Consumer Capital as the Source of Happiness: The Missing Economic Theory Underlying the Income-Happiness Paradox

Abstract:

Self-reported happiness does not generally increase with rising income, as established by Richard Easterlin. We argue that the current debate in economics about the income-happiness paradox has paid too little attention to the theoretical foundation of the expected positive relation between income and happiness, seeking an empirical resolution through better data and more elaborate estimating equations instead. We return to the history of economics and revisit the contributions of Irving Fisher and Kenneth Boulding for the missing economic theory that underlies the income-happiness paradox. According to both Fisher and Boulding, “consumer capital” is the ultimate source of welfare, whereby consumer capital is defined as an accumulated stock of tangible and intangible instruments that yield a stream of services over their useful life. In the view of Fisher and Boulding, it is the utilization of this capital stock that renders happiness to individuals. Moreover, income that pays for the goods of consumption can be a “bad,” reflecting the cost of maintaining the consumer capital stock. Therefore, Fisher and Boulding’s insights bring a new perspective to the Easterlin paradox, showing that the empirical finding that rising income contributes only little, if anything, to levels of happiness has been overemphasized at the expense of the theoretically more relevant relation between consumer capital and happiness, and the exact role of income therein.

Keywords::

• capital
• economic theory
• experienced utility
• happiness
• income

JEL Classification Codes::

• B00
• D60
• I31

Notes

¹ Closely related is the concept of intangible capital, which John Tomer (2008, 4), building on Veblen (1919), defines as “the many things that are in humans or in their relationships, things that enable people to perform well in their work situations, and thus be productive and successful [and] things that enable people to be rational and experience wellbeing.”

² Happiness or subjective wellbeing – we follow tradition and use the terms synonymously – is “a broad category of phenomena that includes people’s emotional responses, domain satisfactions, and global judgments of life satisfaction” (Diener et al. 1999, 277).

³ See Ed Diener and Robert Biswas-Diener (2002), as well as Clark, Frijters, and Shields (2008b), for a review of this work. Ryan Howell and Colleen Howell (2008) provide a meta-analysis of results for developing countries.

⁴ For the sake of completeness, we should note that equation (1(1) $$U_i=f\left(\frac{C_i}{{\displaystyle \sum a_{ij}{C}_j}}\right)$$(1) ) (and the other equations that follow) depicts conceptual relationships, not the exact empirical models that have been estimated in the relevant literature.

⁵ The ability of the eye to adjust to various degrees of light and dark is the best known manifestation of adaptation.

⁶ Boulding’s (1949–1950, 83) exact words on psychic income are: “[P]sychic income is that which is derived from the possession or use or capital, and is the significant welfare concept. ‘Real’ income or ‘output,’ on the other hand, is significant only because of the power which it gives us to increase our capital stock, and hence our psychic income.”

⁷ Thomas Schelling (1984, 344) similarly argues that “we consume past events that we can bring up from memory.”

⁸ Fisher’s concept of psychic income has never caught on, not even on the waves of the recent popularity of happiness measures in economics. The history of economics, however, contains some traces of the ideas embodied in the concept of psychic income. Arthur Cecil Pigou (1932, 10), for instance, found that “the elements of welfare are states of consciousness.”

⁹ Tomer’s (2008, 4) work is insightful here by finding that individuals’ intangible capital includes “things like standard education and training which [not only] provide knowledge and know-how,” but also “noncognitive qualities of people.”

¹⁰ Coming full circle, adaptation (Frederick and Loewenstein 1999) can provide the psychological underpinning for Boulding’s idea (mentioned above) that psychic capital can deplete in the same way that desirable mental states “depreciate” (Boulding 1950, 140-141). In fact, adaptation could explain why happiness does not rise over time, even when consumer capital does exhibit steady increases. Alternatively, adaptation can be seen as a form of depreciation that reduces a capital’s stock ability to render services which satisfy preferences.