Charities – the good, the bad, and the frequently misunderstood

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There was a popular TED talk doing the Facebook rounds last year by Dan Pallotta entitled ‘The way we think about charity is dead wrong’. Essentially, Pallotta, a veteran social entrepreneur, was presenting an argument that the modern nonprofit sector is severely constrained by the way society expects charitable organisations to operate. These preconceptions we hold, Pallotta argued, are often not based on careful thought, which leads to problematic outcomes for those trying to make a meaningful difference in the world.

The nature of the ‘charity market’ (if you’ll excuse that terminology) is a topic that has interested me for a number of years now. In fact, this was the topic of my recently completed economics thesis. For the last couple of months, I think I would have imploded if I had so much as thought about charities – I’m sure anyone who has written a thesis can relate to the feeling. Nevertheless, after a bit of a vacation from the topic, I thought it would be worthwhile to pen the observations and conclusions that arose from my research. Of course, as an economics thesis, what I wrote was about 90% mathematics (the other 10% being jargon). For those that are interested in the original thesis, I am happy to pass it on. Here, however, I offer a translation (to the best of my ability). To make it easily digestible, I have broken it down into a series of seven remarks.

Remark 1: Charities are far more important to our economy than you realise.

In the United States, the nonprofit sector represents a larger portion of GDP (an economy’s annual output) than agriculture. Here in Australia, the nonprofit sector is larger than agriculture, communications, and defence. I found this to be a particularly startling fact. Far from being a minor anomaly in the modern economy, the charity sector is actually a major employer and a major service provider for the most economically marginalized members of our local and global communities. I was quite taken aback by how little previous research there had been into the operation of the charity sector within the economics discipline. My suspicion is that many economists have not fully grasped the importance of nonprofit organisations (from a purely economic perspective, that is). With this in mind, it is perhaps less surprising that so little attention has been given to the question of what is desirable (or ‘efficient’) and what is undesirable (‘inefficient’) in terms of the activities of our charities.

Remark 2: When someone says to you “Charity X will spend Y% of your donation on fundraising”, they’re not quite on the money.

We have probably all heard someone say something like this in the past, and, if you’re guilty yourself, don’t be embarrassed – it seems to be a pretty common argument that’s based on a genuine concern. However, it also involves a formal logical error. In the economics jargon, it involves mistakenly conflating ‘marginal cost’ and ‘average cost’. In English, when I give a charity $100, it doesn’t matter how much was spent by that charity to get that $100 – that money has been spent, it’s gone! What matters is how the charity then goes and spends that $100 you have given it. You might find it helpful to think about it like a production line. In order for a charity to ‘produce’ $100 in donations, it needs to spend some money on fundraising (charities don’t just spend money on advertising for kicks – they do it because they need to generate money to fund their charitable activities).

(A more difficult question is whether the charity sector as a whole spends too much on fundraising as a result of competition for donations. For various reasons, this one is actually surprisingly complex, so I won’t tackle it in this blog post, though you’re welcome to send me an email if you’re really interested.)

Remark 3: When someone says to you “Charity X will spend Y% of your donation on administrative expenses”, your response should be “So what?”.

This is probably the most common misunderstanding when it comes to what is desirable and what is undesirable in our charity sector. Again, people raise this concern with the best of intentions, but again the thought process is not logically correct. Or, more accurately, it would be logically sound if every charity was producing a unit of ‘social impact’ in their respective area for exactly the same cost. What the hell does that mean? Consider this: a charity is not like a distribution company. They don’t take your dollar, carry it across the world, and give it someone who needs it. Rather, what they do is they take your dollar and use some kind of program to try and get the most social impact from it. A poverty alleviation charity takes your dollar and invests in clean water, education, or microfinance programs. A cancer research charity takes your dollar and hunts down the most promising line of research that seems to be presently underfunded. However, different charities have different strategies that cost different amounts. The real question, then, is not how much of the charitable dollar is going to ‘administration’ (which is a very poorly defined term anyway). Some programs are very complex to implement, and therefore have a large staff requirement, but their potential social impact can be very large too. Instead, the question should be, colloquially, how much bang do I get for my buck. That is, where will my dollar have the most impact.

Interestingly, the administrative expenses criticism is one that is often leveled at larger charities. However, perhaps surprisingly, all the empirical evidence to date indicates that larger charities actually have a lower administrative expenses ratio. That is, there are cost benefits to being a large charity (in the economics jargon, ‘increasing returns to scale’). Nonetheless, as I have noted above, this doesn’t mean that the actual per dollar impact of these charities is necessarily higher or lower.

Remark 4: Having multiple charities is a good thing.

One of the main issues I was interested in for my thesis was whether or not we actually need many charities. After all, if larger charities are more efficient, why not just have one super monopoly charity fighting poverty alleviation, one fighting homelessness, and so on. Of course, this is not what we observe in reality. In basically any charitable field you can think of there will be multiple charities operating. The answer is actually fairly simple: in the same way that having many firms in the for-profit sector encourages efficiency, having multiple charities competing for donations forces each charity to try and be the best. When I can choose between two nearly identical poverty alleviation charities, I will choose the one that is having the greatest impact. This forces both charities to compete by vying for the greatest social impact, lest they fail to maintain their donor base.

