Is It Income Adaptation or Social Comparison? The Effect of Relative Income on Happiness and the Easterlin Paradox in India

Abstract

Income adaptation and social comparison are the standard explanations for the lack of a direct long-run relationship between income and happiness. Individuals evaluate life satisfaction relative to past income or income of others. As individual income increases, so also expectations and the mismatch between income and aspirations hold down the happiness level. When everyone’s income increases, the relative position of individuals remains the same, and hence, average happiness does not increase commensurately with increase in income. The validity of the Easterlin Paradox and the relevance of income adaptation and social comparison explanations in India are examined by replicating cross-country analysis with cross-states analysis using the World Values Survey data for 1990–2014 and by applying ordered probit panel estimation. The empirical analysis shows that the long-run income-life satisfaction gradient is negative across states and over time. The panel estimates show the negative relative income effects dominate the positive absolute income effect. There is perfect income adaptation at the individual and aggregate levels. The immediate neighbourhood income—the state average income—is the relevant reference group income. Reducing the income gap and augmenting income sources of the poor may reduce the effect of relative comparison and increase happiness level in the long run in India. JEL Classification: C23, C35, I31