Economyths - ten ways economics gets it wrong Part 9

As Partha Dasgupta wrote: "we economists see nature, when we see it at all, as a backdrop from which resources and services can be drawn in isolation. Macroeconomic forecasts routinely exclude natural capital. Accounting for nature, if it comes into the calculus at all, is usually an afterthought to the real business of 'doing economics.' We economists have been so successful in this enterprise, that if someone exclaims, 'Economic growth!,' no one needs to ask, 'Growth in what?' - we all know they mean growth in gross domestic product (GDP)."24 The GDP is equal to the total amount spent for all final goods and services produced within a country. (A final good such as a bicycle may include intermediate goods such as tires that are not included separately.) Bees, fish, or oil do not count unless they are part of some economic transaction. Pollution is not included, but cleaning up pollution is.

While the GDP is often used as a proxy for standard of living by media and governments, it is actually a measure only of economic activity. If you believe in efficient markets, see the economy as a rational machine for optimising utility, and so on, then that makes sense. Governments also like it because it correlates with tax revenue. However, because it ignores the negative effects of growth, GDP gives a misleading impression of an economy's state of health. A number of alternative measures have therefore been developed in recent years, which typically address both environmental and social factors.

A leader in this area was the tiny Buddhist kingdom of Bhutan, which in 1972 replaced GDP with Gross National Happiness. This combines a number of economic, cultural, social, and environmental measures into a single number. Perhaps as a result, the environment is taken seriously. According to Nature: "The country has some of the most progressive - and controversial - environmental regulations in the world, including bans on plastic bags, timber exports, hunting and even tobacco sales."25 They also control tourism by charging visitors around $200 a day. But you get a hotel and personal guide.

Another measure is the Index of Sustainable Economic Welfare (ISEW), developed by ecological economists Clifford W. Cobb and John B. Cobb, Jr. in 1989. This corrects the GDP for factors such as uncounted household services, so it's the same if you clean the house yourself or pay a cleaner; and subtracts for effects such as environmental degradation and resource depletion. In America the ISEW generally tracked the GDP until the 1980s, but since that time it has been on the way down, because the negative factors have outweighed the positive economic growth.

A related measure is the Genuine Progress Indicator, which includes additional factors such as social inequality and crime rates. A number of countries have measured GPI and again seen a slow decline in the past few decades, even as GDP has soared. In my home province of Alberta, Canada, a 2005 study by the Pembina Inst.i.tute revealed that, despite a 500 per cent increase in GDP since 1961, boosted in large part by oil sands development, the GPI shrank by 20 per cent in the same time. The study noted that, on the plus side, "premature mortality and infant mortality has declined, life expectancy has increased, there are fewer fatal car accidents, unemployment rates are down, weekly wages are up." On the downside, "household debt is on the rise, the gap between the rich and the poor is growing, as are greenhouse gas emissions and forest fragmentation."26 Alberta is still a great and, I believe, privileged place to live, but the study shows that being a boom province also brings problems.

The Happy Planet Index is defined by the New Economics Foundation in the UK as life satisfaction, multiplied by life expectancy, and divided by ecological footprint.27 It therefore offers a kind of efficiency measure, in terms of happy years per unit of planetary area. Germany scores about twice as high on this index as the US, because people in both countries have similar scores of life satisfaction and life expectancy, but Germans consume resources at about half the rate. Nine of the top ten countries are in Latin America, with Puerto Rico topping the rankings.

In 2009, a commission appointed by Nicolas Sarkozy, the French president, recommended that GDP should be replaced or augmented by measures that take into account factors including general well-being, educational standards, non-market activities such as childcare and leisure, and environmental sustainability. The report also noted that, while France's GDP per person in 2005 was 73 per cent of America's, French people also work shorter hours and fewer days, and get better government services. So the real difference was half as big.28 Working less is also usually easier on the environment. One of the few bright spots from the credit crunch was that it helped reduce global carbon emissions by around 2.6 per cent in 2009, which was the largest annual fall in 40 years, according to the International Energy Agency.29 How to balance these different factors and combine them in a single indicator is obviously a difficult and ambiguous task, and the result is more like a report card, with a number of separate sections and a total overall grade, than a hard economic metric. The great appeal of the GDP is that it makes no such attempt - any transaction is the same as any other. As Herman Daly noted, economics is based on the "Pythagorean a.n.a.logy" between "fuzzy" reality and "well-defined, a.n.a.lytic number."30 However, economics has a long history of adopting models that are simple but wrong. n.o.bel laurel leaves have been sprinkled on risk formulae, based on the normal distribution, that are simple but wrong. The Gaussian copula used to value mortgage securities is simple but wrong. In exactly the same way, the GDP metric is simple but wrong, and by hiding the underlying complexity, it leads to the same kind of miscalculation.

