Is your brother/sister birthday, or a friend of yours birthday, fast approaching? If you’re looking for the perfect gift for that special someone, who better to ask than an economist?
In 1993, Yale economist Joel Waldfogel published a famous paper on the optimal gift-giving strategy. His assessment won’t come as a surprise to anyone familiar with the buzz-killing tendencies of the dismal science: gift-giving holidays are inefficient. Indeed, Waldfogel found that holiday gift giving “destroys between one-third and one-tenth of the value of gifts.”
Why is gift giving inefficient? As Waldfogel notes, a standard principle of economics is that individuals know their own preferences better than anyone else. One might love his or her partner immensely. One might sincerely want to give a gift worth giving. But absent perfect knowledge of your loved one’s utility function, Waldfogel argues, gift swapping is likely to make us worse off on net.
So what’s the best gift you can give for a birthday? According to Waldfogel, if you want to maximize your loved one’s consumer utility, the best gift is always cash.
Of course, such advice should come with a giant warning label. There’s obviously a lot more that goes into the gift recipient’s utility function than “maximizing consumer utility.” When it comes to gifts, effort and thoughtfulness tend to matter much more than practicality. Giving your brother/sister or significant other cash as a birthday present is unlikely to end well. For all his economic acumen, homo economicus is destined to be single.
Waldfogel’s advice contains an important truth: consumers are well suited to make the best decision for themselves, and the more choices they have, the better off they will tend to be. This lesson is especially insightful when it is applied to money, since our choice in currency is less likely to be subject to the sort of exceptions that apply to intimate gifts.
That choice in currency is a good idea for those otherwise stuck using a bad money is painfully obvious. Citizens of a nation undergoing hyperinflation, like Venezuela or Zimbabwe, find it difficult to save and plan for the future in their domestic monies. Access to alternatives allows them to escape this hyperinflationary nightmare.
The best examples of how competition and choice can be an impetus for improved monetary policy come from the developing world. Following the collapse of the Bretton Woods system, average inflation in the developing world rose from roughly 3 to 4 percent between 1950 and 1970 to more than 25 percent from 1971 to 1990. These high and variable rates of inflation had a chilling effect on savings and net foreign investment in the developing world, as investors were hesitant to invest in nations with unstable monetary and political regimes.
Thankfully, average inflation rates across the developing world have fallen back to single digits over the past few decades. This enormous progress didn’t result because central bankers in developing nations suddenly became more enlightened about how to wield their discretion more wisely. Rather, competition and consumer choice compelled central banks to adopt better policies.
Increased capital mobility across nations and financial innovations made it easier for savers in inflationary nations to move their funds into more stable monies. This forced many central banks to adopt stricter monetary rules. Some nations, like Hong Kong and Estonia, established currency boards to stabilize their domestic currencies by backing them with a more stable foreign currency. Others, like Panama and Ecuador, decided to import monetary policy from more reputable central banks by dollarizing.
As F. A. Hayek argued in his seminal pamphlet Choice in Currency, increased competition between national currencies reduced inflation. This helped usher in the explosion of trade and foreign direct investment in the 1990s and 2000s.
Individuals should also be free to decide which medium of exchange best fits their specific needs. Millions of people today use privately provided cryptocurrencies like bitcoin because they enable them to make cheap and relatively anonymous transactions with buyers and sellers anywhere in the world. Cryptocurrencies are becoming increasingly popular in the developing world precisely because they offer citizens a faster, safer, and cheaper way to send or remit money over long distances than traditional payment services. Just as the ability to choose between national currencies tends to improve those on offer, so too does access to cryptocurrencies.
When it comes to choosing a birthday gift for a special person, limiting your options to a few tried-and-true staples is a safe strategy. With currencies, in contrast, we are better off with more choices.