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.

Another Newspaper Makes Its Inability to Turn a Profit an Asset

I was recently asked my opinion on the announcement of the Salt Lake Tribune being granted approval to become a nonprofit by the IRS. Specifically, the question was "What do you think of this model for newspapers?"

My quick answer:

For newspapers it is a lost cause—like all you can drink water for someone drowning in a river. Newspapers are a dead medium. Journalism is potentially a different story.

This is an old idea as indicated in the story. I think Tampa [Bay Times] went this route about 10 years ago. The Poynter Institute has advocated this for longer than that. On the one hand I like it from the standpoint of independence; however, I don’t think pragmatically it can be sustainable. It is just too expensive to fund journalism without advertising. And it doesn’t sound like they have any intention of giving up advertising.

On the other hand I don’t like it because I don’t think we should have a tax system that plays favorites (non-profit versus for-profit).

Here is a little more coverage from Nieman Lab. Unlike previous versions, this move to non-profit status is somehow more completely nonprofit. I am not quite clear if there is a material difference. I do find the appeal for charitable donations interesting in a kinda gross sort of way. Remember that every time you grant one entity tax-favored status, you increase the burden on all other tax-paying entities. Undoubtedly, many find this to be just fine.

In the religion of journalism, newspapers are a metaphorical holy land. There is a great sense that without them we cannot have credible news. Within this belief is a zealotry proclaiming local newspapers as the glue binding local society together. This like so many things in religion is not based on fact.

Our access to vacuous gossip and shallow conjecture is greater now than ever--we just don't have to pay so dearly for it and wait for it to be hand delivered to our doorstep. Newspapers like most of "professional" journalism have always delivered an array of facts that deserve more scrutiny and a biased narrative. That bias comes in one of three varieties: intentional slant to protect a powerful interest, unintentional slant repeating mistaken conventional wisdom, or simple ignorance introducing the ailment knowing enough to be dangerous.

I'm not saying non-professional journalism is better in any of these regards. I'm just pointing out that the only difference by and large is that being a professional really just meant you could (in some cases still can) get paid for it.

What do you mean a multi-billion $ gov't program has problems?!?

How could this be? Back in the 80s a government program was hatched with the explicit goal of ensuring the poor had access to telephones and the implicit if originally unintended goal of making some firms profits while politicians felt good about themselves. Somehow it went awry. Well, the implicit purpose got out of hand enough that the program has crossed over into waste, fraud, and abuse land.

I asked how can this be? Exhibit 1 (the Baptists):

The Lifeline program—begun in 1984 to ensure that poor people aren't cut off from jobs, families and emergency services—is funded by charges that appear on the monthly bills of every landline and wireless-phone customer. 

Exhibit 2 (the Bootleggers):

The program, which is administered by the nonprofit Universal Service Administrative Co., has grown rapidly as wireless carriers persuaded regulators to let people use the program for cellphone service. It pays carriers $9.25 a customer per month toward free or discounted wireless service.

That's how.

I have personally seen this program in action from both sides: Poor consumers on a street corner under a tent signing up for a phone, and a newly rich entrepreneur rent seeker whose company signs up said consumers and then passes them on to a carrier or administers the telephone plan himself. And still somehow the program's illusory value carried it passed the media's suspicion for some time. I really don't know what it takes to sufficiently raise media suspicion--that would be valuable information.

This problem has more than just some good lessons in incentives including the classic B&B example. I think it also tells us something about how we think based on our reaction to the story (i.e., who we blame and who we pity).

If asked to list out the victims and culprits, who would go in which category? To me the victims are the people taxed to pay for this program and the poor consumers who the program intended to help--more on this second group shortly. The culprits are government officials who created the program especially those who helped craft its evolution to the current mess and the private firms who participated in the fraud--this extends to lobbying to expand/continue the program and encouraging or failing to properly discourage fraud.

Notice how I don't include the poor consumers in the culprit category. Not broadly at least. While certainly there were many who knowingly abused the system, I find it hard to put much blame on people in very difficult situations responding to incentives. In fact, programs like this can be a victimizing force in the lives of those it is designed to help. There are consequences to welfare programs, poorly designed or otherwise, and those consequences can include dependency. People in tough situations do not have the luxury of always taking the ethical high road. Just evaluating what is the ethical high road may be out of their reach.

Most Charity is a Failure

I know you want to do good, and I know you want to think that wanting to do good combined with doing something results in doing good. Unfortunately, you are very likely and in most cases completely wrong. 

I suspect that most people will either reflexively disagree with and disregard my position on this or accept it at face value as a necessary consequence of human social failure. I also suspect that most people who have extensively studied this area as well as most people deeply involved in this realm will either strongly agree or disagree with me. 

For this post I imagine each of these four constituencies as potential audiences. 

First of all understand that charity isn’t always about doing good as Robin Hanson would tell us. Often it is a bundled good which combines a desire to dream altruistically and be recognized as altruistic with little connection to outcomes.

