Fair Is Fair: With Guests John Thorn & Richard Thaler

SPEAKER 1: For support, press 2. For sales, press 3. For account changes, press 4.

CAMERON: Ovation Mobile. This is Cameron. How can I help you today?

SPEAKER 3: Yeah, hi. I’d like to upgrade my phone, but the last agent that I spoke to told me that I’d have to give up my current data plan, and I really don’t want to do that. I’ve had it for ages, and the new plan, it’s way more expensive, but it’s basically the same service, and I’m really not happy about this. I’m actually thinking about switching carriers.

CAMERON: Oh, I’m sorry to hear that. Just let me have a look at your account here. I see you’ve been on the Freedom Unlimited data plan with long distance. Yeah, the thing is, we don’t actually offer that plan anymore. It’s been discontinued.

SPEAKER 3: I know. I can only stay on it if I stick with my old phone, which is really on its last legs. Is there anything that you can do at all?

CAMERON: OK. Well, I see you’ve been with us for over five years. That helps. I’ll tell you what—I think I can extend your current plan for two years, and you can just pay the difference on the cost of your new phone.

SPEAKER 3: That could work.

CAMERON: Yeah. Obviously, next time you need a new phone, you’re going to have to move to the new plan, but I think this will work for you. Can I go ahead and extend your current plan?

SPEAKER 3: Sure, yeah. Thanks for making that extension. That seems totally reasonable to me.

CAMERON: Excellent. All right, let me just get your shipping details for the new phone. I have your address here as …

KATY MILKMAN: Have you ever been in a situation like this? The terms of a deal change in ways that don’t seem fair. Maybe the price goes way up on your cable bill, but the service stays the same, or you notice that the snow shovels are marked up at your local hardware store the day after a blizzard, or that rental car rates go up in August, right when you need a car for your vacation.

Today on the podcast, we look at a phenomenon that describes how we determine what’s fair and what’s not in certain transactions. I’ll be speaking with Nobel laureate Richard Thaler about what first led him and his collaborators to notice and study this phenomenon and how it impacts all kinds of different decisions we make at work and at home. We’ll also look at a fascinating chapter in Major League Baseball history, when a clever compromise helped everyone feel all right about resolving a seemingly unfair advantage for pitchers.

SPEAKER 5: Strike three—you’re out.

KATY MILKMAN: I’m Dr. Katy Milkman, and this is Choiceology, an original podcast from Charles Schwab. It’s a show about the psychology and economics behind our decisions. We bring you true stories involving high-stakes make-or-break moments, and we explore the latest research and behavioral science to help you make better choices and avoid costly mistakes.

SPEAKER 6: October 12, 1920. The supple right arm of Stanley Coveleski pitched the Cleveland Indians into the baseball championship of the world at League Park this afternoon, when the accomplished pitcher humiliated Brooklyn in a 3-0 shutout.

KATY MILKMAN: That’s the lead from a New York Times article from 1920. It announced the World Series champs, the Cleveland Indians, after a triumphant home game against the Brooklyn Dodgers—or Robins, as they were known at the time. The article continues …

SPEAKER 6: It was in this hotbed of baseball that Coveleski brought victory to Cleveland today. In winning his third game of the World Series against the Robins, the impresario of the spitball took his place with the great flingers of the past who have won a trio of games. Covey’s name is linked forevermore with the greatness in the game.

KATY MILKMAN: League Park in Cleveland was overflowing with fans ingame seven of the World Series. When the last batter struck out against Stanley Coveleski’s devastating pitching, the fans spilled out onto the field to celebrate their city’s first World Series victory. The Associated Press wrote at the time that Coveleski’s performance “will go down as one of the most standing features of World Series history.” What the headlines didn’t mention was that Coveleski’s signature pitch, the spitball, had recently been banned by Major League Baseball. So how did he get away with it?

First, some background on the state of baseball in the early 1900s.

JOHN THORN: Many of the concrete-and-steel stadiums started coming in 1909, 1910, 1911. There was the Shibe Park in Philadelphia, there was Forbes Field in Pittsburgh, and the Polo Grounds. The ballparks were cavernous and tended not to be filled with spectators unless it was a holiday or a doubleheader.

KATY MILKMAN: This is John Thorn.

JOHN THORN: I’m John Thorn. I’m the official historian for Major League Baseball.

KATY MILKMAN: Over a century ago, baseball in America was a different sport than we see today. There were fewer big hits and runs. The scores were low, and the stands were often empty.