If the alternative metrics seem fuzzy, ambiguous, and multidimensional, that's because the real world is too. In fact, one could argue that metrics of any type are over-used in our number-obsessed and target-driven society. Metrics can take on a life of their own, as they become the objects of government or corporate manipulation; and as with risk models, over-reliance on them can weaken our intuition and common sense. The best option may be to maintain a range of complementary metrics, but treat them with a grain of salt, and realise that each captures only a part of the full story.

The living economy.

The term "ecological economics" should be a little redundant, as both words share the Greek root oikos (household) and together mean something like household-study household-law. It is telling that the two fields of ecology and mainstream economics have grown so far apart in the century and a half since they were named that they now represent completely different sets of principles.

The basic idea of ecological economics can be summarised by Daly's argument with the World Bank economists: when you draw the box for the economy, you have to put it in a larger box called the environment. The human economy is a subset of the world system. Our inputs, in terms of natural resources, and outputs, including pollution, are like the metabolism of a kind of super-organism. We can a.n.a.lyse it using the same kinds of tools as we use to a.n.a.lyse other living systems, such as a cell, or a beehive, or a complete ecosystem.

Instead of being a closed system, like a machine, the economy is open to the environment. Attention therefore s.h.i.+fts from the inner mechanics of the economy to big-picture questions related to things like scale and timing and the flow of energy. Is the economy becoming too big relative to its environment? Is it consuming resources at too fast a rate? Is it adequately disposing of its own waste? Is it endangering the food chain on which it depends for survival?

One application of ecological economics is to estimate the value of "services" provided by nature. For example, a 2008 study in the journal Ecological Economics estimated that the worldwide economic value of insect pollination services, provided mostly by bees, was $217 billion, which is about 9.5 per cent of the total value of the world agricultural food production. Some might yawn, but the report also showed that in terms of value, the crops most vulnerable to a loss in pollinators are the stimulants, coffee and cocoa. Lose those bees, and the whole human economy is going to slow down a notch as we wander around with glazed eyes, searching for the last remaining Starbucks stores.31 In 2006, the Stern Review on the Economics of Climate Change included ideas from ecological economics to estimate the damage caused by climate change, taking into account the impact on future generations.32 An inherent problem with these reports is that, by necessity, they a.s.sign economic values to things that cannot be directly measured but only estimated or inferred. This might be reasonable for something like bee pollination; but we can weigh the rights of future generations only by making complicated value-based judgements of what they might want, what alternatives they might have, and so on. The future impact of climate change is impossible to predict, because as discussed in Chapter 1, our models of the atmosphere aren't much more reliable than our models of the economy.33 Even so, it is still possible to draw up reasonable targets, and monitor whether the situation is getting better or worse.

A different approach, sometimes known as environmental economics, is to let the market make the decision, or infer price from consumers' choices. As a resource becomes more scarce, its price should increase accordingly; if we care about future generations, or endangered species, then we will take that into account when we make our purchasing decisions. This is just mainstream neocla.s.sical economics in another guise. As one textbook on environmental economics states, in a perfect market, "prices ration resources to those that value them the most and, in doing so, individuals are swept along by Adam Smith's invisible hand to achieve what is best for society as a collective. Optimal private decisions based on mutually advantageous exchange lead to optimal social outcomes."34 This argument can be summarised as the theory that the price is right. Markets can cost everything, including future risk. But if markets cannot correctly price a CDO2 mortgage contract, with its billion-page doc.u.mentation, then they certainly can't price something like the CO2 bond we hold with our billions of descendants.

Ecology vs. economics.

The different a.s.sumptions and worldviews behind ecological and mainstream economics mean that the two come up with very different policy recommendations. For instance, mainstream economists, along with most politicians and media, are almost religiously in favour of economic growth, as measured by GDP. The one thing every politician around the world could agree on after the credit crisis was that growth needed to be restored; less often was it mentioned what kind of growth. Some ideologues even argue that the best way to protect the environment is by growing the economy - as if a healthy planet is a luxury that only the rich can afford.35 Yet there is now ample evidence that GDP growth is often a.s.sociated with a decline in environment-sensitive indicators such as GPI. Quality matters.

Scale matters too. Ecological economists believe that when the human economy becomes too large relative to the natural systems that support it, then the problems caused by economic growth can outweigh any benefits. The world is already stretched to capacity to feed the current human population. We can increase production by improved efficiency, but there is always the trade-off between efficiency and robustness - intensive monoculture farming, for example, is inherently fragile and requires large amounts of fertilisers and pesticides to maintain it. Our agricultural system exhibits the same lack of modularity, redundancy, and diversity as our banking system (Chapter 2), but it is even more important for our survival. As the old saying goes: if you want to collect honey, don't kick over the hive.