Second of all note that government action (i.e., forced collective action) is usually worse in all regards. At the very least with a failed charity we can more easily delude ourselves that what we are doing is on net beneficial and not resource or happiness destructive. And then there is the side benefit that we did it basically through voluntary agreement and persuasion rather than the threat of ultimately deadly force. 

Third of all let us distinguish between charity and other not-for-profits.* A charity is looking to benefit an underserved beneficiary. There are other not-for-profits that are actually just tax-favored gifts to one's own hobbies and personal enjoyments. The focus of this post is charities as commonly understood.

The problem with not-for-profits in general is that they are responsive to donors rather than customers as Arnold Kling elaborates. 

Donors and customers both have desires they want met. To understand if they are satisfied the donor is presented the answer while the customer largely gets to judge for himself. The marketing to donors strongly tends to be aspirational and promise-based whereas customers have to consider the actual outcome and experience. Additionally, donors have two biases at play further constraining their willingness and ability to be critical: selection bias (they already are supportive of the cause ex ante) and confirmation/endowment bias (they want to believe they made good choices).

Sam Harris makes great points in this podcast like how charities don’t stop existing often enough—they can be failing or have completely succeeded but they still are in operation, which implies they are wasting resources.

Just like in the fine art market where no participant has a strong reason to discover much less publicize a forgery and does have powerful incentives to suppress such information, participants in the not-for-profit sector are incentivized to self-promote and cross-promote the whole edifice as being successful. 

The challenge for charities are the classic problems of the seen versus the unseen, moral hazard, conflicts of interest, and the law of unintended consequences. 

This TED talk on African orphanages has elements of all four problems. 

ProPublica has been reporting for years on the failings of the American Red Cross.

TOMS Shoes has faced forceful criticism about its charitable program of donating a pair of shoes to a poor child for each pair of shoes purchased. In a rare case of reversal TOMS now donates 1/3 of its profits directly to "grassroots" efforts. This may be much better than their prior famous-cum-infamous program that had the unintended consequence of displacing development in poor countries. 

New York not-for-profit hospitals asking their patients for donations makes one wonder just how not-for-profit they really are. 

There are unintended consequences for heartwarming charities like Make-A-Wish, et al. When resources are directed to one thing, they cannot also be used in any other area. There are always tradeoffs.

Add to the classic problems listed above the simple element that good intentions are not sufficient for successful solutions. Case in point would be food drives where the obvious need is not the obvious solution.

It is possible to bring strong doubt to the ultimate value of any charitable organization. The fact is most do not stand up to scrutiny.

Yet we want to do good; so what is a good doer to do?

I am a weak proponent of effective altruism. It is a way to distinguish between what works and what does not. To quote admirable, strong effective altruism advocate Peter Singer, "Effective altruism is based on a very simple idea: we should do the most good we can." He goes on to explain:

Effective altruism is notable from several perspectives. First, and most important, it is making a difference to the world. Philanthropy is a very large industry. In the United States alone there are almost one million charities, receiving a total of approximately $200 billion a year, with an additional $100 billion going to religious congregations. A small number of these charities are outright frauds, but a much bigger problem is that very few of them are sufficiently transparent to allow donors to judge whether they are really doing good. Most of that $200 billion is given on the basis of emotional responses to images of the people, animals, or forests that the charity is helping. Effective altruism seeks to change that by providing incentives for charities to demonstrate their effectiveness. Already the movement is directing tens of millions of dollars to charities that are effectively reducing the suffering and death caused by extreme poverty.

Second, effective altruism is a way of giving meaning to our own lives and finding fulfillment in what we do. Many effective altruists say that in doing good, they feel good. Effective altruists directly benefit others, but indirectly they often benefit themselves.

Third, effective altruism sheds new light on an old philosophical and psychological question: Are we fundamentally driven by our innate needs and emotional responses, with our rational capacities doing little more than laying a justificatory veneer over actions that were already determined before we even started reasoning about what to do? Or can reason play a crucial role in determining how we live? What is it that drives some of us to look beyond our own interests and the interests of those we love to the interests of strangers, future generations, and animals?

Finally, the emergence of effective altruism and the evident enthusiasm and intelligence with which many millennials at the outset of their careers are embracing it offer grounds for optimism about our future.

It would be nice to have a roadmap and a good introductory guide. Given all of this, effective altruism seems like the way to go. So, why am I only a weak proponent?

Well, it turns out the world and its problems aren't quite so simple. Consider Peter Singer's famous thought experiment on the drowning child from his book The Life You Can Save (taken here from a Vox interview):

Imagine you’re walking across a park. Somewhere in that park there’s a pond. You know the pond is quite shallow, but you see something splashing in the pond. When you look closer, you’re shocked to find that it’s a small child who seems to have fallen into the pond and is flailing around because it’s too deep for this small child to stand. So, you look around for the parents or the babysitter, but there’s nobody. There seems to be only you and the child. Your next thought is, I better run down to the pond, jump into the pond, and grab the child. Not hard to do. No risk to me because the pond is shallow.

