An Economic Analysis of Tipping and Other Things

By

Sterling Portwood, Ph.D.

Most people are resentful or at least displease by the American custom of tipping. I was somewhere on the spectrum myself until I sat down and did an economic analysis of the custom.

Waiters are generally paid minimum wage plus tips. If tipping were abolished, as many would like, what would happen? The answer is that the waiters would not work for minimum wage. Why is that? First, it's because they are on the average quite capable people and can make significantly more than minimum wage at some alternate job, so you might think waiters would need to get paid what they can earn at an alternative job.

But that's not sufficient either. Waiters have to earn more than they could make at a regular alternative job because the waiters job is in many ways less desirable and more demanding than the typical job. Seldom do waiters have a straight eight hour shift. Usually they get dressed, go to the restaurant, work one meal, then go home, get undressed, kill time for a couple of hours, then get dressed again, go to the restaurant and work another meal; all to get their eight hours. Such split-shift work usually takes up most of the day, only part of which is compensated.

Also waiting is a difficult job in that waiters have to deal with the public. To do this job well, a waiter must be an amateur psychologist and adapt his behavior and demeanor to the personalities and moods of the diners, not to mention cranky cooks and pushy hostesses. Under such working conditions, the waiter needs to be a multi-tasker who is on and sharp all the time. This doesn't compare favorably with the typical, laid-back office job. For all of these reasons the restaurateur would need to paid waiters in the ballpark of $20 per hour to maintain a qualified workforce.

Well, with no tips, the restaurateur would have to come up with the extra money to bring waiters' pay up to about $20 per hour. So is that it, the restaurateur gets stuck with the loss? No! He's not running the restaurant just for the fun of it. He passes is additional costs through to the customer in the form of increased food and drink prices. (Economically, it's a little more complicated than that, but the complication is technical and has no significant effect on the outcome.)

So, is the customer right back where he started from? No, he's worse off. He's paying approximately the same amount for the food as he was paying before for the food plus the tips, but the customer is now getting service that is far inferior and less pleasant than he received before. Tips generally motivate service personnel to be pleasant and friendly and supply good service.

Conclusion: The tipping custom seems a needless expense, but it actually costs virtually nothing extra and on the average supplies a far more pleasant experience for the diner.

Another, Even More Interesting, Way of Looking at It: For the same $20 per hour, the tipping custom tricks the waiter into being pleasant and trying to exert himself to satisfy the diners. If there were no tipping custom the waiter would still get about $20 per hour, but wouldn't have to exert themselves on behalf of diners. It's really an interesting turnabout to understand that diners think they are being had, when in actual fact it's the waiters who are being had. It's sort of like Adam Smith's invisible hand, but with an ironic twist.

Generalization: Most people do economic analysis and, I might add, legislating and other forms of planning and analysis, like they play chess, i.e., one move at a time. They generally don't consider that subsystems, in this case economic subsystems, exist in an equilibrium state, which is the self-adjusting result of a large number of countervailing forces. If they monkey with the subsystem and change one of the variables or forces, they are always surprised when the whole subsystem readjusts into a new and different equilibrium state. It's like removing one rock from a pile of rocks. Many rocks are likely to shift and come to a new equilibrium state. The new and different subsystems state might be considered positive, negative, or mixed; but the only way to know the resulting state is 1) by "experimentation" or 2) through knowledgeable, multi-move economic analysis, a rare process indeed. I often say about the outcomes of one move legislating or planning: go left and you'll get right, go North and you'll get South.

Another Example, of Which There Are Hundreds: The State legislators wished to help out poor renters, so, in their wisdom, they put into the Law that renters cannot be charged a deposit of more than one month's rent. On the surface, it looks like a great idea and beneficial to the poor. In actual fact, it's a bad idea and devastating to many renters, of all social levels. Why? Well, if we look beyond the first move, we see that the landlord is not going to take a risk of renting to anyone with bad credit, even if they have plenty of money. The well intended Law has killed the landlord's ability to offset the risk posed by applicants with bad credit, by offering the option of additional deposit money. Many such people find it very difficult to rent at all and/or have to pay higher rents to be allowed in...and I would rather pay higher deposits than higher rents anytime.

