Happiness, Herds and the Financial Crisis Andrew Oswald University of Warwick.

Happiness, Herds and the Financial Crisis

Andrew OswaldUniversity of Warwick

Economics is changing

Economics is changing

Researchers are studying mental well-being.

Economics is changing

Researchers are studying mental well-being.

We are drawing closer to psychology and medicine.

Using random samples from many nations:

Researchers try to find what influences the psychological wellbeing of

(i) individuals

(ii) nations.

Regression equations

Mental well-being = f(Age, gender, education level, income, marital status, friendship networks, region, year…)

Could we perhaps learn …

..how to make whole countries happier?

Preferably without relying on implausibly good fortune:

England 8 Brazil 0

On a technical note

To economists and any mathematicians here:

On a technical note

To economists and any mathematicians here:

I have in mind a class of problem where utility depends on relative actions.

Imagine a person is choosing an action a to solve:

Maximize u(a) + v(a – a*) – c(a)

where a* is what everyone else is doing.

Then if v is concave (convex) in status, it is rational to act similarly to (deviantly from) the herd.

So how is ‘happiness’ or well-being measured?

From the U.S. General Social Survey (sample size 40,000 Americans approx.)

• “Taken all together, how would you say things are these days - would you say that you are very happy, pretty happy, or not too happy?”

The distribution of life-satisfaction levels among British people

0

5

10

15

20

25

30

35

Per

cen

tag

e o

f P

op

ula

tio

n

1 2 3 4 5 6 7

Self-rated Life Satisfaction

Source: BHPS, 1997-2003. N = 74,481

Typical GHQ mental-strain questions

Have you recently:

Lost much sleep over worry?Felt constantly under strain?Felt you could not overcome your difficulties?Been feeling unhappy and depressed?Been losing confidence in yourself?Been thinking of yourself as a worthless person?

Average GHQ Psychological Distress Levels Over Time in Britain: BHPS, 1991-2004

Oswald-Powdthavee, Economic Journal, June 2007

10.90

10.95

11.00

11.05

11.10

11.15

11.20

11.25

11.30A

vera

ge

GH

Q-1

2 (l

iker

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1991-1994 1995-1999 2000-2004

The road to nowhere

• Growth in income is now not correlated with growth in happiness

• This is the “Easterlin paradox”

Average Happiness and Real GDP per Capita for Repeated Cross-sections of Americans.

1.8

22.2

2.4

2.6

Mea

n H

app

iness

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00

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00

021

00

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eal G

DP

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1975 1980 1985 1990 1995Year

Real GDP per Capita Mean Happiness

A taste of research (1)

A taste of research (1)

Happiness is high among:

The young and oldMarried and cohabiting peopleThe highly educatedThe healthyWomenPeople with strong friendships

But is it really possible to study happiness and mental wellbeing in a systematic way?

Brain Responses in Two Pictures(MRI Scans)

Source: Richard Davidson, University of Wisconsin

Reported happiness is correlated with…

• A person’s happiness as assessed by friends, family and spouse

• How many times a person smiles• Person’s recall of good and bad events• Heart rate and blood pressure response to

stress• The later risk of getting coronary heart

disease• Cortisol levels

Other observables

We know too that reported well-being levels are predictive of

The probability of:

Other observables

We know too that reported well-being levels are predictive of

The probability of:

a marriage splitting up

Other observables

We know too that reported well-being levels are predictive of

The probability of:

a marriage splitting up

a worker quitting a job

Across nations, hypertension and happiness are correlated (Blanchflower and Oswald, forthcoming, Journal of Health Economics)

0

10

20

30

40

50

Figure 2.The Inverse Correlation Between Hypertension and Life

Satisfaction: 16 European Nations Aggregated into Quartiles

Countries in the Countries in the lowest quartile highest quartile of blood-pressure of blood-pressure

IrelandDenmarkN'LandsSweden

SpainFranceLuxUK Austria

ItalyBelgiumGreece

E. GermanyW. GermanyPortugalFinland

P

erce

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f citi

zens

ver

y sa

tisfie

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ith t

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Per

cent

age

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very

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ith

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Happiness is also U-shaped over the life course

The pattern of a typical person’s happiness through life

4.9

5.0

5.1

5.2

5.3

5.4

5.5

5.6

15-20 21-30 31-40 41-50 51-60 61-70Age group

Ave

rag

e li

fe s

atis

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What about money?

What about money?

