Arnold Kling  

On Profits vs. Non-profits

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I am curious about the intuition that people have about non-profit work. The standard intuition is that going to work for a profitable company means that you are not serving people, only the profits of the company. On the other hand, working for a non-profit means serving the community. Do I have that right?

Of course, I think that profit-seeking enterprises serve the community, also. In fact, they do it in a way that is more sustainable and more accountable. It is more sustainable, in that the value of what they produce is greater than the cost of the resources (including labor) that they use. Otherwise, they would not make a profit. However, a non-profit can very well use more resources than the value of what it produces. A profit-seeking enterprise is more accountable, in that a profit-seeking business must satisfy consumers or else go out of business. Hence, it must provide something of value to its customers. On the other hand, if a non-profit fails to provide any benefit to its customers, it still might be able to obtain grants from the government or from donors.

Is my perspective valid? If so, why is the conventional intuition so pervasive?


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COMMENTS (29 to date)
matt writes:

A couple of things...
1. Non-profit work is often about showing you care not necessarily doing actual good.
2. It has to be this way, because often non-profits are dealing with intractable problems like poverty and poor behavior. Often solutions aren't obvious, and trying to help may not lead to positive results. Should we not try? Perhaps we need to show we care, in order to eventually find something that works.
3. How does this point jibe with your intuition that private institutions should be responsible for dealing with social problems? Since those non-profit charitable institutions dealing with problems like the poor may not have good incentives to improve their services.

steve writes:

I think its just a simple case of people largely believing the ambitions and motivations of the companies founders as stated.

The for profit entrepeneur often starts a company for the purpose of making a profit with serving the community as a means to that end.

The non-profit is often started with the goal of serving some perceived need in the community with funding serving as a means to that end.

Most people don't think like an economist and don't look any deeper then the surface. They think the altruistic stance of the non-profit must be better.

Seth writes:

I think your perspective is valid. I explored this topic (less succinctly) in this blog post.

As to why the conventional wisdom is so pervasive, that's a good question. I think there are many answers. One answer is what folks perceive as the intentions of the organizations.

Our hearts are not warmed by the profit-seeking intentions of a company that might produce more social benefit as a byproduct, but are warmed by what appear to be the good intentions of a non-profit organization.

Another answer is that folks take for granted the benefits generated by profit-seeking companies.

I think another answer may be how people view profits. They don't typically see them as value created in positive sum transactions. Rather, people tend to view profits as if they were derived from rent-seeking, exploitation or extortion.

Anonymous writes:

I work at a non-profit institution. My experience tells me your perspective is valid. From what I have observed, it is the misallocation of resources created by the absence of profit and loss accounting that leads non-profit workers to believe they are engaged in some kind of noble "struggle" to provide a service market forces cannot. It is a kind of self-fulfilling prophecy. The confusion created by not being able to accurately gauge the correct amount of material or labor required to do a job, or even if the job is worth doing in the first place, is a sort of "fog of war" we in the non-profit world interpret as a feature, not a bug, of non-profit work.

Whether or not this feature is corrected by more intense management or more accurate accounting might depend on the size of the psychic benefit non-profit workers gain from considering it the nature of non-profit work, rather than an inevitable effect of the absence of profit and loss accounting.

sbanicki writes:

[Comment removed policy violations.--Econlib Ed.]

Aaron Miller writes:

I think your perspective is accurate. I also think your criticism is accurate.

The disconnect is largely caused by the fact that nonprofits generally should produce public goods, which are often hard to contain within typical market exchanges. (We can't create all public goods through taxes or pooling. That's where altruism-funded public goods come in.)

The result is a massive public trust for nonprofits, one that is often not sufficiently indoctrinated into nonprofit managers. Too many nonprofit managers make decisions to benefit their organization's welfare at the cost of social welfare. For example, one paper shows that competitive fundraising can have this effect.

Link: Nonprofit Fundraising in Competitive Donor Markets

brian writes:

In your framework, in what way do private donations to non profits and payments to profits differ? More to your point, maybe some of the intuition you describe is driven by the difference in the typical goods provided by non profits v profits. Namely perhaps non profits are more likely to provide public goods which people may perceive as doing more "service" for the community than private goods.

Kevin Bob Riste writes:

See: Hanson, Robin.

Dave writes:

The common view of non-profits being full of kind-hearted do-gooders is as laughably false as the idea that all for-profit folks are self-absorbed profiteers.

I've worked for both non-profit and for-profit companies and my experience is that I have contributed more to society in the for-profit position. I find the first commenter's thoughts on intractability interesting, but it isn't my experience that non-profits are nimble generators of innovative solutions to complicated problems.

