Why economists hate giving gifts and why you should too

Why is giving gifts socially inefficient? And why do we continue doing it?

As an aspiring economist, the act of giving gifts has always intrigued me. From a personal experience, my gifts have often received mixed reaction from the recipients. Be it my addictive compulsion to buy books to signify the thoughtfulness or my lazy yet cautious purchase of popular music CDs to play it safe.

In most cases, giving gift is a laborious exercise. It involves high search cost (unless you know exactly what to get), price you pay to obtain the gift, and an often unmet expectation that it would provide high satisfaction to the recipient. From a pure utility standpoint, this dissatisfaction creates disutility at both our ends, making you wonder if there is any economic rationale to buying in-kind gifts.

Economists argue that since people typically know their own preferences better than others do, so we might expect everyone to prefer cash to in-kind transfers. It reflects the problem of asymmetric information where I do not have perfect information about the wants of my friend, to match it with an appropriate gift. Thus the intimacy of my relationship with the recipient eventually decides whether I create or destroy value. Thus the ideal gift is as good as cash which let's "them" purchase the gift of their choice.

For instance, the $100 I paid to get a plaid sweater for a friend could be valued as low as $75 by her, with an instant erosion of 25% of the actual value. The $25 is a dead-weight loss. Deadweight loss, which is also part of the name of Waldfogel’s widely noted 1993 paper on the topic, refers to a loss to one party that is not offset by a gain to another. To think of it in terms of total Surplus, the Consumer Surplus to me and my friend is -$25 (assuming no emotional significance). The Producer surplus is a small amount above $0, assuming in a competitive market, the sweater is priced at its marginal cost. The Total Surplus to the society for the 1 unit of sweater is -$25. The Negative amount signifies deadweight loss.

Wharton Professor Joel Waldfogel estimated that Deadweight loss from Christmas Holiday gifts, on an average is around 18%. In an absolute Dollar terms, in 2007, where US spent $66 Billion on Holiday gifts, resulted in value destruction close to $12 Billion. Globally he estimates Christmas yuletide spending in 2006 to be close to $145 Billion and a staggering $25 Billion of value destruction.

Assuming, these numbers were plausible, this Annual figure outmatches annual disbursements of Bill-Melinda foundation, which has a total endowment of US $33.5 Billion (in 2009) and could eradicate infectious diseases and malnutrition in all third world countries. Waldfogel’s noble arguments as misstated by a lot of sources is not about stopping the traditional act of giving gifts. Rather, in his book “Scroogenomics” requests readers to think about the problem carefully, before rushing to buy your gifts. He articulates that the ideal Christmas gift is a carefully chosen item that delights the user and opens a new world of consumption choices. Below is his suggestion to a carefully selected, efficiency increasing selection of gifts.

Relationship Waldfogel's estimate of value Children Adults Rich Adults
1 Partners, Siblings, Parents 102%-97% Gifts Gifts Charity cards
2 Friends 91% Gifts Gifts/Gift cards Charity cards
3 Aunts/Uncles/Grandparents 80%-75% Cash/Gifts Cash/Gift cards Charity cards

He reasons that people who know our preferences well, should give in-kind gifts. In some exceptional cases, process of giving gift could outperform their retail values in cash. Firstly, they will chose gifts which we know we need. Secondly, behavioral economics show that contrary to our expectation, people do not always have rational preferences. They constantly forget/change their preferences. And quite often do not know what they really need. Thus, paternalistic instinct of the givers could promote new and better consumption choices which were previously unknown to us. Studies have found that we as individuals like to be pleasantly surprised by new consumption choices. For instance, the first keyboard from my dad which triggered my interest in music, or Steven Levitt’s “Freakonomics” from my friend which has prompted me to take up Economics in my grad school (not sure if this can be considered positive). This is also true especially for kids, who may not make rational decisions on using cash appropriately and may positively benefit from new consumption choices.