Mainstream economists treat money in abstract numerical terms, as something that can grow and expand without any constraints. Ecological economists see this as an illusion, and believe that money should be tied more closely to real physical wealth. Under fractional-reserve banking, banks can lend out far more money than they hold as reserves. The result is a debt-based financial system in which most of the "money" is in the form of credit, and everyone is running around frantically trying to pay it off. The situation is exacerbated by the existence of complex financial derivatives. The huge tower of money that was sitting uneasily on top of the world's oil supply in 2008 was an imaginary thing that could vanish as easily as it was created (though its effects on humanity were real enough). One of the biggest obstacles to a sustainable, controlled-growth economy is that governments would have to get out of debt in order to afford it. Ecological economists therefore argue that we should reduce the amount of credit in the economy, even to the extent of returning to full-reserve banking, in which the only money that can be lent out is backed by deposits.36 Mainstream economists treat the planet's resources and pollution sinks as if they were essentially infinite, but according to estimates from the World Wildlife Fund we are already living beyond our means. The ecological footprint of the human race - as measured in terms of the amount of resources we need to support ourselves sustainably - is now equivalent to 1.3 planets.37 The extra 0.3 planets-worth of resources is being borrowed from future generations. If all countries had the same ecological footprint as the United States, the total would be equivalent to ten planets. We are building up a large and unsustainable debt of a different kind that far outweighs anything produced by the subprime housing market.

The healthy economy.

To reduce this debt, a first step is to make both resource use and pollution reflect their real environmental cost. Key to this is the way we handle energy. One approach is to s.h.i.+ft the tax burden from things like salaries towards environmental negatives, through use of a carbon tax. This will not only make conventional carbon-based energy sources more expensive, but will affect the cost of all energy-intensive items, and therefore change price signals throughout the entire economy. Locally-produced goods, for example, will cost less than imported goods; housing and transportation will be pushed to adopt energy-saving technologies.

Another approach is to put a floor price in rich countries on non-renewable energy sources such as coal or oil, equivalent to the price of the nearest renewable subst.i.tute. One scheme, suggested by George Soros for the US, would be to impose a price on carbon emissions through a carbon tax or auctions of pollution permits, and use import duties to keep domestic prices above a certain level. This would help spur the development of alternatives and eventually bring down their cost. For this to be politically acceptable, the expected income from the plan would have to be distributed to the public in advance.38 While price signals will steer the economy towards a more sustainable path, they don't directly address the problem of resource depletion. As with fisheries, sometimes the only way to protect the resource is to put a hard limit on the extraction rate. Under a cap-and-trade system, the rights to extraction are auctioned off to companies, in the same way that rights to bandwidth are auctioned off to mobile phone companies.39 Such schemes violate the neocla.s.sical principle that we shouldn't monkey with the market. But everyone is monkeying with the energy market anyway. When oil prices are rising, oil producers keep their product in the ground, waiting for it to appreciate further in value. OPEC countries get together to set their own quotas. Large consumer nations including China subsidise oil prices in their home markets. Venezuela uses oil as a tool to promote its Bolivarian revolution (though Chavez's anti-American rhetoric is somewhat undercut by the fact that his country's economy is based primarily on supplying them with oil).40 Inst.i.tutional investment funds wade in and out of the energy market depending on the astrological position of the moon and stars, or on whatever Goldman Sachs tells them to do. Oil is about the most important thing in our world economy, driving both economic growth and the threat of climate change, and the fuel gauge is edging towards low. But the way that we handle it is less sophisticated than the mechanics of a 19th-century steam engine. If we want to avoid a Minsky Moment of global proportions, then we had better strap a governor onto the world energy markets.

Finally, we need to make the economy as a whole more robust to environmental shocks, even if this is at the cost of traditionally-defined efficiency. In previous chapters, I argued that in order to understand things like systemic risk, we need to adopt a systems approach to the finance system. A similar systems approach is adopted by ecologists in areas such as ecosystems-based fisheries management. Guiding principles, according to University of Was.h.i.+ngton fisheries professor Robert Francis and colleagues, include: "Keep a perspective that is holistic, risk-averse and adaptive," and "Maintain resilient ecosystems that are able to withstand occasional shocks."41 Similar principles could apply quite well to the human economy in general. Industries such as agriculture and retail are built around ma.s.sive corporations and supply chains that circle the globe. These are highly efficient, in a narrow economic sense, and benefit from economies of scale, but also lead to uniformity, lack of regional self-reliance, and fragility. One benefit of a carbon tax is that it would make transportation more expensive and lead to a greater diversity of local supply chains, therefore reducing systemic risk.

The main problem with the economy, after all, is not that it is hard to predict or is expanding insufficiently quickly, but that in many respects it appears to be in a state of ill-health. As Galen wrote in On Medical Experience (2nd century AD): "In those who are healthy ... the body does not alter even from extreme causes; but in [the unhealthy] even the smallest causes produce the greatest change." The extreme instability seen in the markets, the extreme inequalities in wealth, even the extreme weather that may become more common with climate change, are all signs that the system is out of balance. Economists will never be able to predict the exact timing of a crisis like the oil shock, any more than a doctor can predict the exact timing of a heart attack, but they can at least make general warnings, and detect whether a situation is getting better or worse. (Of course, one reason why doctors are less willing than economists to make unsound predictions is because they can be sued for malpractice.) Models can play a useful role, by enabling us to picture and simulate the complex linkages within the economy-environment system.42 As in biology or ecology, the predictive power of such models is usually low, because of the complexity and intractability of the system. As Evelyn Fox Keller noted, nature "is not completely bound by Logos." The main use of models is to elucidate basic principles; consider different future scenarios; and perhaps even make the system less stressed and unpredictable in the first place.

