Why gift-giving is flawed, from an economic perspective

John Perry is an assistant professor of economics at Centre College in Danville.
John Perry is an assistant professor of economics at Centre College in Danville.

Winter is here, and the holiday season is in full-court-press mode (as are the Wildcats). My home is decorated, I have broken out my Harry Connick Jr. Christmas albums, and my beautiful kids have rewritten their letters to Santa more times than I can count.

There is much on our minds during this time of year, and much of it involves money. I have taken a bit of a vacation from answering readers' questions — one of my New Year's resolutions is to get back to that — but I thought this month would be ideal to offer some thoughts on money and gifts.

A couple of years ago, University of Minnesota economics professor Joel Waldfogel published a fascinating paper that aimed to measure the "efficiency" of gift-giving, a topic only an economist would consider. The popular conception of holiday spending is that it supports the economy, and that is true. Many retailers' years hinge on sales during this season.

However, Waldfogel's work pointed out that gift-giving tends to generate less "happiness" than could have otherwise been had with the same amount of money. That might sound a bit odd, but we have all had such an experience. When Aunt Betty gives you fluffy house shoes, you open the present and think to yourself, "Really?" Your mind wanders to things that you would have preferred to receive that cost the same. You are happy to have gotten the gift, but you would have been happier if you had gotten something different. That is lost happiness.

Economists, in spite of being labeled dismal scientists, are very concerned with happiness. In fact, a fundamental tenet in standard economics is that people tend to do what they do because it gives them happiness. From that flows the idea that the best person to make a decision for you is you. Why? Because you know you best. The only reason you buy something for $25 is that you expect to get at least $25 of happiness from it.

Waldfogel estimated that on average, about 10 percent to 20 percent of "happiness" is lost when we buy gifts for other people. In short, if you spent $100 on the gift, the recipient feels as if he or she got somewhere between $80 and $90. The catch, though, is that $100 was spent. This loss of potential happiness is inefficient — and economists despise inefficiency.

Of course, the amount of lost happiness is related to how well you know the recipient and what he or she might want. You probably do well buying for your wife but lose big when buying for your wife's second cousin.

This all sounds a bit dismal, I know. But the story is not that gifts are bad. Not at all. It is just that much of today's gift-giving is inefficient, which should push us to take more care in picking what we give. This is perhaps why gift cards have become much more popular as gifts. Gift cards allow the recipients to choose what they want, which is efficient, while avoiding the perceived rudeness of cash. I am not advocating giving only gift cards — just efficient gift-giving, however you might do it.

A topic that goes hand in hand with efficient gift-giving and maximizing happiness comes from research that economists and psychologists have conducted on happiness. One of the most insightful results from the expanding field of research is that experiences tend to generate more lasting happiness than do material items.

For example, spending the same amount of money on a trip with people you care about yields more lasting happiness than buying a new couch. Why? In general, possessions lose their ability to give us happiness over time. The couch's newness wears off, and it becomes the thing we sit on in the front room. Experiences, on the other hand, are replayed in our minds over and over, allowing us to revisit them anew. When I reflect, even the possessions I most wanted pale in value to my most recent trip with my family.

So what is the takeaway advice? Maximize happiness. Give gifts as efficiently as possible, and always focus on what is lasting. Whether you spend $10 or $100, do so with a focus on what will bring the recipient and you the greatest happiness now and in the future.

And with that, have a safe, efficient, and happiness-filled holiday season.