By Winton Bates, on March 16th, 2011
I had thought about writing something about gift giving before Christmas, but it might have looked as though I was complaining about how difficult it can be to buy gifts for people who seem to have just about everything they need already. (Perhaps I might even now be wandering into dangerous territory.)
In the past, economists have had some difficulty in understanding why people exchange gifts. The reason is that since the satisfaction that a person obtains from consumption spending is determined by her or his personal preferences it is difficult for anyone else to know what she or he would like. (I hope this is getting me out of trouble rather than digging a deeper hole.) Thus, some people end up with gifts they don’t want. (Fortunately, this rarely happens to me!) The remedy some economists have proposed is predictably crass: give money not goods. Neerav Bhatt has provided an entertaining discussion of this view here, including a clip from an episode of Seinfeld showing Elaine’s reaction to Jerry’s gift of cash for her birthday.
Greg Mankiw provides a good economic explanation of gift-giving in terms of signaling theory. If a person is able to provide a thoughtful gift – despite the difficulty of discovering what the receiver would really like – this sends a signal of the feelings that the giver has toward the receiver.
I suppose that is how gift giving helps to strengthen bonds. It can be wonderful when that happens. (In my experience it is most likely to happen when the potential receiver of the gift is willing to send some signals by dropping a hint or two about what she might like.)
The exchanges of gifts among members of social and business organizations at Christmas functions etc. is presumably also intended to promote bonding. One approach, which is probably fairly common, is for everyone attending such functions to buy and wrap an inexpensive gift, with all gifts being distributed randomly at the function. A member of a club that I belong to recently proposed a different approach: the names of all members would be put in a hat and each person would draw out a name and buy a gift anonymously for that person. This might have resulted in more people being given things that they might appreciate and might have helped to bond individual members of the club to all other members. It seems likely that if you know that the person who has given you a gift that you appreciate is a member of the club, but you don’t know who it is, you might have good feelings towards all other members. (As it happened, the club decided to continue with the practice established a couple of years earlier of donating gifts for children to a local charity rather than exchanging gifts between members. It would be interesting to know if the proposed method of gift exchange has been used elsewhere and what the effects have been.)
 While bonding helps explain exchanges of gifts between close friends and members of some organizations, does it is also explain exchanges of gifts between people who don’t know each other well? Exchanges of gifts between people in different organizations in the modern business world can be viewed as gestures of goodwill (albeit often tax deductible). Some anthropologists and archaeologists have encouraged the view that such exchanges of gifts to establish goodwill were much more common in tribal societies. According to this view, people in pre-industrial economies exchanged gifts to cement relationships, but people in modern economies trade with each other to make profits. Matt Ridley  suggests that is ‘patronising bunk’ (‘The Rational Optimist’, p. 133-4). As Ridley suggests, there is no reason to suppose that traders in all cultures have not always been acutely aware of the desirability of getting a good bargain for the valuable items that they are exchanging. There is some evidence that money can change the way that people perceive exchanges, but this seems to me to be based on misconceptions about money. An exchange of goods with strict reciprocity (barter) might appear more like an exchange of gifts than a commercial transaction, but people are fooling themselves if they think it is different in important respects (other than possible tax avoidance) from an identical exchange facilitated with the use of money.
By Claus Vistesen, on January 11th, 2011
If you ask the layman about what economics is the answer you get is likely to contain the notion of money. This is understandable. After all, if economists do not study money in some form or the other what are we doing then?
As such, you might be surprised to learn that in the grand sweep of the economic literature, economists have often found it very difficult to explicitly model the role of money and indeed to incorporate this role into the overall model framework. Put very generally, graduate econ students will see two types of models which incorporate money. The first is the money in utility model (MIU) where money is simply added, alongside consumption, to the utility of the representative individual and where some form of monetary instrument (e.g. bonds) are added to the wealth and thus inter the problem through the budget constraint. The other is the cash in advance model (CIA) where we essentially assume that consumers must hold cash solely for the purpose of buying the goods that they want. Or in more convuluted terms; to facilitate the exchange of goods and services.