When dealing with many social problems for-profits are unfailingly labeled evil and exploitative when providing services that poor people actually need, like access to credit, cheap products, and entry-level jobs. However, non-profits can offer essentially the same services with a veneer of altruism and "get away with it." To reword Kling's last points, one problem with non-profits are that their "customers" are funders (which are typically gov't and large institutions like United Way) rather than the people they service.

Dan Carroll writes:

Nonprofits generally address problems that have large externalities or non-financial profits (if solved) but small individual profits. In most cases, the value-added is given away. The benefits are difficult to measure by definition. Indeed, some charity work is a form of social R&D - looking for ways to solve intractible social problems.

Nonprofits are generally perceived better because of the personal sacrifice that many employees of non-profits make (i.e., lower compensation). Which is why when stories of highly paid nonprofit executives surface, they make for juicy headlines, even if those salaries are low by the standards of high level private sector executives.

I would not make the same set of observations about government-connected non-profits.

Yancey Ward writes:

People like to think well of themselves. Non-profits offer this good for sale. As far as I am concerned, people can buy whatever they wish.

Mike writes:

I think your general intuition is correct.

I don't know that I agree with your sustainability and accountability claim. Sure businesses have owners/shareholders that demand accoutability (profits). But non-profits have employees and/or board members that demand accountability (raises, increased benefits and perks, more valuable status signals).

Proft / Non-Profit is just tax status distinction. I work for an educational non-profit. When I explain the tax status difference to potential students while also explaining we charge tuition because we need to be "profitable" I get confused looks in return.

As an aside, I don't think the public choice dynamics are much different between a for-profit lobbying for a crop subsidy, versus a non-profit lobbying a contract to help the homeless.

Awarding the crop subsidy and the homeless contract will have the same predictable results too.

Alejandro writes:

People often have the basic intuition, however misguided, that economics is a zero-sum game. It follows that a company making a profit must be making it at the expense of someone else, whereas a non-profit might be genuinely helping someone else.

vinod writes:

[Comment removed for supply false email address. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

MikeDC writes:

I think there's a lot more to it.

There are a substantial number of ostensibly for-profit companies that basically live off government grants and government established, monopsonistic prices. And conversely, there are a variety of non-profits that largely or totally rely on market pricing mechanisms.

We need to separate corporate structure from market participation. We tend to focus on the former, but my guess is the latter it's more important to ask about the state of the market in question.

Shangwen writes:

You have the perspective right, but a couple of points:

1. Institutional culture matters. Many people respond to Apple as if it were a non-profit, since they seem to ascribe comparable motives to its leaders. On the other hand, few would sympathize with non-profits like the American Banking Association.

2. I once worked as the director of a non-profit (children's health). Resistance to measuring outcomes--even the softest kinds of measurement--is endemic, and when some non-profit unsurprisingly fails to eliminate poverty or hunger, they complain that the problem is multi-determined and has vast "root causes" (poverty, racism, etc.), which seems to defeat the point of the intervention. Donors and funders are surprisingly relaxed about this weakness. They seem to buy into Matt's (comment #1) belief in "just trying something", even though most non-profits are intervening in areas where there is ample empirical research that runs counter to their effots.

See Easterly, W.

dete writes:

Sometimes libertarians are so funny. It seems pretty simple to me:

There is a service that I think my community wants. If the the link between payer and beneficiary is obvious and direct, I make a for-profit enterprise. I might do it purely for profit, I might do it purely for love (a certain type of book or record store, for example), but ultimately the community gets something and I get something. Capitalism at it's finest.

But what if the service doesn't have a direct link between payer and beneficiary? I want to create a soup kitchen. I believe that there are people in the community who would want to fund such a thing (either out of altruism, or just to "keep the damned homeless out of my garbage bins"), but the direct beneficiaries can't pay for it. In this case, I create a non-for-profit. Why? Because -- by making my business formally not-for-profit -- I'm signalling to the payers that they are getting what they paid for without them having to come down to my soup kitchen and count bowls. Without having to taste the soup to see if I'm watering it down.

It's not perfect, but I think it's useful. I *could* create a for-profit soup kitchen, but I imagine most folks would be way less likely to donate to it, for a whole host of reasons (not just tax incentives).

Jeff M. writes:

It may be useful to distinguish between actual value and perceived value when suggesting for-profit ventures are more sustainable because if they didn't provide actual value they wouldn't make money.

This is not to say non-profits are more valuable. I think comparisons between particular non-profits and for-profits is more useful than trying to generalize across all of each category, because instances of both can be run in such distinct useful/useless ways.

Daublin writes:

It's worth distinguishing non-profit and volunteer. A non-profit organization, like Mike describes, is a for-profit organization that has special restrictions from the tax code. It's basically a tax dodge and otherwise it's a normal business.

