In Defense of Tipping, Part III: Market-Enhancing Norms

In two previous articles defending tipping, I argued that gratuities helped solve principal-agent problems and leveraged price discrimination to the benefit of customers, employers, and employees. These were strictly economic arguments relying on the notion that everybody involved in the transaction was trying to maximize their net benefit, a common assumption in mainstream economic analysis.

But this raises an empirical puzzle that befuddles the cost-benefit crowd.

Why would anybody leave a tip at a restaurant that they know they will never return to? 

It is economically rational to tip at a restaurant you visit regularly. Generous gratuities signal that you desire attentive, customized service in the future. At a minimum, leaving an average tip ensures you won’t get lousy service upon returning. This logic is contained within our discussion of principal-agent problems wherein the principal (customer) is incentivizing the agent (waiter) to behave in the principal’s interest. 

But if you are on vacation and stop at a roadside diner you most certainly will never visit again, it is not economically rational to voluntarily leave more money on the table than what the bill says you owe. Remember, economists posit that we are rational utility-maximizing individuals. With no expectation of future service, a diner should pay the lowest cost possible, which means no gratuity. Our discussion of reserve prices from my previous article implies this. If a restaurateur only charged ten dollars for a meal that a customer was willing to pay $15 for, the customer could pay the minimum asked ($10) and capture the gains-from-trade ($5) for herself. 

Nonetheless, people do tip at restaurants they know they will never return to. And, interestingly, we tip taxi drivers in big cities even though the chance of riding with them again is negligible.


It Begins with the Wealth of Nations

Adam Smith famously made the argument that the wealth of nations is dependent upon the division of labor within society. The more that people specialize in a task, the more efficient they become and productivity increases. That equates to increasing social wealth.

But the division of labor is contingent upon the extent of the market. If we all specialize in one particular activity, we will need many other people to perform tasks for us so that we can feed, clothe, shelter, and entertain ourselves. This is why hermits and small autonomous communes are never rich, and why countries that trade freely with others prosper.

Alas, a problem arises when we expand the size of markets. The more people we rely upon for providing our everyday needs and desires, the more we must interact with people we know little about. Trade becomes anonymous or “quasi-anonymous.” How does one trust a stranger to deal honestly? If I purchase a 12-year-old bottle of scotch from a vendor I’ve never met before, can I ensure the liquor was indeed aged a dozen years? There are ample opportunities for strangers to cheat one another if they never expect to have to deal with one another again. 

If we cannot trust one another, trade will be severely curtailed and prosperity lost.

Writing explicit contracts and having those contracts enforced by a coercive government are one way of overcoming the problem of trust. Lemon laws take care of this problem for some big-ticket items like used automobiles. But contracts are costly to enforce. Think of the time and hassle it takes to file a legal claim against a dishonest business, realizing that there is a possibility that a judge may find against you. And who is to say that one can trust the government to enforce violations of laws reliably? Politicians can be paid off, as we know. Regulation is, at best, a partial solution to the trust problem inherent in quasi-anonymous trade.

Moreover, contracts cannot specify every possible contingency where an exchange could go sour; contracts are inherently imperfect. Who pays for an unforeseen problem? Can we hope that the seller will make things right, or that the buyer will be able to pay? We need something more than mere contracts.

Michael Munger, in Tomorrow 3.0, argues that “platform” technology has managed to lower the transaction costs associated with trust. Websites such as Yelp or rating mechanisms built into apps such as Uber allow buyers and sellers to gather information about one another more easily, lowering the  inherent uncertainty surrounding trade with strangers. These are all just more convenient versions of things that have been around for a while, such as the Better Business Bureau and Underwriter’s Laboratory. Internet technology makes it easier for businesses to rate and share information on customers as well as securing payment through third-party enterprises. This solution is not perfect, though, as such apps can easily be gamed.

Although technology does alleviate some of the problems of trusting strangers, the world has been Yelp-less for most of human history. Indeed, formally-specified contracts with adequate third-party enforcement have been historically rare as well. How did humans ever learn to trust strangers (and extend the market)?

Social Norms to the Rescue

Our ancestors were not idiots. Even before Adam Smith, they realized that trade produced wealth. The question was how to foster trust among growing networks of economic exchange.

A common method of signaling trust and good intentions was to offer a seemingly-irrational sacrifice of resources. By expending resources that one is not required to give up, a person indicates that they desire a long-term relationship with someone else. The only way to recoup the cost of their initial “burnt offering” would be through a long-term relationship where both individuals were honest and generated mutual benefits. This is the logic behind engagement rings and wedding dowries. 

Performing upfront sacrificial acts also reveals that if something ever went wrong in an exchange, the sacrificing party is more likely to fix mistakes. They have proved a priori that they are willing to bear a cost to guarantee a relationship. One is more likely to trade with a stranger knowing that he will correct mistakes should they occur. In part, this is a sign of graciousness, an indication that one will be willing to be generous and kind even amidst difficult situations. 