JOHN THORN: The largely empty stadiums characterized the era, and the question that Major League Baseball owners had at that time was whether the lack of offense was contributing to the lack of enthusiasm, whether they had overbuilt for their product.

KATY MILKMAN: This period of baseball history was called the dead-ball era.

JOHN THORN: The dead-ball era was thus named because it was dominated by pitchers rather than hitters. Batting averages were low, home runs were few. Pitchers pretty much had their way with the batters.

KATY MILKMAN: Pitchers used a variety of techniques to make their pitches harder to hit. The spitball was the most famous doctored pitch. In the 1870s, some players discovered that they could affect the final trajectory of the ball just before it arrived at the plate by doctoring the ball with a bit of moisture. The technique was popularized in the early 1900s, coinciding with the beginning of the dead-ball era. The goal of throwing a spitball was to make the bowl dart in a way that was difficult to hit.

JOHN THORN: Well, there were two ways of throwing it. One is to moisten the ball and allow the fingers to be on the moistened portion so the ball would squirt from your fingers and come up like a dead fish and kind of drop. The other was to have the moistened portion exposed to the air so the aerodynamics would make the ball dart left or right or down. The spitball in this period was dominating. It was not a trick pitch. It was not regarded as something that you had to deceive the umpire into believing you were throwing something else. The rise of the spitball encouraged other pitchers to put sandpaper in their gloves, an emery ball, or put candle wax on the ball. All of these substances had the same thing in common, which is to make the ball dart in the direction opposite the substance.

KATY MILKMAN: Some substances, like tobacco spit, made the ball soggy, making it even harder for most batters to hit far into the outfield. There was one batter, however, who seemed to buck the low hitting trend.

Again from The New York Times:

SPEAKER 6: Boston, June 30, 1919. Babe Ruth’s long distance has scored him home runs on every grounds of the American League this season.

KATY MILKMAN: In 1919, Babe Ruth hit a record 29 home runs, and that drummed up serious excitement from fans.

JOHN THORN: I think that the gate attraction that Babe Ruth had become in 1919, followed by his sale to the Yankees for, in effect, $125,000 plus a mortgage on Fenway Park convinced the owners that offense was the way to go, and you wanted the ball to be driven farther.

KATY MILKMAN: Babe Ruth’s cannon-like home run hits were thrilling for baseball fans. The executives running Major League Baseball saw rising attendance at games featuring the Babe. Packed stands meant more money and more enthusiasm for the sport, so in early 1920, Major League Baseball made a move to tip the balance back towards the batters. They decided to ban the spitball.

JOHN THORN: There was a consensus that pitching and defense were depressing scoring, and scoring is what the fans liked, and if you’re not going to give fans what they like, then you’re in the wrong business. The motivation for the ban, which is today regarded as largely safety and sanitary, was at that time principally to aid the offensive side of the game.

KATY MILKMAN: But there was a small problem. Making this abrupt change would ruin career spitball pitchers. Dozens of careers would literally be destroyed overnight. Take Burleigh Grimes of the Brooklyn Robins. He had spent years perfecting his spitball, and he wasn’t adept at other pitches. Many pointed out that it would likely be impossible for veteran spitballers to switch to, say, throwing curve balls, since it uses very different muscle motions.

Team managers worried that they wouldn’t be able to replace the talent that would be lost by the ban. Even Stan Coveleski, the star pitcher for the Cleveland Indians who had helped lead them to their World Series championship, would surely see his future evaporate. So how do you arrive at a fair deal?

KATY MILKMAN: To solve the conundrum, 17 pitchers were given legacy status, meaning they could continue to throw spitballs for the duration of their careers, while all the new pitchers were forbidden from using this technique.

JOHN THORN: The 17 pitchers could not only continue to throw the spitball but could have extended careers of pitching as they had been trained ever since minor-league ball. So instead of asking pitchers who have been trained one particular way for their entire livelihoods to switch into something that was bound to be less successful for them, I think organized baseball stepped up and stepped in, in an appropriate way.

KATY MILKMAN: With these 17 pitchers granted legacy status, Major League Baseball could move ahead with the new rule and increase the fun of watching games without unfairly pulling the rug out from under veteran spitballers.

JOHN THORN: I think everyone agreed with the decision that a player should not be deprived of his livelihood because of a Major League rule change.

KATY MILKMAN: After this rule change, along with another rule about replacing baseballs that had become discolored and difficult for batters to see, the game of baseball was rebalanced between offense and defense. Batters had more hits and more home runs. The game was more dynamic, and attendance figures blew up.