Our current approach to the economy is schizophrenic.43 We design an unregulated system that is economically and ecologically unstable; model it using techniques that a.s.sume stability; try to make predictions of the future; and then react in surprise when something goes wrong. If instead we acknowledge that the system is unstable, that opens up the opportunity to actively improve it, rather than pa.s.sively try to guess its next move.

It is often said that growth is necessary in order for the economy to avoid collapse. The whole point of capitalism, after all, is to use borrowed money to generate innovative products and services that increase productivity, raise standards of living, and pay off the debt. Consumers, for their part, are in a constant search for novelty and excitement. Social inequality guarantees that only the productive will be rewarded and prosper.44 A low-growth economy would lead, it is claimed, to unemployment, mounting debt, inefficiency, and ma.s.s boredom. However, the current arrangement, in which the benefits of increased productivity are sequestered by the elite, as the middle cla.s.ses sink deeper into debt, the poorest struggle to survive, and the planet comes under increasing stress, doesn't look very stable either. It will look even less stable if the world population reaches 9 billion people, as it is projected to do by 2050.

We therefore need to re-orient our definition of growth away from GDP, and encourage innovation in strategically useful technologies and policies such as low-carbon housing and transportation. We also need to rethink our approach towards consumption and the material world in general. Neocla.s.sical ideology, and our faith that unchecked market mechanisms will safely navigate our path to the future, are probably the biggest impediments to solving the environmental crisis. The switch to an ecological perspective means that we can no longer pretend that optimality is somehow achieved by letting everything run free, or by naively a.s.suming that the price is always right. When it comes to things like economic growth, the truth is a lot more complicated. In fact, as shown in the next chapter, we may already have overpaid.

CHAPTER 9.

THE UNHAPPY ECONOMY.

One should never direct people towards happiness, because happiness too is an idol of the market-place. One should direct them towards mutual affection.

Aleksandr Solzhenitsyn, in Cancer Ward (1968).

I think you can reach a certain state of consciousness, a state where you're not aware of anything ... you're just being. The happiest people are those who are being, more times a week than anybody else. It's just down to that.

John Lennon (1968).

According to the Victorian founders of economic theory, the main aim of growing the economy is to make people happy. But despite bigger houses, more cars, and a historically unprecedented abundance of material wealth in the richer countries of the world, measurements of happiness have actually declined slightly since the early 1960s. Meanwhile, countries with lower material standards of living often report higher happiness than those that are better off. It seems that we are working harder and longer, without becoming noticeably cheerier. This chapter explores the fuzzy and often contradictory relations.h.i.+p between money and happiness, and asks whether our future happiness depends on our ability to change the way we make economic decisions at the individual and societal level.

Neocla.s.sical economics was forged during one of the most exciting periods of scientific history. Until the mid-19th century, scientists had a vague notion that there existed a mysterious quant.i.ty, energy, that permeated the universe but took many different forms. There was kinetic energy, the energy of motion, which Leibniz called the vis viva, or living force. Roll a ball down a ramp, and it gains kinetic energy as it speeds up. There was thermal energy stored in heat, which Leibniz and Newton believed was the energy of the random motion of atoms. And there was potential energy, which an object acquires in a force field - be it gravitational, mechanical, electrostatic, magnetic, or chemical. Alfred n.o.bel earned his prize-funding wealth by finding a way to store potential energy in the form of dynamite.

In 1845, the English physicist and brewer James Prescott Joule presented a paper, "On the mechanical equivalent of heat," which described an experiment that shows how gravitational potential energy and heat energy are related. The apparatus consisted of a weight rigged up in such a way that, when it fell, it spun a paddle-wheel in an insulated barrel of water. The stirred water grew slightly warmer because the paddle's energy of motion was transferred to heat, just as your hands grow warm if you rub them energetically together. The potential energy of the weight in the gravitational field was therefore translated, as the weight fell, into thermal energy of the water (a small amount was also lost to friction or to kinetic energy of the weight). By measuring the change in temperature, Joule could quant.i.tatively relate the amount of energy stored in heat to the energy in the gravitational field.

In 1847, the German physician and physicist Hermann Helmholtz, motivated by his study of muscle movement, postulated that mechanics, heat, electricity, magnetism, and light were all different aspects of a single type of energy that was at all times conserved. The connection between the last three was made explicit by James Clerk Maxwell, who showed that light consisted of oscillating electrical and magnetic waves. Emmy Noether later showed that Helmholtz's principle of the conservation of energy was equivalent to a symmetry of the laws of physics in time.

