By Kevin Hassett
Sunday, December 10, 2006
When Caspar, Balthazar and Melchior arrived at the manger on the first Christmas, they set a precedent that would withstand the test of time for every Christmas to come. Most of the gifts they brought were, at first glance, terrible.
Caspar, what were you thinking? Myrrh? The resin from a tiny shrub was used for embalming. It would be like presenting your bundle of joy with Dr. Science's Junior Mortuary Kit.
Balthazar hardly did better. His gift of frankincense was the first of many billions of thoughtless perfume presents. If you want to show someone you love them and have less than a minute to shop, buy them perfume or cologne.
But fortunately for Caspar and Balthazar, Melchior came through. The third king presented the Holy Family with the gift that classical economics has long suggested is best: gold. In other words, he gave them the money.
The merits of this seemingly wise decision, as opposed to those of giving specific gifts, have been hotly contested in economic research circles of late. If you're scratching your way through a holiday gift list, you may want to enter the latest evidence into your shopping calculations.
Some social scientists make the case that too few of us take Melchior's logical step. One survey found that only about 9 percent of Christmas gifts are cash. Gift cards, which are like cash, have been surging in popularity but will probably account for only 5 percent of holiday sales this season. This drives economists crazy for a simple reason. Perhaps the most important tenet of their science is that people know their own preferences best. If you give someone money, she can go out and buy exactly what she wants. If you give her a gift, you may luck out and pick just what she would have purchased herself. Odds are, though, that you'll give her something she values less.
So holiday gift giving is highly inefficient. Wharton School economist Joel Waldfogel came up with some staggering numbers in his 1993 study, "The Deadweight Loss of Christmas," published in the American Economic Review.
Surveying college students, he found that people tended to prefer their own choices to gifts they received -- 10 percent to 33 percent more, in fact. So up to 33 percent of holiday sales can be thought of as wasted. Based on a National Retail Foundation (NRF) holiday sales forecast of $457 billion for this year, this amounts to an annual loss to Americans of a whopping $152 billion because of the scourge of holiday gifts. And people seem to give particularly disappointing presents during the holidays. According to the NRF, 8.8 percent of gifts will be returned after the holidays, up from the average of 7.3 percent during the rest of the year.
If Waldfogel's numbers were the end of the story, the scale of the loss caused by Christmas would be so enormous that a law banning Christmas gifts could deliver about as much economic benefit as significant tax reform. After all, $152 billion is about 1.4 percent of the total U.S. economy. While the proposal may seem extreme, my informal poll of Washington policy analysts suggests that such legislation is more likely than Social Security reform.
Fortunately for those who love Christmas presents, some of the most interesting work at the frontier of economic research suggests that holiday gift giving may be far more beneficial than economists had previously believed.
The key insight of this new line of research is that people do not always behave like the super-rational automatons that traditional economic analysis makes them out to be. If you want to understand why holiday gift giving persists, psychology may be more important than economics.
Strikingly, sentimentality has been found to apply even to gifts given randomly in an experimental setting. In one famous study, "Experimental Tests of the Endowment Effect and the Coase Theorem" by Nobel Prize-winning psychologist Daniel Kahneman and two coauthors, published in 1990 in the Journal of Political Economy, students at Simon Fraser University in Canada were given coffee mugs from the college bookstore and then asked whether they would sell the mugs at prices ranging from 25 cents to $9.25. A second group was asked whether they would buy a mug at the same prices. Those who received the gifts were possessive of their new treasures, and were coaxed into giving them up only at prices above $7.12. But those who did not receive the mugs as gifts found them unattractive, and were willing to buy them only if they cost less than $3.12.
That $4 difference is attributable to the psychological value of a gift. The recipient experienced a thrill when he or she received the mug, which became the apple of their eye. Those who were offered a chance to buy a mug experienced no such thrill.
This shows that gift giving has the potential to generate tremendous positive value. If you select a gift that can arouse a sentimental response, then the recipient will value the gift far beyond its cost.
In 1998, economists John List of the University of Chicago and Jason Shogren of the University of Wyoming wrote "The Deadweight Loss of Christmas: Comment" in the American Economic Review, a continuation of Waldfogel's research. Their experiment was designed to identify the value that students at the University of Central Florida placed on gifts they received. The economists found, as did Waldfogel, that when students were asked to hypothetically value their gifts, the gifts appeared to be losers. But List and Shogren went beyond the speculation and allowed the students to auction off the items to other students. They found that students were much more attached to their gifts when confronted with the possibility of having to sell them. Students exposed their gifts to auction only if the minimum price they would receive was about 27 percent higher than the true cost of the gift. If that psychological value is applied to all gifts in the United States, then the net gain each year from holiday gift giving is about $123 billion.
That gain, of course, is not available if your gift is money. A dollar will always have a psychological value of a dollar. But a specific gift can deliver so much more.
This research leads to two observations. First, you shouldn't fret too much about the likely success of your gifts. College students are a noticeably unsentimental lot. If they become emotionally attached to mugs from the college bookstore, given to them in an experimental setting, imagine how much value a wife may attach to a gift from a beloved spouse, regardless of its exact nature. You may even get away with perfume.
Second, the latest psychological research is good news for Caspar and Balthazar. The frankincense and myrrh probably generated a textbook sentimental response in Mary and Joseph, as these substances were traditionally associated with kings. The arrival of the wise men may have been the first human sign to the parents that the outside world would recognize that their son was special.
Like the mug-loving college students, Mary and Joseph must have been enormously attached to their presents. According to legend, the poor carpenter and his wife never sold the valuable gifts, despite the family's financial needs. To this day, a case that purportedly contains the gifts of the magi is on display at a monastery in Greece. If the gifts truly were preserved for all time, it is probably because the human response to Christmas gifts has changed little since that first night.
Kevin Hassett is director of economic policy studies at the American Enterprise Institute.