If the story above is the one that trickles down into the the university classroom the real world is of course more complicated and any student who starts to dig deeper will find a diverse literature which, notably, have been greatly enriched on the back of the financial crisis.
A paper from the Chicago Fed by Ed Nosal, Christopher Waller, and Randall Wright takes a look at recent endeavors in this field.
The first question which you would probably like to ask is; why the neglect by economists of money and the explicit modelling of something so important? Well, in the word of the authors, blame it on the general equilibriumnistas;
The reason many economists either ignore institutions like money, or slip them in with short cuts, is this: they do not take seriously the nature of the process of exchange. Following classical general equilibrium theory, agents do not trade with each other, but trade only against their budget constraints. Any bundle that is worth no more than the value of ones endowment is available, with no discussion of how it is to be acquired. Everyone worth his salt understands that there is no role in Debreus frictionless paradigm for money, intermediation, or anything else that facilitates the process of exchange since this process is not part of model.
But this is not the whole explanation (fortunately). As the authors go on to explain, many economists sees the working of money as the plumbing behind the scene and thus that it should be assumed to simple do its work (i.e. facilitate the exchanges in a Arrow-Debreu GE world). However, as the authors point out; what happens when the plumbing goes wrong? Indeed, what happens when liquidity, credit and ultimately money transmission mechanisms breaks down?
Some have argued that modeling the details of exchange and intermediation is nothing more than studying the plumbingof the economy it all works well behind the scenes and so we do not need to pay attention to it. This seems wrong. How do we know it is working well if we do not pay attention to it? What happens if the plumbinggoes bad? We know what this entails, and it is not pretty. We believe that it is dangerous to ignore the details of plumbingand that the recent
nancial crisis makes this obvious. We therefore think that it is important to study institutions that help to facilitate exchange, and the papers in this special issue do just that.
And here then is the cue to go read the paper or at least to bookmark it. Note in particular how the authors group recent contributions in the context of money, credit and liquidity and thus what was originally simply a facilitator of exchange has now become a much broader concept.
Naturally, economists of an Austrian pedigree have known this for a while and one decidedly fruitful consequence of the financial crisis is the nascent incorporation of their thoughts into the mainstream economic methodology [1].
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A lot has been written about Japanese savings and especially about when they would run out so as to make the country dependent on foreigners for the financing for the ever growing mountain of public debt. I have written extensively about this basically arguing that while the flow of savings in Japan is indeed inadequate for the ongoing financing of the debt, Japan has two things in their favor. The first is a large stock of domestic savings of which not everything, yet, is parked in government bonds and secondly, central bank which will be forced into taking up any bid that would otherwise have gone to yield hungry bond vigilantes.
A recent working paper by Tokuo Iwaisakoy and Keiko Okadaz from the Japan Ministry of Finance Policy Research Institute (PRI) looks to be well worth reading; (my emphasis);
The decline in Japans household saving rate accelerated sharply after 1998, but then decelerated again from 2003. Such nonlinear movement in the sav- ing rate cannot be explained by the monotonic trend of population aging alone. According to the life cycle model of consumption and saving, popu- lation aging will increase short-run uctuations in the saving rate, because the consumption of older households is less sensitive to income shocks. Ana- lyzing income and spending data for di¤erent age groups, we argue that this is exactly what happened during the recession following the banking panic of 1997/98. Two important changes in income distribution are associated with this mechanism. First, the negative labor income shock, which in the initial stages of the lost decadewas mostly borne by the younger genera- tion, spread to older working households in the late 1990s and early 2000s. Second, there was a signi
cant income shift from labor to shareholders asso- ciated with the corporate restructuring being undertaken during this time. This resulted in a decline in the wage share, so that the increase in corporate saving o¤set the decline in household saving.