The conservation of energy is the archetype of a successful physical law. It is stable and immutable - as far as we know, it holds for all times and all places. It unifies many disparate phenomena - motion, heat, light - into one theory. It embodies a deep property of symmetry. And it reduces complex reality to a single number. As the physicist Richard Feynman observed, the law is "a most abstract idea, because it is a mathematical principle; it says that there is a numerical quant.i.ty, which does not change when something happens. It is not a description of a mechanism, or anything concrete; it is just a strange fact that we can calculate some number, and when we finish watching nature go through her tricks and calculate the number again, it is the same."1

The physics of happiness.

While these properties were remarkable enough, neocla.s.sical economists believed that the power of the law extended even further. Helmholtz had been motivated by his studies of human muscles, which convert food energy into labour. So why not apply the law to human volition, which converts our labour into utility? Could it not even be used to describe all human behaviour? As Jevons wrote in The Principles of Science: "No apparent limit exists to the success of the scientific method in weighing and measuring, and reducing beneath the sway of law, the phenomena of matter and mind ... Must not the same inexorable reign of law which is apparent in the motions of brute matter be extended to the human heart?"2 The philosopher Jeremy Bentham had already shown how to compute the human tendency to action by summing up "all the values of all the pleasures on the one side, and those of all the pains on the other" to give the total utility. And utility was like energy in that it could take different forms. For example, if a landowner orders a worker to dig a hole, then the worker will suffer a certain negative utility - the pain of labour - which will be compensated when he is paid. Suppose he then buys a loaf of bread with his earnings, and later eats it. Then over the cycle, utility will have transformed from the pain of labour, to money, to the purchase of food, to the pleasure of eating, in exactly the same way that Joule's mechanism transformed potential energy into heat.

Of course, a problem was that one could never directly measure utility or pleasure. However, Jevons argued that in reality we can never directly measure forces, only their effects: "For instance, gravity cannot be measured except by the velocity which it produces in a body in a given time. All the other physical forces, such as light, heat, electricity, are incapable of being measured like water or timber, and it is by their effects that we estimate them. So pleasure must be estimated by its effects." 3 Indeed, economics was in a fortunate position, because there was a wealth of data available - the markets: "we may estimate the equality or inequality of feelings by the decisions of the human mind ... and its oscillations are minutely registered in the price lists of the markets."4 To create a physics of happiness, the neocla.s.sical economists therefore believed that they needed only to make a simple subst.i.tution between physical and economic quant.i.ties. In place of atoms, there were individuals or firms, and in place of energy, there was utility, in all its different forms. The result, claimed Jevons, would be "a kind of physical astronomy investigating the mutual perturbations of individuals."5 Even if the available mathematical and statistical tools were not yet sufficiently refined, it would only be a matter of time: after all, "Previous to the time of Pascal, who would have thought of measuring doubt and belief? Who could have conceived that the investigation of petty games of chance would have led to the creation of perhaps the most sublime branch of mathematical science - the theory of probabilities?"6 Leon Walras likewise described economics as "a science that resembles the physio-mathematical sciences in every respect." Vilfredo Pareto believed the theory was so deep that "People who know neither mathematics nor rational mechanics cannot understand the princ.i.p.al conception of my book." According to the economist Francis Edgeworth, "The application of mathematics to the world of the soul is countenanced by the hypothesis ... that Pleasure is the concomitant of Energy." The trajectory of each soul could be computed by a.s.suming that its aim is to realise "the maximum of pleasure."7 The net effect over a society would be to satisfy Bentham's "greatest happiness principle," which was to provide the greatest happiness to the most people. The economy was nothing other than a mechanism for maximising (a word invented by Bentham) utility-a kind of giant pleasure machine. And rather than being a "dismal science," economics was the science of good times and easy living.

Bad energy.

A recurrent theme of this book has been how ironic it is that economics gains its scientific credibility from its a.s.sociation with physics. It would make sense if, for example, its neocla.s.sical founders had been physicists; or if they had at least shown a solid understanding of physics; or if their ideas had been endorsed by prominent physicists.8 But they were really just grabbing ideas from the air and transplanting them into economics without any concern for basic principles, such as units of measurement or the fact that people are not machines. If you perform Joule's experiment, then the potential energy of a raised weight will transform into the thermal energy of a bucket of water as the weight falls, in a repeatable way. If you perform Jevons' experiment, and calculate the flow in utility as a man digs a hole and is rewarded, then you will get one answer if he's a union worker, another if he's doing it at gunpoint, and still another if he's digging a hole in his own garden for fun. As an a.n.a.logue for energy - let alone as the basis for a grand theory of human behaviour - utility has little use.

Jevons' argument that market mechanisms optimise utility, and therefore utility can be inferred from market prices, is an example of the circular logic that characterises neocla.s.sical economics. As with the efficient market hypothesis, it boils down to the statement that markets know all and the price is right.

