The economics of reclining airline seats

The problem of reclining airline seats and the related fights between passengers was a big thing in the media in 2014 (see here and here), but has been back in the media recently. The Economist's Gulliver blog had an excellent piece earlier this month entitled "Who owns the space between reclining airline seats?". It's an interesting read, and highlights several things we discuss in ECON100 and/or ECON110, including: (1) externalities and the Coase theorem; and (2) quasi-rationality and endowment effects.

If Person A (who is sitting in front of Person B) reclines their seat, they reduce the amount of space available to Person B. This is a negative externality (an adverse impact of one person's actions on the wellbeing of a bystander). There are a few things we can take away from this example. First, as Coase originally noted, externality problems are jointly produced by the person who creates the externality and the person who is affected by it. If no one was sitting in Person B's seat, then there would be no externality problem. The externality problem only exists because of both passengers' actions (Person A reclining their seat, and Person B sitting in the seat behind). [*]

Second, the polluter pays principle is not always the best solution to an externality problem. The polluter pays principle essentially says that the polluter (in this case, Person A) is always at fault any must avoid the actions that affect the other party (by not reclining their seat), or pay them compensation. If we believed the polluter pays principle is the best solution in this case, no one would be allowed to recline their seat.

In contrast, the Coase theorem suggests that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without any government or other intervention). As Gulliver notes:

According to the theories of Ronald Coase, who won the Nobel Prize in Economics in 1991, the space between airline seats is a scarce resource. Therefore it should not matter who has the initial ownership (assuming there are no barriers to a deal being made). The market will out: whoever values the space more will buy it from the other. (In this case it would normally revert to the recliner.)

What happens if we allow passengers to make these bargaining solutions? We really don't know, as no airline has ever tried it (as far as I know). However, Gulliver writes:

Would such fights be prevented if ownership of those four inches were up for auction? This was the starting point of an experiment by Christopher Buccafusco and Christopher Jon Sprigman, two law professors, which they have written up on the Evonomics website. 

Their aim was to discover whether recliners’ pleasure at being more horizontal is greater than the amount of suffering this inflicts on the person behind. One obvious way to do this is to put a monetary value on it: find out how much the flyer in front would be willing to pay for the right to recline his seat, and compare that with the amount the person behind would be prepared to shell out to stop this from happening. 

In an online survey the researchers asked people to imagine that they were about to take a six-hour flight from New York to Los Angeles. Respondents were told that the airline had created a new policy that would allow flyers to pay those seated in front of them not to recline their seats. Some were then asked how much the passenger behind would have to pay them not to recline during the flight. Others had to specify how much they would be prepared to pay to prevent the person in front of them from reclining.

I suggest reading up the Evonomics article by Buccafusco (Cardozo School of Law) and Sprigman (NYU School of Law), as there is lots of interest there. Note that it is a stated preference study - we don't know for sure what people would actually do when faced with these choices, but this is what they said they would do:

Recliners wanted on average $41 to refrain from reclining, while reclinees were willing to pay only $18 on average. Only about 21 percent of the time would ownership of the 4 inches change hands...

That sounds fine, and was based on the current default set of property rights - that people have the right to recline their seat. But then things got interesting:

When we flipped the default—that is, when we made the rule that people did not have an automatic right to recline, but would have to negotiate to get it—then people’s values suddenly reversed. Now, recliners were only willing to pay about $12 to recline while reclinees were unwilling to sell their knee room for less than $39. Recliners would have ended up purchasing the right to recline only about 28 percent of the time—the same right that they valued so highly in the other condition.

So, when people had the right to recline their seat, they wanted $41 to give it up. But, if they didn't have the right, they were only willing to pay $12 for that right. If that seems odd to you, then welcome to the world of behavioural economics. The Coase theorem suggests that the initial allocation of rights should not matter, because if the person who values the right the most doesn't start out with it, they will simply purchase it from the other. But what Buccafusco and Sprigman found suggests that this simple solution might not work. What they found was an endowment effect.

Because people are loss averse, losses make us much less happy than an equivalent gain makes us happier. For example, losing $10 is more bad news than finding $10 is good news. One of the consequences of this is that we are unwilling to give up something that we already have - we require more in compensation to give it up than what we would have been willing to pay to obtain it in the first place (this is what we call an endowment effect). Note that endowment effects are working for the 'reclinees' as well - they are willing to give up their extra knee room for $39 if they had the right to keep it, but would only be willing to pay $18 to get that right if they didn't start out with it.

