4 min read

Tragedy of the Commons

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by Bryan Lopez

When I sat down to write this, I had my opening line already mapped out: “There are only two of Adam Smith’s theories that I remember from my economics classes—the Invisible Hand and the Tragedy of the Commons.”  It was going to be a glorious opening line, and the 25% of people that didn’t immediately tune out after an introductory statement referencing an economist who has been dead for over 225 years were going to be in for a treat.  But then when I started to dig a little deeper I realized that there is in fact only one concept that I remember from Adam Smith, because apparently the idea of the Tragedy of the Commons is actually based on a theory put forth by another economist, William Forster Lloyd, in 1833, and perpetuated by the ecologist Garrett Hardin in 1968.  In fact, the Tragedy of the Commons is essentially a counter theory to Smith’s Invisible Hand, at least according to Wikipedia, which is never wrong about anything, ever.  So, now that we have established that, let’s try a different approach to introducing this theory.

At WMS Partners we have not one, but two microwaves in our kitchen, which I believe makes us the “Google of wealth management firms”.  They are there for all employees to use, but it is no one’s direct responsibility to keep them clean.  Thus, it is implicitly everyone’s job to make sure the microwaves stay clean after each use.  On a scale from 1 to 10, with 10 being surgically sterile, exactly how clean would you guess those microwaves are on any given day?  If you said “2”, you were being generous.

So why would most people fail to clean up the inside of the microwave at work after a spaghetti sauce explosion, when they surely wouldn’t leave their own home microwave looking like a science experiment gone awry?  Therein lies the crux of the Tragedy of the Commons—in a nutshell, people are apt to abuse shared resources for which there is no direct feeling of ownership (or related consequence of this misuse).  When Lloyd put forth this theory, it was meant to be applied to an exhaustible resource, such as grass on a common pasture where everyone’s cattle could graze, so perhaps the microwave isn’t the best example.  However, there is one other example that may be more apt, and it is one that we often encounter in our line of work.

An amazingly high percentage of our client base is first generation wealth.  By definition, though, as our clients get older that wealth will transfer to the second generation and beyond.  Our advisors do an amazing job at planning for these transitions, both tactically through specific planning strategies, and emotionally through conducting family meetings and making sure all parties are properly educated.  As our CEO, Tim Chase, pointed out in his recent post, “Does Your Family Need a Metric?”, we really see it as our job to help the next generations become superior stewards of the family wealth.

Part of this process is making sure that adult children have a sense of ownership (whether current or future) of the family wealth—it’s not just a magical pot of money for them to spend.  Particularly in cases where there are siblings involved and inheritance is expected to be split evenly at some point in the future, it is human nature to try to use as much of that resource for one’s own benefit prior to the transition event occurring.  As an example, let’s say there are two siblings who are each going to inherit a million dollars upon the death of their parents, with the rest of the money going to charity.  The amount of the inheritance is fixed at this amount, and the proper trusts are set up to limit access to the funds until the children reach an age where they can be responsible with the money.  All prudent steps have been taken.  Essentially, though, a defined benefit plan has been set up for the children and they have no sense of ownership in any downside risk between now and then.  In most cases the children would not have unfettered access to any funds prior to the transition event occurring, but kids can be persuasive when asking for gifts from their loving parents.  If the parents give in and essentially write “blank checks” to their children for anything they want, there is the potential for there to be a Tragedy of the Commons.  The children know that anything above and beyond their “guaranteed” inheritance is going to either be spent by someone or ultimately go to charity, so why not try to let their own cattle graze in that money pasture for as long as they are able?

This isn’t to say that you shouldn’t give gifts to your children.  There can be an altruistic element to giving of any kind, whether to charity or family, but there is also an element of self-satisfaction that comes from it.  If you have worked hard and earned a significant amount of wealth, being able to give is one of the perks that you should be able to enjoy.  However, everything should come in moderation.  Limits should be set and children should not have a sense of entitlement towards unlimited amounts of spending.  In the book The Opposite of Spoiled, Ron Lieber makes a strong case for being open and honest with children about money from an early age.  It is ok to give children an allowance and Lieber is a proponent of not tying the allowance to doing chores around the house.  Chores are the responsibility of everyone living in the house and no one gets paid extra to do them.  The purpose of the allowance is to teach the children important lessons about money and to give them a sense of ownership—they have to learn firsthand the tradeoffs between spending, saving, and giving.  Also, there is no inherent reason why wealthier families can’t give their children more of this allowance than less wealthy families.  This order of magnitude alone will not spoil a child, as long as they are taught the proper ways to manage money and not given a limitless amount of it, irrespective of their decisions.

The Tragedy of the Commons is a concept that grew out of a very specific example that may not be as relatable today in a very different era.  However, its applications are seemingly endless, especially if you stretch them a little bit as I am wont to do.  Whether you are talking about cow pastures, or microwaves, or family money, the main takeaway is that people need to be given a sense of ownership and consequence if you expect them to treat shared resources in the same manner that they would treat their own.  The secondary takeaway is to not put a frozen bean burrito uncovered in a microwave for five minutes.  It will not end well.