People did try to warn them. Replying to a letter from Walras, the French mathematician Henri Poincare warned that the unrealistic a.s.sumptions of the theory might make the conclusions "devoid of all interest."9 The mathematician Norbert Wiener later wrote that "economists have developed the habit of dressing up their rather imprecise ideas in the language of the infinitesimal calculus ... To a.s.sign what purports to be precise values to such essentially vague quant.i.ties is neither useful nor honest, and any pretense of applying formulae to these loosely defined quant.i.ties is a sham and a waste of time."10 Richard Feynman said of the tendency for social scientists in general to mathematicise their work: "I have a great suspicion that they don't know, that this stuff is [wrong] and they're intimidating people."11 The a.s.sociation with 19th-century physics doesn't explain how economics has managed to maintain its "hard science" aura. All sorts of once-fas.h.i.+onable psychological and sociological theories have been built around hazy notions of energy, but have failed to qualify for n.o.bel Prizes. These days, people prefer to build flaky theories around something a little more recent, like quantum theory or relativity.

The main reason for the persistence of neocla.s.sical economics is that it tapped into something much more enduring. As seen in previous chapters, it is based on ideas of unity, stability, and symmetry that have characterised Western science since the time of the ancient Greeks. Go back to the Pythagorean list of opposites (Chapter 5), or consider the latest theories of supersymmetry or strings, and you will see those same principles there. Economics therefore has the look and feel of traditional "hard" science. It exploits this by "dressing up" its ideas in mathematical equations that are inaccessible to those "who know neither mathematics nor rational mechanics."12 The other reason that economics is considered a hard, mathematical science is of course because, as Jevons noted, there is a lot of data available. The economy is based on the idea of number - that's why coins have numbers on them. It is the realisation of the Pythagorean statement that "number is all."

But can we really put a price tag on happiness? Are free markets really a machine for maximising pleasure? And if so, why aren't we getting happier?

Share the joy.

In the neocla.s.sical framework, money is seen as a store of utility-a kind of potential energy that can be transformed into pleasure just by spending it. I wonder how the neocla.s.sical economists would have seen the credit bubble of the early 2000s. A huge pleasure field that pervaded the atmosphere, perhaps. Or a ma.s.sive, brewing electrical storm.

While money can certainly be used to buy pleasure, the two quant.i.ties - money and pleasure - are actually very different. For example, if you have some money, it doesn't necessarily decay, because you can deposit it in an interest-bearing account. With pleasure, it lasts for a while, but soon dissipates. Studies have shown that lottery winners don't stay ecstatic for long, but soon return to something close to their previous levels of happiness. Conversely, we can learn to cope with most forms of misfortune, though of course some traumatic events never fade.13 Money also builds up in an additive fas.h.i.+on. If you have a million dollars, and earn another million, then you're twice as rich. But pleasures tend to saturate. Making the first million might make you very happy, but the second million is less of a thrill. In the terms of neocla.s.sical economics, its marginal utility is lower. Materialistic desires therefore have an addictive quality - the more we have, the more we need.

Because money is lasting and additive, if left unspent it will tend to acc.u.mulate over time, which, as discussed in Chapter 7, is one reason for the extreme inequalities in world wealth. Pleasure is self-limiting, and short periods of great joy don't necessarily add up to lasting happiness. Happiness is more democratic than money in that it is more stable and equally shared. As Jevons wrote to his brother: "I have a lurking suspicion that the sum total of a person's enjoyment is generally equal to what we should call in mathematics a 'constant quant.i.ty.'"14 The main determinants of long-term wealth include country of birth, education, ability, who your parents are, ambition, work, health, social networks, luck, opportunity, and whether or not you have access to a trust fund. Long-term happiness also depends to an extent on character traits, some of which may be inherited from your parents, and social networks, though they needn't be from the best school.15 Health, family, a satisfying job, and societal trust are also important. However, the materialistic, acquisitive bent necessary to produce wealth doesn't correlate particularly well with happiness. One paper from the German Inst.i.tute for Economic Research found that "Nonzero sum goals, which include commitment to family, friends and social and political involvement, promote life satisfaction. Zero sum goals, including commitment to career success and material gains, appear detrimental to life satisfaction."16 Money has no intrinsic value on its own, because the worth of a banknote depends on how things are priced in the stores. Furthermore, impressions of wealth are relative. If all of your friends and acquaintances and neighbours have more than you, then you feel poorer, which also affects happiness.17 The easiest way to feel rich is therefore to move to an area where your neighbours all earn a little less. A problem with social inequality is that we tend to compare ourselves with those who have more than us rather than less - especially if we are constantly hearing about them through the media.

Pleasure, in contrast, is both an internal subjective experience and at the same time a shared emotion with positive network effects. According to a study of over 4,700 American people, who were followed over a twenty-year period from 1983 to 2003, happiness spreads between individuals rather like an infectious disease (but a nice one). Having a happy friend or neighbour boosts your own feelings of happiness by an estimated 9 per cent. If that's true, it would make sense for us all to take a half-day off work each week just to socialise. Even friends of friends have an effect. As one of the co-authors of the study, political scientist James Fowler, put it: "The pursuit of happiness is not a solitary goal. We are connected, and so is our joy."18 To feel happier, you should move to a place where the neighbours look not less happy, but more.