The endowment effect means that this problem isn't really amenable to a simple solution, because recliners already have the default rights, and are understandably unwilling to give those rights up. And any change in policy is going to incur passenger protest - because even though we may gain knee room, passengers would be giving up their right to recline, and loss aversion almost ensures that would be a painful and unwelcome trade-off for most passengers.

*****

[*] Of course, Person B probably has little choice about where they are seated. But, there are plenty of other examples of externalities where there would be no problem if the affected person was simply somewhere else. One example I've blogged about before is people who choose to live next to mushroom farms.

Dealing with squealing children, NSW edition

I've written a couple of posts in the past about dealing with the problem of squealing children (see here and here). When I read this article last month, I thought it was time to write another. From the article:

A SYDNEY mum is furious after receiving a letter from her apartment building strata company threatening her with legal action unless she can stop her toddler from creating “excessive noise”...

In the letter, which Ms Mayer posted to Facebook over the weekend, the strata company says it has received reports from her neighbours of “shouting and screaming”, disturbing other residents and putting her in breach of the strata scheme by-laws.

Squealing (or shouting and screaming) children is a classic negative externality - an uncompensated impact of the actions of one party on a bystander. The poor residents of the apartment block face a cost that is imposed on them by the actions of the child (shouting and screaming create noise pollution). Since the child has no incentive to take into account the costs that they are imposing on the apartment residents, they generate too much noise compared to the socially efficient optimum.

How can the externality problem be solved? One solution is proposed by The Coase Theorem, which tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention, or the intervention of the building strata company in this case).

However, a bargaining solution is unlikely to work for the apartment building, because it would require the child (or rather their mother) to enter into an arrangement with each of the other residents of the apartment (separately or all together). We know that bargaining solutions break down (or fail to arise) when there are many parties to the bargaining - either because of coordination problems, or because one or more parties may try to hold out against a solution, in order to get a better deal for themselves (what we refer to as a 'hold-out minority').

Instead, the apartment in the story uses a command-and-control policy - a rule against excessive noise, which if breached results in a penalty of $550 for the perpetrator (or in this case, their parent). This solution is based on the "polluter pays principle". Under this principle, the party that is responsible for the pollution is solely responsible for making restitution for the damage they cause.

However, the polluter pays principle is not always the best solution to problems of negative externalities. That is because there may be other ways of solving the problem that involve a lower cost (as I have argued before). Following this 'least cost principle', instead of imposing fines on parents for their noisy children (which would be an ongoing cost to the parents), perhaps the apartments could be better sound-proofed. That would only entail a one-off cost, and although that cost might be high initially, it would also reduce the problems of externalities from neighbours who enjoy loud dinner parties or other loud activities. Avoiding those other activities entails an ongoing cost that may be more costly overall.

Read more:

• Solutions to the problem of squealing children, Japan edition
• Dealing with squealing children at least cost

Mushroom farming causes a stink

Earlier in the week, Hawke's Bay Today reported on an ongoing battle between Te Mata Mushrooms and the Hawke's Bay Regional Council (on behalf of local residents):

The owner of Te Mata Mushrooms has lashed out at Hawke's Bay Regional Council, saying its prosecution over an alleged breach of resource consent conditions amounts to a bid to have the company shut down.

The Havelock North business is facing six charges and a maximum $600,000 in fines after complaints it has failed to contain odours generated by the compost it makes to grow its mushrooms in.

Under its 2012 resource consent, odours from the mushroom farm must not waft over its boundaries but the council says it has received numerous complaints...

The mushroom farm had been on its Brookvale Rd site since 1967 and in the past few years Hastings District Council had allowed more than 160 houses to be built nearby, Mr Whittaker said.

Ronald Coase argued that externalities are jointly produced. That is, it takes two parties to create an 'externality problem' - the party that generates the externality, and the party who is affected. In this case, if there were no residents living in close proximity to the mushroom farm (as was the case until relatively recently), then the odour from the compost would not be a problem.

Since there are now nearby residents who are affected, we need to consider whether government intervention is necessary. The Coase Theorem tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution under the Coase Theorem, it depends crucially on the distribution of entitlements (property rights and liability rules).

