Document Type : Research Paper

Authors

• Morteza Khorsandi ¹
• Mahnoush Abdollah Milani ²
• Teimour Mohammadi ³
• Pardis Hejazi ⁴

¹ Associate Professor, Department of Energy, Agriculture and Environmental Economics, Faculty of Economics, Allameh Tabataba’i University, Tehran, Iran

² Associate Professor, Department of Theoretical Economics, Faculty of Economics, Allameh Tabataba’i University, Tehran, Iran

³ Professor, Department of Theoretical Economics, Faculty of Economics, Allameh Tabataba’i University, Tehran, Iran

⁴ Ph.D. Candidate in Theoretical Economics, Faculty of Economics, Allameh Tabataba’i University, Tehran, Iran

Abstract

The effect of income on subjective well-being, often used as a key measure of well-being, has been widely studied. However, various dimensions of this relationship remain unexplored. The current study aimed to examine the nonlinear effect of income on the subjective well-being of 58 countries over during 2005–2020. The analysis relied on two distinct scenarios. The Panel Smooth Threshold Regression (PSTR) model, derived from regime-switching models, was employed for the analysis. Additionally, the study investigated the effects of income, unemployment, inflation, life expectancy, and income inequality on subjective well-being. The findings revealed that in a nonlinear relationship, the effect of GDP on subjective well-being diminishes at a certain threshold value of income inequality. Consequently, while policymakers aim to increase national income and reduce income inequality to enhance well-being, it is crucial to recognize that further reductions in inequality beyond a certain threshold may reduce the effect of income on well-being. This suggests that after a certain threshold, governments should prioritize reallocating resources toward other essential needs rather than solely focusing on reducing income inequality.
1.Introduction
Well-being is one of the primary indicators of development and a crucial element in social progress, making it a growing focus for policymakers. In a seminal 1974 article, Easterlin found that wealthy individuals are generally happier than their poorer countrymen. However, at a cross-national level, the average happiness in wealthier nations does not exceed that of poorer nations. Furthermore, despite significant economic growth in the United States between 1944 and 1970, no corresponding increase in average happiness was observed. These findings became known as the Easterlin Paradox. Easterlin contends that while economic growth may boost happiness in the short term, it has no lasting impact (over 10 years or more) on a nation’s happiness. Policymakers, seeking to address the question of what constitutes a fair level of income inequality, have thought of various policies. For some, the relationship between income inequality and economic growth is the primary focus of policymaking. Easterlin contends that while economic growth may boost happiness in the short term, it has no lasting impact (over 10 years or more) on a nation’s happiness. Policymakers, seeking to address the question of what constitutes a fair level of income inequality, have thought of various policies. For some, the relationship between income inequality and economic growth is the primary focus of policymaking. Research in the field of happiness economics has sought to explain the Easterlin Paradox and adjust macroeconomic policies accordingly. To date, the threshold factor (in the case of the effect of income on subjective well-being) has often been determined exogenously, visually, or based on the assumption of a linear relationship. The present study sought to answer the following question: Does income affect subjective well-being, taking into account the threshold factor of income and income inequality?
2.Materials and Methods
The present study used the Panel Smooth Threshold Regression (PSTR), which is a generalized version of the Panel Threshold Regression (PTR) model introduced by Gonzales et al. (2005). This nonlinear model extends regime-switching models, where regimes are determined by a threshold variable. The explanatory variables included inflation, unemployment, life expectancy, and gross domestic product (GDP) adjusted for purchasing power parity (PPP). The data for these variables was sourced from the World Bank, while the inequality dispersion ratio was obtained from the World Inequality Database. Numerous studies have investigated the effect of macroeconomic variables on subjective well-being indices. Such studies tend to examine inflation and unemployment together, with their potential interdependence typically overlooked. The dependent variable was subjective well-being, assessed using various components and scales. The data on subjective well-being was obtained from the World Happiness Report database. The report employs the life ladder scale, in which individuals rate their subjective well-being on a 1–10 scale.
3.Results and Discussion
Various factors influence the subjective well-being of countries, with income emerging as a key determinant that has been extensively studied. However, certain aspects of this relationship remain underexplored. Using income inequality as a threshold factor, the present study examined the nonlinear effect of income on subjective well-being across a sample of 58 countries. Two scenarios were analyzed to address the main research question. The first scenario examined the linear relationship between income and subjective well-being. The findings revealed that income has a positive and significant impact on subjective well-being, whereas income inequality exerts a significantly negative effect.
The second scenario examined the nonlinear relationship using the PSTR model, which extends regime-switching models. The results indicated that while income continues to positively influence subjective well-being, the magnitude of this effect diminishes as income inequality increases.
Drawing on the theory of relative deprivation, the study demonstrated that income inequality significantly affects subjective well-being. Moreover, in line with the tunnel effect theory, it was shown that changes in living conditions (e.g., increasing income inequality) can weaken the positive effect of income on subjective well-being.
At an income inequality threshold of 2.16, the coefficient representing the effect of income on subjective well-being decreases from 0.1 to 0.09. Additionally, the findings from the first scenario confirmed that income inequality has a significantly negative effect on subjective well-being, with a coefficient of -0.058.
4.Conclusion
The study of subjective well-being, alongside economic well-being, has garnered significant attention among economists. In economics, well-being is traditionally assessed through an individual’s capacity to purchase goods and services. However, subjective well-being encompasses a broader range of factors beyond income, focusing on overall quality of life. As a result, governments should consider subjective well-being as a critical aspect of policymaking, given its broader scope and its measurability through subjective and composite indicators. Equally important is addressing the social cost of inadequate subjective well-being. Mental illnesses are a leading cause of pain and suffering, significantly reducing productivity. Strengthening social connections can foster positive psychological effects, which, in turn, improve physical health. Thus, prioritizing subjective well-being could encourage governments to a shift in the reallocation of resources from solely physical health to mental health. In addition, enhancing subjective well-being can help reduce both psychological and physical costs in society. Rising income inequality has been shown to diminish the impact of income on subjective well-being. Consequently, if policymakers aim to promote well-being by fostering national income growth and reducing income inequality, it is essential to recognize that reducing inequality beyond a certain threshold may weaken the positive effect of income on subjective well-being. This suggests that after a certain threshold, governments should prioritize reallocating resources toward other essential needs rather than solely focusing on reducing income inequality.

Keywords

• Happiness Economics
• Well-being
• Panel Smooth Threshold Regression
• Easterlin Paradox
• Income Inequality

Main Subjects

• Behavioral economics