A volunteer organization gets much of its income by donations, including both money and labor. Its only accountability is to its donors. Nominally, the organization is supposed to be helping some external cause, but there is little incentive for anyone involved to look too closely. Practically speaking, volunteer organizations help their donors more than their nominal benefactors. They help their donors by making them feel better, by giving them practice at a hobby, and by helping them meet other like-minded people.

Volunteer organizations tend to be nicer to hang out at that a for-profit work place. However, they're a terrible way to actually get anything done.

mike shupp writes:

I haven't seen enough of the world obviously -- I'm only in my 60's -- but I never met a person who made the profit-vs-nonprofit distinction you describe.

I HAVE met a lot of people who made distinctions between low-status workers in "business" and higher-status workers in "government service" -- the latter being policemen, firemen, soldiers, and others who risk their lives in their labor, unlike teachers and garbage collectors and DMV clerks. Note the distinction refers to fairly low level occupational ranks -- clerks rather than manufacturing executives, sergeants rather than Cabinet ministers.

I suspect this perception of "worthy employment" dates back to the middle ages. The notion that working for a non-profit organization is particularly genteel or affords high status is at best Victorian, and probably stems from the notion that such institutions were staffed by affluent do-gooders with private incomes. (Consider the many references to "visiting the poor" in Jane Austen and Charles Dickens.)

In short, these are preceptions grounded in history and sociology, which predate most of economics, and I think it very unlikely that you could argue many people out of such views.

Ted writes:

People view profit vs. non-profits in the way you speak of it because of the inferred motivations of both the organizations abstractly and their contributors. For-profit institutions are typically driven by selfishness. Non-profit companies (and their employees) are driven to succeed by some notion of servicing the community. This is just a fact. We view non-profit institutions as altruistic and caring and thus attribute the "serving the community" status (whether this is accurate or not is another discussion altogether). Our perceived motivations for actions are arguably more important in determining our perception of the actions that the actions themselves. I agree that with you it's incorrect to suggest that for-profit work isn't serving the community whereas non-profit work is, but I don't necessarily agree that for-profits are "more important" than non-profit per-say.

My general view is both for-profit and non-profit enterprises serve incredibly important functions in our world and trying to parse out who has done more or less isn't going to get us anywhere because they serve such different roles. How would I compare the social impact of the Red Cross versus Wal-Mart? They serve such radically different purposes I don't know how I could compare them.

Also, I agree accountability is less in non-profits - but this is mostly because donors don't seem to care how it's spent or just wrongly assume it's spent well. However, this doesn't necessarily mean a priori they aren't servicing the community better. A charity like Vegfam is well organized and has undoubtedly saved thousands of lives. Despite little market discipline they have contributed enormously. So, to make sweeping generalizations is unhelpful and confuses the issue. I also think it's clearly wrong that negative surplus companies can't survive -at least in the medium to short-run. Also, aren't you forgetting about externalities? When neither a producer nor consumer internalizes these costs, then the market mechanisms serves no use in disciplining these negative surplus companies. Finally, it's worth noting for-profit companies waste tons of money all-the-time (especially large ones). My favorite example is Microsoft's online activities division. It loses billions of dollars every single year, barely employs anybody - and yet the company continues to cross-subsidize it for some unknown reason (you'd have to be an idiot to believe their online division is going to turn a big profit in the near future to justify all this wasteful internal subsidy). You see this wastefulness is almost every major corporation, but Microsoft's is the most absurd because they could just close it up tomorrow with almost no adjustment costs.

Brad writes:

1) For-profits have profits; non-profits have surplus.
2) Non-profits are tax-exempt; for-profits pay taxes.
3) Non-profits can collect charitable donations.
4) Non-profits raise money also by municipal bonds.
5) Non-profits have to file 990s to the IRS and show charitable activities.
6) Non-profits and for-profits differ in what political activities they can engage in.
7) For-profits can sell shares.
8) Some large organizations, like hospitals, might be composed of several companies, some for-profit, some non-profit.

Alexandra Thorn writes:

I'm not an economist, and I may be misreading what you're trying to say, but it sounds to me like your model misrepresents what a non-profit is.

According to Wikipedia: "A nonprofit organization (abbreviated as NPO, also known as a not-for-profit organization) is an organization that does not distribute its surplus funds to owners or shareholders, but instead uses them to help pursue its goals." (Permanent link: http://en.wikipedia.org/w/index.php?title=Nonprofit_organization&oldid=436947989)

That is to say, the definition of a non-profit has nothing to do with charity or grants, but simply a question of what happens to revenues: To qualify as a non-profit company, any surplus revenue must either 1) go into employee salaries, 2) be used to reduce the price of the product for the consumer, or 3) be directly reinvested in production. In a for-profit company, some of the revenue goes to the owners as well. So as far as I can tell, both are accountable to the consumer, but the for-profit company is also accountable to the stockholders. In order for a profit company to compete with a non-profit, it might need to be more efficient, but I don't see why this efficiency would benefit the consumer.

rpl writes:

Arnold,

I think that you are using the term "non-profit" where you mean "charity". However, on the chance that you really do mean "non-profit", here is a question for you: Which of the following organizations provides more effective delivery of electricity in the Washington, DC area? Novec (non-profit) or Pepco (for-profit)? Which one is more accountable? (I'll punt on the issue of "sustainable," since I don't know what you mean by that.)