The Usual Counterargument: But what about the greedy landlord, he can then charge two months, three months, four months deposit to everyone? He could, if the free market system, that this country is largely based on, didn't work. What's to stop the landlord from doubling or tripling his rent? Answer: Nothing..., except the free market competition from other greedy landlords, i.e., Adam Smith's invisible hand. There is no law against increasing rents, why should there be a law against increasing deposits? Setting prices optimally in these kinds of situations, on a day by day basis, is what capitalism does best, far better than legislators who were voting maybe 40 years ago and had no idea of the complex mechanisms within the residential rental market even in their day, much less today.

Acquiescence to the Unconvinced: If the above doesn't convince you that free market capitalism generally keeps prices in check, I'll just have to admit that you're smarter than I am. And, to take advantage of your greater intellect, I suggest that you start a restaurant or any other business and charge double what the competition is charging. I'm sure that you'll be so rich after a year or two that you'll be able to retire to a luxury condo on Waikiki Beach.

Newsflash: Capitalism works in the vast majority of situations and, when it doesn't, that failure is generally consistent with economic theory and predictable by those few who can do quality economic analysis.

Repealability of Obamacare

Well, the health-care bill has passed and the talking heads generally agree that it cannot be repealed. Their argument is that the entitlement programs generate their own constituency and politicians dare not cross such a voting block.

Normally this would be a good argument, but this time it's not. The great majority of the beneficiaries of Obama care are the poor and they generally vote Democratic anyway. Hence, Republican politicians do not need to worry about losing this cohort of voters, because they never had them.

C. Sterling Portwood, Ph.D.

CBO vs. GIGO

Years ago when I worked as an analyst at the Pentagon, we had a saying, "gigo," for garbage in garbage out. I can't believe that in the current health-care debate I haven't heard gigo in relation to the CBO projections.

The Democrats shovel to the CBO a bunch of faulty assumptions (e.g., $500 billion can be taken from Medicare with no loss to Medicare recipients), i.e., garbage inputs, and the CBO cranks out a lot of garbage results, deduced from the lies originally input. Then the Democrats quote the garbage outputs like they are findings, direct from God.

It is shocking that Republicans have not dealt with this fraudulent shell game appropriately. Gigo is the simple, direct, and proper retort. But, if the Republicans wanted to go all the way and blow the Democrats' trickery right out of the water, they could give one of the big, prestigious accounting firms a set of realistic assumptions (i.e., inputs) concerning Obama care and then quote the accounting firm's findings (i.e., outputs) in response to Democrats?

C. Sterling Portwood, Ph.D.

Foreign Policy Expertise Is the Indispensable Quality for a President

Recently I was writing a working paper on what voters should consider in choosing a new president. In the middle of my analysis, I tumbled to something I had not realized before. I determined that a candidate's performance in the foreign-policy arena is far and away more important than his performance in any other domain.

Errors in domestic policy can be damaging, be wasteful, and are not easy to reverse. Yet the cost of foreign-policy errors can be colossal in blood and treasure. Further, the correction of foreign-policy mistakes often require a Herculean effort and prodigious amounts of time, both person-hours and calendar time.

World War I resulted from a horror show of mistakes, miscalculations, communication lapses, and other types of errors perpetrated by almost every country in Europe. Mistakes made in the treaty ending World War I and in its implementation led directly to World War II, as Pat Buchanan argues in his new book, Churchill, Hitler, And the Unnecessary War.

