EVERYBODY loves a fat pay rise. Yet over the past half-century, as developed economies have got much richer, people do not seem to have become happier. Surveys suggest that, on average, people in America, Europe and Japan are no more pleased with their lot than in the 1950s. This is curious, because at any given time richer people say they are happier than poorer people do. For instance, 37% of the richest quarter of Americans claim to be “very happy”, compared with only 16% of the poorest quarter. That might lead you to expect that, as a country grows richer and incomes rise, rich and poor alike would become happier. However, they have not. Here lies a paradox: an individual who becomes richer becomes happier; but when society as a whole grows richer, nobody seems any more content.
In recent years the study of “happiness”—as opposed to more conventional economic measures, such as GDP per head—has attracted increased attention from economists. In a series of lectures* earlier this year, Richard Layard, an economics professor at the London School of Economics, reviewed the various evidence from psychology, sociology and his own discipline to try to solve this paradox. One explanation is “habituation”: people adjust quickly to changes in living standards. So although improvements make them happier for a while, the effect fades rapidly. For instance, 30 years ago central heating was considered a luxury; today it is viewed as essential.
Keeping ahead of the Joneses
A second and more important reason why more money does not automatically make everybody happier is that people tend to compare their lot with that of others. In one striking example, students at Harvard University were asked whether they would prefer (a) $50,000 a year while others got half that or (b) $100,000 a year while others got twice as much. A majority chose (a). They were happy with less, as long as they were better off than others. Other studies confirm that people are often more concerned about their income relative to others' than about their absolute income. Pleasure at your own pay rise can vanish when you learn that a colleague has been given a much bigger one. The implication of all this is that people's efforts to make themselves happier by working harder in order to earn and spend more are partly self-defeating: they may make more money, but because others do too, they do not get much happier. The unhappiness that one person's extra income can cause to others, argues Lord Layard, is a form of pollution.
Worse still, working harder in order to be able to afford more material goods could even end up making people unhappier if they do not have enough spare time. Although people value their income in relation to that of others, this does not seem to be true of their leisure time. The same Harvard students were also asked to choose between (c) two weeks' holiday, while others have only one week and (d) four weeks' holiday while others get eight. This time a clear majority preferred (d). In other words, people's rivalry over income does not extend to leisure. The result of this, suggests Lord Layard, is that developed societies may tend to work too hard in order to consume more material goods, and so consume too little leisure.
If governments' ultimate goal is to maximise the well-being (ie, “happiness”) of society as a whole, then, says Lord Layard, some highly controversial implications for public policy follow. Conventional economic theory argues that taxation distorts the choice between leisure and income. Taxes reduce the incentive to work an extra hour rather than go home, or to put in extra effort in the hope of promotion. But Lord Layard's argument implies that people have a tendency to work too much. Far from being distortionary, taxes are therefore desirable. He suggests a marginal tax rate of 30% to deal with the “pollution” that one person's extra income inflicts on others, and the same again for habituation. The total of 60% is a typical European level of taxation (taking both direct and indirect taxes into account).
This flies in the face of what most economists think about high European taxes. In America, workers are allowed to keep more of the income from an extra hour's work. Many economists think that this is why Americans work longer hours than Europeans. Over the past two decades average annual working hours have increased slightly in America, but fallen sharply in Europe; continental Europeans now work, on average, 15% fewer hours than Americans do. High taxes, it is argued, have undermined Europe's competitive edge. Lord Layard's analysis suggests an alternative view: it is not that Europeans are working too little, but that Americans work too long, driven to choose more income instead of leisure by an urge to keep up with the Joneses. Higher taxes in Europe encourage workers to choose more leisure rather than work, and so keep this urge in check. America's economic performance is superior if judged by GDP alone. But GDP is a flawed measure of economic well-being. Happiness demands leisure as well as material consumption. Americans may be richer than Europeans, but are they any happier?
Seductive stuff, especially when read in August in a Tuscan villa or on a Mediterranean beach. Yet even if Lord Layard's theory is right, his figure for the optimal tax rate looks like little more than convenient guesswork. A lower number might be just as good. And Europe's high taxes still have negative effects. They put some people off working altogether, and discourage employers from offering extra jobs. As Lord Layard himself says, unemployment visits terrible unhappiness on those it afflicts. Yet this is not to deny his main point: the pursuit of material comforts does not always lead to happiness.
* “Happiness—Has Social Science a Clue?” Lionel Robbins Memorial Lectures 2003, Centre for Economic Performance, London School of Economics.
This article appeared in the Finance & economics section of the print edition under the headline "Chasing the dream"