An important aspect of Japan’s economy is the ongoing increase in corporate savings which is just about the only chart on the Japanse economy (apart from the public debt to GDP one) going up. Indeed, it may just be one of the most important charts to understand Japan’s economy;
(click for larger image)
Retained earnings have grown at an average of 4% since 2000 and has thus offset, to a large extent, the decline in private household savings.
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[1] – Indeed Austrians seem have become more mainstream in the aftermath of the financial crisis as a whole. This is no doubt to their great lament since it means you actually have to provide policy advice and not just advocate eternal damnation and bloodletting.
By Winton Bates, on May 4th, 2009
Money is the medium of exchange as well as the unit of account and store of value. As the medium of exchange money makes life easy because we don’t have to spend a lot of time trying to find someone who is prepared to trade the goods we want to buy for the goods we want to sell. I have never been able to understand what Marshal McLuhan was talking about when he said “the medium is the message”, but the question I want to consider is whether we behave differently when we have money on our minds.
The idea that people may behave differently when they have money on their minds has a long history. Everyone has heard the biblical claim: “the love of money is the root of all evil”. What does this mean? This is not really an assertion that it is evil to collect coins, is it? It seems to me that the statement was not really about money at all but about the love of the worldly goods that money can buy.
The question of whether people behave differently when they have money on their minds also comes up in discussing when it is or is not appropriate to attempt to motivate other people using money. Tyler Cowen, for example, has used several parables to discuss this question, including the dirty dishes parable. Is paying one of your children a good way to ensure that the dishes are washed? Probably not. Children may feel less obligation to do their share of family chores if a voluntary exchange relationship is established in which the parent becomes an employer providing money in exchange for work, rather than a family leader “who is due some amount of obedience in his or her own right” (“Discover your Inner Economist”, p 14).
Is the payment of money intrinsic to this parable? I think that many economists would tend to say that the parable would apply in the same way if the child is paid in kind, e.g. in tickets to rock concerts, rather than in money. In the minds of many economists the issue would appear to be whether strict reciprocity is appropriate to the circumstances rather than about the method of payment that is used. Economists often say that money is a veil.
However, I am not sure that many parents would rule out all forms of bartering as being inappropriate as a means of motivating a child to do his or her share of family chores. It seems to me that bartering could be appropriate if it is about the things that parents do for their children that are beyond what might be generally considered to be the core responsibilities of a parent. For example, like many other parents, while my kids were in their teens I used a substantial part of my leisure time providing an unpaid taxi service to ferry them and their friends to and from various sporting and entertainment activities. Would it be inappropriate for a parent to suggest to a child that it would be unfair to expect provision of such services unless he or she does an appropriate share of family chores without having to be constantly reminded?
This raises the question of whether responses to provision of incentives have more to do with perceptions of the appropriateness of particular incentives than with concepts such as the strictness of reciprocity or the money value of the incentives provided. There is some evidence that actions that merely remind people of money can have a significant effect on behavior. For example, Kathleen Vohs, Nicole Meade and Miranda Goode report an experiment in which participants were primed by sitting at a desk facing posters showing various denominations of currency or posters showing either a seascape or a flower garden. The participants were then presented with a nine-item questionnaire in which each question asked them to choose between two leisure activities – an experience that only one person could enjoy and an experience that two or more people could enjoy together. Participants primed with the money poster tended to chose more individually focused experiences. The authors report similar results for eight other experiments (‘The psychological consequences of money’, Science, 318 (5802), 2006).
So what if responses to incentives are strongly influenced by perceptions of the form in which the incentive is provided and the language used when the offer is made? The most obvious implication is that a lot of care is required in selecting incentives that are perceived to be appropriate and in presenting them in an appropriate way to achieve the desired effect. There are quite different implications in relation to prevention of corruption. The ethics of accepting a bribe do not change merely because the incentive offered is more subtle than a bundle of notes in a brown paper bag.
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