Does money really make Europeans happy?

Economists care about economic growth; the man or woman in the street wants to be happy. But to what extent are income and happiness related?

One of the most striking findings of research on life satisfaction is the relationship between income and happiness.

In early years of studies on self-reported life satisfaction, Richard Easterlin established the ‘Easterlin Paradox’, according to which life satisfaction correlates with income growth only up to a certain limit (around 20,000 USD per year). Beyond this limit, an increase in absolute income no longer brings additional happiness – only increases in relative income do.

In recent decades, as happiness scholars have collected more data, the Easterlin Paradox has been repeatedly challenged and has generally been invalidated. Current research shows that the relationship between income and happiness on a ten-point scale is robust, monotonous and virtually linear – both across and within countries. Controlling for other determinants of happiness, every ten percent increase in income is associated with a 0.04 point increase in self-assessed life satisfaction on a ten-point scale.

However, another happiness paradox has – until recently – pre-occupied happiness scholars.

Since the very beginning of transition from plan to market, residents of post-communist countries kept reporting a substantially lower life satisfaction than their counterparts with similar incomes in non-transition countries.

Despite rapid economic growth in 2000s in the emerging nations of Europe and Eurasia, the ‘transition happiness gap’ remained in place. Does this mean that the view that economic growth results in happiness is wrong, at least in some parts of the world?

Various studies have explained this transition happiness gap by the pain of macroeconomic instability of transition, reduced access to public goods, depreciation of pre-transition human capital and an increase in corruption and inequality. Many scholars argued that as the transition progressed and adjustments took place in both social and economic structures and public expectations, the happiness gap would disappear. This did not happen by the end of 2000s – as the Great Recession disproportionately affected the transition countries that depended on capital flows and commodity prices.

But as the post-crisis recovery took place, the ‘happiness convergence’ finally happened. In the latest Transition Report by the European Bank for Reconstruction and Development (‘Transition for all: Equal opportunities in an unequal world’) we show that in 2015-16 the transition happiness gap was finally closed. Controlling for income and other determinants of happiness, the residents of transition countries are now as happy (or as unhappy) as their counterparts in western Europe.

While the transition happiness gap has turned out to be a temporary phenomenon, there are other factors that are important for our understanding of the relationship between economic growth and life satisfaction. Yes, income growth raises happiness in both transition and non-transition countries. This reassures advocates of the view that the relationship between economic growth and happiness is universal.

But income growth does not provide a complete picture. What is common for both types of economies is the effect of unemployment on happiness.

A first-year economics textbook implies that as unemployment is a temporary problem, a simple redistributive policy should make up for a short-term loss of income. The happiness research – both in transition and non-transition countries – delivers strikingly different conclusions. The impact of unemployment on life satisfaction is far greater than that of the lost income. Unemployed people understand that it is not the today’s income that they lose; they also increasing fall behind their employed counterparts in terms of human capital and career perspectives.

This observation suggests that it is not only long-term economic growth that matters for happiness – short-term business cycles are important as well. In addition to supporting technological progress and globalisation, policymakers need to make sure that displaced workers are provided with new skills that open new job opportunities. Otherwise, the pro-growth policies will raise incomes but – paradoxically – generate unhappiness and, in turn, populist reversals.

The relationship between unemployment and happiness raises a question regarding the usefulness of the so-called universal basic income (UBI). While the UBI is supposed to help the losers from globalisation and technological progress, it may not fully work. If UBI recipients only get income, but not jobs, they may feel socially excluded and dissatisfied.

So the UBI should be accompanied by active labour market policies, such as access to skills, financial services and, if necessary, relocation, as a step on the road to greater happiness.