JOHN THORN: Well, the very same stadiums in the decade of 1910 through 1919, which had never seen a million fans come during a home schedule, the 77 games, you now had New York’s Polo Grounds and the Yankees drawing over a million fans, which seemed prodigious at the time. So it is the return of offense to the game for the first time since the 1890s, only now in modern stadiums and somewhat shortened walls, which promoted home runs, promoted run scoring,and gave to the fans a game that they loved.

KATY MILKMAN: The spitball lived on, legally at least, for several years after the ban.

JOHN THORN: Of the 17 pitchers, Burleigh Grimes lasted the longest. With a pitch that was banned in 1920, he went as late as 1934, and he rode that spitball and the lore associated with it into the Hall of Fame, had some very fine years. It was as if Grimes was the last dinosaur.

KATY MILKMAN: Rules in a sport like baseball are always under review to help maintain the delicate balance between offense and defense that makes the games most exciting.

JOHN THORN: I think it’s important to recognize that baseball is not a pure athletic contest, like, say, the hundred-yard dash, where every runner goes for the tape, and the winning time comes down decade after decade after decade as athletes improve. This is an athletic entertainment, a sport, and its rules are managed by the proprietors, so that whenever, from 1876 forward, whenever offense has threatened to dominate defense, or defense has threatened to dominate offense, the owners have stepped in to make minor changes in the rules, which might have outsized results in the game on the field.

KATY MILKMAN: Many other sports besides baseball are constantly balancing and rebalancing rules to keep things exciting and entertaining, while also trying to avoid alienating players who may have adopted techniques or equipment that give them an advantage. In fact, earlier this year, World Athletics, the governing body for track and field, ruled that Nike’s controversial Vaporfly shoes would be allowed at the Olympics, but they also issued rules that would outlaw certain modifications to the shoes

JOHN THORN: Major League Baseball is being encouraged right now to introduce rule changes that reduce the number of strikeouts—and perhaps consequently reduce the number of home runs—and put more balls in play, because that’s what fans appear to like. On the other hand, younger fans tend to like the home run because baseball then resembles an arcade game, with which they are very familiar, with which they grow up. So it is older gents like me, who recall, say, the game of the 1950s and ’60s as being baseball in an ideal form. The problem is that for older people and younger people alike, we tend to identify the golden age of baseball not as a particular period, but precisely when we were 12 years old.

KATY MILKMAN: John Thorn is the official historian for Major League Baseball. He’s also the author of several books, including Baseball and the Garden of Eden: The Secret History of the Early Game. You can find links in the show notes or at schwab.com/podcast.

We brought you this story because it demonstrates some interesting aspects of our notions about what’s fair. We saw two groups, the executives who run Major League Baseball and who wanted to make the game more exciting for the fans and more evenly balanced between offense and defense, and the pitchers, who had the deck stacked in their favor when they used spitballs—but also felt like it would be unfair if they weren’t allowed to maintain the status quo and keep using a technique they’d spent their careers perfecting. By granting spitball specialists legacy status and allowing them to continue playing by the old rules while prohibiting spitball throwing by other pitchers, Major League Baseball’s leaders cleverly evaded a major kerfuffle. They allowed parties who would have been harmed to retain their reference point while still adjusting the rules in a way that would increase the profitability of the sport.

Similar ways of handling people’s expectation that they’ll be able to retain whatever reference point they’ve become accustomed to in transactions come up in a lot of different settings. At the beginning of the show, you heard a customer service representative agree to grant legacy status to a customer to a discontinued cell phone plan in order to satisfy that customer’s sense of fairness and maybe avoid losing that customer to a competitor.

Fairness is generally an important constraint on profit seeking and one that economists largely failed to acknowledge in their models of markets until the 1980s. Consider a company that wants to raise the price of a popular product or service when it’s in high demand—say, a beverage vendor that wants to raise the prices of its drinks in its vending machines on hot days or a pharmacy that wants to raise the price of hand sanitizer during a pandemic. Those kinds of price increases are exactly the right response to a boost in demand with no accompanying change in supply, according to traditional economic theory. But what behavioral economists have proven is that those kinds of increases are typically seen as unfair because customers know that just a few days ago, the same vendor carried the same product at a different price. If vendors increase prices in response to increased demand, then customers may punish them, ceasing to be loyal in the future.

Uber and Lyft have made big strides in normalizing dynamic pricing, but they’ve done so by educating consumers that the same ride under different market conditions has to cost more to ensure their market works. Another interesting exception is that research has shown if the cost of manufacturing or labor goes down for a company and it becomes cheaper to make a product—meaning their profits are going up—customers won’t be upset if the price tag doesn’t drop because they’re used to paying the price.