While money and pleasure are closely related in some situations, e.g. while shopping, the linkages between the two are usually far more complex and ambiguous. Money doesn't always buy happiness - and even if it does, the happiness it buys may be offset by other effects. As one study by the behavioural psychologist Daniel Kahneman and collaborators pointed out, high-earners spend more time working and commuting, and less time relaxing and hanging out with friends. As a result, they concluded: "People with above-average income are relatively satisfied with their lives but are barely happier than others in moment-to-moment experience, tend to be more tense, and do not spend more time in particularly enjoyable activities."19 On a societal level, comparisons of "subjective well-being" and wealth also appear only weakly related. Although measuring happiness across different societies and cultures is obviously much more difficult than measuring GDP, it appears that, while poor countries do report lower happiness than rich countries, the correlation is small for countries with average incomes above $15,000, and disappears completely at $25,000. Countries such as Indonesia, Vietnam, El Salvador, and Mexico report high levels of happiness, in total defiance of economic principles. This is one reason why, as discussed in the previous chapter, measures such as the Genuine Progress Indicator or the Happy Planet Index do not track with GDP. Comparisons over time show the same thing. World GDP has grown enormously in recent decades, so if we were to insist that happiness and GDP are related, people must have been pretty d.a.m.ned miserable a hundred years ago, or a thousand years ago. But that doesn't seem to have been the case.

Another demonstration of the difference between pleasure/ happiness and money is the fact that we are often happy to work for free - and in some cases, even happier than if we were paid. Volunteer work has been shown to bring many benefits, including the chance to make new friends, the satisfaction of seeing results, and even the sensation of being less selfish.20 Achievements such as Wikipedia, or the open-source computer language Unix, stand testament to the power of unpaid labour. In fact, we often prefer to work for free than for a reduced wage - lawyers will work pro bono, but hardly ever pro cheapo. The reason is because happiness and money engage completely different parts of our brains and our personalities.

Warm and fuzzy.

As the behavioural psychologist Dan Ariely observes in his book Predictably Irrational: "we live in two worlds: one characterized by social exchanges and the other characterized by market exchanges." Social exchanges are "warm and fuzzy" and include offers of help, exchange of gifts, neighbourly collaborations, and volunteer work. The pleasure is in the action itself, and immediate reciprocity is not expected or demanded. Market exchanges, in contrast, are "sharp-edged" and based on numerical calculations of wages, payments, and prices. 21 Social norms are more right-brained and intuitive, while market norms are left-brained and calculating.22 In most situations, we manage to keep these two worlds separate from one another, and it can lead to all sorts of misunderstandings when we mix them by accident or design. In one experiment, psychologists tested to see what would happen at a day-care centre if parents were fined when they showed up late for their children. Under the usual system, parents felt guilty when they were late, so avoided doing it again in future - the situation was governed by social norms (at the nursery I use, the phone call from the director usually does the trick). When fines were imposed, the parents stopped feeling guilty and started calculating instead - with the unintended effect that many chose to show up late and pay the penalty.23 Interestingly, when the day-care centre removed the fine after a few weeks and went back to the old system, the number of parents gone AWOL remained high. Instead of easily reverting to social norms, the parents were still operating under market norms - only now, being late was a really good deal. It seems there was a kind of hysteresis effect at work, in the sense that it was easy to go from social to market norms, but much harder to go back.

This preference for market norms is also shown by experiments in which subjects were primed to think about money, for example by seating them in view of a pile of Monopoly cash, before carrying out some tasks. The effect of the exposure to money was to make them less likely to ask for a.s.sistance, or make offers of help, or collaborate with others. They even preferred to sit further away from other people.24 Our ability to slip easily into market norms is perhaps because they have become so established throughout our society that they are now the default mode. People have always been interested in money, but we seem to be taking the obsession to new lengths. If we are taught and believe as a society that material success equates to happiness, and that market norms are in some sense more rational and real than social norms, then of course we will tend to favour them.

Unfortunately, though, getting stuck in market mode doesn't make us happy, because happiness relies more on social and psychological realities than a number in a bank account. A network of friends, a sense of purpose and harmony in life, the joy of "just being" aren't available down at the mall.25 Our economic theory promises us a road to happiness, but what it offers is an illusion. We built a machine for optimising happiness, only to find out we're not happy living in a machine.

The pursuit of unhappiness.

According to the neocla.s.sical model, the working life is a bit like Joule's experiment. You lift up a heavy weight (perform labour in exchange for money), then release the weight (drop some cash), thus stirring and warming the bucket of water (your soul). In practice, though, it often seems that we are left more stirred up than warmed; more agitated than content. Some aspects of our economic system seem designed to make us unhappy.