If Te Mata Mushrooms has the right to compost on their property, then the default solution is that the residents just have to put up with the smell, or move elsewhere. The alternative solution is that the residents could pay compensation the mushroom farmer in exchange for the farmer reducing production, or altering their production method to produce less odour. The alternative solution would only be feasible if the compensation paid by the residents was individually less costly to each of them than the amount that they value the loss of enjoyment created by the odour, and the compensation was more than the lost profits of the mushroom farmer. Of course, the problem here is that getting all residents to collectively pay the farmer is difficult due to free-riding (some residents could choose not to pay, but would still receive the benefits if the farmer reduced the odours).

On the other hand, if residents have the right not to have their nostrils assailed by compost stench, then the default solution is that the mushroom farmer must reduce odours (through reduced production, or altered production method). The alternative solution is that the mushroom farmer could pay compensation to the residents for their loss of enjoyment of their property.

In this case, given that there are resource consents in place that limit Te Mata Mushroom's activities in terms of the odours it generates. So, it is clear that the residents have the over-riding rights. Even though the mushroom farm was there first, the time for the farmer to fight this battle over rights was at the time of the resource consent, not now. It is too late and they have to either comply, compensate the residents to placate them and avoid complaints, or face the consequences.

This might seem like a straightforward application of the polluter pays principle, but is also probably the least-cost solution to the externality as well. The cost to the farmer (who can presumably relocate further from residential areas if necessary) is likely to be lower (and a one-off capital or relocation cost) and concentrated in a single party, compared to an ongoing cost to many residents from the farm's activities.

Solutions to the problem of squealing children, Japan edition

Back in December last year, I wrote a post on dealing with the problems of squealing children at least cost:

Now, squealing children is a classic negative externality - an uncompensated impact of the actions of one party on a bystander. The poor residents of Stonefields face a cost that is imposed on them by the unscrupulous actions of the children. Since the children have no incentives to take into account the costs that they are imposing on the residents of Stonefields, they generate too much noise compared to the socially efficient optimum.

How best to deal with the problem of squealing children? In Japan, they use a command-and-control policy - a daytime noise limit of 55 decibels (night-time 45 decibels) in residential suburbs. That's not much louder than bird calls, i.e. a pretty extreme limit not conducive to playing children. Parents can be fined if their children exceed the noise limit, a solution to the problem that is based on the "polluter pays principle". Under this principle, the party that is responsible for the pollution is solely responsible for making restitution for the damage they cause.

However, Robin Harding reports in the Financial Times that Tokyo is considering changes to the noise regulations:

“In the past this wasn’t an issue but recently more people have been complaining to city halls, saying ‘the children are too loud, please stop them’,” says Yukie Nogami, chairwoman of Tokyo’s environment and construction subcommittee. “The law says city halls have to act.”

Ms Nogami’s committee will soon debate a proposal to carve out an exemption from the noise rules, either for children under 12 or for certain places such as parks and kindergartens.

In line with what I argued in December, the 'least cost' solution to squealing children might not be command-and-control policies like noise bans (which entail a high cost in foregone fun for the children), but sound-proofing the neighbourhood homes. Sound-proofing entails a one-off cost for each home, versus an ongoing cost of foregone fun. Of course, the cost of soundproofing every residential property (rather than just those located near playgrounds or day care centres) would likely be prohibitive.

However, once you have a command-and-control policy in place (like Japan's noise limits), it's going to be difficult to back out of. The noise limit created a new property right (the right to extreme residential quiet), and once created there is no Pareto-improving way to remove the right - that is, there is no way to remove the noise limits without making at least some people worse off. Who is going to be worse off? From the FT article:

About two-thirds of respondents to a consultation support the change but a minority is strongly against, complaining about everything from the lax upbringing of modern children to the effect on property prices.

The effect on property prices may well be real. If extreme quiet is valuable to Japanese homeowners (and prospective home buyers), then removing that property right is going to lower the value of residential homes (especially those close to playgrounds and day care centres). So at least some homeowners are right to be worried.

Moreover, the homeowners whose properties will be affected have a large incentive to protest the change in noise limits - the cost of the changes (in terms of lost property value) are likely high for each homeowner relative to the cost of protesting. Whereas the gains from the change in noise limits are spread widely among children and their parents, each of whom probably only gain a little from the changes. So expect lots of argument over this planned change, unless the homeowners can be adequately compensated. Following the compensation principle, if those who gain from the policy change (children and parents) can adequately compensate those who lose (affected homeowners), then the new policy (no, or higher noise limits) should be preferred. Since it would be difficult for children and parents collectively to compensate homeowners (free riders, anyone?), the compensation would likely have to come from taxpayers instead.

