Why Non-Profits?

Arnold Kling questioned the value of non-profits:

A profit-seeking enterprise is more accountable, in that a profit-seeking business must satisfy consumers or else go out of business. Hence, it must provide something of value to its customers. On the other hand, if a non-profit fails to provide any benefit to its customers, it still might be able to obtain grants from the government or from donors.

Fabio Rojas responded:

Non-profits provide services that are not sustainable in a for-profit format. … The customers simply can’t pay for what might benefit them and “we” (the donors) have decided that these people need the service. The non-profit format is a way to handle donations to third parties in an organized and semi-public fashion. … Examples include services to poor children (e.g., Boys and Girls Clubs), women (e.g., battered women’s shelters) and immigrants (e.g., many religious groups donate time and services to poor immigrants). My intuition is that it would be hard for a profit oriented institution to help battered women or poor children. …

It’s signaling. Not only in the Hanson “I do this because I care” sense, but as a commitment to a specific issue. The people who run the local church organization for recent Mexican migrants have to show that they won’t bail in order to give shareholders a slightly higher return. Rather, by making their organization non-profit, they show an allegiance to a specific type of person, not their wallet.

Fabio suggests that the main function of non-profits is as intermediaries between those who want to donate and the deserving recipients they want to help. But the obvious question here is: why can’t non-profits give these deserving recipients vouchers for service at for-profit firms? Why do non-profits need to provide the services themselves? Remember that 51% of non-profit revenue goes to medical orgs like hospitals, and 14% to schools — vouchers are quite feasible for both of these kinds of services.

Admittedly, in some cases there are strong complementarities between the task of deciding who is a deserving recipient and actually providing services. This applies, for example, to service coordinators such as social workers, who evaluate aid candidates and suggest relevant services to them. But why must the services that coordinators coordinate be provided by non-profits?

Now there might be good reasons for customers to sometimes choose non-profit service providers. Such a choice might assure customers that advice being given is not overly influenced by profit motives. But this reason should apply to many sorts of customers all across the economy – there is no obvious reason to expect a correlation between people donors consider deserving of help and people who buy trustworthiness by buying from non-profits.

So why don’t the non-profits that donors use to distribute help usually give vouchers to recipients, vouchers valid at either non-profit or for-profit service providers? Once one has decided who needs what sort of help, why does it matter what kind or organizations provide that help?

I suspect that what is going on here is that non-profit donors and employees both dislike the idea of letting money to go for-profit firms, regardless of how much that might benefit aid recipients. They affiliate with non-profits in order to gain an image of “doing good” and substantial affiliations with for-profits in that process taints that image.

Added 5p: Several commenters pointed out that many prefer to volunteer time, and without money mediating between their time donation and the cause. That is, they don’t just want to work at whatever makes the most money and have that money used for the cause – they want to personally spend their time on the cause. This also seems to fit my basic theory – that the more money and profit are involved in the process, the more that taints the do-gooding image of their donation.

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  • http://theviewfromhell.blogspot.com Sister Y

    Nonprofits are a solution to the basic problem of charity: satisfy empathetic aims of individuals without threatening their competitive aims.

  • Josh

    I suspect that what is going on here is that non-profit donors and employees both dislike the idea of letting money to go non-profit firms, regardless of how much that might benefit aid recipients.

    I think you mean for-profit firms.

    • http://hanson.gmu.edu Robin Hanson

      Oops, fixed.

  • Dee

    Wouldn’t services provided by non-profits be cheaper since the money is going to pay for costs and not profits?

    If non-profits gave out vouchers instead, these vouchers would cost more than providing services themselves because they would be paying for costs AND profits at a for-profit firm (also for-profits tend to have much higher salary costs). Then there would be fewer deserving recipients served.

    This seems like a very simple and obvious point, so what am I missing?

    • Josh

      As long as there is robust competition, we wouldn’t expect in the long run to observe excess profits for any one firm above the opportunity cost of their capital.

