On Habit Formation
Habit formation is a staple of macroeconomics, finance, and behavioral economics, and deserves to be taken seriously in thinking about tax policy. My star student Jiannan Zhou has nailed down the parameters of habit formation preferences using a hypothetical choice survey that he designed and fielded on MTurk and analyzed using the computational power of Hamiltonian Markov Chain Monte Carlo. (It will be straightforward to collect another round of data on a more representative survey such as Arie Kapteyn’s Understanding America Survey—a web survey that will accept any serious scientific survey question given the requisite funding.)
In words drawn straight from his paper “Survey Evidence on Habit Formation,” here is what Jiannan finds:
Habit formation exists, as a phenomenon distinct from adjustment and cognition costs.
Habit depreciates by about two thirds per year.
Neither additive nor multiplicative habit is consistent with people’s behavior. Almost all current habit formation models in the literature assume either one of these two habit utility functions …
The effect of habit formation on utility is about as strong as that of keeping-up-with-the-Joneses.
Habit formation combined with keeping-up-with-the-Joneses could generate the income-happiness pattern of the Easterlin paradox.
Jiannan is also able to distinguish between internal habit formation (one’s own past consumption as a reference point) and external habit formation (other people’s past consumption as a reference point). Both internal and external habits exist, with external habits accounting for about 17% of habit.
Jiannan has a high-level of statistical precision even with a modest sample size because the hypothetical choices can be—and are—designed to reveal a lot about people’s preferences.
The Easterlin paradox is the puzzle that happiness and life satisfaction often seem nearly flat over time even when per capita income is dramatically increasing. (There are strong versions of this claim that are questionable empirically, but there is little dispute that the rate at which happiness and life satisfaction go up with income is surprisingly low—low enough that dividing by these income coefficients in a regression yields surprisingly high—and potentially suspect—estimates of willingness to pay.)
Jiannan may undersell his result about the strength of habit formation plus keeping-up-with-the-Jones by tying it to the Easterlin paradox. The Easterlin paradox is a “paradox” in part due to a crucial assumption that happiness as measured on surveys is the same thing as utility (plus noise). Bob Willis and I question that assumption in our paper “Utility and Happiness.” Jiannan’s result is clearly about revealed-preference utility as long as one is willing to consider hypothetical choices as revealing preferences. What Jiannan has found is that people state strongly that their future experience would be better if other people’s current and past consumption were lower or if their own past consumption were lower.
Here is an example of the kind of survey questions Jiannan uses:
The strong dependence of people’s stated preferences on their situation relative to other people and relative to their own past gives me pause. Some might think that means it is difficult to make everyone better off. But—optimist that I am—I like to think it points to the importance people place on respect, dignity and being “part of the club,” and that it is possible to design society so there is more of these social goods for everyone. As it is, those things come mainly to people who are high up on the ladder. But what if he could have the kind of world where everyone who keeps the most basic necessary rules of society gets respect and dignity and full belonging?
Jiannan is on the job market right now. Anyone who doesn’t have him on their interview list should. And even those not searching to hire should read his paper if they have any interest in macro, finance, behavioral economics or tax policy. Here is the link to his website. And here is the current version of his presentation slides for his habit formation paper.
Don’t miss this post about the academic work of my most famous student, Noah Smith:
See links to some of my other papers on happiness here:
Postscript: Jiannan is the first student for whom I have been the main advisor since I moved to the University of Colorado Boulder. See “Miles Moves to the University of Colorado Boulder.”