– December 20, 2019

If there is one thing that can make the dismal science even less appealing, it would be an economist telling the nation that holiday gift-giving generates unacceptable deadweight loss.  Bah, humbug.

But this is precisely what Joel Waldfogel did in a famous article for the American Economic Review that spawned numerous op-eds and the popular book Scroogenomics: Why You Shouldn’t Buy Gifts for the Holidays. Prof. Waldfogel had a good point, which we will explain below. However, economics need not lead us to Grinch-like conclusions. Gift giving is not as awful as some scholars think. Indeed, exchanging presents may even have virtuous effects on the economy, but many of them show up outside of quarterly measures of Gross Domestic Product.  Exchanging gifts often creates trust and forms community. We explain how.

Santa’s Bag of Deadweight Loss

Before ringing in the good news, we should first explain the bad. Prof. Waldfogel argued that giving gifts generates a great deal of social inefficiency (expressed in deadweight loss) because we often give gifts that other people don’t want. Moreover, we waste an inordinate amount of time in the malls shopping for these unwanted items – time that could be spent on more productive uses.  

This isn’t difficult to understand for most people because everyone has a story about “that one gift” they received from a friend or relative that now sits in the closet taking up space. Admit it.  You probably have that quintessential “ugly cat sweater” that your Aunt Lucy gave to you even though you dislike cats and are allergic to wool. This gift is a deadweight loss because the material resources and labor that went into producing it provide you with no value, and those resources could have been employed elsewhere.  

Asymmetric information and mismatched preferences are the culprit here. You know best what you like, but your aunt can only guess and she often guesses wrong. A sweater that could have made someone else happy now sits at the bottom of your dresser taking up valuable space needed for more desired clothing. Moreover, to make Aunt Lucy feel good, you wear the sweater once a year at the family gathering and endure the incessant giggles from your nephews and nieces who realize how awful you look. Annual holiday humiliation is a cost no one should have to bear.

It is not just your aunt that causes this waste, but millions of other people are giving gifts that nobody wants during Christmas, birthdays, and other celebratory times. Prof. Waldfogel, in Scroogenomics, estimated this loss to be roughly $12 billion in 2007. And this only covers the material cost that is easy to count; the disutility of your having to keep the sweater around to please Aunt Lucy and enduring the wisecracks from Uncle Linus are impossible to measure.  (We won’t even mention all the boxing material, wrapping paper, ribbons, and tape that disguised those hideous gifts because the additional deadweight loss calculation would put environmentalists into a frenzy.)

And then there is the opportunity cost of all the shopping your aunt had to do to find that perfectly ugly garment, not to mention your own time wasted picking up gifts for your relatives that they may not have much use for either. The time spent wandering the malls could have been used cleaning your house or binging Netflix.

Couldn’t Aunt Lucy (and all of our aunts) just have given you cash instead? Cash allows you to prioritize the things that are most urgent. Cash would save a lot of time and would allow you to buy things that you really want, such as paying that electricity bill that is overdue. Prof. Waldfogel thought so and recommended as much. You see, cash is fungible, which means it can be transformed into whatever the recipient of the cash gift wants. Cash eliminates the problem of asymmetric information and allows preferences to be satisfied more fully.

The Puzzle of Cultural Prevalence and Persistence

It is easy to see the inefficiency of gift giving when calculated merely as the stock of unwanted gifts. But this only raises a more interesting puzzle: If gift giving is so inefficient, why has this cultural tradition persisted for so long? And why do so many different cultures rely upon gift giving institutions? In his classic work The Gift, noted anthropologist Marcel Mauss pointed out that gift giving is a type of exchange that is a near-universal cultural practice amongst all societies irrespective of time or place. Market institutions are just one particular form of exchange that takes place under specific legal and political rules.

Economist Armen Alchian has argued that markets rely upon an evolutionary process where different types of products, production strategies, and methods of marketing are constantly suggested by entrepreneurs. Those that produce more value, on average, will edge out those that don’t produce as much value. Digital photography displaced most film. Henry Ford’s assembly line made small-scale production less prevalent. And Amazon is changing the way we shop.

If inefficient economic institutions can be weeded out by business entrepreneurs, wouldn’t we expect the same of cultural institutions? Better social norms and values that produce greater benefits for society should replace ones that hold back human flourishing. We see such cultural evolution over time, from how we’ve changed our views of women in the workforce to the increasing disapproval of smoking. Longstanding cultural institutions do change if they are not suited to the needs and desires of a society.

So why not gift giving? With billions of dollars and countless hours wasted every year, why do we keep giving each other unwanted cat sweaters?

