The economics of happiness (or “stated well-being”) has enjoyed a decade-long surge, including recent articles in top general interest journals, cover stories in Time and The Economist, surveys in the Journal of Economic Literature and The Journal of Economic Perspectives and dozens of books for both academic and mainstream audiences. Most of the attention has focused on questions about what makes people happy (money, marriage, employment and so on). Recently, however, economists have attempted to use happiness surveys to address a central question of public policy—valuing public goods.
One basic purpose of government is to provide goods that market forces will not, and a central task of economics is to place monetary values on those goods so that governments can prioritize projects. That task, however, requires knowing how much people will be willing to pay for these non-traded goods. Methods have included travel cost models, hedonic housing price estimations and, more recently, and controversially, contingent valuation or stated-preference surveys. Now a new tool has entered the field—happiness economics.
Illustration: Jayachandran / Mint
The fundamental idea is straightforward. Survey people as to their incomes, how happy they are, say for example on a scale from one to seven, and any other demographic data available. Collect data, perhaps from other sources, on the amount of the local public good present for each respondent. Then estimate respondents’ happiness as a function of their incomes, the public good, and other observable data. Presumably happiness will increase with income and with the quantity of the public good, all else equal. The estimated function tells us exactly how much income, on average, people would be willing to give up (perhaps in higher taxes) in order to receive more of the public good.
Not surprisingly, this new approach to valuing non-traded goods is fraught with problems. One of the biggest involves the fact that happiness, income and the public good are determined simultaneously and may depend on one another. For example, while income may make people happy, happier people may also earn higher incomes.
Perhaps more troubling, few studies account for the fact that the level of the public good may be determined simultaneously with happiness. People desiring a particular public good may relocate to areas with high levels of it or lobby their local governments to provide more of it. Afraid of crime? Live in a gated community, or vote for higher police expenditures. Asthmatic? Move to a place with clean air, or vote for tough pollution control laws.
A related concern is that people may become habituated to whatever level of public good they currently experience. Many of us were not terribly bothered by smoke in restaurants until smoking in public places was banned, and now a tiny whiff of smoke makes us unhappy. We were habituated to the smoke, and now we are habituated to its absence. If asked to compare a restaurant today with its smoky equivalent years ago, each would make us equally happy. But if asked to compare a restaurant today with its smoky equivalent next door, the smoke-free restaurant would make non-smokers happier, as they have become accustomed to the lack of smoke.
This poses an enormous problem for the valuation of public goods using happiness data, because by definition everybody in the same region experiences the same level of the public good at the same time. Studies regress individuals’ happiness on regional annual averages of the public good (terrorism, flood control, airport noise and pollution). If people in a particular region locate there because of its public good, lobby their governments to provide the good, or become habituated to the local level of the good, the public good coefficient will be underestimated, and the valuation using this approach will be too small.
In a recent working paper, I have tried to address this problem by using daily local air quality. This is a special case of a public good that varies daily, for reasons external to any particular respondent, and presumably too quickly for anybody to become habituated. I use the General Social Survey, which each year asks several thousand people throughout the US “taken all together, how would you say things are these days? Would you say that you are very happy, pretty happy, or not too happy?”
I calculated that, on average, people are willing to forgo about $40 of annual income for a one-standard-deviation reduction in the particulate matter in the air for one day. I try numerous specifications, with various control variables and interactions, and the point estimates range from about $20 to about $60.
In the end, we should probably not put too much faith in the $40 estimate. It makes strong assumptions about preferences by comparing the stated happiness of different individuals.
Nevertheless, this new approach to valuing public goods contains promise. Its shortcomings differ from those of the typically used approaches, so that if nothing else, it serves as a useful point of comparison. It comes from nationally representative surveys, and so can be used to assess how willingness to pay for public goods varies over time and by region, age, income, education and current public good levels.
Edited excerpts published with permission from VoxEU.org. Arik Levinson is an associate professor in the economics department, Georgetown University. Comments are welcome at firstname.lastname@example.org