Papers of the Day: Money and Methods

Money Does Matter! Evidence from Increasing Real Incomes and Life Satisfaction in East Germany Following Reunification by Paul Frijters, John P. Haisken-DeNew and Michael A. Shields, American Economic Review, Vol. 94, No. 3, June 2004

ABSTRACT. In this paper we investigate how life satisfaction (or happiness) is affected by a substantial increase in real income. Our context is East Germany in the decade following reunification, and we implement a new fixed-effect estimator for ordinal life satisfaction and develop a decomposition approach that accounts for new entrants and panel attrition. Using data from the German Socio-Economic Panel we find that average life satisfaction in East Germany increased by around 20% between 1991 and 2001, leading to a clear convergence with West Germany. Importantly, increased real household incomes in East Germany accounted for around 35-40% of this increase, which corresponds to the economists' view that money surely matters.

The great thing about this paper is not that it tells us that money matters, but that it is better statistics, doing something to take into account individual fixed effects.

I also highly recommend Frijter's and Ferrer-Carbonell's paper comparing various statistical methods for analyzing happiness data. The thing that really sticks out in their comparisons is that methods that take into account individual differences, like personality, produce quite different, but more likely accurate, results. “We call for more research into the determinants of the personality traits making up these fixed effects.” Me too! It's also fun to note that the various methods disagreed a lot about whether kids were good or bad for self-reported happiness. Almost every method shows that money is good for SWB, by the way, albeit weakly so (better than being married, or having kids, not as good as being healthy.)

I liked the concluding thought in the methodology paper:

Finally, a note on the unimportance of income for happiness. The coefficient of 0.11 of log-income in the OLS individual fixed-effect model, implies that an individual would need an income increase of over 800000% to achieve an increase of one for general satisfaction on a (0,10) scale. This in itself raises the question of why individuals expend so much effort on obtaining more income to the extent that most economists since Jevons (1871) have taken this as the main human motivation. The psychologists Brickman and Cambell (1971) long ago answered this question by proposing that humans can be on an ‘hedonic treadmill’ in which they are constantly chasing objectives that cease to be satisfying once reached. This often repeated argument would fit the finding that average satisfaction hardly increases in countries where incomes increase (Diener and Suh, 1999; Kenny, 1999), but it would seem to need a high degree of imperfect forecasting and self-delusion on the side of individuals to be true. Is there perhaps more to individual choice than happiness?

Now, as you know, I think the self-report data is quite unlikely to accurately track individual or average increases in objective well-being, so I think the correlation between the self-report and income understates the correlation between real well-being and income. That said, I like their concluding thought. Even if folks do have some problems with forecasting how they will feel, surely you'd need to be pretty silly to have the experience of something failing to satisfy you hedonically over and over again and yet keep doing it because you're looking for hedonic satisfaction. Donald Davidson would not accept this! The best explanation is that people keep doing it because they're looking for something else.

[Cross-posted from Happiness and Public Policy.]

  • Brian


    I think there are several aspects of your argument that are problematic. First, I would take issue with equating the attention of a problem given by the media with its relative importance. Acid rain may or may not be a problem, but I would be loath to base that assessment on the frequency of hearing the term, particularly in relation to other environmental concerns. Second, I think it is debatable to what extent acid rain has been alleviated by cap and trade – at least in ways that are repeatable for carbon. As DMonteith mentions, some of this may be related to moving a portion of our manufacturing base over seas. But a bigger stumbling block may be that the technical challenges for dealing with SOX and NOX are far easier than carbon.

    SOX and NOX are the result of the presence of sulfur and nitrogen in the fuel (sulfur in the hydrocarbons and nitrogen in the combustion air) and the resulting SOX and NOX can be mitigated by through “cleaner” fuel and altering the combustion process (NOX is formed in high temperature or long duration combustion), or through chemical scrubbing process such as limestone/lime (Ironically, some of these scrubbing process produce more CO2 but back in the day that was a perfectly good trade-off). I don’t know if any comparable methods exist for CO2. The problem with CO2 is that it is (by definition) a direct product of combustion. Reducing CO2 isn’t really possible other than reducing combustion (Unlike SOX and NOX which can be reduced without a change in combustion quantity) although CO2 could be captured in some way. This isn’t to say that cap and trade couldn’t have played a role in pushing these cleaner technologies for SOX and NOX (I don’t know enough about the history of the regulation in the 70s and 80s), only that I fear the low hanging fruit (so to speak) may already have been picked.

