easterlin-paradox

What Is The Easterlin Paradox? The Easterlin Paradox In A Nutshell

Business / By / February 10, 2022

The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.

Understanding the Easterlin paradox

It is worth noting that it is the long-term trends in happiness and income that are unrelated. In the short term, the two factors normally go up and down together. For example, consider the sentiment that accompanies stock market crashes. Consumers tend to be sad in the immediate aftermath of a crash but become happier as the market starts to recover.

The Easterlin paradox has been hotly debated because of the inherent problems with defining happiness and the far-reaching implications for public policy. Indeed, if economic growth does little to enhance happiness beyond a certain point, should governments instead focus on measures of national happiness?

Easterlin paradox findings

In a comparative study using data from the United States and 11 other countries, Easterlin reported the following findings:

  1. Within countries, wealthier individuals reported a higher level of subjective wellbeing (SWB) than did poorer individuals.
  2. Across countries, there was no comparable difference in the SWB of countries deemed to be rich and countries deemed to be poor.
  3. Third, the results of a longitudinal study found that the economic development of a country did not increase the individual SWB of that countries’ citizens.

From these findings, Easterlin made two conclusions:

  • On the micro-level, the income of an individual increases subjective well-being significantly.
  • On the macro level, the national economic growth of a country expressed as per capita GDP does not necessarily increase subjective well-being.

Interestingly, these conclusions were consistent across countries with different traditions, cultures, natural environments, economic environments, and political systems.

Criticisms of the Easterlin paradox

In addition to subjective definitions of happiness and broader policy implications, there is much debate around the validity of the Easterlin paradox itself. Though beyond the scope of this article, Easterlin’s data collection and analysis techniques have been called into question.

Subsequent empirical studies found that SWB was much higher in rich countries than it was in poor countries. What’s more, there was also a significant correlation between per capita GNP and national wealth with the subjective well-being of a nation’s citizens. 

Another study in 2006 by Veenhoven and Hagerty found that the SWB in developing nations such as India, South Korea, Philippines, South Africa, Brazil, and Nigeria had increased substantially over the previous 50 years. In releasing their data, the pair refuted Easterlin’s claim that economic growth did not add to the quality of life measures that increased happiness. 

Further economic data from China also cast doubt on the Easterlin paradox. The data showed that Easterlin’s conclusion at the micro-level was supported. However, at the macro level, the data showed that stagnation in SWB among Chinese citizens was evident but not because of economic development per se.

In the case of China, the period of rapid growth caused many citizens to lift themselves out of poverty and become happier as a result. However, the fact that the period of growth occurred for so long meant the increase in happiness was offset by widening income inequality. These two effects canceled each other out and caused SWB to trail behind economic growth in the country – but not for the reasons Easterlin’s theory stipulates. 

In response, Easterlin revised the theory and posited that a U-shaped pattern best illustrated the relationship between economic development and SWB. In the short term, SWB is positively correlated with a nation’s economic growth. In the long term, however, this growth has a limited effect on individual income. This revision, at least to some extent, made the Easterlin paradox more convincing to skeptics and arguably more relevant to countries undergoing similar economic growth.

Key takeaways:

  • The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent. It was first described by then professor of economics at the University of Pennsylvania Richard Easterlin in 1974.
  • The Easterlin paradox found that on the micro-level, the income of an individual increases subjective well-being significantly. On the macro level, the national economic growth of a country does not necessarily increase subjective well-being.
  • The Easterlin paradox has attracted criticism for the data on which it is based. Subsequent studies found a strong correlation between economic growth and subjective well-being in developing countries. Data from a period of growth in China also found that the relationship between income and happiness was more nuanced than the Easterlin paradox accounts for.

Main Guides:

heuristic
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.
recognition-heuristic
The recognition heuristic is a psychological model of judgment and decision making. It is part of a suite of simple and economical heuristics proposed by psychologists Daniel Goldstein and Gerd Gigerenzer. The recognition heuristic argues that inferences are made about an object based on whether it is recognized or not.
representativeness-heuristic
The representativeness heuristic was first described by psychologists Daniel Kahneman and Amos Tversky. The representativeness heuristic judges the probability of an event according to the degree to which that event resembles a broader class. When queried, most will choose the first option because the description of John matches the stereotype we may hold for an archaeologist.
take-the-best-heuristic
The take-the-best heuristic is a decision-making shortcut that helps an individual choose between several alternatives. The take-the-best (TTB) heuristic decides between two or more alternatives based on a single good attribute, otherwise known as a cue. In the process, less desirable attributes are ignored.
biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman since 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.
bundling-bias
The bundling bias is a cognitive bias in e-commerce where a consumer tends not to use all of the products bought as a group, or bundle. Bundling occurs when individual products or services are sold together as a bundle. Common examples are tickets and experiences. The bundling bias dictates that consumers are less likely to use each item in the bundle. This means that the value of the bundle and indeed the value of each item in the bundle is decreased.
barnum-effect
The Barnum Effect is a cognitive bias where individuals believe that generic information – which applies to most people – is specifically tailored for themselves.
nudge-theory
Nudge theory argues positive reinforcement and indirect suggestion is an effective way to influence the behavior and decision making of individuals or groups. Nudge theory was an idea first popularized by behavioral economist Richard Thaler and political scientist Cass Sunstein. However, the pair based much of their theory on heuristic research conducted by psychologists Daniel Kahneman and Amos Tversky in the 1970s.
bullwhip-effect
The bullwhip effect describes the increasing fluctuations in inventory in response to changing consumer demand as one moves up the supply chain. Observing, analyzing, and understanding how the bullwhip effect influences the whole supply chain can unlock important insights into various parts of it.
einstellung-effect
Maslow’s Hammer, otherwise known as the law of the instrument or the Einstellung effect, is a cognitive bias causing an over-reliance on a familiar tool. This can be expressed as the tendency to overuse a known tool (perhaps a hammer) to solve issues that might require a different tool. This problem is persistent in the business world where perhaps known tools or frameworks might be used in the wrong context (like business plans used as planning tools instead of only investors’ pitches).
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