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

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 Source: BHPS, 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, Oswald-Powdthavee, Economic Journal, June 2007

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.

A taste of research (1)

Happiness is high among: The young and old Married and cohabiting people The highly educated The healthy Women People 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)

Happiness is also U-shaped over the life course

The pattern of a typical person’s happiness through life

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 2005 GDA 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:

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)

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.

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.

Why does it happen?

We know that people care about relative things.

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

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.

…another kind of herd action.

Unfortunately, we do have to have some lean years

Summing up

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 Oswald University of Warwick Papers downloadable at