princeton University and the Nobel Prize (for economic sciences) winning psychologist Daniel Kahneman called the U-Index.
The U-Index or the measure of ‘unpleasantness’ attempts to measure the time spent by a person in an unpleasant state. The index is divided into two parts:
- U1: It is the time spent in a miserable state, which is when the minimum negative feeling is greater than the maximum positive feeling.
- U2: It is the time spent in melancholy state, which is when the maximum negative feeling is greater than the maximum positive feeling.
There is evidence to show that, the index is a good measure of well-being. For example: When compared to a perception of life survey it was found that U2 was 49% among those who reported not being satisfied by their lives at all i.e. those who reported not being satisfied by the then current state of their lives spent 49% of their time in a melancholy state. The U2 index also tracks well with the instances of suicide over the course of a day.
Figure 1: U2 Index by Global Life Satisfaction
Figure 2: U2 Index and suicide rate by Time of Day (suicide rates among Italian women)
The index was constructed using a very comprehensive methodology called the Day Reconstruction Method (DRM). It is a detailed questionnaire that asks the subject to reconstruct their day episode by episode, and how they felt during each episode.
The measurement of subjective well-being has consequences for both research and policy making. In research it allows us to study economic growth across time for a country, and be able to see how time allocation changes as an economy grows. It also supports study of behaviours of subpopulations like men vs. women or the rich vs. the poor, and to make comparisons between countries; hence, allowing us to compare it to other indices like the welfare index discussed above. It can also contribute to economic theory and improve our understanding the utility function. In terms of policy making it will allows us to do impact evaluation of both microeconomic and macroeconomic policies eg: If people are given more health insurance do they feel more “calm and pleasant” or does introducing a tax on cigarettes improve welfare. Another application can be to gauge the value of current economic indicators.
The subjective well-being of people is closely tied to material outcomes and their sustainability. It has far reaching consequences for political stability and outcomes. A dissatisfied people often seek immediate, rapid, and radical change. In the political sphere such lack of well-being materialises as more extreme positions and often a call to return to ‘better’ times (often non-existent).
Summary and Conclusion
In the light of a recent to an art gallery let’s summarize with pictures. Below are two plots from Klenow (2015), which plot the measure of welfare against income, and the ratio of welfare to income for a broad set of countries. Hopefully this gives the reader an insight into the nuances of the measurement of welfare.
Figure 3: Cross-country welfare comparison
An important distinction in case of subjective well-being is the difference between perception of life satisfaction and emotional well-being. It has been found that increases in income closely related to rise in life satisfaction, while emotional well-being is found to increase only to a certain level of income around $75,000 per annum, after which it flattens out for any further increase in income. This fact is illustrated by the graph below taken from a study by Daniel Kahneman and Angus Deaton.
Figure 4: Annual Income against Emotional well-being
Despite its limitations and criticisms income is also related to well-being in a country. Research by Betsey Stevenson of University of Michigan shows that income is positively related to perception of life/well-being measures; moreover, there is no evidence for a satiation after a certain level of income and well-being only increases with income. To put it in perspective we would see plateauing (flattening slope) of the graph between income and well-being (see below).
Figure 5: Log-Income against Life Satisfaction
One last point our choice of how we measure progress and prosperity merges into the larger philosophical debate between individual freedom and power, and collective welfare of the society. Different societies will choose to value progress in different ways, and this choice will draw from culture, history, politics, and ethos of the particular society. A footnote from one of the research papers holds the essence of this article.
Beyond GDP? Welfare across Countries and Time.( http://klenow.com/Jones_Klenow.pdf)
Subjective Well Being (http://dataspace.princeton.edu/jspui/handle/88435/dsp016108vb296)
Subjective Well Being and Income: Is there any evidence ? (http://users.nber.org/~bstevens/Papers/Satiation(WP).pdf)
 High Income improves life evaluation, but not emotional well-being. (http://www.pnas.org/content/107/38/16489.full.pdf)
 The Great Escape, Angus Deaton (https://goo.gl/8Vl4Wb)