    Finally, my understanding, which I admit may be a bit limited, is that Europe is, in fact, having difficulty with their carbon trading scheme – particularly as a result of the current economic conditions ( They aren’t on their backs, but I think they do offer a warning of what not to do – although you recognize this as well.

    This is to say nothing of the issue as to whether there is any significant danger to increasing carbon emissions in the first place (I remain skeptical for a variety of reasons), but as Nathan mentioned, the usefulness of cap and trade (or any pollution scheme for that matter, I suppose) is dependent on the ability to understand the negative social costs. I don’t have the sources at the moment, but I recall hearing a pretty wide range of estimates on the cost of carbon.

  • Yes, it was definitely all those bizarro, Obamaniacal policy whack-jobs who caused the otherwise staid, sober Randian fundamentalists to lose their composure.

  • Incidentally, while it’s useful to think about Schumpeter in this context, he’s certainly not just Rand-for-political-economists. The routinization of innovation was a crucial part of his model.

  • mickster99

    Hmm. I am not a believer in strictly exclusive OR thinking (x but not y, y but not x). I think most big innovations, when they happen, are likely composed of small incremental steps. As a musician and software developer the methodical (or random) tiny steps may lead to startling epiphonies (aka big innovations). Whether you’re John Coltrane or Jonas Salk or trying to put an astronaut on the moon. Innovation is more about thinking outside of the box (rusty cliche) but valid. Getting there can be pretty much stepwise. Innovation and small stepwise refinementss are necessary complements to each other in my experience.

    One last thing: the last statement in your post is utter crap to my way of thinking. Makes for a provocative comment-inducing babble but should be labeled for what it is: utter crap.
    Utter crap.

  • R. Kevin Hill

    Part of the reason I’m so reluctant to comment on politics is because almost everything everyone says about it is such nonsense, a confection of wishful thinking, untestable conjecture, and self-aggrandizing blame of the partisan opposition. But here goes anyway. It is not at all hard to figure out what the root cause of the current crisis is, and it is neither the oppression of the self-styled Galts who have suffered under what they imagine to be the interminable Obama administration which began sometime a few decades ago, nor is it due to the zero government spending, gold standard following Bush administration with its well concealed exploitation of labor power, colonial and domestic. It was artificially low interest rates induced by the Fed, a practice begun in the 90s when Greenspan drifted from righteous concern about price stability to panicky concern about keeping bubble stock prices artificially high. Low interest rates mean excess borrowing by the unqualified, artificially high prices for what they buy (real estate), culminating in massive defaults. Low interest rates mean lenders have to make up in quantity what they lack in quality. Securitization of risk was the anaesthesia facilitating the process. There’s enough blame to go around to make everyone uncomfortable, but the root causes are at the Fed, or more to the point, at the very idea of there being such a thing as the Fed.

    I was at a party once and someone defiantly asked me “name one businessman who resembles a positive character in Atlas Shrugged.” I promptly replied, “Ed Land of Polaroid.” If I were asked again today, I would add Steve Jobs. I can’t think of anyone else. I doubt Miss Rand would disagree. But her extraordinarily peculiar and still largely misunderstood book is also filled with repulsive businessmen who engage in unfair competition, monopolistic practices, lobbying for special favors, manufacture of tortious products and services that kill people, etc. etc. etc. When innovation leaves, the world they’ve built destroys itself. Interestingly, no one identifies themselves or others with all of those characters. Fans and critics alike misread her if they think they know who she supported or opposed, or would support or oppose. As for what happens when the creative dynamo upon whom everything depends walks away and then returns, historians of Apple, Inc. know the answer to that, as do its shareholders.

  • great statistical implemention method measuring the attitude of women’s and men’s.