The general tendency for people to feel entitled to their reference points intransactions is called the principle of dual entitlement. It was first pointed out in seminal research by Daniel Kahneman, Jack Knetsch, and Richard Thaler in the 1980s. As a result of the coronavirus pandemic, Richard Thaler joined me remotely from Oakland, California, where he was sheltering in place, to talk about how he and his collaborators came to recognize and study this phenomenon.

Hi, Richard. Thank you so much for joining me. I really appreciate it.

RICHARD THALER: It’s a pleasure, Katy, as always.

KATY MILKMAN: I wanted to ask first a really basic question, which is just what is the principle of dual entitlement? Could you define it for us?

RICHARD THALER: The idea is that if you and I are engaging in something, we’ll do it with an implicit set of ground rules, in which we each think that we’re entitled to some things and that if either of us is asked to give up one of those things, we will think of it as a loss. We know people are loss averse, so people are unwilling to give up what they consider to be theirs.

KATY MILKMAN: How did you and your collaborators get interested in studying this back in the 1980s?

RICHARD THALER: I went and spent a year visiting with Danny Kahneman in 1984, ’85, in Vancouver. I had my first sabbatical. We had a friend there, Jack Knetsch, who had a grant from the Canadian Bureau of Fisheries, of all things. For reasons I don’t quite remember, we had access to a telephone polling bureau that was teaching people to be telephone interviewers, and they had a shortage of questions. We viewed this as a research opportunity. Every week we got to send them three or four versions of five questions that they would ask to at least a hundred people. The only rule was one of the questions had to be about fish, and those questions were invariably boring. The question we decided to use this new tool for was to ask what people think of as fair.

You can think of this as a kind of empirical philosophy exercise. Philosophers don’t usually do empirical work, but we weren’t interested in defining fairness—or what people should think is fair—we were just interested in what do people think is fair. That was the research question.

KATY MILKMAN: And that got you to the principle of dual entitlement—is that right?

RICHARD THALER: Yeah. I mean, we didn’t start with a theory and then go to test it. We started out with some intuitions and then went on a glorious fishing expedition, asking questions. The most famous question is a hardware store has been selling snow shovels for $15. The morning after a blizzard, they raised the price to $20. Rate this action as completely unfair, somewhat unfair, acceptable, totally fair. Then we ended up asking something like 700 of these. The reason why this wasn’t really a fishing expedition is when we … well, we started out with intuitions—we knew people were not going to like this raising the price, but because data was essentially free, anything that we found interesting we would replicate. We happened to publish the snow shovels, but the same would be true for a wide variety of things. It doesn’t have to be a hardware store. It doesn’t have to be a snow shovel.

Then we were looking for organizing principles, and Danny was the one who came up with this idea of dual entitlement. It’s not a phrase that I particularly love, but the concept is right.

KATY MILKMAN: Could you talk a little bit about why you think it is that traditional economists would say the snow shovel data should come out one way and it actually comes out another? Could you talk a little bit about that tension and what’s interesting about it?

RICHARD THALER: Yeah. Here’s another interesting fact. I teach a course called Managerial Decision Making. Before the course starts, we administer a survey of all the students, asking all the standard heuristics and biases questions. We do overconfidence and anchoring and adjustment and so forth and so on. Each week, what that allows us to do is show the results of the original classic experiments and show the students that they behave exactly the same way as the subjects in the original experiments. That’s true every week of the class, except the one where I talk about fairness, because my MBA students think raising the price of snow shovels is completely fair. The reason why they think that is the previous quarter they had taken microeconomics, where that was the right answer, right? If a question—there’s a fixed supply of X, the demand shifts, goes up, what happens to the price? The right answer is the price goes up. Furthermore, economists think that that’s always a good thing. Why? Because it makes sure that the snow shovels get to the people who value them most, and that’s thought to be efficient.

Now, that’s true. It will get the snow shovels to the people who value them most, as long as we measure how much they value them by how much they’re willing to pay. But obviously there are distributional considerations here as well. Rich people will end up with more shovels than poor people if we do that—as opposed to first come, first serve, for example, where people who have less money but more time may get to the hardware store a half-hour before it opens and be ready to grab the snow shovels before they run out.

KATY MILKMAN: I want to switch gears a tiny bit to get at a related concept, which is just how do policies that allow someone to retain an existing set of rules or prices relate to this principle of dual entitlement? We’ve talked a lot about snow shovels, but there are all sorts of legacy clauses that I think are closely related as well  that you studied with Danny Kahneman and Jack Knetsch in the ’80s.