Remark 5: But we probably have too many charities already.

Great, so I should go and start my own charity to make the charity sector even more efficient, right? Probably not. I say ‘probably’ because there’s no available empirical data on this issue, and because there are theoretical exceptions anyway. Still, if you make a couple of basic assumptions (which I won’t go into here) the theory suggests that more than two charities competing over the same donor would be superfluous, and indeed cost-inefficient. And it’s not hard to think of two charities for pretty much every charitable cause. Moreover, there are charities that are formed for the wrong reasons (for instance, vanity, or, in the economics jargon, ‘ego rents’), which means it’s quite probable that we already have more charities than we need, unfortunately.

The exception, of course, is when you have a particularly unique method that you’re wanting to employ, or if you believe you will be particularly good at getting donations from people (e.g. you’re a celebrity). Otherwise, you’re almost certainly going to have more of an impact by donating to an existing charity and keeping your day job.

Remark 6: Donors are not like shareholders. They’re more like customers.

Often donors feel as though their contribution should buy them the right to tell a charity how to operate. This is kind of like me feeling like I have the right to tell Apple how to make their products because I choose to buy them. Charities do not have shareholders. Instead, charities have missions. To eradicate Malaria, AIDS, or Polio. To end absolute poverty. To fight for Americans’ right to own guns (yep, the NRA is a charity…). As a donor, you choose to give money to a charity because you actually benefit from the work they do in a roundabout sort of way. I want to live in a world in which children do not have their physical development stunted by malnutrition; I want to live in a world in which nobody suffers from diseases that are curable. These are my preferences, analogous to my preference for Verdelho over Semillon. Of course, these preferences are more fundamental to who I am as a person. But the point remains: I choose to give to a particular charity because I believe that doing so will help bring about the world I want to live in, and I believe that the particular charity I’m giving to is able to deliver the biggest social impact with my contribution. In the same way that a discerning customer must choose between multiple different products, a discerning donor must find the best charity to give their money to. The only difference is that the stakes are much, much higher.

Remark 7: Charities don’t already receive enough money.

As most of us see it, the work of making our world a better, kinder, and more sustainable one is already being done, and will continue to be done whether or not we give. The problem, however, is precisely that this is how most of us see it. We free ride off the donations of others, and tell ourselves that only the very rich need give a nontrivial portion of their income away. The irony, of course, is that we are the very rich, and if we don’t give abundantly, there’s no reason to expect that others will. The question that we have to ask ourselves, then, is what kind of world would we like to live in, and what are we willing to pay to make that world a reality. If you just try to take this ‘free riding’ element out of the equation for a moment, you may notice that living in a world that is free of abject hardship is far more important to you than many of the things that you allocate your money towards.

Somebody once told me that the answer to the question ‘How much should I give?’ is always the same: ‘More’.

11 thoughts on “Charities – the good, the bad, and the frequently misunderstood

  1. Great start, Tom. Jim Collins makes a useful observation in support of your comments on admin costs. The point is not what a sports club spends per player. What matters is how much they spend per win. (Jim Collins, “Good to Great for the Social Sector”)

  2. Tom Devlin! I would love to have a copy of your thesis, if you’re happy for me to read it (or attempt to). I’m super interested in this!
    Hope you are well.

    • Hey Em! Long time no see. Yeah that’s totally fine, I’ll send you a copy. So long as you’re not that interested in the economic theory side of things the math is actually not all that important, so you can just skim straight over it. Same with all the jargon. Let me know if anything doesn’t make sense.

  3. Love your work mate. For what it’s worth I do think it’s worth looking at fundraising expenses (alongside, as you brilliantly point out, the actual social outcomes). But as you point out the question is, not, “how much of this money have they already spend on soliciting my donation”, but “how can this money I’m giving now be used to leverage a greater number of people to give”.

    • Thanks for the feedback Andy. A few people now have suggested a more in-depth discussion of fundraising would be good, so I might write a follow up post just on that issue.

  4. This is amazing. I’m drunk on a Friday night, so it’s not going to be great commentary on my end. But I’ve been toying with donating a secular tithe to charity when I get a proper income, but I’ve been mentally non-commital. You’ve definitely helped tip me over the edge.

  5. Really interesting post Tom! its given me lots to think about. Remark 4 talks about how competition among charities is a good thing – does this require the assumption that people make rational choices (e.g. based on bang/buck) rather than making choices based on who has the best marketing? I guess I’m interested in how charities present themselves compared to what they actually do, and also how difficult a sector it is for newcomers compared to others.

    • Hey Tom. Thanks for the feedback. A few people have indicated that the nature of competition could be elaborated on, so I’m actually going to write a follow up post specifically on that issue (as well as, perhaps, a discussion of remuneration within the nonprofit sector). As a general point, though, it’s hard to give an authoritative answer re how people decide where to allocate their donations in the absence of empirical data.

      • Looking forward to that post.
        I suppose the marketing departments of larger NGOs would have that kind of data.

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