Economic Problems of Charity

Economic Problems of Charity
by Joseph Rowlands

One of the unintended benefits of a free market is the way the price system creates efficiency in the production of goods and services. Businesses seek to gain profits, and they can do so only if they can sell a product for more than it cost to produce. Products that can't sell for more than the cost will be discontinued. Products that sell for significantly more than the cost will earn a profit that attracts others to compete for that market. Inefficient uses of resources, measured by a lack of profitability, will whither away as very efficient uses of resources will grow quickly.

The fundamental reason why this works is that the consumers have limited purchasing capability so they must select between the various products. They use their own needs and desires to determine which of the myriad options available to them best serves their purposes. Through this process of selection and exchange, some products will sell better than others. Desirable products will be more profitable and less desirable products will be less profitable. Businesses can then shift from worse products to better products.

The consumer selection is the key to efficiency. Every product in the marketplace may be desired to some extent by the consumers, but their limited supply of money requires them to choose the products that best satisfy their needs. Without this selection, there would be no way for economic efficiency to exist. If consumers could print their own money and buy anything and everything they want, prices would no longer communicate any information. Every business would be profitable. No matter how high they raised their prices, consumers could purchase it without thought or concern.

Without the need for selecting, economic efficiency couldn't exist. A better use of resources implies that some uses are more desirable than others. If all products were consumed with equal fervor, there would be no way to determine which products are better.

This brings us to the problem of charities. Charities provide their resources to anyone willing who fits the specified criteria. The benefits provided are free of charge. This means the recipient of the charity performs no act of selection. They simply receive the goods. If there are many charitable groups, a recipient does not have to choose between them.

This leads to the question of how a charity can determine if it is efficiently using resources. Since there is no selection process by the 'consumer', how does one determine that one charity is utilizing the resources better than another? If you were going to select a charity to give to, can you tell which one is better?

One method used is to look at how many dollars of a donation actually make it to the final beneficiaries. If the charity consumers half of the money itself for organizational overhead, this might appear to be a waste of resources. This kind of method is flawed, though. It doesn't look at the actual results of the charitable giving. It assumes that every dollar given is equal to every dollar given by other charities. There's a complete dismissal of the effectiveness of the charity.

A different method of measuring efficiency could be tried. In a communist country, the price system may be broken but other methods of determining efficiency can be used. If people are starving, a central planner could decide that more food is needed and less entertainment. The people may not be able to select, but a central planner could do it. He may have all kinds of metrics for what he imagines efficiency to be.

Charities can do the same. Instead of relying on selection and a price system, they can try to determine the efficiency of the money spent by measuring the results in terms of their own set of values. They can see how many people are helped, or how poor the people are, how much food was provided, or how much medical care was made available.

The problem with this approach is the same as the problem of central planning. It substitutes the central planner's values for the values of the recipient. Take the case of food stamps. Although not technically a charity since it is a government forced program, it attempts to substitute the government's values for the recipients. Instead of providing cash so the recipient can make his own choices and optimize accordingly, the government attempts to limit his options so he utilizes the charity in a way that the government approves of.

Even if cash is provided, allowing the recipients to make optimal uses of it, there is still a question about overall efficiency. Was the right amount of money provided to the recipients? Should there have been strings attached? Should the money have been provided to other recipients? Should money have been spent on preventative measures?

A different approach claims that the consumers of the charity are not really the beneficiaries, but the donors. Since donors select which charity to give to, the selection process still exists. The charities are providing a service to the donors, and that should be the measure of efficiency.

It's not clear what kind of efficiency a focus on donors can create. If the goal is simply to make them feel good about themselves, with no actual concerns for the recipients of the charity, than this can work. The product is good feelings and the customer is the donor. The recipient of the charity is at best secondary. He may be helped, but only so far as it efficiently makes the donor feel good. The efficient charity would be one that maximize benefits while minimizing costs. In this case, that means maximizing the good feelings of the donors while minimizing the actual resources provided to the recipients.

This is probably not what people would hope for in a charity. A preferable view of efficiency would be to maximize the benefits provides to the recipients while minimizing the costs. They should be getting the most out of every dollar. But when the selection process is performed only by the donors, it is natural that the efficiency will be measured by their benefits, and not the benefits to the recipients.

In practice this may not be as bad as it sounds. The best way to make a donor feel good may be to prove how significant the results of the charity are. There is an overlap of interests. The donor will feel good if his donation makes a real difference.

There is an additional problem though. If the donor's good feelings are the measure of efficiency, then the criteria of success is emotional. Charities with emotionally satisfying results will be more popular. This is true even if there are potential recipients that would benefit more from the charity.

The concept of efficiency with charities is tough. A charity can consume an infinite amount of resources and have an unending number of potential recipients. Since the donations are given away, it operates at a loss by definition. This normal indicator that a business is running inefficiently is a defining feature of a charity.

It becomes more complicated when trying to compare a charity with businesses. Is money better donated to a charity or invested in a business. Among businesses, the answer is clear. The more profitable company is the more efficient use of the money. But it is impossible to compare a charity with a business by this standard, since the charity seeks to behave like an unsuccessful business by running at a loss.

In practice, charities and business are viewed as two completely separate and unrelated endeavors, without any method of comparing or contrasting them. The goals are viewed as entirely different. Charities are viewed as aimed at helping others, while business are usually viewed as seeking personal benefit. This is a faulty description. In reality, both businesses and charities seek to provide value to others. A business seeks to create products or services that customers want and are willing to exchange for, with the goal of creating a mutually beneficial exchange. Charities skip the mutually beneficial exchange and instead seek donors who are willing to make up the difference.

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