(credit: Vitaly Vlasov)

The cost of entitlement

On economics, law and personal conviction

His business involved using two large marble mortars set in brickwork against the party wall, in which loaf sugar and other ingredients were broken up with two equally large wooden pestles held in position by bearers fixed to the party wall. Mr Bridgman engaged in this activity typically every day between 10am and 1pm. In fact, he (and before him, his father) had been using one of the mortars for sixty years, and the second one for 26 years. But now, the noise and vibrations were noticeable in Dr Sturges’ new consulting room, preventing him from examining patients with pulmonary conditions through auscultation, and making it impossible for him to engage in any activity which required thought and attention. So Dr Sturges sought an injunction to stop Mr Bridgman using his noisy equipment.

The law may not know best

This is one of the cases that figure in Ronald Coase’s classic 1960 paper, The Problem of Social Cost, in which he discusses the concept of externalities (and which was instrumental in his being awarded the Nobel prize in 1991). Here, it was the confectioner who, in conducting his business, imposed a negative externality: the noise that harmed the physician.

In the event, Dr Sturges won the case, and the injunction was upheld in the subsequent appeal by Mr Bridgman. As an economist, however, Coase wondered whether this outcome ensured the optimum allocation of resources. A good way to find out would be to allow the two parties to bargain.

My big brother makes a much bigger racket (photo: Republica)

Dr Sturges could have waived his right to silence and permitted Mr Bridgman to continue producing noise as well as sweets, in return for a payment that would more than compensate him for the cost of moving to a more peaceful location, curtailing his business hours, or building a separate side wall rather than using Mr Bridgman’s. If this would have cost the confectioner less than the mandated cessation of using his loud equipment (by changing his business’s operation or by moving it elsewhere), this would have been a better solution.

What if Mr Bridgman had won the case? Then the same logic would apply: the doctor could then have offered him money to quit using the equipment. If Dr Sturges would lose more income if Mr Bridgman continued to pound away in his kitchen, than doing so was worth to the confectioner, again, both parties would have been better off with this arrangement.

This is the essence of Coase’s theorem: if it is possible to trade in the externality, and the transaction costs are sufficiently low, then a bargain will lead to a Pareto-efficient ** outcome, irrespective of how rights are allocated initially. (Pareto-efficiency means it is not possible to change the allocation to make one party better off, without making the other one worse off, i.e., there is no further opportunity for a win-win.) In practice, Coase admits, the transaction costs for such a bargain are often prohibitive — just imagine a factory at a larger scale than Mr Bridgman’s, with noisy machinery affecting not just one neighbour but dozens. Reaching individual settlements with every household in the neighbourhood would be impossible.

If you want truly epic on the impossibility scale, think of the French transport strike. Thousands of workers are on strike over a dispute with the government over its pension plans, preventing millions from using public transport, who are not directly involved in dispute. We definitely have a negative externality here. The workers are within the law in withholding their labour, but just like the confectioner in Coase’s paper, the third party (the tormented travellers) might be willing to pay the strikers to get back to work. That is in principle of course — a negotiation between thousands of strikers and millions of transport users is pretty much unfeasible.

Transaction cost in the mind

It is interesting to look into this economic concept of the transaction cost, as it is not only relevant in the case of externalities, but also with ordinary exchanges.

If I have something to sell that you are interested in buying, and my asking price is lower than the maximum you’re willing to pay, we can do business — provided the cost of actually concluding the trade is not excessive. For example, if I insist that you pay me in cash, or if my website’s checkout process is annoyingly slow, you may find that makes the transaction not worth it.

This transaction cost can be in our head. Let’s go back to Dr Sturges and Mr Bridgman. Imagine the physician was convinced that he was entitled to peace and quiet in a residential area — would he then as easily accept an offer from Mr Bridgman? Likewise, if Mr Bridgman was adamant that he was entitled to keep conducting a business he had been conducting for decades, would he then be willing to pay to continue doing so?

Our sense of entitlement can stand in the way of a reasoned consideration of costs and benefits. Perhaps this is behind the prolonged transport strike in France which, the day this is published, is in its 44th day. Public sector workers lose 1/30 of their gross monthly pay for every day they strike, so the strike has already cost them six weeks’ salary. Could it be the sense of entitlement to the generous pension that has been on offer for years, that makes them less than rational in calculating what the strike is costing them (and what they are likely to gain — as the government seems hardly less unyielding in their position)?

The conviction that we are in the right means we are not just looking at the economic gains and losses in a potential transaction. We also see ‘giving in’ or ‘selling out’ as part of it, and that comes with a price tag.

Consider this real-life case. In 2008, the owners of a guest house in Cornwall refused to let a gay couple in a civil partnership in a double room. We could say that their perceived entitlement to decide what went on under their roof made the transaction cost too high. We could imagine the couple offering more money if they really wanted to stay in the double room, and the owners refusing such an offer. We could also imagine the unwillingness of the guests to pay more, because of their own sense of entitlement to not being discriminated. But the matter went to court, and eventually, after losing the initial case, losing the appeal, and losing in the Supreme Court, the owners had to pay £3,600 (€4,400, $4,800) in damages, giving us an idea of the magnitude of the transaction cost in their mind.

Transaction costs in social relationships

As so often, economic insights apply just as much in the transactions we engage (or refuse to engage) in, in our social life. The David Lynch movie The Straight Story describes the remarkable journey of the elderly war veteran Alvin Straight. We never learn exactly what happened between him and his brother Lyle, but they have not spoken with each other for more than 10 years. However, when Alvin hears that Lyle has had a stroke, he is determined to go and see his brother and make amends before it is too late. Unfortunately, he has had surrender his driving licence as he is visually impaired and has bad legs. Undeterred, though, he decides to hitch a trailer to his lawn mower and ride it the nearly 240 miles to his brother’s home at a maximum speed of 5 mph.

Transaction cost: a 240 mile drive on a lawn mower (image: YouTube)

It is a beautiful film, which for me exemplifies very nicely two key elements of our social interchanges. There is the high transaction cost to patch up the relationship, which means it doesn’t happen for ten years. The brothers don’t say it with so many words, but it is easy to imagine them thinking “I am not taking the first step, not even for a million dollars”, both convinced they were in the right over whatever the conflict had been. And there is the sudden, profound turning point, where Alvin chooses to making an exceptional effort, paying a high transaction cost to visit his brother, thus signalling how highly he values the relationship after all.

Our social relationships are built on the sacrifices we are refusing to make, and the ones we are willing to make. When these are in the financial or material domain, it’s usually easy to work out whether a transaction is worthwhile. But when convictions of entitlement are involved — perhaps the idea that we are entitled to someone’s the admission of fault — standing firm can come at a high transaction cost. When we do, we would do well to ask ourselves if it is worth it.

Originally published at http://koenfucius.wordpress.com on January 17, 2020.

Thanks for reading this article — I hope you enjoyed it. Please do share it far and wide — there are handy Twitter and Facebook buttons nearby, and you can click here to share it via LinkedIn, or simply copy and paste this link. See all my other articles featuring observations of human behaviour (I publish one every Friday) here. Thank you!

Accidental behavioural economist in search of wisdom. Uses insights from (behavioural) economics in organization development. On Twitter as @koenfucius

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