If Clinton had seen the writing on the wall after the first Twin Towers attack in 1993, as many people did, and treated extremist Muslim terrorism as a high priority item and/or as a military issue, rather than a law enforcement issue; the world might have looked totally different and better today. If he had taken Osama bin Laden when Sudan and then Saudi Arabia offered him to Clinton in 1996 or if he had taken him out on one of the two opportunities he had in 1999 and 2000, 911 may not have occurred and we might not be fighting extremist Muslim terrorism today. If W. had begun his first term with the understanding that terrorism was a major and growing threat, rather than an annoyance, and acted accordingly; 911 might still be just an emergency number.

We can ultimately control and correct mistakes within our borders. It may take an election cycle or two, but, if enough people are against the "error," it can be corrected. For foreign policy errors, even with 100% backing from the US population; other governments, countries, populations, and groups may resist the reversal. It might take a hundred years, many millions of lives, and uber trillions of dollars to correct a mistake unleashed internationally.

Hence, the a voter's s estimate of a candidate's future successfulness in foreign policy is far more important and should be weighted much heavier than the candidate's expected performance in the domestic policy arena.

Why National Security Republicans Should Rejoice in the Obama Victory

Go left to get right. Go east to get west. The older I get, the more I realize that the world is often counterintuitive. A simple, logical, obvious answer is sometimes correct and sometimes it's not. Wars are about winning, aren't they? Sometimes and sometimes not. Sometimes wars, when fought intelligently, are more significantly about shaping the postwar world.

It is now known that the Soviet-Afghan war was intentionally prolonged by the United States, via withholding stinger missiles from the mujahedin, to further strengthen the forces for change within the Soviet government. The strategy led directly to the disintegration of the Soviet Union and the end of the Cold War.

Sometimes elections are about winning so your policy objectives can be achieved and other times elections should be about losing so your policy objectives can be achieved. The latter is possible, due to a phenomenon I call "offside" action.

President Nixon was from the anti-Communist side of the political spectrum. His action in initiating the opening to China and the attendant slap in the face to Taiwan, appeared out of character for a Republican, with anti-Communist credentials. Americans would have expected such action to come from the left side of the political spectrum and not from the right side, i.e., the off or opposite side.

Initially, about 50% of Republicans and 90% of Democrats were willing to accept that Nixon wouldn't have taken such action unless it was the right thing to do. If a Democratic president had initiated the opening, the Republicans would have howled that the Democrats were simply soft on communism and would likely have sabotaged the whole strategy.

If a Democratic administration had been in office at 911 and followed exactly the same antiterrorist strategy as followed by the Bush administration, including the war in Iraq, said Democratic administration would have been able to take advantage of their offside political position. The controversy within the country would have increased over time, but less vociferously and at a much slower rate. For the Democrats to transition to an anti-Iraq war position against a Republican administration is a very easy, natural, and predictable low friction slide.

Coming up to present, how does offside action figure into the current state of affairs? If McCain had won the election, he would likely have pulled combat troops out of Iraq on a more or less continuous basis. Nevertheless, political parties need raw meat to gain political strength and political advantage. Therefore, Democratic strategists would have taken advantage of the current anti-Republican and anti-Iraq war emotions within the country and engineered additional dissatisfaction with the pace of withdrawal, the lack of a stated withdrawal schedule, the open ended commitment of noncombat troops, the cost, etc., etc., etc.; resulting in increased antiwar and anti-McCain fervor.

Further, unless the Afghan war showed fairly rapid progress, followed by steady and scheduled troop withdrawals, Democratic strategists would also take advantage of this opportunity to attack the McCain administration and its policies. This political strategy would lead to ever increasing and emotional dissatisfaction with President McCain's Middle East and anti-terrorism policies and, as planned, a continuing shift in sentiment in favor of the Democratic Party. By the midterm election and the next presidential election cycle, the outcry and shift would have been extreme and many voters would have become emotionally unhinged.

