The Endowment Effect's Disappearing Act
The "endowment effect," a tendency for an individual to state a minimum amount for which he might be willing to sell an item that is greater than the amount the same individual is willing to pay for the same item as a buyer, is quite popular in the legal literature and elsewhere these days (it even has a Wikipedia entry, as does the rather lengthy "list of cognitive biases"). An unrestricted Westlaw search (JLR) turns up 541 articles mentioning the endowment effect. 189 of these articles appeared over the past three years, and 46 in 2005 alone. I will be the first to admit that I have not read all of these articles. However, I have read enough to get a sense that the template goes something like this: (1)the "endowment effect" exists; (2) Coase was wrong; (3) there is a market failure; and (4) insert proposal for regulatory intervention.
A recent American Economic Review article by Charles Plott and Kathryn Zeiler, " The WTP-WTA Gap, the 'Endowment Effect,' Subject Misconceptions, and Experimental Procedures," is a must read for scholars contemplating entry into this literature. Some highlights:
The issue explored here is not whether a WTP-WTA gap can be observed. Clearly, the experiments of KKT and others show not only that gaps can be observed, but also that they are replicable. Instead, our interest lies in the interpretation of observed gaps. The primary conclusion derived from the data reported here is that observed WTP-WTA gaps do not reflect a fundamental feature of human preferences. That is, endowment effect theory does not seem to explain observed gaps.
"by implementing different procedures, the phenomenon can be turned on and off. When procedures used in studies that report the gap are employed, the gap is readily observed. When a full set of controls is implemented, the gap is not observed. The fact that the gap can be turned on and off demonstrates that interpreting gaps as support for endowment effect theory is problematic."
Problematic? I'd say. That experimenters can eliminate or create the effect by modifying experimental procedures is at least problematic. So why is the effect so easily replicated if it doesn't really exist? Plott and Zeiler's answer: "[t]he thesis of this paper is that observed gaps are symptomatic of subjects' misconceptions about the nature of the experimental task." That is, experimental procedures and not biases in individual preferences explain the gap. Anyway, read the whole thing.
A final thought. To my mind, proponents of endowment effect-based regulation must confront a burden that looks something like this characterization offered by Steve Bainbridge a few years ago here:
The regulator ought to be confident that (a) the endowment effect is really present; (b) as a result of the endowment effect, an inefficient outcome is proving sticky; (c) that market experience cannot remove the anomaly; and (d) there is a superior regulatory solution.
Prior to reading Plott & Zeiler, I was fairly confident that the number of "endowment effect" regulatory proposals meeting this standard was small, and possibly zero. Pending convincing contradictory evidence that the effect actually exists in markets, the set of qualifying proposals now appears to be null. My only question is: What would the law reviews do with all that extra space?