Tuesday, December 12, 2006

Tuesday column: Could Christmas gifts be bad?

So, you’re dreading Christmas. I am too. Not the day itself, but the agonizing hunt for presents in the weeks leading up to it.

I am prepared to spend a lot – most working Australians plan to spend around $830 according to the financial group AXA – but I don’t know on what.

My fear is that unless I buy extremely well, I will spend maybe $50 on something that is worth much less than $50 to the person who receives it.

Economists have a name for this concept: a deadweight loss. Small government advocates are always evoking it...

The government collects from you say $20,000 a year, and spends it on your education, health and so on. But because the government doesn’t know what you need as well as you do, you won’t get as much value from the $20,000 as you would have had you spent it yourself.

Some estimates put the deadweight loss of taxation as high as 20 per cent. That means that for each dollar of our money the government spends for us, we only get 80c worth of value.

Over Australia's entire economy the annual lost value the deadweight loss might be $70billion.

But what about Christmas? How much value might be lost to us each Christmas because we swap inappropriate presents instead of swapping cash?

It's the sort of question only an economist would ask. Economist Joel Waldfogel, from Yale University, asked it first 13 years ago in a seminal paper entitled The Deadweight Loss of Christmas.

He asked university students to estimate both the amounts paid for the gifts they had received and the amounts that those gifts were actually worth to them. He found that at least 10 per cent of the value of the gifts was destroyed in the giving.

In a later, more sophisticated study, he put the figure at between 10 and 18 per cent of value lost as much as $9billion throughout the United States each Christmas. If you doubt Professor Waldfogel about the inefficiency of present giving, consider present recycling.

A survey conducted by American Express found that 28 per cent of us rebirth some of the presents we receive as gifts for other people. And then there are returns. The US Journal of Consumer Research has concluded that 16 per cent of all gifts bought by men are returned to shops by the recipients; 10 per cent of all gifts bought by women. (Women are better at choosing the right gifts than men).

So given the anguish gift buying causes people like me, and given that from a financial point of view the process is pretty much the same as tearing up $100 notes, why on earth do we still do it?

Two British economists Todd Kaplan and
Bradley Ruffle have set out to answer the question in a paper just published in the Journal of Economic Literature entitled: Here's something you never asked for, didn't know existed, and can't easily obtain: A search model of gift giving.

Their theory, summed up by the title, is that there are situations in which the gift giver will know more about the desires of the person receiving the gift than they do themselves. I am sure you know the feeling; it is often a wife or a husband. As well, the gift giver might have knowledge about the latest products or how to obtain things that the recipient doesn't have. I remember well the day my dad gave my aged grandfather a modern shaver for Christmas. Grandpa hadn't known that they
existed, and he didn't normally approve of Christmas, but he was thrilled.

I bought my wife an iPod (about my one success in the field of gift-giving) and she loved it because the whole idea was new she hadn't really been aware of it.

Present giving is extremely common when we come back from overseas. We've been able to obtain something exotic that the person receiving the gift couldn't get at home.

So important do Kaplan and Ruffle think this phenomenon is that they say it might just cancel out the deadweight loss identified by Waldfogel. They say that: "just maybe, on average, gift giving may make people better off than in its absence".

But other things are important as well. Many of us don't like spending on ourselves.

A few years back, Ran Kivetz and Itamar Simonson from Columbia and Stanford universities, offered 6000 Americans the chance to take part in a lottery. They were given a choice of what to accept as a prize in the unlikely event that they won either cash or a luxury prize of lesser value. One lottery offered the choice of either $55 in cash or a premium bottle of red wine (retail value $50). Another offered the choice of either $85 in cash or a one-hour facial (maximum retail value $80).

Financially there is no question as what's best the cash. You could spend the cash winnings on a bottle of wine or a facial and have money left over. And yet about a quarter of the Americans tested went for the luxury prize. Asked why, they said things like: "If I chose the cash, I would probably spend it on something I need rather than something I would really enjoy" and "This way I will have to pamper myself and not spend the money on something like groceries".

Perhaps that's why we continue to give presents notwithstanding what may be their economic inefficiency. We like to be pampered, and usually we're too stingy to do it ourselves. I know exactly the double CD I want for Christmas, and I have dropped a fairly unsubtle hint about it. Normally I'd be reluctant to spend the money, but at a time of indulgence, what the heck?

And the look of pleasure on my wife's face at the look of surprise and pleasure on mine will make it all worthwhile.