This is the logic behind gift-giving. Marcel Mauss (among others) noted that trade between archaic tribes was preceded by elaborate gifting rituals that involved a waste of resources on useless trinkets or an overabundance of food at a feast that would go uneaten. If someone refused to make the expected sacrifices, their long-term motives were questioned and they would be ostracized from future interactions. 

Although such rituals prove beneficial in helping strangers become long-term friends, larger societies still need to foster norms of trust and forgiveness among individuals who will encounter one another infrequently if not only once. In other words, successful market economies need to build a generalized culture of trust and graciousness to grease the wheels of commerce in large societies. 

Keep this in mind the next time someone argues that “capitalism” is inherently exploitative. Free markets require widespread generosity and graciousness to foster the generalized trust needed for the efficient operation of impersonal market exchange. This assertion has been generating significant empirical support in economics and psychological anthropology.

Tipping Is Graciousness in Action

Tipping, in essence, is a subcategory of gifting; a ritualized practice of sacrifice and graciousness. Individuals who voluntarily leave a gratuity at the end of a meal indicate that they appreciated the service and are happy to contribute more to the server than is legally required.

Of course, as noted earlier, tipping may be very instrumental in nature. We tip generously at establishments we visit frequently because we want to incentivize future good service. This is the principal-agent concept at work. 

However, the instrumental rationale for tipping fails for one-time visits to restaurants or cab rides. Our propensity to tip in such instances indicates we have been taught to be generous towards strangers even when it is not in our narrow economic interest. Indeed, parents often use the practice of tipping to explain to their children the importance of being kind and gracious. 

Think about how this helps foster quasi-anonymous and anonymous trade in extended markets. If we are to engage in economic relationships, we need to know that others will not cheat us and are willing to sacrifice generously if mistakes arise. Consider taking a potential business partner out for dinner. The partner agrees to pay for the meal, but refuses to leave a tip. You might praise her for frugality, but will this leave you wondering whether or not she will bear a financial burden if a problem requires some short-term sacrifice in the enterprise? Better yet, think about the signal sent on a first date if the person agreeing to pay for the night out doesn’t tip generously? How one treats the wait staff may be an indication of how generous they will be in the future relationship.

To the extent that the vast majority of people in society adhere to the norm of appropriate and gracious tipping, we can assume that most people we encounter (even if we do not know them well) are reasonably trustworthy in their dealings. The stranger who stops at a roadside diner will expect quality service and the waitress will similarly expect a reasonable gratuity. This is how generalized trust is built.

One may object to my categorization of tipping as “voluntary” given that there is immense peer pressure to tip, but it is the internal guilt of not doing the socially proper thing that keeps us all in check. Let’s face it. We all want to be kind, but we often need to be reminded and nudged to be so.

A Few Caveats

This is where I expect readers to shout out, “But Gill, I’ve been to France and they don’t have the norm of tipping and I receive perfectly fine service and I’m not afraid of quasi-anonymous trade!” This is possibly true. (Interestingly, Kerry Segrave writes that France did have a vibrant tipping culture until the late 1940s. Why this norm disappeared so suddenly presents a great research project for an aspiring scholar.)

I am not claiming that tipping is the only means of building generalized social trust. There are numerous cultural norms and signals that perform similar functions. Indeed, in areas frequented by tourists, there is a strong incentive for vendors to indicate their trustworthiness to one-time visitors lest they pass by the gift shop without making a purchase. Those mechanisms I will leave for others to discover. (For those of you ever worried about being ripped off at a tourist gift shop, this is the psychological feeling of mistrust that accompanies quasi-anonymous trade.)

With societies that do tip, however, gratuities are one way of inculcating the importance of sacrifice and graciousness. And the benevolent willingness to be kind to others is absolutely essential in market economies. Societies with paranoid and vengeful populations do not work well (as the Soviet Union demonstrated). 

None of this implies that this social norm cannot be corrupted. There are growing complaints that tipping is increasingly irritating because of payment technologies that ask customers to select pre-determined gratuities while the server stares at them. This is particularly grating when no principal-agent problem exists (as discussed earlier). I agree. This is a bastardization of the norm that only undercuts its effectiveness. Instead of allowing me the voluntary opportunity to be gracious, these new technologies only enhance the notion that tipping is little more than extortion. Institutions are not perfect and they evolve over time, sometimes in ways that make them less effective. We will see if tipping is resilient enough to overcome some of its shortcomings.

A Final Tip

Free market economies are often portrayed in a bad light because mainstream economics posit that they operate on the basis of self-interest. “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest,” Adam Smith famously wrote in The Wealth of Nations. But Smith also understood our moral sentiments and the value of benevolence. Our self-interest is best served when we act benevolently towards others and anticipate that they will reciprocate with kindness. Offering gratuities – a cognate of “graciousness” – is an excellent way to ensure this. (For those interested in a more extensive defense of tipping, a gratis version is available at the Journal of Private Enterprise.)

The post In Defense of Tipping, Part III: Market-Enhancing Norms was first published by the American Institute for Economic Research (AIER), and is republished here with permission. Please support their efforts.