      • Dee

        Right, but there is no cost of capital for non-profits–that’s the idea of donations.

      • y81

        Replying to Dee, universities and hospitals are large bond issuers. (They can usually issue at tax-exempt rates,using procedures too complicated to explain here.) The rates they must pay on their bonds depends on the credit rating of the institution in question. So they do have a cost of capital. And if they spend from their endowments to fund capital costs, they have an opportunity cost equal to their lost earnings on that portion of the endowment.

      • Arlin

        thus, in the long-run all businesses will be “non-profit”…excellent observation!

    • Sigivald

      Wouldn’t services provided by non-profits be cheaper since the money is going to pay for costs and not profits?

      Not-for-profits still pay hefty salaries and all that. They’re money-making enterprises, not charities, in most (almost all?) cases – they just aren’t making “profits” in the legal sense, and get nice tax benefits.

      It’s vitally important, in discussions like this, to remember that “non-profit” is not the same as “charitable” or “not motivated by money at all”.

      Plenty of non-profits (many notional “charities”) do far more paying-their-own-salaries-and-inflated-benefits-packages than helping-the-notional-beneficiaries.

      (See what ubersquareuber and Jess Riedel said below!

      And contra Viliam, note that non-profits are not necessarily or always run or primarily staffed by volunteers. See every non-profit college, with the exception of the poor exploited grad student TAs…)

    • Arlin

      you’re not missing anything. the for-profiteers are witnessing the exponential growth of the 501(c)(3)

  • ubersquareuber

    I work at a non-profit medical association (more of a professional association as we don’t deliver medical care). It is always strange to me that people somehow assume that the people who work at nonprofits are ‘immune’ to the ‘evils’ of market forces. We still have profit/loss statements, sales targets for our publications, internal battles for prestige/corner office. Ironically I make tens of thousands of dollars more annually at this nonprofit than in my previous “for profit” occupation. If it weren’t for the tax breaks and the weird psychic attachment people have to the supposed altruism of non-profits…they wouldn’t exist.

  • http://www.viliam.bur.sk/en Viliam Búr

    People working for for-profits expect to receive some part of the company income. In non-profits many volunteers work for free. These volunteers are something like donors — they donate their time and skill. Non-profits could be described as some people donating money and other people donating time and work for the common cause; a cooperation of donors.

    (This description fits private donors. With state as donor, the situation is more complicated. Unlike private person, the state is donating someone else’s money.)

    If there is no profit, it means that when a volunteer donates more, the cause receives more. This motivates the volunteer. When there is a profit, increasing volunteer’s work may mean increasing owner’s profit, without any benefit to the cause. That is demotivating.

  • Brian

    I agree that when the service is well controlled/regulated (think hospital care), distribution of vouchers is a viable alternative to the non-profit actually providing the service. On the other hand, services with fewer controls (think higher education) are often better delivered by non-profit organizations (how many top universities are for-profit entities?).

    • http://www.uweb.ucsb.edu/~criedel/ Jess Riedel

      how many top universities are for-profit entities?

      (A side note: from the inside, private universities look and feel very much like for-profit companies. In principle, they build their endowments to fund future academic research, but in practice they routinely appear to favor short-term cash/prestige over research, e.g. by charging absurd overhead costs—order 50%—on grants professors bring in from the outside.)

      Your confusion seems to be in thinking that the mission of the top private universities is to educate. But The Purpose of Harvard is Not to Educate People. The purpose is to produce scholarship. And currently, there do not exist for-profit sources of scholarship except the professors themselves, i.e. there seems to be no need for the professors to band together and sell scholarship collectively. Maybe this has something to do with the face that, unlike food and medicine, there is no market for scholarship (unless it is eligible to be intellectual property).

