Thursday, October 30, 2014

The Trouble With Not Working For Profit

Arnold Kling writes:
For-profit firms ultimately are accountable to customers, while nonprofit enterprises are only accountable to donors. As a result, consumers are consistently over-charged and ill-served in sectors that are dominated by nonprofits....
The intention heuristic is to evaluate at an action, person, or institution in terms of its stated intention: if the intention is good, then it is good. Instead, we ought to evaluate outcomes. If you do that, then you will find that the small-business sector produces more socially desirable outcomes than the large nonprofit sector....
We should not elevate nonprofits to a higher pedestal than that of for-profit firms. We should stop telling our children that working for a nonprofit is in any way morally superior to working for a profit-seeking enterprise.
Read the whole thing. Over the years reading Kling has served to strengthen my position against a favored status for nonprofit organizations. While Rand gave me a moral position to question their status altogether, this is a more economically founded reasoning that I believe many more will find persuasive.

Borrowing from Kling, my view is that not-for-profit firms should only exist where for-profit firms won't but should--where there is a true, absolute positive externality and little to no internalizable benefits. If the positive externality is strongly believed to be real but there is also a profitable firm(s) operating in that space, then simply subsidize the for-profit firms to get more of what is desired.

A big problem with nonprofits is that they tend to live on past the point when they should. We seem to have an urge to keep inefficient, undesirable nonprofit entities in existence. Part of the problem is the intuitive but incorrect viewpoint that because they don't generate profits, nonprofits need extra help. But a larger part is simply that nonprofits lack the feedback mechanism that for profits have that reveals when resources are being wasted. This poor incentive structure is at work throughout these organizations from the day-to-day operations up through to the overall mission.

Another important difference is that for-profits must pay taxes while nonprofits do not pay taxes giving them an advantage that has deadweight loss implications. This has a vicious-cycle effect to it as the conferred advantage favors the firms not using resources most prudently. Since they can distribute the profits to the owners (presumably when reinvestment would not be in the owners and hence society's best interest), for-profits have built-in incentives to use resources well. Nonprofits must reinvest their profits (proceeds in excess of cost) into their operations even if this is not desirable (further investment would be wasted resources).

A firm should not be advantaged in practice or in esteem because of how it uses the fruits of its endeavors. A rose by any other name would smell as sweet--so too, a profit for any ultimate use.