The data show that richer people are happier and healthier.

But in particular

Relative income is what seems to matter to humans.

(consistent with Easterlin’s paradox)

In terms of economic theory:

u = u(y/y*)

where y* is what other people earn.

Such relative-income variables show up consistently in well-being equations.

Blanchflower-Oswald, Journal of Public Economics 2004

Luttmer, Quarterly Journal of Economics 2005GDA Brown et al, Industrial Relations, forthcoming

A taste of research (2)

Happiness is particularly low among:

A taste of research (2)

Happiness is particularly low among:

The unemployed

A taste of research (2)

Happiness is particularly low among:

The unemployed

Newly divorced and separated people

A taste of research (2)

Happiness is particularly low among:

The unemployed

Newly divorced and separated people

ps… and children have no effect on happiness

Low life-satisfaction among those who become unemployed

(From the work of Andrew Clark)

The evidence suggests that when a person is made unemployed:

The evidence suggests that when a person is made unemployed:

• 20% of the fall in mental well-being is due to the decline in their income

• 80% is due to non-pecuniary things (loss of self-esteem, status..).

A taste of research (3)

A taste of research (3)

Countries are happier if they have low unemployment and inflation, and generous welfare benefits.

A taste of research (3)

Countries are happier if they have low unemployment and inflation, and generous welfare benefits.

‘Fear’ depresses happiness.

R. Di Tella, R. Macculloch, A.J. Oswald American Economic Review, 2001.

In a recession

there is a widespread decline in mental well-being, we think because of the generalized insecurity.

The importance of relative things to well-being provides an important clue about what has driven the Credit Crunch.

Herd behaviour and

the crisis

• "Men … think in herds; they go mad in herds, … they only recover their senses slowly, and one by one."

C. Mackay

Extraordinary Popular Delusions and the Madness of Crowds, by Charles MacKay, published in 1841.

Extraordinary Popular Delusions and the Madness of Crowds, by Charles MacKay, published in 1841.

Far from the Madding Crowd, by Thomas Hardy, published in 1874.

Herd behaviour is very often natural and individually rational. But it has the potential to be disastrous for the group.

Herd behaviour is very often natural and individually rational. But it has the potential to be disastrous for the group.

Why does it happen?

Why does it happen?

We know that people care about relative things.

Subconsciously, humans are frightened of falling behind:

Subconsciously, humans are frightened of falling behind:

• Bank lenders and brokers felt they had to match rivals.

• Home buyers paid extraordinary prices in order to keep up.  

• Money managers -- rewarded on relative performance against other managers -- copied what the others did.

When rewards depend on your relative position

it will routinely be

When rewards depend on your relative position

it will routinely be

(i) dangerous to question whether the whole group’s activity is flawed

(ii) rational simply to compete hard within the rules that govern success.

When rewards depend on your relative position

it will routinely be

(i) dangerous to question whether the whole group’s activity is flawed

(ii) rational simply to compete hard within the rules that govern success.

Correct dotcom analysts were fired.

The pressures for conformity are strong.

• Finally to the housing market, which started our problems.

Real house prices in the United States over a century

Real house prices in the UK 1975-2006

So all the historical data suggested that house prices were unsustainable.

Yet -- even two or three years ago near the peak -- few people spoke about the apparent likelihood of a crash.

Yet -- even two or three years ago near the peak -- few people spoke about the apparent likelihood of a crash.

…another kind of herd action.

Unfortunately, we do have to have some lean years

Summing up

Points to take away

Points to take away

1. Unemployment is extraordinarily damaging to human well-being.

Points to take away

1. Unemployment is extraordinarily damaging to human well-being.

2. Recession ‘fear’ hurts everyone.

Points to take away

1. Unemployment is extraordinarily damaging to human well-being.

2. Recession ‘fear’ hurts everyone.

3. We have to integrate herd behaviour into economics.

Points to take away

1. Unemployment is extraordinarily damaging to human well-being.

2. Recession ‘fear’ hurts everyone.

3. We have to integrate herd behaviour into economics.

4. Some lean years are now needed.

Points to take away

1. Unemployment is extraordinarily damaging to human well-being.

2. Recession ‘fear’ hurts everyone.

3. We have to integrate herd behaviour into economics.

4. Some lean years are now needed.

5. The madness of crowds will be back.

Happiness, Herds and the Financial Crisis

Andrew OswaldUniversity of Warwick

Papers downloadable at www.andrewoswald.com