Thursday, January 2, 2014

2/1/2014: Economics of Christmas

This is an unedited version of my Sunday Times column from December 29, 2013.

December is the month that economic forecasters learn to love and to hate.

They love the role the month plays in the annual aggregates for core economic time series. Get December trends right and you are free to bask in the warm glow of having an in-the-money forecast until the first quarter results start trickling into the newsflow.

They learn to hate a number of things that can make Christmas seasons notoriously volatile, especially around the time when economies switch paths from, say, recession to growth. Miss that moment and your forecasts will be out by a mile for a long time to come. Remember 2008-2009 when all analysts were racing against the tide of real data to update their projections downward? One of the reasons for this was that the peak of uncertainty fell on the last quarter. Secondly, Christmas behavior – by both consumers and businesses – is saddled with deep behavioural biases. This does not make holidays’ data fit well with mathematical models.

Ireland is a great case study for all of the above forces interacting with each other to underwrite our economic fortunes. Take the latest statistics, released last week, covering quarterly national accounts through Q3 2013. While this period does not include holidays shopping season, it is revealing of the strange currents in underlying data. Adjusted for inflation, personal consumption fell 1.22 percent in Q1-Q3 2013 and was down 1 percent in Q3 2013 relative to Q3 2012. In other words, household demand continues to underperform overall GDP and GNP in the economy.

This contrasts with continuous gains recorded in consumer confidence, which rose more than 21 percent year on year by the end of Q3 2013. In fact, the two series have been moving in the opposite direction since the mid-2009.

Some of the reasons for this paradoxical situation were revealed in the recent Christmas Spending Survey 2013, released by Deloitte. Despite the positive newsflow from the GDP and GNP aggregates, consumers in Ireland are more concerned with the state of domestic economy than their European counterparts. Overall, the percentage of Europeans who believe their purchasing power has diminished in 2013 compared to 2012 amounts to 41 percent. In Ireland, the figure is 48 percent. Only 26 percent of Irish consumers are expecting their disposable incomes to rise next year. In core spending cohorts comprising the 25-54 year olds, average proportion of population expecting improved incomes over the next year is even lower.

In other words, it seems to matter who asks the question in a survey and it matters what type of question is being asked. A question about confidence asked by an official surveyor yields one type of a reply. A question about actual tangible income expectations asked by a less formal private company surveyor yields a different outcome. These are two classic behavioural biases that wreck havoc with the data.

Despite the gloom, however, Ireland still leads Europe in terms of per capita spending during the Christmas season. Per Deloitte survey we plan to spend around EUR894 per household on gifts, entertainment and food in the last three weeks of December 2013, down from EUR966 reported in surveys a year ago and down from the actual spend of EUR909.

In brief, we are a nation of confident consumers with pessimistic outlook on the present and the future, who are spending less, but still outspend others when it comes to Christmas. A veritable hell of reality for our forecasters.

But what makes December a nightmarish month for those making a living predicting economic trends, makes it so much more exciting for research economists interested in explaining our choices and behaviour. For them, Christmas is when social mythology collides with reality.

Christmas purchases allow us to gauge the consumers’ ability to assess the value of things. In economics terms, the valuations involved are known as willingness to pay and willingness to accept. The former reflects the price we are willing to pay to obtain a pair of the proverbial woolen socks with a Christmas tree and Santa embroidered on them. The latter references the price we are willing to accept in order to give up the said pair of socks after they are passed to us by our kids with a ‘Merry Christmas, Dad!’ cheer.

In numerous studies, our willingness to accept is substantially higher than our willingness to pay – a phenomenon known as the endowment effect.

Christmas shopping data actually tells us that the endowment effect is present across various cultures. The data also tells us that the sentimental or subjective value attached to a gifted good is not a function of price. In other words, spending three times as much on Christmas festivities and gifts as the Dutch do, does not make Irish consumers any merrier.

But spending more has its costs. Some recent surveys indicate that up to one third of all Irish consumers will take on new debt during the Christmas season. In the Netherlands that figure is around one fifth. And long-term indebtedness is a costly proposition when it comes to social, psychological and financial wellbeing.

On the other hand, intangible quality of gifts matters to the consumers both in terms of giving and receiving. As the result, we tend to form expectations of what others value in gifts we give and we also match these expectation with our personal preferences. This induces series of biases and errors into our choices of gifts we purchase.