In this type of political environment, truly radical candidates can rise to power, with predictably dire consequences. Hitler took advantage of German outrage over the Weimar Republic's (the first government elected under Germany's new parliamentary democracy) ratification of the surrender treaty ending World War I, the onerous terms of the Treaty of Versailles itself, the hyperinflation (up to 3,000,000,000% over 10 years) of the 20s, and the unemployment of the Depression to garner 44% of the vote in 1932 and an appointment as Chancellor, even though his radical views had already been delineated in Mein Kampf.

When a significant proportion of voters perceive political conditions to be so dire that any candidate who promises a new approach is acceptable, the country is at great risk. In the reason elections, there was a degree of this desperation, although far less reality-based and in 1932 Germany (but it's the strength of the voters' feelings and emotions that counts, not the validity of the circumstances which generated the desperation). If McCain had won, by the next presidential election cycle, this desperation would likely have reached a fever pitch. This would have been a dangerous state of affairs for the country.

Aside: Does it surprise you that political strategists from both Republican and Democratic parties would manufacture issues, they probably don't even believe in themselves, and lead a major portion of the citizenry by the nose to heights of emotional fervor against the party in power and its policies for the purpose of gaining political advantage? If this does surprise you, you may have a ring in your nose.

Since both wars are eminently winnable, a President McCain would probably have been able to carry both wars to completion, even though, apropos the Soviet-Afghan war, rapid completion may not be the goal. In any event, the ever increasing antipathy for the McCain administration and its anti-terrorism strategies (even though, by design, almost no one has any idea what the strategies are), would have limited President McCain's ability to respond to other international crises, e.g., bombing Iran's nuclear sites if he could not otherwise prevent them from developing and deploying nuclear weapons.

All in all this situation would be pretty messy, having your own countrymen reviling you and fighting against you, while your administration is trying to carry out a long, complicated, and secret strategy against terrorism plus numerous other strategies, both international and domestic.

On the other hand, McCain didn't win and Obama did. If President Obama were to follow the exact same strategy that McCain would have followed, both Obama and his freedom of action would benefit from his offside political position. He could camouflaged any changes from previous campaign positions through the deft use of smoke and mirrors, as politicians often do, and neither Democratic nor Republican criticism, for slowly terminating Iraq and Afghan wars, would be extreme. Additionally, if President Obama found it necessary to attack Iran in the same manner mentioned above, the Republicans would probably grumble to preserve the issue for possible future political advantage, but would progress to vehemence only very slowly and Democratic complaints would be muted, except for a small minority of committed pacifists.

From the standpoint of a national security oriented Republican, President Obama's aforementioned situation would be far better than that of a President McCain, due to Obama's offside political location. President Obama would have more flexibility in his pursuits of the Iraq and Afghan wars and much more freedom to generate implied threats of credible military action, because he wouldn't have to worry about an extreme reaction from his right political flank. The latter capability should ironically decrease the probability of military conflict and correspondingly increase the probability of negotiated settlements.

On the other hand, Obama ran on an implied platform against almost all wars, especially preemptive wars. So, as president, Obama might do as he said or hinted during the campaign. First, he might pull American troops out of Iraq before the Iraqi military and government are ready to take over. Second, he might pursue victory in the Afghan war, but, if it takes longer than he thinks it should, he might do what he suggested for Iraq, just pull out and let the chips fall where they may. Third, a President Obama might not take an aggressive stand against Middle East terrorists and might not move militarily to prevent Iran from developing and deploying the bomb, even if there were no other way to stop them.

Let's take these one at a time. Concerning pulling out of Iraq, Obama's promise was that he would pull troops out of Iraq within 16 months, whether or not conditions warranted. This was a political position taken to cozy up to McCain's position and yet keep him just to McCain's left, a standard strategy for maximizing the vote harvest. This is not good foreign-policy, but it is a smart political position for Obama to run on.

Interestingly, Iraq seemed to be leaning toward Obama's firm 16 month position even prior to the election. This was quite confusing to many people who felt that Iraq would prefer a McCain victory. But, possibly, Iraqi politicians were a lot smarter than anybody gave them credit for. Maybe they understood, as is the theme of this working paper, that a Democrat in the White House would be locked in to the equivalent of a national-security-Republican strategy by the logic of the international circumstances. Yet a Democratic president would have more political freedom to pursue aggressive policies in the Middle East than would a Republican.

