Eugenio Proto

A Reassessment of the Relationship between GDP and Life Satisfaction

The scientific debate on the relation between Gross Domestic Product (GDP) and self reported indices of life satisfaction is still open. In a well-known finding, Easterlin reported no significant relationship between happiness and aggregate income in time-series analysis. However, life satisfaction appears to be strictly monotonically increasing with income when one studies this relation at a point in time across nations. Here, we analyze the relation between per capita GDP and life satisfaction without imposing a functional form and eliminating potentially confounding country-specific factors. We show that this relation clearly increases in country with a per capita GDP below 15,000 USD (2005 in Purchasing Power Parity), then it flattens for richer countries. The probability of reporting the highest level of life satisfaction is more than 12% lower in the poor countries with a per capita GDP below 5,600 USD than in the counties with a per capita GDP of about 15,000 USD. In countries with an income above 17,000 USD the probability of reporting the highest level of life satisfaction changes within a range of 2% maximum. Interestingly enough, life satisfaction seems to peak at around 30,000 USD and then slightly but significantly decline among the richest countries. These results suggest an explanation of the Easterlin paradox: life satisfaction increases with GDP in poor country, but this relation is approximately flat in richer countries. We explain this relation with aspiration levels. We assume that a gap between aspiration and realized income is negatively perceived; and aspirations to higher income increase with income. These facts together have a negative effect on life satisfaction, opposite to the positive direct effect of the income. The net effect is ambiguous. We predict a higher negative effect in individuals with higher sensitivity to losses (measured by their neuroticism score) and provide econometric support of this explanation.

Democracy, Collective Action and Intra-elite Conflict

We analyze a model where there is uncertainty about the future power of two ex-ante symmetric elites to appropriate surplus, and ex-ante surplus sharing agreements are not binding. We show that in an oligarchy, the stronger elite appropriates the entire available surplus, whereas a democracy results in a more balanced surplus allocation between the two elites. In a democracy, the newly enfranchised non-elite organize to act collectively, so that the weaker elite can credibly threaten to form a coalition with the organized non-elite against the stronger elite. Such a threat ensures that the more balanced surplus sharing proposal chosen by majority voting is renegotiation-proof. Therefore, sufficiently risk-averse elites unanimously choose democracy as a form of insurance against future imbalances in relative power. We emphasize that franchise extension to, and low cost of organizing collective political activity for, the non-elite are both necessary features of a democracy. Our formal analysis can account for the stylized facts that emerge from a comparative analysis of Indian and Western European democracies.

Smithian growth through creative organization

We model technological progress as an external effect of organizational design, focusing on how factories, based on labor division, could spawn the Industrial Revolution. Dividing labor, as Adam Smith argued, facilitates invention by observers of production processes. However, entrepreneurs cannot internalize this benefit and choose labor division to facilitate monitoring. Equilibrium with few entrepreneurs features low wage shares, and high specialization, but a limited market for innovations. Conversely, with many entrepreneurs, there is a large market for innovation but little specialization because of high wage shares. Technological progress therefore occurs with a moderate scarcity of entrepreneurs. Institutional improvements affect growth ambiguously.

Life Satisfaction, Household Income and Personality Theory

We show that personality traits mediate the effect of income on Life Satisfaction. The effect is strong in the case of Neuroticism, which measures the sensitivity to threat and punishment, in both the British Household Panel Survey and the German Socioeconomic Panel. Neuroticism increases the usually observed concavity of the relationship: Individuals with higher Neuroticism score enjoy income more than those with lower score if they are poorer and enjoy income less if they are richer. When the interaction between income and neuroticism is introduced, income does not have significant effect on his own. To interpret the results, we present a simple model where we assume that (i) Life Satisfaction is dependent from the gap between aspired and realized income, and this is modulated by Neuroticism and (ii) income increases in aspirations with a slope less than unity, so that the gap between aspired and realized income increase with aspirations. From the estimation of this model we argue that poorer tend to overshoot in their aspiration, while rich tend to under-shoot. The estimation of the model also shows substantial effect of traits on income.

Intelligence, Personality and Gains from Cooperation in Repeated Interactions

We study how intelligence and personality affect the outcomes of groups, focusing on repeated interactions that provide the opportunity for profitable cooperation. Our experimental method creates two groups of subjects who have different levels of certain traits, such as higher or lower levels of Intelligence, Conscientiousness, and Agreeableness, but who are very similar otherwise. Intelligence has a large and positive long-run effect on cooperative behavior. The effect is strong when at the equilibrium of the repeated game there is a trade-off between short-run gains and long-run losses. Conscientiousness and Agreeableness have a natural, significant but transitory effect on cooperation rates.

LABORATORY EVIDENCE FOR EMOTIONAL EXTERNALITIES: AN ESSAY IN HONOR OF EJ MISHAN

Professor EJ Mishan was a world expert on the idea of externalities. In this paper, we provide evidence for the intuitive idea of “emotional externalities”. These might be viewed as psychological spillovers from the well-being of one person upon the well-being of another. A new form of laboratory experiment is implemented. “Happiness” answers are elicited in the first few seconds of the experiment. Tragic life events — like family illness and bereavement — are then studied. The paper documents evidence consistent with a powerful caring-about-others effect. The paper’s results also suggest an approximate equivalence between life-satisfaction data and happiness data.Statistical offices should incorporate questions to capture people’s life evaluations, hedonic experiences and priorities … All these aspects of subjective well-being (cognitive evaluations, positive affects and negative affects) should be measured separately to get a satisfactory appreciation of people’s lives. Which of these aspects matters more, and for what purpose, is still an open question.Stiglitz et al., Commission on the Measurement of Economic Performance and Social Progress, 2009

Bank fragility and growth expectations

Abstract Banks supply liquidity to insure individuals against possible short-term consumption shocks. The higher this level of illiquidity insurance the lower the investments in long run assets, and the higher the risk of a bank run generated by a real negative shock. If individuals are sufficiently risk averse, competitive banks trade off liquidity insurance for portfolio risk. High growth expectations, typical of emerging economies, increase the optimal liquidity supply even when this increases the risk of a bank run. On the contrary, deposit contracts offered when economic performances are very uncertain (like in less developed economies), and where output fluctuations are milder (like in developed economies), are less exposed to the risk of a bank run. In this setting, a bail-out in case of crisis is ex-ante Pareto efficient even if it always increases the risk of crisis.

Growth Expectations and Banking System Fragility in Developing Economies

The likelihood of a banking crisis appears to be higher in fast-developing countries.An explanation is provided in a Diamond and Dybvig framework, where banks are vehicles of consumption-smoothing, offering insurance against shocks to the consumption path of consumers.The theoretical model shows that the higher consumer growth expectations, the higher the optimal level of illiquidity insurance even if it implies higher exposure bank runs.Empirical evidence supports this result and suggests that the effect of deposit interest rates on the probability of crisis is stronger after a period of high, uniterrupted growth.Policies of providing bail-outs or deposit insurance are demonstrated to be efficient even when they increase the fragility of the banking system