What is the difference between experience and happiness levels?

Experience level is common for all your islands and it's constant, you can only increase it. It is the identificator of your general game progress. You gain experience absolutelly from all the game activities and new levels always give you new opportunities: new buildings, quests, etc.
Happiness level is different for all islands and it may vary. You can increase it as well as decrease. To gain happiness points you should always build new decorations, social and entertainment buildings for your villagers. New happiness levels achieved allow you to construct residential buildings and increase your population. Note that number of your workers cannot be more than your happiness level.
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