Friday 18 May 2012

How Much Is Enough? - The Easterlin Paradox

What is the link between money and happiness? How rich do you have to be to feel happy? And are rich people consistently happier?

Research shows that having more money does not always make people happier; rather being 'comfortable' seems to have a greater influence on our overall level of happiness.

The Easterlin Paradox was devised in 1974 by the American economist Richard Easterlin. The paradox is the seeming contradiction between:
  • the cross-section evidence on the relation between income and happiness, which shows that they are positively related at a point of time among income groups within a country; it is also true of comparisons at a point in time of richer and poorer countries
  •  the time-series evidence that within a country, as income goes up, happiness does not rise the way one would expect it to, on the basis on the cross-section.

So, although people with higher incomes are more likely to report being happy, rising incomes do not lead to increases in subjective wellbeing. In international comparisons, the average reported level of happiness does not vary much with national income per person, at least for countries with income sufficient to meet basic needs. Similarly, although income per person rose steadily in the United States between 1946 and 1970, average reported happiness showed no long-term trend and declined between 1960 and 1970.

The Easterlin Paradox suggests therefore that once we reach a certain level of income our satisfaction tends not to increase, however much our income rises beyond that point.

Recent research at the University of Pennsylvania claimed that it had identified a statistical relationship between happiness and the logarithm of absolute income, suggesting that happiness increases more slowly than income, but that no "saturation point" is ever reached. However, Easterlin updated his research in 2010 and claimed that his original paradox held (an interview with him is available here). (Even more research on happiness is reported here.)

One explanation put forward by Easterlin is that as people's incomes go up, their material aspirations rise. If their aspirations stayed the same, and their incomes went up, they'd closer to achieving what they considered to be the good life in material terms. But when their aspirations go up, that undercuts the effect of the actual improvement of incomes. So, they end up no happier than before.

Research published by Princeton University in 2006 suggested that the link between income and happiness is mainly an illusion. People surveyed about their own happiness and that of others with varying incomes tended to overstate the impact of income on well-being. Although income is widely assumed to be a good measure of well-being, the researchers found that its role is less significant than predicted and that people with higher incomes do not necessarily spend more time in more enjoyable ways.

Further research at Princeton University in 2010 estimated this 'happiness' earnings level at around $75,000. As income decreased from $75,000, respondents reported decreasing happiness and increasing sadness and stress. The data suggest that the pain of life’s misfortunes, including disease, divorce, and being alone, is exacerbated by poverty.

However, the level of the 'happiness' earnings level will obviously depend on your lifestyle and other factors in your life. You might be paying for you children's education or healthcare or have a large mortgage. You may also be worried about the current economic environment and the risk of redundancy or enforced early retirement.

My own take on this is related to the Wealth Potential concept: the relationship between outgoings (expenditure) and incomings (income from a job, savings or investments). When the two sides of the equation are in balance, I suspect that most people will be reasonably happy. However, this balance can be achieved at a high or a low level of expenditure. Therefore the happiness level may be related more to the fact of the two sides of the equation being closer in balance (or better, with surplus income) than to the absolute level of expenditure.

The practical application of this is that it is obviously easier to generate sufficient income for a more modest lifestyle. As highlighted previously on this blog, adopting a more modest lifestyle now means that with the excess income you can save more to build up a passive income that will help you to retain your standard of living in retirement.

And then hopefully continue to be happy.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

1 comment:

  1. I've been poor. So for me, my investment approach is driven by the need to feel secure. "Enough" will be when I have saved enough to pay my living costs, provide for my family and fund my retirement. Ironically, because along the way I picked up a compulsive work ethic, it probably won't be enough then, either....