Having been a long-time customer of Novec (and having heard the Pepco horror stories), I believe it wins on both counts.

John writes:

In general I do not think your intuition is correct.

I do think one can find examples for any of the positions but in general think that the non-profit form or organization is just as good at delivering social needs efficiently as a for-profit. The two forms setup different incentive structures and each is better suited for certain settings.

There was an old article about hospitals being non-profits but generally owned by a group of practicing physicians. Why? It's more efficient for the hospital not to act in ways that capture any of the surplus, allowing the owners to capture the value. An analogy might be that of successive monopoly, vertical integration will actually increase the total surplus by avoiding the dead weight loss of the transaction between the monopolist.

As someone else pointed out, sometimes and return to investors/owners will not be a pecuniary form. Charity might be a case here. For profit simply makes no sense here.

Last, a comparison between mutual (a form of non-profit even if not qualifying for special tax treatment) and for profit savings banks shows that the "non-profit" for manages risk better for it's depositor/owners.

PrometheeFeu writes:

I think non-profits are most useful when they either provide public goods or perform voluntary redistribution. (Neither of which are profit generating) In the case of voluntary redistribution, a common argument made by economists is that you might as well work for an hour and give that money to the people who need it. However, that is not necessarily the case. I definitely have increasing marginal costs to doing the same thing. So, if you want me to work for another hour after my work week, I would normally only do it for $21 per hour. But, because I'm such a nice guy, I do it anyways and get my regular $20 which I donate to an association. That's $1 of value that is destroyed. Now let's say instead I go and volunteer my time. Well, I may not like manual labor much, but the first 2-3 hours every once in a while are kind of fun and I would be willing to do them for $1 per hour. Now, the work that I have done is only worth $6 per hour and so the association is getting only $6 worth of stuff, but the total wealth created is $5. So volunteering can make sense because sometimes it creates wealth while working followed by a donation can destroy wealth.

Ken Voytek writes:

I would suggest that folks read the book by Peter Frumkin, On Being Nonprofit (2002) Boston, MA: Harvard University Press. The distinctions being drawn seem to reflect the hollow and meaningless conversations and debate between W Heller and M Friedman in the 1960s. Alternatively, there are several reasons why the nonprofit sector exists including work done by Les Salamon, Burt Weisbrod, Hansmann, and Rose-Ackerman. I am not sure what you are trying to get at with this post.
Good luck!

Jordi writes:

Ahem. Don't you, sir, work for a non-profit? What was your motivation? The site says Liberty Fund is a "private foundation." Sounds like a standard 501 from the tax code, a non-profit.

Among other issues your comments raise that need greater exploration is the utter inadequacy of talking about non-profits as a group. Non-profit is simply a legal designation and does not get at the core economic, social, or political capabilities and functions of non-profits which range from think tanks to the red cross, from churches to micro-finance organizations to bakeries to IKEA. Yes, IKEA is a non-profit, but more as an example of lax laws and oversight than anything else.

So, it is a flawed premise to even start your discussion. Let's say you meant, why do people assume that non-profts with explicit missions to serve some group of needy or under-served population are more community oriented than for-profit firms that provide a good or service in a marketplace?

Because more often than not, that work is directly serving a community, and moreover, those who give or work for the non-profit derive more value personally from the work they do than the cost to them of labor and effort. Real people, as opposed to homo economicus, have multiple identities and hence motivations.

You are right in your implied critique that some non-profits could be more efficient in their resource use. There may also be cases of people attracted to that work because they are thwarted in efforts to work in more competitive labor markets.

But nuances cut both ways. Not all corporations are generating profit through meeting community needs. Some profitability is rent seeking or expropriation from stakeholders.

Rajeev writes:

So long as the non-profit is entirely voluntary, I don't think you are correct. The intended beneficiaries are better off because nobody is compelling them to consume the output of the non-profit. The employees are better off because they are not compelled to work for the non-profit. The difference between the non-profit and the profit is only that the goods produced are paid for by the donors; there are two groups of people who "consume" the output of the non-profit: the intended beneficiaries, and the donors (who gain utility from the feeling of having done something).
In a free market, applying revealed preference, a non-profit is the best possible use of the time and money of everyone involved.

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