From an economist’s point of view, Christmas is inefficient. if you’d been given £30 to spend on yourself, you’d have got something better than the hideous jumper that Aunt Doris bought you last year. Joel Waldfogel at the University of Minnesota has estimated that people’s own choices generate around 18 per cent more satisfaction per pound spent than do gifts, which means that Christmas shopping wastes billions of pounds. This corroborates Milton Friedman’s claim that we are less careful when we spend money on others than when we do so on ourselves.
It’s tempting to see Waldfogel’s finding as one of those whimsical pieces of “freakonomics” which so annoyed the late John DiNardo. I don’t think it is, as it carries wider messages.
One is that we often cannot act wholly in others’ interests even when we want to, because we don’t know what they want. “Every mind is inscrutable to every other mind,” wrote William Jevons, one of the founders of neoclassical economics.
But of course, thousands of people are expected to act in others’ interests: politicians on behalf of voters; financial advisers on behalf of clients; chief executives for shareholders; and so on. Waldfogel’s research tells us that goodwill and integrity alone are not sufficient to ensure that agents act in principals’ interests. Your aunt Doris has goodwill and integrity – and you’ve got that god-awful jumper. We need more than professional ethics to solve the agency problem. Agents must know what exactly their principals want. The best financial advisers should know their clients well; ticking boxes is not sufficient.
One realm where this condition is absent is politics: the vote does not tell politicians what the people really want.
Even if agents knew what their principals want, though, they mightn’t know how to supply it. Bosses might want to maximize shareholder value rather than their own pay packets, but they don’t necessarily know how to do so. In complex and changing economies, they are as befuddled as grandparents shopping for video games.
Waldfogel’s research, then, reminds us of a central fact about economics: that knowledge is tightly limited.
It has another message – that economic activity is not merely an exchange between self-interested individuals but rather is laden with moral meanings.
The Nobel laureate George Akerlof described labour contracts as partial gift exchange: bosses pay workers more than strictly necessary and in exchange workers do more than the contractual minimum. Firms that don’t conform to this pattern are not only joyless places to work, but also do badly for shareholders: think of Sports Direct or Capita.
In fact, of course, our wages are tied up with our sense of self worth; a big reason why CEOs are paid so much is that none of them wants to be considered worth less than others, with the result that we get an arms race in their pay.
In many countries, though, this race is constrained by perceptions of fairness. So too are many other transactions. Daniel Kahneman, another Nobel laureate, has shown that companies sometimes don’t cut wages or raises prices as much as they could because they don’t want to lose goodwill by being seen as exploitative.
All this tells us that we cannot interpret economic transactions without considering their moral meaning. Doing so can be dangerous. Martin Shkreli, then CEO of Turing Pharmaceuticals, jacked up the price of Daraprim in 2015 without considering the moral dimension of doing so, and he now occupies a big house.
Christmas, of course, exemplifies the fact that moral considerations matter in economics. Exchanging banknotes with our loved ones might be more narrowly efficient than exchanging gifts, but it misses a crucial fact – that gifts have a meaning which cash does not. As that great economist Charles Darwin wrote, “what an utter desert is life without love”.
