How to Combine Income and Life Expectancy into an Index of Wellbeing-Becker

Modern national income accounts developed about 75 years. Although a sterling achievement that won Richard Stone a Nobel Prize in economics, even pioneers like Stone and Simon Kuznets recognized that these accounts had serious limitations as measures of wellbeing. Among the major oversights that remain to this day are that these accounts neglect the value of time spent in households at housework and other activities, they do not attempt to measure investments in human capital, they fail to adjust for the environmental damages due to pollution, and they take no account of improvements in the quantity and quality of life. The UN's Human Development Index recognizes some of these defects in income accounts, and attempts to correct them by combining percentage changes (or percentage levels) in per capita incomes with percentage changes in life expectancy, and percentage changes in education levels. However, as Posner points out, the weights attached to these different changes (1/3 weight to each) are completely arbitrary. Moreover, there is substantial double counting since much of the value to increased education results from its effects on raising incomes and lower mortality, and these are counted separately. The UN Index ignores modern research that provides a method that is well grounded in economic analysis to combine changes in national income with changes in various types of mortality risk. This method calculates the "statistical value of life", which essentially measures how much individuals are willing to pay for various improvements in mortality rates. To get a measure of the per capita change in what has been called "full" income, one simply adds the per capita change in real income to the value placed on the improvements (or deterioration, as in some African countries due to Aids) in mortality risks. One can divide this change by the initial level of per capita real income to obtain a measure of the percentage changes in full income. These full income measures combine changes in life expectancy and in ordinary income not in some arbitrary way, but by extending the willingness to pay concept that is used in national income accounting to valuations of changes in life expectancy. Hundreds of estimates of statistical values of life have been made for different countries. They are derived from evidence on how consumers and workers value various types of risks to their life. The most common type of study determines how much individuals need to be paid to choose occupations, like construction, that involve relatively large risks of fatal accidents. Other studies use the speed of cars under different circumstances, recognizing that after a point greater speed raises the risk of a deadly accident. Still others examine the willingness of individuals to pay for expensive drugs that are believed to reduce the probability of dying from different major diseases. There is a range of estimates even for a given country, but the central tendency of estimates for young Americans is that they require some $500 to take on a risk that adds about 1/10,000 to their annual risk of dying. So the statistical value of a typical young American life in this case would be $5,000,000=$500/1/10,000. Based on similar calculations for a number of countries, a rough approximation is that young persons in other countries would have statistical values of life that multiply the American value of life by the ratio of per capita income in that country to the American per capita income. In a paper I published with Tomas Philipson and Rodrigo Soares in the American Economic Review, March 2005 called "The Quantity and Quality of Life and the Evolution of World Inequality", we apply this method to estimate the relative changes in full income from 1960-2000 in about 100 countries. A common finding on income growth is that the usual measures of per capita incomes grew only a little more rapidly during this period of time in poor and less developed countries than in richer countries. Even that slight degree of income convergence is found only when income changes in each country are weighted by its populations since the two largest countries with about 40 per cent of the world's population, China and India, experienced unusually rapid growth in per capita incomes. That conclusion about little change in inequality among countries is altered quite significantly when changes in full incomes are compared. Since mortality declined more rapidly in poorer countries than richer ones, adding the value placed on declines in mortality to get measures of changes in full incomes affect the calculations for poor countries more than for rich countries. In fact, the percentage increases in full incomes are on the average much more rapid in poorer countries than in richer ones, which imply a sizable convergence in full incomes across nations during the past several decades. The main reason for this convergence was the transfer of antibiotics and other drugs and medical knowledge from rich to poor countries.

Comments

[Diversity]

Becker's inspired and calculating common sense astounds once again.The improvement in mortality is the elephant in the room for studies of the change in inequality between countries.

I had picked up the importance of differential mortality for the returns to higher education (in a note that is with the editors of The Economist's Voice) and I had been looking recently at the improvement in relative mortality here in Spain as compared to the rest of Western Europe, but I was blind as a bat to this. It is by far the most important economic aspect of differences and changes in our risk of dieing.