RICHARD THALER: The essential result here is that people feel entitled to what they have. When I got my teaching job at Cornell, there were a certain set of benefits, like tuition benefits, that were very generous. At some point they decided that these benefits were too generous, and they reduced them, but the people who had been teaching there before …

KATY MILKMAN: So to make everyone happy, those people who’d been teaching there before got to keep their old deal.

Here’s a funny story about this applying in a place where you wouldn’t think it would otherwise. What I consider to be the best chapter in my book Misbehaving describes in detail the procedures that Chicago Booth business school used in allocating offices in its new building to the faculty. I won’t go into the whole process, but just one little sub-chapter. The process was just like in the NFL draft, for sports fans. Somehow they devised an ordering in which people got to pick offices, and when your turn came up, you would get to pick any of the offices left, and you got to see who had picked first, in case you wanted to be near or far away from somebody else.

The day that we’re actually doing this draft, at some point, one of the faculty members asks, are they sure that the measurements they’ve given us of the offices are correct? The answer turns out to be no, as he suspected, there were some mistakes. Since people were, amusingly, putting a great deal of weight on the estimated square footage of an office, this was viewed as a catastrophic failure, and the whole thing was stopped and delayed for a couple of weeks while they went back and checked all the measurements. Then they started the thing all over again.

Now, the amusing thing that’s related to what we’re talking about today is when they did it again, they started from the beginning, but with the proviso that when your turn came up, you had the right to take the office that you had taken last time. Now, you would’ve only owned the right to that office for maybe a couple of hours, but nevertheless .... So even at the Chicago business school, people get property rights very quickly in ways that are kind of amusing and surprising.

KATY MILKMAN: Thank you for taking the time to do this. I so appreciate it. This has been terrific.

RICHARD THALER: No problem, Katy. It’s always fun to talk to you.

KATY MILKMAN: Richard Thaler is a Nobel Prize–winning economist and the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the University of Chicago’s Booth School of Business. He’s the author of several books, including Misbehaving: The Making of Behavioral Economics. You can find links in the show notes or at schwab.com/podcast.

How you adhere to reference points can impact the important financial decisions you face, like when to sell an investment or when to claim Social Security benefits. Decisions like these are the focus of our sister podcast, Financial Decoder. Host Mark Riepe, head of the Schwab Center for Financial Research, shares strategies for improving the way you approach financial crossroads. You can find it at schwab.com/financialdecoder or wherever you listen to podcasts.

While the principle of dual entitlement is not a decision-making bias in itself, it is the result of our belief that we’re entitled to our reference points, or the status quo, which is absolutely a bias. It’s called status quo bias. It leads to all sorts of peculiar behaviors, including a surprising tendency we have to go along with whatever default settings come with products we buy, government regulations, or employment contracts. We talked at length about status quo bias and default effects in a previous episode you might want to check out if you missed it, called “The Simple Choice.”

The key role reference points play in all of this is that any negative change from what you’ve gotten used to—that is, your reference point—will be seen as a loss, and we find losses more painful than gains, so we get really exercised about accepting a loss relative to our reference point. That’s what leads to “legacy” solutions, like the one we examined in this episode. The principle of dual entitlement guides what we perceive as fair and unfair, and it can lead us to end long-time relationships with other people, with service providers, and even with employers. As a result, I think it’s important to be familiar with this principle so you can avoid making unwanted enemies, perhaps by coming up with clever solutions to problems, like Major League Baseball did with spitball pitchers.

Being familiar with the principle of dual entitlement may also help you understand why you get so incensed by certain price increases and rule changes. The truth is, you may be right to be incensed. After all, there seems to be a pretty general agreement among everyone except MBA students that it’s not OK to increase the price of snow shovels after a snow storm, even if demand has spiked with no change in supply. But thinking about what’s happening with a little more perspective may help you keep a cool head and make better decisions as a customer, employer, or service provider.

You’ve been listening to Choiceology, an original podcast from Charles Schwab. If you’ve enjoyed the show, we’d be really grateful if you’d leave us a review on Apple Podcasts. You can also subscribe for free in your favorite podcasting apps. And if you’d like to get my newsletter to learn more about behavioral science, you can sign up at katymilkman.com/newsletter. In the next episode, we’ll explore a simple strategy that can help us manage complex situations and even avert disaster in outer space. I’m Katy Milkman—talk to you soon.

SPEAKER 9: For important disclosures, see the show notes or visit schwab.com/podcast.