      So really, the donation arm of universities exist to assemble expertise to channel funding from the laymen donor to deserving sources of scholarship. Alternatively, donors may donate to, or create, a foundation which makes such expert decisions itself, e.g. the benefactors of my research, FXQi and the Templeton Foundation. (I guess our group slipped through the cracks…) Or, if the donor thinks himself smart enough, he may give money to the professors directly as Robin Hanson blogged on previously. (I can’t find the link right now).

      As to your initial thought: why are all the good professors at private universities? I imagine there is a strong status feedback loop yielding large benefits to the non-profit historical first movers. Good professors attract wealthy students attract money attracts good professors. This is consistent with the fact that the best universities rarely change.

  • Ross

    A more critical issue, I believe is that by providing the services, non-profits are more effective at monitoring the recipients of those services, than they would be if they merely distributed vouchers. One significant advantage of private philanthropy is its ability to “busy-body”, whether in the form of better identifying the needy and/or giving themselves the opportunity to get at the deeper causes of the misfortune of the unfortunate.

    When I donate to a non-profit, I expect such diligence. If I pay to have sandwiches handed out to people living under NY bridges, say, I’d better see some sandwiches there, not food vouchers being traded for meth. I expect to see such shenanigans with WIC and such, but not with my voluntary donations.

    So sometimes illiquidity can be a feature.

  • donK

    Do you really mean that to say that for the same money more people could be served with private food stamps on the open market than a food bank distributing donated food with volunteer help? The services of a food bank, soup kitchen, and emergency shelter are not the equivalent of a grocery store, restaurant, and hotel. I don’t disagree that some non-profits are mismanaged and wasteful or that more transparency would force them to be more accountable to their donors.

    • Josh

      Do you really mean that to say that for the same money more people could be served with private food stamps on the open market than a food bank distributing donated food with volunteer help?

      I think Trader Joe’s or Safeway can feed people better, and at a lower cost, than your local food kitchen.

      • Douglas Knight

        “food kitchen” seems to be a conflation of “food bank” and “soup kitchen.”

        A soup kitchen is serving cooked meals. It is not comparable to a food store. A food bank acquires food for soup kitchens. It usually acquires food for free, such as food that would be thrown out by restaurants. I don’t know if it is as efficient as buying food from costco, but it has the additional goal of not wasting food.

        A soup kitchen is, effectively, a very cheap restaurant. Maybe if it offered vouchers for 90% of its operating cost, cheaper restaurants would appear, but existing restaurants are probably more expensive.

  • Robert Koslover

    Ross (above) is getting close to the meat of this. Give a homeless person a voucher, money, or anything else that can possibly be traded away to another person and you have a high likelihood that he/she will indeed trade that item away for money with which to buy alcohol or drugs. But give that same person a seat at a table, and serve him/her with a plate of chicken and vegetables, and they will be stuck with accepting what you actually wanted to have that charitable gift accomplish.

  • nazgulnarsil

    I’ll reiterate the point with a bit more detail. Charity is a means for the rich to impose values on the poor. We see this thread going back thousands of years where the poor being risen to virtue is a recurring theme. Pure charity is pure redistribution. If the rich are going to spend their money they are damn well going to get something for it, in the case of charity they are using other people to signal virtue by proxy.

  • y81

    Prof. Hansen and Mr. Kling are making too much of the for-profit/non-profit distinction, which is mostly a historical accident with some modern legal consequences. (In that respect, it is similar to the way that some businesses, e.g. accounting firms, are organized as “partnerships,” while others are organized as “corporations”–a historical accident with some legal consequences). If you look at the major non-profits, you will see that churches, hospitals and universities derive most of their revenue from the consumers of their services (including government to the extent that it funds research), just like any other business, and the rest from some mix of altruism and nostalgia on the part of donors. If a non-profit fails to deliver quality services to the service recipients, or sentimental gratification to the donors, it will fail, and many do.

  • Khalmojo

    I’m sure it’s been mentioned already but since a lot of people volunteer at non-profits, it’s very possible non-profits provide more value per dollar spent than for-profits once dollars saved by volunteers are factored in.