[Thomas B.]

Isn't there an economic model that implies that global prices for goods and services will converge over time with the internationalization of markets? (I'm no economist, so I'm sure much of the Heckscher-Ohlin model is lost on me.)

Even if "full incomes" are converging, isn't there still a meaningful question as to why wage rates are not converging more rapidly outside of China and India?

[John Thomas]

My compliments on the fascinating analysis. I think however the dilemma is that people tend to care more, especially in the immediate term, about their income levels than their life expectancy, especially when the factors holding back their life expectancy happen later in life. This is short sighted yes, but historically it has been a grave problem in improving the economic well-being of countries. Take for example Latin America in the 1960's. There modernization of infrastructure and health practices, often funded in part by the US, produced large gains in life expectancy, however, these gains increased population numbers and ate away at income gains. This stagnant income, while hiding the real improvements, provided fuel to communist, protectionist and ultra-nationalist movements that would destabilize the area in years to come.

There is the dilemma, in countries with incomplete industrialization, income growth = higher life expectancies which usually = higher population levels, which dampen per capita income, which fuels desires for economic quick fixes which undermine long term growth which can actually increase per capita income.

I can see no easy solution to this problem, except attempts to properly educate the population about economics, politics and health, or developing a strong integrity in the political class that will enable them to resist quick fixes. Both of those options however, are difficult to achieve.

[Diego Isasi]

Professor Becker:
How should we do an evolution of the full income for a country for say 100 years? (I mean if we do not want to analyze how much the full income change between a period of time, but how it evolved during some years). We value the increase in life expectancy because in those years we can earn more money and have more time for other kind of “works” at home (some call it “leisure”). So if in year 1 we increase the life expectancy from 65 to 66 years, we increase the full income because this extra year of life represent more time of work in the market and in the household. We are valuing today that we made possible a future production. But when we get to the year 66 and people that leave one more year (thanks to improvement in year 1) produce more goods and we count this goods in the national accounts, aren’t we counting part of this production (that one done in the market) two times? Once when we increase life expectancy and again when we actually produce the goods? Thank in advances for your comments.
Diego Isasi

[citoyen]

Professor Becker:

I recently read the book "Development as freedom" of Amartya Sen. I miss in your article some reference to his thesis. I would be happy if you could signal convergences-divergences of yours and his approach.

Thank you

[Jack]

Diego: Food for thought:

If you think of lives in terms of what can be produced and added to GDP (which I don't advise) the loss of young adults to war, traffic fatalities etc. is the saddest and costliest to a society that has "invested" a quarter million in raising a member of its next generation but has lost them before their adult lives and productive years even begin.

Typically, the next phase of life is the "give back" of three or four decades of producing more than we consume; ie often paying more taxes than we derive benefits, pitching in to SS and Medicare that is paying out to older folk, as well as raising the kids who'll become the next generation.

By one's mid-sixties (perhaps a bit older these days) typically one may be consuming more than he/she produces; ie SS, Medicaid, and all too often welfare or other types of subsidies.

So in terms of economic benefit to the economy extending the retirement years is something of a negative.

On the other hand (I don't think there are any economists with just one hand) the demand for housing, food, medical care and entertainment from the retirement set provides jobs for younger folk, though, if wealth were distributed widely, younger folk would be wealthier for not having the burden of serving the needs of older folk; housing would be freed up for them and they'd not have to pitch in as much for SS, Medicare et al.

Thus.......... as I lamented earlier here, GDP is a soullessly poor measure of human well-being and the reason for life extension is as you see in movies with good endings; to enjoy a few more of those golden years, to see another son or granddaughter marry happily; in short to enjoy life as one should for all of the years we're allotted.

Which brings me to the conclusion I've long held; that our democracy and GDP are here to serve us, not the other way around.

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