Happiness Economics Butchers Marginal Utility Theory
There’s a new wave of economic thought gaining popularity. It’s called Happiness Economics, and it attempts to place happiness at the centre of economics and public policy. Although it is replete with fallacies, I shall focus on the movement’s treatment of utility and value. I will attempt to highlight it’s theoretical misunderstandings and argue that empirical evidence does not support redistributive measures.
Here is one of the theoretical insights from Richard Layard’s Happiness: Lessons From A New Science:
In fact, the benefit from extra income is less the richer the person, so if money is transferred from a rich person to a poorer one, the poorer person gains more happiness than the rich person loses. Thus a country will have a higher level of average happiness the more equally its income is distributed.
We can see where Layard is coming from if we consider the following propositions:
- money has a diminishing marginal utility
- a “rich” person values an additional € less than he values his previous hundreds of €
- a poor person values an additional € very highly
- therefore, we can increase overall utility/welfare/happiness by transferring money from rich to poor.
The above is a prime example of an economic non-sequitor. The conclusion does not logically follow from the previous statements. The first three statements are true however, for the following reasons:
- humans value the first unit of an economic good more highly than they value subsequent units of the same homogeneousgood. This requires no testing or validation; it is true a priori
- it follows that a person with many €s will value a subsequent € less than the €s he already owns. As an aside, the rich person’s actions demonstrate that the person prefers the additional € to the leisure he sacrificed
- similarly a person with few or no €s will value an additional € very highly
Now the problem is, where did Layard make the quantum leap of assuming that the poor person values the € more highly than the rich person? How does he know that redistribution will lead to increased overall happiness? Marginal utility theory simply descibes how a human values subsequent units of economic goods. How can we possibly compare the value scales of different humans? We simply cannot perform such an operation – unless someone has invented a utilitometer.
Layard’s statement reveals a level of ignorance of marginal utility theory. Humans’ value scales are ordinal, not cardinal. A human will place the first unit of a good toward the use he values most highly. The second unit will be directed to the second most valued end. And so on. It is for this reason that we cannot claim that the first unit gives us triple the utility of the next unit. We cannot add, subtract or multiply utilities, nor can we compare Smith’s value scale to Jones’.
Layard also falls into the “utility maximisation” trap. As utility is ordinal or cardinal, there is no concrete amount of “happiness” or “utility” to be maximised . For this I turn to Rothbard:
The chief errors here consist in conceiving utility as a certain quantity, a definite functionof an increment in the commodity, and in treating the problem in terms of infinitely small steps. Both procedures are fallacious. Utilities are not quantities, but ranks, and the successive amounts of a commodity that are used are always discrete units, not infinitely small ones. If the units are discrete, then the rank of each unit differs from that of every other, and there can be no equalization.
Many errors in discussions of utility stem from an assumption that it is some sort of quantity, measurable at least in principle. When we refer to a consumer’s “maximization” of utility, for example, we are not referring to a definite stock or quantity of something to be maximized. We refer to the highest-ranking position on the individual’s value scale. Similarly, it is the assumption of the infinitely small, added to the belief in utility as a quantity, that leads to the error of treating marginal utility as the mathematical derivative of the integral “total utility” of several units of a good. Actually, there is no such relation, and there is no such thing as “total utility,” only the marginal utility of a larger-sized unit. [Source]
Layard’s analysis is theoretically unsound. Even though empiricism is not the correct approach to economic science, it’s worth checking out the data. So what does it say?
The research conducted by the Institute of Economic Affairs claims that there is no correlation across time between the Gini coefficient and average happiness in the United States. In an excellent monograph, the IEA also argues that happiness isn’t correleated with violent crime, government spending, gender income inequality, life expectancy or unemployment either. So how can happiness be used as a basis for public policy?
Why start a New Economics if you can’t even get the basics right?