But then it does occur to you that [saving the child] is going to ruin your most expensive shoes. You’ll be up for some hundreds of dollars to replace them and other clothes you might ruin. So, you think, why shouldn’t I just walk away and not have to go to the expense of replacing my shoes? Now the question for everybody is: If somebody did that, would you think that was really the wrong thing to do? Would you think that you had done something seriously wrong in leaving the child very probably to drown? Most of the people who I ask this of say that would be an awful thing to do — it would be terrible to allow a child to drown because you didn’t want to go to the expense of buying new shoes, even if they were expensive ones.

The point of the thought experiment is to then switch to the situation that we really are in. We live in an affluent society where we often have considerably more than we need to meet all our basic needs, enjoy life, and make reasonable provision for the future. We also are living in a world in which there are millions of children who die each year from preventable causes and there are effective organizations that would gladly accept a donation from you that would increase their ability to save some of these children. So, if you’re not helping to save some of these children, then are you really all that different from the person who walks past the child in the pond?

This is a compelling story and a powerful argument in an of itself. However, there is something bigger going on here. Why is this child drowning? As an analogy for children suffering, dying in fact, on a daily basis, where are the parents? Why are these children dying when they could so easily be saved? Why are they repeatedly falling into the pond to drown? The deeper question becomes what is the institutional, societal, cultural failure that has brought this about. 

Effective altruism has a blind spot. It does not do much more to seek to correct the underlying causes of problems than do all the other naïve approaches to charity. It may have a better rate of attaching bandages to wounds, but they are still just bandages. 

Perhaps that is too uncharitable. I don't mean it to be so harsh. Yet the fact remains too often organizations that pass the effective altruism test are not addressing underlying causes of problems. 

I like Agnus Deaton's response:

It is an illusion that lives can be bought like cars. For a start, the evidence is nearly always in dispute. The alleged effectiveness of the Deworm the World Initiative—which, at the time of this writing, ranked fourth in GiveWell’s list of top charities—runs contrary to the latest extensive review of the evidence by the Cochrane Collaboration, an organization that compiles medical research data. Maybe Cochrane is wrong, but it is more likely that the effectiveness of deworming varies from place to place depending, among many other things, on climate and on local arrangements for disposing of human waste.

More broadly, the evidence for development effectiveness, for “what works,” mostly comes from the recent wave of randomized experiments, usually done by rich people from the rich world on poor people in the poor world, from which the price lists for children’s lives are constructed. How can those experiments be wrong? Because they consider only the immediate effects of the interventions, not the contexts in which they are set. Nor, most importantly, can they say anything about the wide-ranging unintended consequences.

However counterintuitive it may seem, children are not dying for the lack of a few thousand dollars to keep them alive. If it were so simple, the world would already be a much better place. Development is neither a financial nor a technical problem but a political problem, and the aid industry often makes the politics worse. The dedicated people who risked their lives to help in the recent Ebola epidemic discovered what had been long known: lack of money is not killing people. The true villains are the chronically disorganized and underfunded health care systems about which governments care little, along with well-founded distrust of those governments and foreigners, even when their advice is correct.

I consider effective altruism as a second-best solution. What would the first best be? Something as unpalatable to most as it is highly effective: economic growth through a pro-business environment that embraces free trade of all kinds and open borders in all places. 

Production vastly outworks charity. That is the way to escape poverty of all dimensions. 

It is a big world with complex and complicated problems. There is a role and a need for charity. Part of that is the moral and spiritual benefit bestowed upon the giver. Part of that is the actual good delivered to the beneficiary. 

We should strive for charity that is effective and efficient--that accomplishes the goal and does so without an unnecessary use of resources. A very big part of that is properly defining the goals long before and continually as we evaluate the options, analyze the progress, and retire the accomplished. 

The natural state of man is abject poverty. Charity does not and cannot solve that. Charity is funded from production to smooth out that which production illuminates as a temporary and undesirable shortcoming. Put another way: Charity fills the gaps we can at least hope to fill by virtue of production until production can eliminate them altogether. 

P.S. Alternatively, perhaps you're interested in ineffective altruism?

*In the debate between the terms 'not-for-profit' and 'nonprofit' I think I believe nonprofit (or non-profit) is the worse term as all entities earn profits, or at least they should. The critical distinction is what the entity can do with the profits earned and if profit is the ultimate goal.  A for-profit firm is and should be ultimately concerned with maximizing profit (we can litigate another day how Milton Friedman was completely right on this). A not-for-profit is not primarily driven to generate or maximize profit. It is driven to achieve outcomes but do so in an efficient manner (not destroy more resources than it creates). Being nonprofitable is prima facie bad since that organization is more explicitly in the pursuit of achieving particular outcomes without doing so profitably.