Mar 13, 2008

Happy Economics or which measure is right?

A good economist should always be open to new ideas and try to minimize his/her prejudice towards other economists’ argument. A sentence, that probably applies to any other discipline. To my disgrace I have to admit that when it comes to the “Economics of Happiness” I have a hard time adhering to this rule (as Pierre-Louis might recall). The general argument that supports the maximization of happiness as opposed to, say GDP, is based on the assumption that well-being derives from many factors not only income. And if the study of economics has as ultimate goal the well being of people, economic modeling/empirics should take account of other factors. The most important implication of such a line of argument is that there may be a conflict between maximizing well being and maximizing GDP (though higher GDP is found to be increasing happiness, these empirical findings do not preclude a possible conflict between the two).

My first reaction to this logic was something like this:
Happiness, to me, is a very subjective concept per se. As such, I find it extremely difficult to imagine a reasonable formalization of it that allows us to work with this concept analytically.
Being a subjective concept, I question myself how one may go about measuring happiness properly. For some people it is just a healthy and long life for others it includes things like having found the sense of life. So how am I to judge which person is happier by asking them questions and more importantly what are the policy implications, if happiness is achieved for different people in a different way?

I did not think about these issues for a while until my father, a teacher for geography, called me and asked me about the ingredients of the GDP measures we – economists - use when comparing various countries’ level of development. I gave him the “usual” explanation pointing to the importance of PPP adjusted values etc. Being unsatisfied with my answer, he asked me whether GDP values include the shadow economy. To my shame, I had no answer! Being a theoretical rather than empirical economist and certainly no statistician, I tried to excuse my non-knowledge. Nevertheless, I recalled the unprecedented increase in Greece’s GDP announced in 2006, due to the revaluation of the shadow economy (as a “side product” the budget deficit in % of GDP declined significantly). However, I was not sure whether any GDP value that we have at hand includes the shadow economy. Looking at various national measures I did not find a generally accepted way of how to incorporate shadow economy estimates.

So besides the notorious difficulties that arise through the computation of PPP weights (see the IMF for a recent revision which lead to a decrease in World growth), the question as to how the shadow economy should be a part of GDP causes another big trouble. Just consider two country’s of equal population with equal prices. Assume that our measure of GDP includes the shadow economy and country A has a GDP of 8 trillion $ and country B a GDP of 7 trillion $. In country A 2 trillion $ are generated in the shadow economy and in country B 0.5 trillion $ are generated in the shadow economy. Which country is better off? Most people would probably answer country A. Let us assume our measure does not include the shadow economy. Clearly, not knowing about the shadow economy, all of us would say that country B is better off. This is a trivial example. However, the shares of the shadow economies are not unreasonable.
The point I want to make is the following: Even when agreeing on measuring GDP only in terms of the “official” economy, we can not derive that well being as measured by purchasing power is necessarily well reflected by this measure. On the other hand, if we agree on a way of how to include the shadow economy, we have the trouble of deciding whether a unit generated in the shadow economy is worth as much as a unit generated in the “official” economy.
On top of all this, most national measures of GDP vary in the way in which the shadow economy is included in the GDP estimates.

What is the link between the talk to my father and the discussion I had with Pierre-Louis? Well, given that the comparison based on GDP is also a very shaky concept and it is hard to choose between the use of two shaky concepts, I decided to give more credit to the “Economics of Happiness” than I did so far. One might say this is a marginal change, but isn’t it all about that?



Pierre-Louis said...

And what about maximising the human development index, as suggested by Amartya Sen, a Nobel prize winner??? But honestly, I think the most important thing is to minimize inequalities, thats the real problem...

Maribou said...

Ok, Sebastian, you have now officially challenged me...due to lack of time today, I will retort upon my return on Sunday. Watch this scace!

Pascal said...

As we all know GDP is something like “the goods and services produced within a year and within a country”. There are many good arguments why this is not the sole measure that we should try to maximize. But are there good arguments that we should maximize happiness, even if we had a perfect measure? I guess most religious leaders and many moral philosophers would disagree with the idea that the pursuit of happiness is the ultimate purpose of life, disregarding the means. Maybe it is better to stay with a clearly incomplete measure of well being, taking into account its short comings, than with a seemingly complete measure.

Cam said...

I am really curious as to how you measure / define 'happiness', and how this compares to notions of 'wellbeing' and 'pleasure'?

Perhaps as many eminent philosophers (Nietzsche, Kant, Socrates, Dalai Lama, etc.) have pointed out, happiness isn't a goal in itself, rather it is derived as a byproduct of doing something else (even J.S. Mill noted that whilst happiness is valuable, it is something that is not achieved by trying to attain it.).

So maybe that means I should stop doing this cursed Canova Problem Set and do something else that will bring me more 'happiness'........1

Dany said...

There are several papers measuring the shadow economy and economists that are dedicated just to study money laundry and informal economy, that now are becoming very consulted after all the terrorist boom....the smartest way to measure shadow economy is by the use electricity. There is a one to one relationship between the use of electricity and GDP, so economies that deviate from the correlation have bigger unreported activity.
If you haven’t hear about, I recommend to read “The Mystery of Capital”, a powerful book by Hernando de Soto , one of the most celebrated graduated from HEI, that explains how developing countries can boost their economies incorporating the informal business.
About the measure of happiness…………..mmmmmmmmmm……… difficult, but definitely the correlation with GDP is not one to one, and I’m tempted to say that is negative, or at least non linear.