Tuesday, March 11, 2008

Economics of Philanthropy

Americans gave $295 billion to charity in 2006, equal to 2.2 % GDP, up from about 1.8 % from the mid-70s to the mid-’90s, according to the Center on Philanthropy at Indiana University. Today the rich and the super rich have been joined by the regular citizens. According to the Urban Institute, Americans devote about 2 percent of their after-tax income each year to charitable donations. According to another non-profit, Giving USA, these individual contributions totaled $199 billion in 2005.

Traditional philanthropists were those rich and super rich who wrote cheques and remained passive donors to some cause or agency. They knew that they were often better at providing capital than doing actual social-service work. Therefore they felt that it was often best to give their donations to high-quality non-profits and then trust them to spend the money wisely and effectively. They also believed that it was not possible to measure the outcomes of their contributions in any tangible manner. However, today philanthopists and charitable foundations no longer give plain donations, they provide financial resources designed to achieve social aims—and then they make sure that the recipient organizations achieve them. Most philanthropy still comes in the form of small gifts, but there is also a growing group of donors, like Bill and Melinda Gates, who are interested in bringing some of the quantitative rigor of big business to philanthropy.

Traditional philanthropy also focussed only on the major and high profile social causes, while modern philanthropy has diversified to help small, niche and low-profile causes. Further, traditionally only the large and high profile non-profit organizations have received the massive donations, while the small, low profile NGOS have been starved off resources. This too is changing as the new breed of philanthropists are not averse to donating to dedicated NGOs espousing specific causes.

Further, the huge billions donated by the new breed of the high profile, superstar philanthropists like Bill Gates and Warren Buffet may actually be having the effect of triggering off a cascade of similar contributions by other billionaires. These new philanthropists have gained widespread respect by their donations and have set a benchmark for such services and generated a wave of social peer pressure for others to emulate.

Unlike the private sector which is constrained by profit and government sector that is limited by a need to maintain political consensus, the non profit sector has the freedom to operate without the need for consensus or profit. It however has to remain wary of the one element that is responsible for the loss of efficiency of agencies in both government and private sector, and is present in the non profit sector too - bureaucracy!

With the growing size of philanthropic donations, it is important that the not-for-profit sector develop institutions and systems that make them competitive and efficient in mobilizing and spending the received donations. There is an immediate need to develop mechanisms that bring in more accountability and transparency to the way non profit agencies work and how their internal administration and processes operate. Many questions will have to be answered. How are donations mobilized and spent? How are spending decisions are made from a bouquet of options? How is the information assymetry bridged and resources allocated efficiently across the numerous, competing agencies? How do we ensure that there is full bang for the buck?

Henry Blodget has a list of prescriptions for making the non profit sector more creative, competitive and well funded. He argues for an arrangement that addresses "social problems the way venture capitalists and entrepreneurs attacked business problems—with hands-on, we're-in-this-together, failure-isn't-an-option partnerships between investors and investees." The emerging breed of Venture Philanthropists, that seeks to provide venture capital to philanthropic causes. These venture philanthropists seek to provide gap funding, longer-term capital commitments, strategic advice, and professional relationship to small and local non profits that miss out on donations from the major sources.

The incentives driving charitable donations and the different strategies to mobilize these contributions have been widely researched. David Leonhardt chronicles the pioneering field studies of John List and Dean Karlan, profesors at Yale and University of Chicago, on understanding why people donate money. They conducted experiments on matching gifts, which were made conditional on others matching the donation by a specific multiple. A matching gift effectively reduces the cost of making a donation. Without a match, you would have to spend $400 to make your favorite charity $400 richer. With a three-to-one match in place, it would cost you only $100 to add $400 to the charity’s coffers. But experiments revealed that while donors responded more to match offers, they were indifferent to the match multiple. That was surprising, because a larger match is effectively a deeper discount on a person’s gift.

List and David Reiley of the University of Arizona, while raising money for a new environmental research center, wrote letters to potential donors saying that the university wanted to buy computers for the center. They varied the amount of money that supposedly had already been raised. In some letters, they put the amount in hand at $2,000, out of the $3,000 they needed for a given computer; in others, they said they had raised only $300 and still needed $2,700. The results were overwhelming. The more upfront money the Center claimed to have on hand, the more additional money it raised. It is clear that people reasoned that it was more useful to give money to causes where the additional requirement was smaller.

In another experiment using data from sports card shows, List showed that traders became more rational — less emotionally tied to the cards they owned — as they accumulated more experience. This study seemed to suggest that people are rational and that markets work. He also dicovered that people gave more money when they were told their donation made them eligible for a prize, and they gave more the next time they were asked too.

Rachel Croson, an economist at the University of Texas at Dallas conducted experiments about fund raising through radio stations and discovered certain contextual nuances. She and her co-author, Jen Shang, conducted an experiment in which listeners who called to make a pledge were casually told that another caller had made a gift. When the donor was told about a relatively low donation by another caller, they responded with amuch higher donation, having apparently been inspired, or shamed, into being more generous. However, when the donar was told about a relatively high donation (say $1000) by another caller, they generally ignored it and tended to pledge a smaller amount, thinking as Carson reasoned, "That couldn’t possibly be me.”

Steve Landsburg and Tim Harford have argued that donors are more interested in feeling good than doing good. A truly selfless donor would bite the bullet and put his entire donation behind one cause which he or she strongly believes in. But in the real world, it is observed that people generally tend to distribute their donations among a number of causes, thereby giving each cause too little to make any meaningful difference. All these studies prove that there is more to charity than altruism and give an important glimpse of some of the incentives that drive our charitable impulses.

Steve Levitt and Steve Dubner argue about the need to put in place for-profit sector type incentives in the non profit sector, so as to expand it and increase its efficiency. They drive home the importance of running charities as businesses by highlighting two examples. Smile Train, which performs free cleft-repair surgery for poor children around the world, started training local doctors rather than flying in U.S. surgeons; this has helped make Smile Train one of the most productive charities, dollar-for-deed, in the world. The second philanthropy, proposed by a world-class poker player, wants to create a $10 billion “cure cancer” prize with a hitch: a cash dividend paid to the people who donate the $10 billion.

It has been estimated that religious organizations receive something like 60 percent of all the individual giving that occurs in the US. The figure will be much higher, probably more than 90% in India. That there is an enormous potential for mobilizing donations in India is borne out by the huge amounts collected in the temple hundis across the country. And fortunately there is enough evidence to suggest that such donations are growing at breakneck pace. The challenge is to put in place institutional arrangements and policies that stimulate people's charitable urges and make them support social causes. This will help rope in the non profit sector as an important partner with the public and private sectors in the development process.

Update 1 (25/7/2010)

Andreas Lange and Andrew Stocking find that reducing the minimum donation threshold did not lead to more subjects donating,but to lower average donations; that by framing the reduction as a special discount the reduction in conditional contributions can be offset by attracting more donors. Further, a charity that requires a larger donation to become a member appears to be signaling that it is a higher quality charity and thus membership has a higher value to the individual.

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