Further, since the firm 16 month position was such an important part of the campaign, the Iraqi politicians must press for Obama's 16 month position to be made a part of the Status of Forces Agreement (SOFA) to keep Obama from losing face and expending political capital on reversing his most highly visible campaign promise. This is not to mention the Iraqi politicians' need to satisfy their own political constituents, i.e., to show that the "occupiers" are definitely leaving.

That being said, all parties realize that the final Status of Forces Agreement can be changed at any time by mutual consent, if necessary or desirable. Also, it is a fact that, 16 months into the Obama administration, the modification, for cause, of Obama's campaign promise and the Iraqi position on troop withdrawals would not be a serious issue for either US or Iraqi constituents.

The prior analysis is based on the assumption that Obama is at least slightly to the right of his firm 16 month position. But, what about the possibility that he might be to the left of that position? As a candidate, Obama's true feelings may have been to the left of his campaign position, but, as president, when faced with the real-world situation, it is unimaginable that he would really pull out of Iraq, if the country were still unstable. This is because he would be blamed if that country reverted to chaos and he might have to go back in, if Al Qaeda was successful in carving out a piece or all of the country for a base of operations against the US, Israel, and Europe. Nevertheless, it is always a little disconcerting to have to assume that a candidate, once in office, will behave contrary to his core beliefs or to his stated campaign positions.

Concerning Obama's position on Afghanistan, it's a little hard to tell if he is really committed to winning in Afghanistan or he was just trying to politically have his cake and eat it too. The latter political strategy would be as follows: come out in favor of the Afghan war so you're not viewed as a pacifist (which is a very problematic label for the commander in chief) and you still get credit for being against the Iraq war.

Again, as president, I don't think Obama could afford to pull out and let Afghanistan fall to Al Qaeda and the Taliban, for the same reason he couldn't allow this to happen to Iraq. These real-world considerations should give President Obama a considerable amount of empathy for President Bush's current foreign-policy plight.

On foreign policy matters beyond the two current wars, certainly President Obama would be less likely to get into new, optional military conflicts like bombing Iran to prevent them from obtaining nuclear weapons, wouldn't he? Answer: Maybe. Such reluctance is a double-edged sword, in that other countries also perceive this tendency and may risk behaviors that they would not otherwise have risked or may not assent to negotiated settlements that they would have otherwise reached, if McCain were president and presenting an aggressive posture.

The King of Siam understood the situation precisely:
When I was a boyWorld was better spot.What was so was so,What was not was not.Now I am a man;World have changed a lot.Some things nearly so,Others nearly not.There are times I almost thinkI am not sure of what I absolutely know.Very often find confusionIn conclusion I concluded long agoIn my head are many factsThat, as a student, I have studied to procure,In my head are many facts..Of which I wish I was more certain I was sure!...Is a puzzlement...

In conclusion, once thrust into the position, the new president will receive a strong dose of reality therapy. He will be made privy to intelligence, secrets, strategies, etc. that he could not have been aware of as a candidate. For any other than the most extreme ideologues, such new information will strongly affect the logic and decision making of the new president. The theory here is that the presidency, the information, and the circumstances largely shape the pragmatic president and his policies and not the other way around.

Hence, in the foreign-policy realm, President Obama will probably follow strategies somewhat similar to those that would have been followed in a Republican administration, while taking pains to camouflage the strategies as new and different. Nevertheless, due to his offside position, President Obama should have far greater freedom of action and far less criticism from the general public. Additionally, the emotional stability of the electorate should return and elections in the near future should proceed with less emotionally stressed voters. This is exactly what a national security Republican or for that matter a patriotic Democrat, the Iraqi government and people, the Israelis, the Europeans, etc. should want.