In cases where givers are not that aware of the recipient's preferences, the next best choice is cash. However social awkwardness in giving and receiving cash could also devalue the gift to as low as 50%. Thus $100 in cash could eventually only signify $50. A way around it is gift-cards. Depending on the recipient's general interest in music, electronics or clothes, you could gift him gift cards from iTunes, Apple Store/Amazon or GAP. Waldfogel is quick to point out that in US alone, ~10% of the value of gift cards are destroyed either due to people forgetting/loosing the cards, cards expiring before use, disinterest in the shop’s merchandise or inability to fully redeem the total value. The latter happens when on a gift card of $100, you purchase a sweater for $95 and find nothing to purchase for the remaining $5. Unused gift-card values are also dead-weight but since the issuing merchant eventually declares it as a revenue (after the card expiry), the value is not all lost. Legislature in some states makes it liable for merchants to redeem buyers in cash for unutilized gift-card amounts. There is also a secondary market for buy-sale of gift cards.

The most interesting case is for richer recipients. Economics teaches us the law of diminishing marginal returns. As we have more of a specific good, our marginal value for each additional unit of the good decreases. Same goes for money. A poor man values every $1 more than a rich man. Thus no matter what gift we give to a rich friend or a relative, he will always value it lower than the original price. Thus rather than giving materialistic gifts, Waldfogel suggests altruistic gifts like a charity card. A market of charity pledge cards is fast catching steam where the issuer is liable to donate a certain amount to the charity of your choice. One could argue that charity donations also are subject to diminishing returns, but since charitable organizations generally produce multifold results for each dollar donated, it is the most efficient gift. For instance, $1/day/kid donated to improve nutrition in diet of impoverished kids in sub-Saharan Africa could result in their improved health and productivity facilitating the growth and development of the impoverished Societies.

In most cases, I do agree with Joel Walfogel and his rationale on selecting the most optimum gift for your recipients. However I am still wary of his estimation of an average 18% value loss from gifts. I have the following concerns -

1. His 18% is made up of different relationships, each with their estimated efficacy of value creation.
2. He discounts the sentimental value created for the giver and the recipient. Agreed that there is a disutility from disappointing gifts but remember it’s the “thought” that most often counts. A poor gift could also be a great source of memory.
3. A gift could lead to high transactional efficiency. For instance, a Kindle which retails in the US for $130 is not available in Singapore. I value it as high as $250. If a friend in States gifts me a Kindle, there is ~100% increase in value.
4. He discounts the value creation for the giver. Giver could have ulterior motives in giving a specific gift. For instance, a Dad gifting his young son, a book on mathematics in a hope he becomes an engineer, me gifting “Scroogenomics” to a friend, in a hope of having an intellectually stimulating discussion on this very topic, or you getting a movie ticket just to ask someone out on a date. These are not always selfish as seen from the examples. The son enjoying maths, my friend enjoying the book and the date enjoying the movie, without the possibility of having a chance to experience them in the first place (without gifts).
5. Gifts as tool to signal your care and affection for the person to the society, should not be discarded
6. Since people voluntarily continue to give and receive gifts, does that mean it is pareto-optimal. If there was any way to improve the benefit, society would have already moved towards that equilibrium (Jef Ely)
7. Finally, the entire process of searching and thinking about the gift, makes you  know the person better and hopefully be better gift givers in the future, thereby increasing the return in subsequent years

Phew, I know this post was really long, but the economics behind it is really fascinating. Economists and social scientists are still on the fence, on how socially efficient, gift giving is. I would also like to include a nice illustration from WePay’s blog on the “Holiday Misgivings”.
Happy Holidays, enjoy all the gifts. But Remember, the next time you shop for one, put in a bit of thought in your gifts ;)

List of great resources on the same subject:
WePay: http://www.wepay.com/blog/2010/12/21/holiday-misgivings-the-real-dynamics-behind-holiday-gifting/
Jeff Ely: http://cheeptalk.wordpress.com/2009/12/23/the-real-economics-of-holiday-gift-giving/

The Deadweight Loss of Christmas: (Joel’s original paper)
The Deadweight Loss of Christmas: Comment : http://www.idc.ac.il/publications/files/393.pdf

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