Well-Being and Economic Development : A Principal Components Analysis

There has been a long-running debate over the relationship between income and happiness. The Easterlin paradox and the paradox of unhappy growth are both discussed at length in the literature. The traditional reduced form regression model, however, limits the structure of relationships that can be estimated. This limitation is the motivation for an alternative approach that can uncover more complicated relationships between well-being and economic development. This study uses principal components analysis to reveal the unobserved latent variables that govern the co-movement of several well-being and economic development variables. Two major components are found: the first has a positive influence on all of the variables, whereas the second has opposite effects on well-being and economic development. Auxiliary regressions suggest that the first component is associated with the level of rule of law and the second is correlated with freedom from regulation