Can economic theory be used to determine human wellbeing?

Rather than a relic of old school economics, recent happiness research shows that CBAs are the tool to bring a wellbeing-centred approach to government decision-making.

Robert F. Kennedy (senior) once quipped that GDP “measures everything… except that which makes life worthwhile”. This clarion call from yesteryear has a lot of purchase these days, with Government’s lining up to replace or supplement GDP with a more wholistic view of human outcomes. For example, the Commonwealth released its Measuring What Matters Framework in 2023 which identified 50 metrics to describe how society is faring. This builds on experience from around the world, including New Zealand’s Wellbeing Budgets (which the new Government has done away with).

Some have framed this sort of change as a way to replace GDP as the objective of Government, while others believe there is a moral imperative to abandon growth entirely.

Putting other criticisms aside, these cases are made on a fundamentally incorrect premise, namely that GDP is not the yardstick by which Government (particularly Treasury) assesses most interventions. That would be the humble cost benefit analysis (CBA). And as it turns out, the humble CBA is already designed to count everything that makes life worthwhile - but only now do we have the tools to make that a reality.

Costs and benefits, it’s in the name

Treasury departments across the country rate CBA as the gold standard for measuring the impact of a program or regulation on society. CBA, as the name implies, seeks to measure the increase in benefits (in dollar terms) that accrue from a policy intervention relative to the costs, while GDP measures the value of transactions. As an example, consider someone who wants a massage. They can:

1. make their spouse do it
2. pay a masseuse to do it

The outcome of both is one massage (of perhaps varying quality), but they show up differently in the economic statistics; a DIY approach will not impact GDP as no transaction occurs, but to a CBA these two scenarios would be considered equal as the same resources are consumed to produce the same output.

That we use dollars to value the costs and benefits does not mean that they are all inherently financial. On the contrary, CBA’s often hinge on non-monetary benefits, such as improvements to health, avoided deaths, or travel time savings. Typically, these benefits are counted one at a time, using a wide array of valuation techniques. In this way, CBAs really are attempts to measure all impacts on human wellbeing.

The pursuit of happiness

So, is that it then? Job done, I guess we’re already living in the wellbeing state? Clearly not. In valuing benefits one at a time, CBAs can only ever make a proxy measurement of an intervention’s impact the ultimate outcome of human happiness.

It is much better, Lord Richard Layard of the London School of Economics argues, to simply measure human wellbeing by asking:

Overall, how satisfied are you with your life nowadays? (on a scale from 0 to 10, where 0 is the least satisfied and 10 is the most satisfied)

While there are other ways you can measure how happy people are, the simplicity of the question above makes it easily understood by respondents. Importantly, it turns out that this one little question contains a great deal of predictive power. It can estimate:

1. whether you’ll be alive in 9 years’ time
2. whether you’ll get divorced
3. whether you’ll lose your job
4. whether you’ll vote back in the incumbent government.

It is upon this question that much of wellbeing economics has been built.

So how can this be used in a CBA to assess a policy intervention? Well, measuring the impact can be done with a simple survey using the question above (in Australia, the HILDA surveys can provide an appropriate benchmark).

However, pricing the results (i.e., estimating a dollar value for a given change in score) is still an emerging area of research. The UK’s 2021 green book guidance states that the value of a one-point increase in life satisfaction that lasts for one year (which they delightfully call “a wellby”) is worth between £10,000 and £16,000 ($20,5800 to $32,928 in AUD).^[1] In this way, a program that increased life satisfaction by one point for one year relative to the status quo would be equal to creating £10,000-16,000 worth of value. 

There are two ways that the brits calculated these estimates: an approach based on the marginal cost approach which estimates how much it costs to produce one wellby (via an increase in income or sudden windfall), or an approach based on the value of a quality adjusted life year or value of a statistical human life^[2]. 

Using the above approaches with Australian data would leads to a value of between $22,000 and $45,500 respectively. This approach is a good template for how Australian governments should measure the impact of their interventions, particularly those that have otherwise hard-to-measure benefits.

Importantly, this would not require governments to throw out the existing approach. On the contrary – human wellbeing has been the object of CBAs all along, and we have begun to treat it as such in our own practice. We’re doing so because we hearing our clients ask for a way to demonstrate the value of social programs in a budget-constrained environment. Life satisfaction gives us the tools to respond to this demand and put human wellbeing front and centre. For example, life satisfaction research helped us estimate the value of a program that enhances social cohesion, helping the NSW Premier’s Department make decisions about ongoing funding arrangements. 

It is in this way, we are now answering questions that could not be answered before and in a way that would make RFK (senior) proud.