In the United States, reported happiness levels peaked some time back in the 1960s, and have remained fairly constant ever since, with a slight downward trend. Metrics of unhappiness, such as suicide and divorce rates, have shown the opposite tendency. One of the biggest profit-makers for pharmaceutical companies is anti-depressant drugs. Given that the US was founded around the Jeffersonian ideas of "life, liberty and the pursuit of happiness," this is something of a concern. Perhaps the problem is that those concepts aren't as compatible as they seemed.

Jefferson's phrase in the Declaration of Independence was based on Adam Smith's "life, liberty, and the pursuit of property" (which was used directly in the 1774 Declaration of Colonial Rights). Milton Friedman's utopia of "a society in which individuals have the maximum freedom to pursue their own objectives in whichever direction they wish, so long as they don't interfere with the rights of others to do the same thing" articulates the same idea. But if you forget all about supply and demand, Pareto optimality, etc., it seems a great leap of faith to a.s.sume that societal happiness is consistent with everyone selfishly trying to maximise their own utility. Instead, according to economist Richard Layard, our atomised societies suffer from "extreme individualism ... We are unhappier as a result."26 Indeed, the whole idea that individuals are in a compet.i.tion for happiness is exactly the kind of thing that makes people unhappy. Everyone becomes paranoid that they're not rich and happy enough. The harder they chase happiness, the more it evades them. The net result is something akin to a mental disease. The psychologist Oliver James has described "affluenza" as "placing a high value on money, possessions, appearances (physical and social) and fame."27 The condition, which is prevalent in rich countries, places people at increased risk of mental disorders including anxiety, depression, and drug abuse. It is worsened by social inequality, which highlights differences in status, and is exploited by advertisers who drum up envy to drive sales. It is the shadow side of the American Dream.

There is also a clear biological link between economic stress and mental and physical health. In a 2007 survey by the American Psychological a.s.sociation, 73 per cent of the respondents cited money as a significant source of stress.28 And that was before the housing crash. Stress affects the body in obvious and immediate ways, such as insomnia, or more subtle ways, such as increased blood pressure or even longevity. A study by a group of epidemiologists from Yale found that involuntary job loss more than doubled the risk of heart attack and stroke among older workers.29 Perhaps the most graphic example of this is Russia, where male life expectancy plunged by several per cent when the country experienced its traumatic s.h.i.+ft to a market economy.

Part of the problem is that, while markets are very good at certain tasks, such as reducing costs and driving innovation, they are less talented in the social sphere. As the former US secretary of labour Robert Reich points out, in the 1950s and early 1960s "issues of economic security, social equity, community, our shared environment, and common decency were central to democratic capitalism." These have lost importance as power has moved away from public inst.i.tutions to consumers and investors: "Today's economy can give us great deals largely because it punishes us in other ways."30 Businesses make their decisions based on cold calculations of profit and loss. That is to be expected. But this att.i.tude has crept over so that it dominates decisions by governments as well. Reich notes that: "Absent from any such calculus is consideration of ... inequality ... economic security ... civil or human rights ... public health or domestic tranquility ... community ... environment ... tolerance and global peace ... democracy. These attributes are clearly difficult to measure or to quantify, but that doesn't make them less worthy of consideration than consumer and investor welfare."31 The dominance of numerical market norms over fuzzy social norms means that we effectively devalue what is most important in life.

It seems that at the level of individuals, businesses, or governments, we have become locked into a particular hard-edged, yang view of the economy as a battle between individuals or firms to maximise their own utility, where selfishness is the only rational behaviour. The aim is to achieve dominance and a.s.sert status over those around you. Yin values such as connectedness or altruism are downplayed, and a.s.sociated jobs such as nursing and childcare are underpaid.32 It is as if we are contorting ourselves to fit the model of rational economic man. The net result, though, is very far from Bentham's principle of the greatest happiness for the most people. It is also rather unreasonable; for as discussed in the previous chapter, our striving for growth at all costs has now reached a scale at which it threatens our viability on the planet. We need to call an end to the race. The best way to do that may be to reform our economic theories.

Reasons to be cheerful.

The fact that money and happiness are totally different concepts somehow knocks the steam out of neocla.s.sical theory, which a.s.sumes precise and mathematical relations.h.i.+ps between utility and price. If the economic machine isn't maximising utility, then what is it maximising?

The answer, of course, is nothing. The economy is what it is. Free markets have many splendid attributes, which must be protected. They are the best way that we have come up with to make a wide variety of economic decisions. They offer individuals and companies the opportunity to either succeed, or fail and make room for others, in the process that Joseph Schumpeter called "creative destruction."33 Markets are a basic form of human interaction that existed before economics was invented, and they don't need neocla.s.sical theories to justify them - any more than human cooperation must be justified by Marxism. But if we are to base our quest for the good life on empirical facts, rather than corny 19th-century ideas, then we need to rebalance our priorities.