In Ireland, books represent top preference as a gift for both giving and receiving. In the majority of other countries in Europe, the matched preferences are for giving cash. Before we pat ourselves on the back for being a literature-loving nation, however, give this fact a thought. Giving cash provides a better matching between preferences of gift giver and gift recipient. In basic economics terms, cash gifts eliminate deadweight losses associated with gift giving. This, in turn, means that in countries where cash dominates physical goods giving, smaller expenditures on gifts achieve better outcomes in terms of recipients’ satisfaction. The reason for this is simple: we say we like something as a gift, but we still end up returning or recycling up to 30 percent (based on various studies) of gifts given to us. Why? Because goods are rearely homogeneous, so our preferences for books do not perfectly distinguish which books we like.

Gifts also have a reciprocal value. Christmas surveys have led us to a realization that the power of ‘give to receive’ thinking works well outside the holidays season as well. For example, charitable donations rise robustly when request for donations is accompanied by a forward gift from a charity. In one study, relative frequency of donations to a charity can rise by up to 75 percent when a gift is included with a request.

Still, research in economics overwhelmingly suggests that Christmas behavior by consumers delivers a significant deadweight loss to the economy and consumers-own wellbeing. In other words, our consumption patterns around Christmas can result in misallocation of resources that are not recoverable through the gains in retail sales, services, taxes and other economic activities. Given evidence from other countries, the deadweight loss from Christmas 2013 to the Irish economy can be anywhere in the region of EUR150-450 million.

Beyond economics of gift giving, popular mythology has it that Christmas is also a period of excess, especially when it comes to food and alcohol consumption. On average, this year, Irish consumers are expected to spend EUR259 on food per household. This is well ahead of the European average and reflects not only differences in prices, but also the level of alcohol consumption and our tendency to bundle food purchases with purchases of alcoholic beverages.

Culinary exploits of the festive season are generally subdued in quality and variety of food, but we make up for it with quantity. Marketing research suggests that the guiding principle to a successful Christmas meal is ‘safe, sound and abundant’ traditional dishes, rather than creative and experimental fare. Thus, virtually all cultures celebrating Christmas have a regulation-issued set of traditions designed to combat the festive season’s calories. These range from New Year resolutions (rarely followed through) to periods of fasting and abstinence (often tried, but rarely verified in terms of health virtues they claim to deliver).

One recent study looked at 54 million death certificates issued in the US from 1979 through 2004. The authors found that “there are holiday spikes for most major disease groups and for all demographic groups, except children. In the two weeks starting with Christmas, there is an excess of 42,325 deaths from natural causes above and beyond the normal winter increase.”

Another medical study found evidence of a significant weight gain in the US population during the December holidays. According to the study, the mean weight increased by 370 grams on average per person during the holidays. This weight gain remained intact during the rest of the year. In other words, all the New Year’s resolutions and health club memberships gifts cannot undo the damage done by turkey and gravy.

Last, but not least, popular mythology ascribes to the economists the definition given by Oscar Wild to a cynic: “A man who knows the price of everything and the value of nothing”. But studies of the Christmas data show that for economists, the size of the gap between sentimental value of the gifts and their retail or market prices is lower than for other professions. It seems, the economists know both the price and the value of Christmas gifts better than other consumers. Sadly, that knowledge seems to be of little help when it comes to understanding what is going on with the Irish economy at large.


The latest instalment in the European banking union saga agreed two weeks ago was heralded by the EU leaders as the final assurance that the taxpayers will never again be forced to shore up European banks in a financial crisis. In reality, the final agreement on the structuring of the Single Resolution Mechanism (SRM) is a sad exemplification of the bureaucratic dysfunctionality that is Europe.

In the US, a single entity is responsible for assessing the viability of a bank experiencing an adverse shock and subsequently determining on the action to be taken in resolving the shock. That authority is the Federal Deposit Insurance Corporation or FDIC.

In Europe, based on the latest agreement between the European Finance Ministers, the SRM will involve at least 148 senior officials across eight diverse decision-making bodies. The resolution procedures can involve up to nine, and at least seven different stages of approval. Majority of these stages require either simple or super-majority voting. The whole process is so convoluted, one doubts it can be relied upon to deliver a functional and timely response to any crisis that might impact Euro area banking in the future.

Is it time we renamed the European Banking Union a Byzantium Redux?

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