Christmas is an awesome time of year. True, it’s not my favourite time (that particular award goes to Easter Sunday and the week that precedes it), but it is filled with carols and mince pies and baked ham.

And Christmas morning is all about gifts.

Something that you should know about economists: gifts drive them mad. And it’s not Christmas gifts specifically: but those are the usual culprits.

Why?

Because, for most economists, gifting is wildly inefficient.

The Deadweight Loss of Christmas

I’ve linked the section title to the now-seminal* paper by Joel Waldfogel, the Yale econogrinch that ruined Christmas.
*yes – that’s an academic term, apparently.

Here is his theory [paraphrased]:

1. Let’s say that I have $15 to spend.
2. Because I am the master of my fate and the captain of my soul, I am best placed to know how I would maximise the use of that $15.
3. And since I’m a person of taste, that means spending it on the deluxe edition of the Imagine Dragons “Night Visions” album.
4. In the gift-giving scenario, however, there is a disconnect: because I am sitting without $15, and the gift-giver is sitting with $15.
5. Therefore, in order for a gift to be optimal, the gift-giver would have to use the $15 in the exact same way that I would have. Otherwise, I’d be better off with the cash.
6. If, however, the gift-giver just knew that I liked music in general, and instead bought me the Kelly Clarkson Christmas album, then something has been lost.
7. To put it in numerical terms: the gift-giver is short of $15; while I am not up by $15.
8. The next question is: how cheap would the Kelly Clarkson Christmas album have to be before I would buy it myself?
9. Maybe if it were on special for $3. Because now we’re talking about the choice between a beer and a Christmas album – and it’s always fun to have diva-style carolling playing in the background over December.
10. So to summarise: the gift-giver has spent $15 to give me a gift that’s worth $3.
11. $12 just vanished in a cloud of wrapping paper, and that 12 bucks is “deadweight loss” to society.
12. It’s not very sentimental, but I’d have been $12 better off if the gift-giver had just slid some cash into an envelope.

So Mr Waldfogel went and investigated by conducting a number of surveys. The essential finding: he demonstrated that the act of gift-giving destroys 10% to 30% of the value of the gift – and that’s consistent across the price range of gifts (ie. even the very expensive gifts lose it). Just think how crazy that is across the world: 10% of everyone’s Christmas gift-spending just evaporates on Christmas morning.

More interestingly, Mr Waldfogel also investigated the impact of the relationship between the gift-giver and the recipient on the value of the deadweight loss. And he pretty much proved the standard experience:

1. The best gift-givers are friends.
2. Followed closely by significant others and parents.
3. While gifts from grandparents and aunts/uncles are the most likely to be exchanged.

He also demonstrated that the amount of deadweight loss is correlated with the likelihood that the gift is going to be cash and/or gift vouchers:

1. Grandparents are the most likely to give you cash.
2. Followed by the rest of the extended family.
3. Parents, friends and significant others do it much more rarely.

So, obviously, the key here is to conclude that you should just do it in cash.

The Key Clause In That Experiment

In those surveys in that seminal* paper, the questions contained the following phrases:

“Apart from any sentimental value of the items”

and

“not counting the sentimental value of the gift”

Which makes the whole experiment a bit blurry, if you think about it. The conclusion being implied in the paper is that it’s generally better to receive a cash gift than a non-cash gift, because that maximises the value for the recipient.

But the minute you re-consider the value of sentiment, all that we can really say is: it’s better to get a gift that you want from someone you like, than it is to receive a gift that you don’t really want from someone you like. And it’s better to get cash from someone you don’t really know.

Which is a little obvious, don’t you think?

The Power of Sentiment

In my experience, there is such a thing as a gift hierarchy. It goes something like this:

1. A gift that you didn’t realise that you really wanted/needed until you got it (so you couldn’t ask for it even if you tried).
2. A gift that you really want that you didn’t have to ask for.
3. A gift that you like that you didn’t have to ask for.
4. A gift that you wanted that you had to ask for.
5. Socks.

In many ways, the demand/utility side of gifts is secondary to the test of the gift-giver’s ingenuity and attention to the detail of the recipient as a person.

To phrase it economically: gifts demonstrate a social utility that is not captured by the purist assessment of value vs price. And that social utility is closely linked to social importance of the pre-existing relationship (ie. there’s no sentiment attached to gifts from distant acquaintances).

But even if you ignore that

There are better solutions to inappropriate gift-giving than cash and gift vouchers. They’re called “wish lists” and “posting stuff on Pinterest“*.
*Epiphany: I just realised the point of Pinterest.

The Real Conclusion

1. Important people get gifts.
2. Other people get cash.
3. Pinterest has a point.

And speaking for myself, fortunately, I have my friend, Jacqueline:

Who rocked the birthday present this year. So to anyone reading this who thought that Imagine Dragons was a hint; please know that Imagine Dragons is covered and played regularly on my drive to work.

And for more on gifts, this WSJ article by Dan Ariely.