Jared Bernstein, a former chief economist to Vice President Biden, is a senior fellow at the Center on Budget and Policy Priorities and author of the new book 'The Reconnection Agenda: Reuniting Growth and Prosperity.'

(Source: Photodisc)

On MSNBC the other day, the always interesting Josh Barro challenged a panel of which I was a member to consider the very logical proposition that exchanging Christmas gifts is a highly inefficient endeavor, fraught with “deadweight losses.”

Such losses make economists shudder as they generate wasteful inefficiencies in the sense that both giver and receiver could be made better off if they didn’t engage in the incriminating activity, in this case, exchanging gifts.

Josh was riffing off this 1993 holiday classic, right up there with Jingle Bells: a paper entitled “The Deadweight Loss of Christmas” by Joel Waldfogel, who writes:

“In the standard microeconomic framework of consumer choice, the best a gift-giver can do with, say, $10 is to duplicate the choice that the recipient would have made. While it is possible for a giver to choose a gift which the recipient ultimately values above its price—for example, if the recipient is not perfectly informed—it is more likely that the gift will leave the recipient worse off the if she had made her own consumption choice with a an equal amount of cash.”

The implication is that I’d be better off if you just gave me the 25 bucks you spent on that sweater I’ll never wear.

Let’s think about why this is right and wrong. As I said in the segment, it does bring to mind the old adage that an economist is someone who knows the price of everything and the value of nothing. Still, just because it’s the holiday season, and we’re all maybe feeling a bit more of the human largesse than usual, isn’t there something we can learn from this theory?

In fact, there is, starting with how it fails to capture parts of reality that economics often gets wrong.

“Nana’s” paperweight: My wife’s stepmother (that would be “Nana”), someone we rarely see, once gave me this paperweight-like object that you can use to hold down the pages of a book. I didn’t think much of it, meaning it was a candidate for precisely the inefficiencies we’re worrying about here. And yet, it lives on my nightstand, and I use it every night, which makes it the most used holiday gift I’ve ever received.

In other words, I didn’t know I needed it. The fact is that no recipient is “perfectly informed” about their needs and wants, so even a throwaway gift can be life-altering — or at least it can keep the pages in place while you’re flossing (TMI??…my bad).

The larger point is that too much economic thinking and modeling is based on the notion of “rational economic actors with full information” vs. the reality of who we really are: often irrational people driven by all kinds of misperceptions.

Sentiment: One source of our irrationality is sentiment, though evolutionary biology has convincing theories about genetic motivations for sentimentality (having to do with promoting your gene pool). In this regard, it’s notable that to get data for his analysis, Waldfogel asked the following of gift recipients: “Apart from any sentimental value of the items…how much would you be willing to pay for them?”

Such analysis points to cash as the most efficient gift, but my wife feels strongly, and she has a point, that giving cash to people is akin to saying you don’t care enough about them to invest the thought and effort it would take to get them a gift.

Okay, but what about gift cards? Surely a Starbucks gift card is a neat hybrid between cash and something more thoughtful. Nope, according to the wife. Her first objection is that it’s just a notch above cash in terms of lameness, but her second is empirical. People tend to hoard and forget about gift cards, while inflation erodes their value. Retailers thus love them because a gift card that lives in your sock drawer for the rest of its life is pure profit for them.

Emotional proximity between giver and receiver matters: An interesting, intuitive angle revealed by Waldfogel is that the closer the giver is in age and/or emotional closeness to the recipient, the less the deadweight loss. Family members are thus perhaps more likely to give you “efficient” gifts than office mates, which provides a good rational for those “white elephant” gift exchanges, where everyone is encouraged to trade gifts with the goal of “Pareto optimality,” meaning trades that make both parties better off.

However, I can hear you groaning that exceptions abound. I could swear my wife said she likes big earrings, but it turns out she likes small ones (though I’m convinced she flips that around on an annual basis). On the other hand, my kids are extremely skilled at revealing their preferences well in advance of the holiday.

Do individuals always make the best choices for themselves? Fundamental to both Waldfogel’s analysis and to all of economics is the assumption that individuals make the optimal choices for themselves. Unlike the rational actor stuff, this strikes most people, myself included, as de-facto true: we choose what we want and avoid what we don’t want. This insight also motivates much anti-government rhetoric by those who view government health, welfare, and nutrition programs as fraught with deadweight loss. Better to give someone $50 than to give them $50 worth of food stamps.

And yet…we obviously don’t always act in our best interest. Where I see this most clearly is in what I’ve termed the “high discount rate problem” wherein we heavily discount the potential downside of future events in the interest of enjoying ourselves today. This problem is not a trivial one: its impact is most damagingly seen in our reluctance to treat global warming as the existential threat that science tells us it is.

For you kids out there, this insight may be why many a grandma will send you a check for your college fund this Christmas. I empathize with your sneer at that, but given your excessively high discount rate, she’s probably onto something.

Anyway, before you castigate us economists too much, note that according to Barro, “Mr. Waldfogel…actually does buy presents at the holidays, at least for some people.”

With that in mind, I’ll give the last word here to my 12-year-old daughter, who, when I explained this theory to her the other day, responded:

“It’s the thought that counts, and you’re not counting the thoughts.”

May your holidays be happy and…yes, I’ll say it…wonderfully inefficient!