  • Drewfus

    Non-profits are more heirarchical than for-profits. The profits are still there, they are just hiding inside the structure of the organization. There is no such thing as a non-profit.

    All organizations are for-profit, else why would they exist? Have you ever heard of a not-for-profit individual?

  • Chip Morningstar

    One complication is that the rules about the fiduciary obligation of businesses to their investors don’t really have a place for institutions that payoff in a mixture of direct profit to investors and charitable benefit to third parties, even if that benefit to those third parties was something the investors actually sought to achieve in the first place.

    • Douglas Knight

      No, a vanilla (“for-profit”) corporation can have whatever charter it wants. Google.org is a “for-profit” charity.

  • Kevin

    I wonder if anyone has tried to look at the incidence of vouchers? What if you give everyone a voucher for medical supplies/schooling/etc and all of a sudden price rise by the amount of the voucher? Perhaps a non-profit is a way to ensure that the supply of the good increases.

    This is likely not a concern with food stamps, but maybe foreign aid is different when we talk about distributing aid to entire villages/populations. It may be that privately provided supply is too inelastic to keep up.

  • http://asymptosis.com Steve Roth

    “why can’t non-profits give these deserving recipients vouchers for service at for-profit firms? Why do non-profits need to provide the services themselves?”

    Because just like voters, purchasers are systematically biased. So their (non-random) errors do not cancel out to zero, leaving the smart choices floating like cream.

    You may say that non-profits (and governments) are equally biased in their (collective) choices, but you could say the same about animal breeders. Personally, I’d rather live with Good Dog Carl than a wolf.

    • Wonks Anonymous

      Animal breeders do not have animal benefit as a goal.

  • IVV

    Personally, I like for-profit, because profit is a good objective indicator of the capability of an enterprise to continue as a going concern (accounting shenanigans aside). The true problem with for-profit occurs when we can no longer focus on profit for enterprise maintenance, and start focusing on profit for profit’s sake. If the owners and managers of the enterprise are owners and managers with the hopes of reaping profits, then the drving mechanism of the enterprise can no longer be a mission to improve the economic vibrancy of a population separate from the enterprise–a health company, for example, can no longer focus on improving the health outcomes of a community, but must focus on improving the bottom line–health outcomes be damned.

    Thus, non-profits. Unfortunately, non-profits still have owners and managers, and they can similarly be reaped for value in the same way as for-profits, by replacing profit with revenue.

    Ultimately, the real issue is that the status gained from owning/managing an enterprise that maximizes economic value for the community remains less than the status gained from owning/managing an enterprise that provides some measure of economic value, but also grants the owner/manager higher personal resources.

    • http://daedalus2u.blogspot.com/ daedalus2u

      I would phrase it differently, the problem is that money can buy status. Why try to get status by helping poor people and saving the lives of poor people when if you make a lot of money you can buy that status easily.

      That is what some corporations and individuals do, they make a lot of money using dubious ethics, then use that money to buy the status that comes with good ethics.

      I think this is what Bill Gates is doing. His very large profit at Microsoft was due in large part to the monopolistic practices that he used to obtain and maintain the monopoly. He made a lot of money by having a monopoly on an essential part of the value-added chain of using computers and used that monopoly to extract a disproportionate share of the value added by that value-added chain.

      To a more extreme degree, organized crime figures donate to charities and support individuals in the community using the profits they extorted from others. So do drug cartels, so do organizations like the Taliban.

      When society has gaps in the fundamental needs that individuals in that society have access too, that opens up a niche for individuals or groups to buy status by providing those needs. Block access to all health care by killing volunteer health care providers (as the Taliban does), then the only health care that is provided is the health care the Taliban has monopoly control over. This same heuristic can be used for any necessity, food, water, access to mates, computer operating systems, health insurance, information, justice.

      A monopoly on any necessity can be used to extract status disproportionate to the status-worthiness of the individual with monopoly power. The king had the highest status because he had the power of life and death over everyone else by virtue of being king.