Of course, the better solution would have been not to have the extreme noise limit in the first place. As I noted in December (in relation to playgrounds in Stonefields):

The Coase Theorem tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution under the Coase Theorem, it depends crucially on the distribution of entitlements (property rights and liability rules). Do children have the right to play and make noise? If so, then the residents would have liability to pay the children to be quiet - maybe buy them a bunch of Playstations and send them indoors to be quiet. Either that, or the children can just keep having fun in the playground and making as much noise as they like. On the other hand, do the residents have the right to peace and quiet? If so, then the children would have liability to compensate the residents for the noise of their playing. Either that, or they have to give up the playground.

Who has the rights? At the moment in Japan it's the homeowners, but I'm not convinced that was ever the least cost solution. As one respondent to the survey discussed in the FT article notes:

“To play and cry and make a big noise is a child’s right.”

Dealing with squealing children at least cost

Paul Little wrote an interesting Herald on Sunday column the week before last, about squealing children:

Spare a thought in your charity for the residents of Stonefields, an "urban village" at Mt Wellington where, among other things, the "planting of pohutukawa trees along the boulevards, mimics the original lava flows", a market includes "substantive family restaurant and other dining/takeaway options" and parks provide "for a range of passive and active recreational spaces".

The planning and design of the joint appears exemplary. Unfortunately, it didn't allow for the people.

Such as those who have been complaining because those parks' recreational spaces are just a little too active.

As resident Alan Gilder says: "The park is awesome but they haven't put a lot of thought into it - the flying fox generates a lot of squealing.

Squealing. How awful, but how true. Where there are children there will likely be squealing.

And where there are flying foxes there will almost certainly be a lot of squealing.

If there is a sound more aggravating than that of children enjoying themselves then I don't know what it is.

Now, squealing children is a classic negative externality - an uncompensated impact of the actions of one party on a bystander. The poor residents of Stonefields face a cost that is imposed on them by the unscrupulous actions of the children. Since the children have no incentives to take into account the costs that they are imposing on the residents of Stonefields, they generate too much noise compared to the socially efficient optimum.

How can the externality problem be solved? One option is government intervention, as Paul explains:

What to do? Perhaps the residents could crowdfund a shush monitor - someone in attendance with a decibel reader who could hiss "shush" at the children when the squealing reached a certain level.

A "shush monitor" is an example of a command-and-control policy. The local government puts in place a limit on the allowable amount of noise, and when that noise is exceeded the nasty noisemakers can be sanctioned - perhaps by fines, or sending them to bed without dessert. If the noise level consistently exceeds the limit, the playground could be closed. No more negative externality.

Now, this solution follows from what is called the "polluter pays principle". Under this principle, the party that is responsible for the pollution is solely responsible for making restitution for the damage they cause. Since the children are causing the noise pollution, they have to pay the cost of making things right. Even if that means closing the playground. So, the cost of reducing the externality in terms of foregone fun could be pretty high.

There is an alternative to the polluter pays principle. Instead of making the polluter pay, we could try to solve the problem of the externality at the least cost (maybe we call this the 'least cost principle'). Instead of closing the playground at the cost of lots of fun times (which would be an ongoing cost, since fun would be lost every year that the playground is not there), perhaps the government could soundproof the houses that are next to the park? That would be a one-off cost, and likely a lower cost in total than the lost fun.

Of course, maybe no government-based solution is required at all. The Coase Theorem tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution under the Coase Theorem, it depends crucially on the distribution of entitlements (property rights and liability rules). Do children have the right to play and make noise? If so, then the residents would have liability to pay the children to be quiet - maybe buy them a bunch of Playstations and send them indoors to be quiet. Either that, or the children can just keep having fun in the playground and making as much noise as they like. On the other hand, do the residents have the right to peace and quiet? If so, then the children would have liability to compensate the residents for the noise of their playing. Either that, or they have to give up the playground.

Probably the right to peace and quiet prevails - in New Zealand homeowners have the right to quiet enjoyment of their property. So, the children will have to compensate the Stonefields residents for their excessive squealing. Or will they? The residents of Stonefields chose to live close to a park, and the cost of the negative externality will be factored into the price of the houses (if squealing children makes houses in Stonefields less desirable, then houses there will consequently be cheaper). So, you could argue that the residents of Stonefields have already been compensated for the negative externality, which has been incorporated into the price of housing (at no additional cost to the children). In which case, the residents should just suck it up or move somewhere quieter.