Should we pay nonprofit workers as much as for-profit workers?


Charity payThis blog post will tackle the perhaps controversial topic of whether those who work in the nonprofit sector should receive the same remuneration as their counterparts in for-profit roles. My short answer is no – that to some extent those who work in nonprofit roles should in fact be paid less than those in for-profit roles. However, what I hope to do is systematically lay out why the existing gap is far too large – in fact, so large that it not only penalises those who work in these roles and those disadvantaged members of our society who rely on the work of the nonprofit sector, but also that it traps the sector in a self-reinforcing cycle of underfunding and lower social impact.

Firstly, let’s tackle the question of whether or not the earnings of those in the nonprofit sector should be less than those in the for-profit sector. In economics there’s a concept known as ‘motivated agents’. In contrast to early classical economics, this theory argues that financial compensation is not the only force that drives people to work, and that there are situations in which people are in fact rewarded by the very nature of the work they do. Entrepreneurs, artists, and those who work in nonprofits are all classic examples of this. Suppose, for argument’s sake, that in the for-profit sector my work is worth $50 an hour (assume that I am willing to work for this rate, and that I get zero additional satisfaction from the job itself). Now suppose that I have an alternative job available to me in the non-profit sector that offers me $25 an hour. Should I take this job? Well it depends. Say I’m a ‘motivated agent’, and that working in a job that contributes directly to positive social outcomes is equivalent to $30 an hour to me in financial gain. Then yes, I should, because the non-profit job is effectively offering me the equivalent of $55 an hour in remuneration. So long as such people exist, the non-profit sector is able to compete in the labour market for the same pool of talent while offering lower financial remuneration. And it absolutely should make use of this fact – in the same way that for-profit firms want to keep labour costs down in order to maximise profits, the nonprofit sector should want to keep labour costs down in order to maximise the social impact it is able to generate with each dollar of donations.

Now let’s suppose our model nonprofit sector needs two employees (to keep it very simple, imagine it’s just one firm), and suppose it continues to offer $25 an hour. For argument’s sake suppose that there are three potential employees in the labour market. I can earn $50 an hour in the for-profit sector and value work in the nonprofit sector at $30 an hour, while Person X can also earn $50 per hour in the for-profit sector and values work in the nonprofit sector at $24 an hour. Person Y, however, is half as productive as myself and Person X, and so can only earn $25 in the for-profit sector; suppose that they receive no value from working the non-profit sector. In this situation, myself and Person Y take jobs in the non-profit sector, and Person X does not.

Can you see what the problem with this situation is? Let’s assume that an employee’s productivity in the for-profit sector is the same as their productivity in the nonprofit sector. Suppose myself and Person X produce 100 units of social impact per hour of work in the nonprofit sector, which implies Person Y produces 50 units of social impact. When the nonprofit sector offers a rate of $25 an hour (with a total labour cost of $50 per hour), it therefore is able to produce 150 units of social impact (this translates to 3 units of social impact for every dollar spent). If, however, the nonprofit sector had offered a rate of $26 per hour, it would have employed myself and Person X and been able to produce 200 units of social impact for a total labour cost of $52 (corresponding to roughly 4 units of social impact per dollar spent). Because this model nonprofit sector has underspent on labour, half of its workforce is competent motivated agents, while the other half are simply incompetent workers who could never have earned a higher rate in the for-profit sector anyway. By offering a greater wage the nonprofit sector would have been able to effectively compete for talented workers and ultimately achieve a greater social impact per dollar spent.

I’ve used this example, while obviously extremely simplified, to demonstrate the following logic: while the nonprofit sector should be able to pay below the market rate due to the presence of motivated agents, if it pays too little the result is a mixture of motivated agents and less competent staff, which in turn depresses the per dollar social impact of the sector

So why wouldn’t the nonprofit sector just increase wages, assuming they are rational? Unfortunately, I don’t think it’s all that easy. People give to the nonprofit sector because they value positive social outcomes (if you want more of an exploration of this issue, have a read of the other posts on my blog on this topic). In effect, then, people are ‘buying’ social impact from the nonprofit sector. If a product is lower quality, you pay less. If the nonprofit sector is not able to generate as much social impact, it receives less donations. It is therefore able to offer less financial remuneration to its staff, which in turn maintains a lower social impact from the sector. This trap is reinforced by two facts: firstly, it can be difficult for the average donor to tell when a charity has increased its social impact; secondly, donors have historically expected remuneration to be quite low in the nonprofit sector (probably because of the role that the church, which produces many highly motivated agents, played in the initial formation of the sector).

Even the most cursory glance at the numbers suggests that the nonprofit sector on the whole simply does not compete for the same talent pool as the for-profit sector. In his TED talk (which I highly recommend), social entrepreneur Dan Pallotta observes that 10 years after business school the median remuneration for a Stanford MBA graduate is $400,000. At the same time, the median remuneration for the CEO of a hunger charity in the US is roughly $80,000. Such charities would only be able to compete for those minds if there was a sufficiently large number of MBA grads that valued social impact against financial remuneration at a ratio greater than 4:1, which seems extremely unlikely. Instead, our best management minds go on to the for-profit sector.

Somehow, we as a society are okay with people making a lot of money for themselves and doing nothing to help the disadvantaged (or advancing causes such as environmental protection or cures for cancer), while those who earn a competitive salary doing good are seen as social parasites – to me, this seems very backwards. It is worth keeping this in mind next time you hear yourself or someone else complaining about the ‘administrative expenses’ of charities, rather than working out where your money can do the most good.