      Why do we allow status to be apportioned that way?

  • Lord

    Many have time to donate, but cannot earn more cash to donate. Many can donate at wholesale rather than retail, and used rather than new. Donations are tax advantaged, allowing much more bang for the buck than any for profit could. Profit is incompatible with donations. Vouchers are an attempt to circumvent this incompatibility, but the donation advantage and tax advantage mean for profits can never be as inexpensive as non profits unless it operates strictly on cash and is so inefficient even taxes (not just on profits, but on returns, wages, and property) don’t make a sufficient difference. Why do for profits donate in kind rather than in cash? Even when donating cash equiv it is often in the form of vouchers for themselves so they don’t subsidize their competition.
    .

  • nw

    Profit is vulgar.

    Besides, when there’s profit there are shareholders. Who would own stock in the Red Cross? Would the Red Cross go out of business after a bad year? What’s a good year for the Red Cross, a year with hurricanes, or a year with no hurricanes?

    A for-profit charity with $100 million profit could have provided $100 million more to the needy. Why would a shareholder buy stock in a for-profit with an incentive to reduce profits? I assume the government would give tax breaks to for-profit charity shareowners.

    • J

      “Profit is vulgar”

      Not sure if you’re serious, but assuming you are, profit is the reason the computer you typed that on exists. It’s also almost certainly (based on the people I’ve run into with that attitude) why you haven’t starved to death, unlike the tens if not hundreds of millions who have starved to death in places run by people with that attitude.

      The question isn’t “couldn’t they have done more?”; it’s “we’re they more effective?” If being more effective is vulgar, I’ll take it.

  • Drewfus

    The terms non-profit and for-profit are effectively normative. In our culture non-profit is code for pro-social and for-profit is code for anti-social. This is based on a lingering Marxist/Socialist worldview that is no longer appropriate.

    As alternative market orientations, non-profit and for-profit could also be described as ‘internally oriented’ (anti-market or a-market) and ‘externally oriented’ (pro-market). As I’m not Marxist/Socialist in my worldview, I prefer this terminology.

  • http://timtyler.org/ Tim Tyler

    Re: “why can’t non-profits give these deserving recipients vouchers for service at for-profit firms? Why do non-profits need to provide the services themselves?”

    The “vouchers” are money? Then they would get taxed. The “vouchers” are valuable non-money? Then they would be forged.

  • Hannes

    The key point is that providing a service instead of a voucher screens out those in need.

    An example: the value of a kidney transplant is minimal if both your kidneys are functioning. Hence it is pointless to pretend that you kidneys are malfunctioning towards a non-profit that is providing this type of surgery.

    Turn to the voucher case. Now there is a third-party, the donor, who can be fooled to giving you a kidney transplant voucher. Either this is not individualized, in which case you can sell it and there is a massive incentive to try and get one disingeniously.

    Or it is individualized, but even in this case there is a big incentive to conspire with the for-profit firm. “You say you did a kidney transplant and we share the benefit” (as the voucher will be payed out in money to the hospital; of course this will be done in a much less explicit way).

    Hence the voucher situation, or the money-situation, has deprived the charitable organization of a fantastic screening mechanism that is in-kind provision. Now it has to spend much more money on monitoring, and the inevitable corruption will decrease trust in the system.

    Note that this is a slightly different argument than just saying provision gives one better information on who is needy. In kind provision makes a lot of dishonest attempts to get help meaningless.

  • Michael Wengler

    The customer is the donor. Suppose I am the donor. If I want to pay for a hot meal and a clean place to sleep for a homeless alcoholic, then I’d best give my money to a non-profit providing those services, as giving cash to the homeless alcoholic will not bring him to Motel 6, but rather to a liquor store.

    My parents paid some for my college. They wanted to pay for my education, not for my cars or travel/entertainment desires.

    I really don’t see a puzzle in charities providing what the donors want to provide, not what the recipients want to get.

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