One possible solution offered to this puzzle is that holiday gift giving is a cultural norm of capitalism to ensure people engage in excessive consumerism so as to keep the economy afloat. News stories following Black Friday and into December always note that the retail sales of the Christmas season are what help many enterprises stay in business. Unfortunately, a Keynesian explanation such as this cannot account for the deep history of gifting that extends well before the advent of modern capitalism.  The reason for gifting must lie elsewhere.

The Dynamic Benefits of Burnt Offerings

The answer to this puzzle becomes clear if one considers gift giving not to be a one-time exchange of worthless items, but an ongoing practice of reciprocity that builds and enhances social networks and promotes trust amongst individuals. Social networks and trust are essential for peaceful societies, and enormously important for market economies to function well.

To understand this, think back to the Hobbesian state of nature where life was solitary, nasty, brutish, and short. In order to make life less nasty, brutish, and short, we as humans need to cooperate. Adam Smith, in The Wealth of Nations, understood that by extending the market (i.e., building cooperative networks of human relations) we could leverage the division of labor and grow richer for it.  

But as markets expand, and networks grow, we enter into a world of (quasi-) anonymous trade where it is difficult to know the intentions of other individuals. How will I know if this new person I am about to interact with is honest or plans to exploit me?  

Here is where gifting presents itself as an ingenious solution to instill broad-based societal trust and build ever-larger cooperative networks. If I am unaware of your intentions, one of the best ways to assure me that you can be trusted is to sacrifice valuable resources when seemingly unnecessary. In some ways, it is similar to posting a bond to enhance credibility.

This is the economic logic of “burnt offerings.” To prove loyalty to a person, group, or set of strangers, sacrificing valuable resources demonstrates a commitment to a long-term engagement, or at least diminishes the perception that you are free-riding on the other person’s good intentions. The ultimate test of loyalty can be found in the Old Testament when God asks Abraham to sacrifice his son (Genesis 22:1-12). To prove fidelity, Abraham had to offer a very valuable gift – the life of Isaac. Throughout the Bible there are additional references to similar, albeit less extreme, sacrificial offerings. Economists today would shriek in horror at the deadweight loss resulting from the loss of sons or first-born calves (see Micah 6:6)!

Marcel Maus noted that such rituals were common between Pacific Island tribes as a means of alleviating fears over destructive warfare. Providing seemingly wasteful gifts in elaborate ceremonies sent signals that the one tribe was willing to pay a high price to interact with another. Reciprocity in such rituals was important to indicate trust on both sides.

And even today, the notion of “burnt offerings” remains strong. A newcomer often is welcomed into a household with a large feast containing more food than can be reasonably consumed. Engagement and wedding rings are expensive signals of a prospective spouse’s fidelity in good times and bad. Clubs, fraternities, and religious organizations often require individuals to go through rigorous rituals to prove their loyalty before gaining the benefits that full membership entails.  

So it is with gift giving for holidays and other occasions. Giving gifts, even ones filled with the deadweight loss of mismatched preferences, indicates that one is willing to forego resources in the present in order to maintain a relationship in the future. When times get tough for you, I will assure you that I will be there to sacrifice again. Knowing that I am willing to sacrifice for you makes you more willing to want to continue engaging with me. Your reciprocal sacrifice helps solidify the mutual trust to make a relationship work effectively.

Societies around the world have ritualized these times of “burnt offerings” as a way of communicating trust and a desire to enter into, or remain in, a social network. We learn to gift within our families in the hope that such generosity will translate itself in the broader society.

Gifting: The Gift that Keeps on Giving

Prof. Waldfogel and other economists who rue the inefficiency of holiday gift giving only see the costs and benefits in static terms. The real benefits are dynamic and embedded in the deadweight losses, ironically. By continually showing, through gifts small and large, our willingness to sacrifice for one another we build a cultural fabric of trust and willingness to assist in times of need. Norms of sacrifice, trust, and graciousness are crucial for the functioning of broad-based markets over long periods of time. Our willingness to give and to reciprocate graciously when receiving is what makes us wealthier over time.  

So be of good cheer.  Give of yourself generously. Remember that when Scrooge fully understood the joy of the season he became a full-fledged member of a truly wealthy society built upon compassion, trust, and strong fellowship.

Michael Thomas

Michael Thomas

Michael Thomas is an Associate Professor of Economics at the Heider School of Business and Student Programs Director at the Institute for Economic Inquiry at Creighton University

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Anthony Gill

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Anthony Gill is a professor of political economy at the University of Washington, Seattle.

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