Friday, September 19, 2008

The Opportunity Cost of Philanthropy

Suppose you have some money and you want to help poor starving children. What is the best thing to do with the money? Let's consider some options.
  1. Put the money in a bank (or mutual fund or stocks or invest it in your own business), earn as much interest as possible, and watch it grow.
  2. Donate to the government.
  3. Donate to a lobbyist who will push for your favorite government policies.
  4. Burn the money.
  5. Donate to an organization that claims to feed the hungry, cloth the naked, and care for the sick, either directly or through some kind of broader economic development scheme like connecting indigenous artists with the American market. Giving money away like this is what I'm calling philanthropy.

If you've eliminated all the options except #1 and #5, than we're ready to get started. Now there are lots of kinds of philanthropy. Some people give to projects which feed starving children now, while others focus on longer-term economic development. Still others give money for the "arts" or for the environment or education for their own sake. But for simplicity I want to define the "highest philanthropic calling" to be roughly the following: To sustainably raise the level of consumption of the poorest people in the world.

How can we compare the effectiveness of options #1 and #5 as strategies for the highest philanthropic calling? This is difficult, or, more precisely, impossible, since category #5 contains such a broad range of activity. (On the surface, it might seem obvious that investing your money, as in #1, would do far more for the poor than giving it away, since investment triggers a chain reaction of job creation, economic growth, opportunities for the poor, and increasing incomes for the poor, whereas money that is given freely risks being wasted in nonprofit bureacracy or hastily consumed for the short-term alleviation of pain and suffering).

However, investment is easier to analyze than philanthropy, given the straightforward profit-seeking structure of free markets. If we can quantify the extent to which saving (saving is just another word for investment) supports the highest philanthropic calling, then we have established a lower bound on the opportunity cost of philanthropy! In other words, we can identify an alternative to philanthropy that's much better than doing nothing, and therefore possibly not a bad option if you're not sure about a good way to go about giving money away.

Here is the Freakwenter's primary research agenda for the next ten years. He will adapt a general-equilibrium micro-founded macroeconomic model of a closed economy to include three representative agents: the rich, the poor, and the altruistic rich. The rich and poor will be taken as "normal" people with no philanthropic agenda - they care only about getting richer and enjoying life. The altruistic rich will behave like the rich in every way except that they will have a variable preference for saving instead of consuming. The Freakwenter will run this model for several different types of parameter calibrations, and observe how changes in the magnitude of the preference for saving among the altruistic rich affects all other variables in the model, but in particular the economic growth rate of the poor.

If the model confirms the Freakwenter's belief that a preference for saving over consuming is an effective way of helping the poor (assuming a certain amount of political stability and lack of an excellent welfare system), then the argument could be made that people who don't completely understand the long-term effects or efficiency of donating to this or that charitable cause should think twice before depriving the world of investment by giving to charity.


Blogger davidc said...

This is an interesting idea, and may have some merit, however the sometime liberal in me demands that I write the following diatribe:

There are less convoluted ways of rationalizing greed and laziness. Effective investment requires effort quite similar to that necessary for effective philanthropy. Decide what sort of results you desire; short term relief, longer term development, etc. When you've made that determination, research the various charitable organizations, and "invest" in the promising ones. Alter your investments according to the changing performance and/or confidence in a given organization.

It's probable that selfish investment indirectly benefits those in need. Increased consumption also has a chance of providing some peripheral benefit. In any case, one doesn't earn positive karma for accidental good deeds.

I am (obviously) of the opinion that active, thoughtful, philanthropy is more beneficial to both the beneficiary and the benefactor than investment guided only by monetary gain.

11:48 AM  
Blogger My Freakwentness said...

There is nothing accidental or ungenerous about deciding to consume less so that you can save more, as long as the increase in savings is not a means of merely delaying consumption: For saving to be an act of generosity, it needs to be permanent.

Saving money is stereotypically a means storing up for future selfish consumption. However, saving—in and of itself—does not necessitate future consumption. If human nature is such that additional savings make additional future consumption inevitable, it is not too difficult to devise a way to make savings permanent and unreachable: See the Ebenezer Scrooge Fund proposal at

It is true that increasing consumption seems to stimulate the economy in the short-term. But for sustained, long-term economic growth, a moderately high rate of savings is required.

12:38 PM  

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