Wednesday, December 24, 2014

People Tend Not to Exchange Gifts with Economic Efficiency, So What Gives?

With Chanukah ending and Christmas on its merry way, it got me thinking about the practice of gift-giving. People exchange gifts as a part of the holiday spirit, but the more I think about it, gift-giving doesn't make economic sense. One of the most basic ideas in economics is that the individual knows their consumer preferences better than anyone else. It's one of the reasons I get annoyed when the government assumes they know what individuals want better than the consumer. Whether it's the government spending money on in-kind transfers or individuals spending money to buy gifts, it creates economic inefficiencies because neither fully understands the individual's preferences. Yet people still give presents during the holiday season, so what gives?

The topic of the economics of gift-giving was heavily discussed in a 1993 study called "The Deadweight Loss of Christmas," in which economist Joel Waldfogel calculated a deadweight loss of $4-13B in 1993 dollars, which would be $62-206B in 2014 dollars. Deadweight loss takes place when a certain good or service is not exchanged at economic equilibrium, thereby creating economic inefficiency. The result is a loss to one party without an offset gain to another party. In this case, the assumption is that the gift-giver buys a gift that they think the recipient will value at the very same level of the gift purchased. The issue is that in many instances, the gift-giver does not have an accurate sense of what gift(s) the recipient would want, i.e., there is an information asymmetry. Since the value of the gift is less to the recipient than it is at the level at which the gift-giver perceives, economic welfare is lost in the process. The Secret Santa gift exchange is a classic example of the phenomenon at hand.

As nice as it is to make an impassioned argument about the economic inefficiencies of gift-giving, it fails to account for what economists call utility. Utility is economic jargon for "the fulfillment one receives from a certain good or service." In more layman's terms, the term could be defined as "sentimental value" or the psychological joy felt as a result of receiving or giving gifts (Gneezy and List, 2006). There is also the argument that gift-giving is a "signal of intensity of effort in one's search (see video below on Valentine's Day and gift-giving)," or another way of saying it: "it's the thought that counts" (Yao, 2009). Behavioral economics also postulates that there is an allure and excitement in gift-giving that brings joy to the giver, and it also strengthens the social connection between the giver and recipient. Although one cannot objectively measure it, one has to be able to consider the social and individual utility produced by gift-giving. And who knows? Maybe by exposing the individual to something new, they might actually like it even more (read: "more utility") than a gift that would have kept them in their comfort zone.

Even with social utility, the economic inefficiency is troubling to me. Making the argument of "stimulating the economy" doesn't work because while it might stimulate some consumer spending in the short-run, it leaves us with less resources in the medium-to-long term to help build the economy in the future. Does this mean that I have an inherent problem with gift-giving or think that gift-giving should be banned? Nope! My issue isn't with gift-giving per se, but bad gift-giving. The inefficiencies are created because the giver really doesn't know what the recipient wants. If you know the recipient well (e.g., parents buying for their children, spouses or best friends buying for each other), then economic efficiency is maintained. However, we don't have that sort of close relationship with most people, and since most gift-giving is done with people to whom we are more distant, the economic inefficiencies are still created.

So my advice on more economically efficient gift-giving goes as follows. If you don't know the person that well, either get to know them better or directly ask them what they would like. If you are too uncomfortable asking outright or simply don't want to better know the person, then give in such a way that is beneficial to the ultimate recipient. Cash is the most efficient form of gift-giving. If giving cash comes off as impersonal or you view it as socially unacceptable, a gift card can both personalize a gift while capturing much of the economic efficiency (I say "much" because $45B in gift cards have been unspent since 2005, which comes out to about nearly $5B each year). Charities are also a good idea, although if you want to give to a place like a food pantry, give them $20 instead of $20 worth of food because food drives are just bad economics. Whatever method of gift-giving you decide, I hope that 'tis the season for more economically efficient gift-giving. Happy Holidays!

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