Emerging Scholars

The (Austrian) Economics of Gifts

The (Austrian) Economics of Gifts
Profile photo of Garrett Petersen

giftGift-giving is a strange custom to most economists. A common observation is that, as people are generally better informed about their own tastes than others are, the most efficient gift is simply cash. But if people all gave cash, the transfers would cancel out, making the entire practice bizarre and pointless.

Greg Mankiw offers an explanation. He thinks we can explain the practice in terms of signalling theory:

“Choosing a good gift for [a man’s girlfriend] is a signal of his love. Certainly, the act of picking out a gift, rather than giving cash, has the right characteristics to be a signal. It is costly (it takes time), and its cost depends on private information (how much he loves her). If he really loves her, choosing a good gift is easy because he is thinking about her all the time. If he doesn’t love her, finding the right gift is more difficult. Thus, giving a gift that suits the girlfriend is one way for him to convey the private information of his love for her.”

In this view, gift-giving is essentially wasteful. Implicitly, according to Mankiw’s theory, couples would gladly abandon gift-giving if they could only find cheaper ways to convey their love. Although I recognize the internal consistency of the signalling theory, it strikes me as inconsistent with common experience. People seem to really like giving and receiving gifts. I’d like to offer an alternative take on the practice. Unlike the many economists who see gift-giving as essentially inefficient, I see gift giving as a net benefit to the people who engage in it.

My take is based in Austrian entrepreneurship theory. While we typically think of entrepreneurs as businessmen, consumers also act as entrepreneurs. The necessity of forecasting under conditions of uncertainty and risk is what makes an act entrepreneurial, and there is plenty of uncertainty in consumer decision making. If I plan on buying a pair of rain boots, I must estimate how often I will be walking in the rain. My judgement as to whether I should buy at a given price depends on how expensive I think rain boots will be elsewhere and in the future. I wouldn’t pay $200 for rain boots if I expected the price to drop to $20 tomorrow. Thus, buying rain boots is clearly an entrepreneurial act.

This means that there is more to consumption decisions than simply knowing one’s own preferences. In principle, I can buy a gift for you that you would prefer to the cash I bought it with if my entrepreneurial judgement is better than yours with respect to the gift. Books are a great example. Someone who has read a given book is always better informed of its quality than someone who has not. This makes buying books for oneself difficult, as we usually buy books before reading them. Therefore, it is reasonable to prefer a $20 book that has been vetted by a close friend to $20 in cash. That’s why books make such great gifts.

You might wonder why the friend doesn’t simply give $20 and a tip about which books are good. The reason, I think, is that it is far easier to have knowledge than it is to convey knowledge. There’s a reason some people can make careers as reviewers. Recognizing whether a book, or a movie, or a restaurant, or a glass of wine is good or bad is straight forward. Telling someone else exactly what makes it good or bad, and convincing them whether they should or should not pay for it, is a specialized skill that not everybody possesses.

This theory has some implications that can help us understand the nature and extent of gift giving. A gift exchange is beneficial when the people exchanging gifts have special knowledge and insight about certain (different) consumption goods, and this insight outweighs the disadvantage of being imperfectly informed about each other’s preferences. This requirement is sufficiently strict that we would only expect it to be satisfied in a small fraction of cases. The fact that we only spend a small fraction of our incomes on gifts is consistent, at least potentially, with gift-giving being generally efficient and beneficial.

I think that people continue the practice of gift-giving because it genuinely makes themselves and their loved ones better off. However, if the practice were extended too far, it would run into the problem that many economists worry about: one’s lack of knowledge of others’ preferences makes buying for them difficult. If you’ve ever told a sister-in-law or uncle not to bother getting you a gift, you’ve contributed to the process of keeping the gift-giving tradition constrained within its efficient sphere. Efficient gift exchanges are possible between people who know each other well, such as close friends and family, and even then only to the extent that these people are differently informed about the goods available to be gifts.

In this case, as in others, an Austrian approach allows us to better understand phenomena we wouldn’t understand otherwise. In an intellectual framework without a prominent role for entrepreneurial judgement and error, something as ubiquitous as gift-giving can seem inefficient and irrational. But when we account for entrepreneurship, we can view gift giving as a means to economize on entrepreneurial judgement. You don’t have to be well-informed about the best jackets if a fashion-sensible friend can get you one as a gift. Your friend doesn’t have to be well-informed about music if you are a music enthusiast who can gift him an album you know he’ll like. Thus, gift exchanges can be mutually beneficial, despite anything naïve economists might tell you.

Emerging Scholars
Profile photo of Garrett Petersen

Garrett is an economics PhD student at Simon Fraser University. He holds an MA in economics from Queen

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