On the economics of gift-giving

Christmas is only days away, and many of us are likely to have wrapped up their shopping, not to mention wrapped up the gifts themselves. Some laggards, however, will continue to brave the stores despite crowds and long checkout lines. So strong is the gift-giving impulse that many will subject themselves to inconvenience, just to have a full lineup of presents under their trees.

But could this impulse possibly be misguided? Some economists, after all, believe gift-giving is inefficient. It’s an academic argument that goes back to at least the last century, when economist Joel Waldfogel of the Wharton School at the University of Pennsylvania wrote the influential paper “The Deadweight Loss of Christmas” in 1993. The technical arguments in the paper were later elaborated on in a 2009 book aimed at a broader audience: "Scroogenomics: Why You Shouldn't Buy Presents for the Holidays.” 
 
Deadweight loss
 
In a normal transaction, one party loses and another gains. Mr. Waldfogel argues that this is not the case with gift-giving, where the loss absorbed by one person “is not offset by gains to someone else.” In economics, this is referred to as “deadweight loss.”
 
Remrick E. Patagan, research director of the Institute for Development and Econometric Analysis (IDEA), a think tank based at the University of the Philippines School of Economics, explains this concept: "The deadweight loss from gift-giving is premised on the condition that there is a discrepancy between the giver's knowledge about the recipient's preferences and the recipient's knowledge of her own preferences. Thus, the value of the gift can either be diminished or increased depending on this condition."
 
Edson Joseph C. Guido, a consultant at the World Bank’s Governance Global Practice, illustrates the concept in cash terms: “[T]he utility derived from receiving a gift worth, say, a hundred pesos may be less than the utility one gets from spending a hundred pesos to buy what one really wants. This is because the 100-peso value of the gift may not be worth 100 pesos to the recipient because of (a mismatch in) preferences.”
 
For his 1993 paper, Mr. Waldfogel surveyed Yale University students. They were asked how much they were willing to pay for the gifts had they bought these themselves barring "sentimental value." The responses were then used to calculate the deadweight loss by getting the difference between the gifts’ price and the students' valuation of the gifts.

The results showed that the students valued the gifts less than the price the giver paid for them. The difference was much bigger among givers who did not really know the recipients.
 
"What’s distinctive about all of this spending is that... the choices are not made by the ultimate consumers. For the rest of the year, the people who will ultimately use the stuff choose what they buy. As a result, buyers normally choose things they correctly expect to enjoy using," Mr. Waldfogel wrote in "Scroogenomics."
 
"But not at Christmas. As a result, the massive holiday spending has the potential to do a terrible job matching products with users."
 
With the waste being created in the gift-giving process, Mr. Waldfogel proposed giving gift cards instead. With gift cards, recipients have the discretion of choosing the products they want and can spend up to the card’s value. This, Mr. Waldfogel claimed, is popular enough among consumers to be an alternative and at the same time, avoids the “ickiness” of giving cash, which is considered an efficient but a “socially awkward” gift.
 
IDEA’s Mr. Patagan noted an inconsistency in the study’s methodology but said he did not "necessarily disagree" with Mr. Waldfogel's findings. "From the perspective of orthodox microeconomics and consumer choice theory, the reasoning behind the arguments is sound and the conclusions are, at the very least, tenable," he said.
 
Boost to relationships
 
As sound as Mr. Waldfogel's arguments might be, his ideas have not been met with wide acceptance among fellow economists.
 
A poll of 46 economists conducted by the Initiative on Global Markets at the University of Chicago Booth School of Business last year showed that only 15% "agree" with the assertion that gift giving is a wasteful activity, with just 2% who "strongly agree." On the other hand, 39% "disagree" and 15% "strongly disagree" while 22% are "uncertain."
 
Those who disagreed pointed out that the benefits of gift giving are not measured by monetary gains or efficiency but by the boost this gives to interpersonal relationships.
 
University of the Philippines economist Agustin L. Arcenas, for his part, said: "You can think of gift giving as having an expected benefit… as it could also be seen as an investment in one’s social capital. ‘Holiday cheer’ is a good that you buy through gifts. From that perspective, it is not wasteful."
 
The World Bank’s Mr. Guido was of the same opinion. “Even if we don’t equate the monetary value of gifts to our actual valuation of these, there is still a ‘value-added’ in receiving gifts. We take into account the thought from our friends, as well as the effort put into buying gifts for us…”
 
Regardless of one’s view of Mr. Waldfogel’s ideas, there is one thing economists are likely to agree with as far as theory is concerned.
 
"One take-away lesson from this is that for as long as the giver is well-informed of the recipient's preferences, then there is a higher likelihood of the giver choosing a gift that will be valued by the recipient at or above its cost," IDEA’s Mr. Patagan said.
 
"To put it simply, it's okay to give gifts to a person you happen to know very well as the values both of you attach to the gift will be, more or less, the same."