Why splitting the bill for lunch can prove a false economy

YOU can always rely on economists to grapple with the big issues. No, I don’t mean the price of oil, the level of interest rates, the China boom or house price inflation. We’re talking big issue here: how best to pay for lunch.

Now there may be no such thing as a free lunch. But there is most definitely such a thing as a better and bigger meal at someone else’s expense. The notion that splitting a restaurant bill equally means equality of benefit is misleading. And the notion that such questions have no bearing on life outside the restaurant is wrong, or at least wrong to economists. How we pay for lunch has, they claim, a bearing on issues such as overfishing, deforestation, air pollution and even arms races.

All of these involve "negative externalities", where people can impose some of the costs of their actions on others, leading to undesirable outcomes for society as a whole.

According to three American economists in a paper published today in the Royal Economic Society Journal, splitting the bill equally for a restaurant meal leads a group of diners to spend more than they would were each person paying for their own order.

Predictable, perhaps. But research for this paper (The Inefficiency of Splitting the Bill), now proves it. For the experiment, several groups of six diners were taken to a "popular dining establishment". In one treatment, the diners pay individually. In a second treatment, they split the bill evenly between the six group members. In the third, the meal is paid for by the experimenter (Boy, ain’t it tough in economics?).

In the experiment, the average spending per person in the free meal was more than twice the average spending per person when each individual had to pay for his or her own meal. The "even split" treatment of the bill brought a total in the middle.

The efficiency implication of the different payment methods is straightforward. When splitting the bill, say the boffins, "diners consume such that the ‘marginal social cost’ they impose is larger than their own marginal utility and largely ignore negative externalities they impose on others. As a result, they over-consume relative to the social optimum." The authors conclude that the only efficient payment rule is the individual one. Interestingly, when asked, 80 per cent chose the individual payment method. But when they agree to split the bill evenly, they nevertheless take advantage of others.

These results, say the authors, have great importance in the design of institutions. "Institutions and rules that ignore the effect of negative externalities are inefficient - not only in theory, but also in practice."

The paper, I fear, is bound to catch the eye of cost accountants in organisations, and here I must tread carefully, as a journalist’s work on meal expenses is a fine and well indulged art.

If "lunching on exes" is shown to be the most inefficient means of payment, what, then, is the economic justification? Why, "goodwill", of course. The "cost" of the lunch is not to be measured in terms of the tab picked up, but the tab less the value of the information gained, or subsequently gained as a result of the goodwill expended.

So beware when you see the sales and marketing team stuck in the canteen: it could be the most sub-optimal result of them all.

Stormy markets

I NORMALLY recoil from folksy summations of stock market behaviour. But seldom has that tired old adage, "Sell in May and go away" looked more apposite.

As if on cue, the prolonged market rally since March of last year has run out of steam. Investors have been besieged by worries over dearer oil, China slowdown, rising inflation and interest rates, and, arguably more disconcerting, a geopolitical sea-change brought about by the disarray in Iraq. This has added two negatives: heightened risk of terrorist attack; and political uncertainty, both in the US and the UK.

Evidence of investor apprehension can be seen in figures showing big outflows from US mutual funds. According to Merrill Lynch, there was a net outflow of $2.4 billion from equity funds overall in the week ending 12 May, the biggest outflow since March 2003. Only the equity income and healthcare sectors saw net inflow. Especially sharp outflows were recorded from Japan and greater Asia funds.

Arguably the most telling indicator of a change in investor climate is to be seen in the sharp rise in market volatility, evident both here and on Wall Street.

Throughout last week there were dramatic intra-day rises and falls on the Dow Jones, evidence of a mounting battle between bulls and bears about the "right" level of the market. The battle to hold "10,000 on the Dow" has been especially intense, with highly volatile and unpredictable rises and falls in recent days. (For "10,000 on the Dow", read 4,500 on the FTSE100.)

But while the storm cones are raised, I am not convinced that a blanket "sell" policy is appropriate. I would also argue that the rest of the year will provide opportunities for investors to take advantage of market over-reaction. There will be occasions to pick up quality shares on the cheap.

What we may be seeing here is a broadly typical playing-out of a market turning point. Year 1 (2003) sees strong recovery. Year 2 (2004) sees some retrenchment, and year 3 (2005) a resumption of strength. Interestingly, the years 1993-1995 in the US broadly confirmed to this pattern. On this perspective, investors should use a retrenching 2004 to do some stock-picking homework while sticking with dividend-paying defensive stocks that have limited downside.