Tuesday, October 02, 2007

Really? No economic theory of tipping? 

Greg Mankiw, while discussing the experiment in voluntary price discrimination that the band Radiohead is about to engage in -- and know this, I will buy that album as I've bought all of the albums before -- says we economists "do not have a good theory of tipping."
Normally, we assume that consumers pay as little as they have to when buying the products they want. Yet, when buying meals, haircuts, and taxi services, most consumers voluntarily pay more than they are legally required. Why does this happen? Why is it more true for some services than for others? Why do tipping customs vary from country to country? I have no idea.
On behalf of my good friend Orn Bodvarsson, I have to disagree. Orn and other writers (including another colleague, Bill Luksetich, and one of our graduates, Sherry McDermott) have surveyed patrons of restaurants to look at their tipping behavior. His analysis is that people are rational maximizers in tipping as much as in other parts of their lives.

Tipping is often a means of overcoming a principal-agent issue with the restaurant for food quality and speed. My son makes a living cooking in different kinds of restaurants. Does he conflict with other cooks? Not much. Conflicts are with aggressive servers. As I explained to him early on, the server is pressured to do so by his or her demand for tips. The server is an agent of the customer at the table. The word itself is derived from an acronym: To Insure Promptness.

Tippers will respond to food quality and speed; they also respond to how the server looks and how much attention they give the tipper. I always let the server know when I am going to be paying the bill at the beginning of the meal, so that I get better service relative to others at the table. (Though, if it's a business meeting, I should want better service for my client -- and usually they get it.)

I've always questioned this with Orn and his co-authors regarding the tip given in a restaurant in a roadside cafe, where most patrons are unlikely to return to the restaurant. If the tip is not for a continuous dealing, what is it for? If you are tipping because "it's the right thing to do" or because you are signaling, the question is whether you tip more or less if you are dining alone?

A few months ago Tyler Cowen argued that tipping wasn't an agency problem at all:
The real question is why America is structured so that waiters and waitresses can sell feel-good services ("you are a generous tipper and a fine man") to strangers, in return for money. In other words, how did waiters end up as fundraisers, noting that the final Marshallian incidence may lower their wages by the amount they receive in tips? Most cross-cultural explanations of tipping start with the agency problem between diners and servers ("can you bring my drink now?"), but I believe that is the wrong approach. I view tipping as correlated with effective fundraising in other areas, and Americans as being especially willing to set this additional fundraising arena in motion.
I like that thought, and understood that way the similarities between restaurant tipping and Radiohead's album pricing mechanism are more apparent. In both cases people are showing they are willing to pay more for what is the same good, and doing so willingly. Dennis Young has a simple story of the lemonade stand that gives away the drink but has a tip jar. Hansmann's theory could be applied to say the restaurant doesn't know how much you value a prime rib dinner, so it prices it low and then relies on customers to pay tips to the servers to reflect their willingness to pay more (and capture that by a lower wage to servers.) But Hansmann argued this method only works for some industry structures -- it assumes there isn't a single price the restaurant can charge that covers average total costs (where the server gets paid a wage and no tips.)

So we don't have NO theory; you might say you don't think the theories out there work terribly well, but how many other economic theories fit THAT bill?

UPDATE: Mrs. Dani Rodrik is a Radiohead customer willing to pay more.