1.5 Economic Role of Nonprofits
The third sector of the United States plays an essential role in maintaining economic stability. Although hidden from the daily scrutiny of the pubic, the third sector performs many of the economic functions that the first and second sectors depend upon. The third sector is “the foundation on which a mixed economy rests” (Gassler, 1986, 16). Economic theory relies extensively on assumptions about human behavior and the constraints of the market. The third sector challenges those assumptions and operates beyond typical constraints. Robert Gassler1, an economist, discusses the role nonprofits have in our economy in terms of allocation, distribution, stabilization and environmental and systematic functions.
All businesses, government programs and nonprofit entities engage in certain allocation activities, which means they divide and set apart goods to be later distributed. There are many criteria which determine how goods are divided; typically external costs and benefits are taken into consideration. It is usually assumed that the government and firms perform the necessary allocation functions for our economy. However, it is theorized that nonprofits “provide public goods that governments cannot provide because of insufficient voter support” (O’Neill, 2003, 48). Governments are obligated to provide certain public goods, such as military defense, regardless of the number of beneficiaries; this is known as the “free-ride” phenomenon (Gaul and Borowski, 1993). There are other goods that have external benefits for minority groups of the population, such as Public Broadcast Service programming, that governments are unwilling to supply due to insufficient voter support. For-profit firms are also unlikely to produce goods for a minority group, since they would appear unprofitable. This is called the “public goods” or “government failure” theory (O’Neill, 2003, 49). Nonprofits exist to serve the unsatisfied minority who demand goods based on increased external benefits or costs. These externalities are typically deemed insignificant to neoclassical theorists.
The production of merit and demerit goods are included in the allocation actions of the economy. Closely related to the “government failure” theory is a theory of “voluntary failure” (O’Neill, 2003, 47) that explains the allocation of merit and demerit goods. Nonprofits typically provide social merit services that are deemed to be in too small of a demand to be provided by the government, such as libraries, theaters and museums. However, the government sometimes takes control over such goods and services when nonprofits experience insufficient funding, too narrow a focus on societal groups or paternalism (excess control by the wealthy). Although this could lead to the disappearance of nonprofits in such industries, nonprofits and governments often avoid this by forming alliances. The government typically provides the funds and nonprofits provide the service.
Allocation also includes the ability of entities to regulate prices, quality or quantity of goods and services through industry competition in the event of market imperfection (Gassler, 1986). Nonprofits are limited here; they can only perform regulatory functions that are subordinate to the government.
Finally, all entities can modify market determination of risk and time differentials (Gassler, 1986). Nonprofits can accomplish this by making future investments with very long payback periods, which is generally avoided by the other sectors. This allows nonprofits to take research and development risks without the obligation of a quick return on corporate investment. Whereas governments and firms operate within a market, nonprofits have the ability to bypass typical market mechanisms in order to influence allocation activities.
The distribution function is closely related to and derived from allocation actions (Gassler, 1986). Distribution consists of modifying personal endowments through certain activities. This can be accomplished by redistributing cash, but this is rarely done by small nonprofits. The effect of distributing the limited resource of cash among a large group of people would be insignificant. It can also be accomplished by redistribution in kind. This is far more popular among nonprofits, since it is easier for nonprofits to confine their distribution to a specific set of functions and to actively measure their activities.
The stabilization function stems from macroeconomic theory. Stabilization refers to activities which make it easier (or harder) for the economy to maintain an acceptable level of nation-wide economic growth (Gassler, 1986). National governments tend to be the only organizations large enough to affect the stability of an entire economy. Furthermore, nonprofits inherently contribute to destabilization. If our country experienced a negative destabilization force, such as a stock market crash, individual and corporate incomes would decrease. Nonprofits, being dependent on individual and corporate funds, would experience decreased income and diminished performance. This would intensify the overall destabilizing affect.
The neoclassical theory presented above is sufficient to explain the allocation, distribution and stabilization functions of the economy. However, the factors that create and influence assumptions cannot be readily explained by neoclassical economics. Since nonprofits have tremendous influence on the assumptions underlying the environmental and systematic economic functions, a different set of theories is needed. Feminist economics provides the different perspective that is required to understand nonprofit industry. Feminist economists have addressed the problem neoclassical theory experiences when dealing with the environmental functions of nonprofits
The environmental function consists of “the setting of the parameters economists usually hold constant in their models” (Gassler, 1986, 19). The environmental function includes three sets of assumptions. The first assumes that individual preferences are strictly concave, meaning individuals tend to choose the most-preferred opportunity. This is simply assumed to be constant and unchanging. “Economists are urged not to discuss the formation or change of preferences” (Dolfsma and Hoppe, 2003, 121). However, feminist economists question the wisdom of assuming that preferences are stable and exogenous. “Environmentally-induced changes in preferences have a major bearing on economic outcomes and hence must be the subject of study (Hewitson, 1999, 72). The “stable and constant” preferences assumption does not account for a “human experience” factor. Feminist economists contend that the changing of preferences results from the inherent long-term relationships market participants develop, such as marriage. Tastes and preferences can be weakly influenced by private sector advertising. However, to truly modify tastes, not merely brand-loyalty, nonprofits must operate independently of the market, changing the attitudes and beliefs of the population. This is accomplished as households, schools and churches influence the sociocultural identity of its members.
The second and third assumptions are rather straightforward. The second is that technology exhibits “constant returns to scale” (Gassler, 1986, 15). This means that most, but certainly not all, advances in the basic sciences happen in a nonprofit university or research setting; this is a necessary step before the innovations of the private sector can take place. The third assumption states that the economy’s stockpile of resources is constant. Nonprofit’s role here is to influence in one period the endowments of individuals and institutions in the next.
Neoclassical theory also falls short when dealing with the systematic role of nonprofits. The systematic function of the economy serves to set the conditions under which market transactions take place. This is clearly the realm of nonprofits, which can bypass typical market mechanisms and operate outside of the profit-making market. “Markets cannot be used in the process of defining tradability, since the process determines when markets are appropriate” (Gassler, 1986, 5). Like the environmental function, the systematic function is constrained by three assumptions. The first assumption is that private property rights have been determined over all economics goods and bads. The determination of what can and cannot be traded is determined primarily through law and custom. For example, the right to trade Africans as slaves was slowly abolished through the efforts of a wide range of nonprofit institutions, including churches and households.
The second assumption involves trust among buyers and sellers. Trust is established through the economic socialization of churches, schools and households. People are taught to behave honestly and to expect the same from other market participants. When trust is violated, buyer and seller often turn to a neutral third party, a nonprofit organization, to settle the dispute.
The last assumption deals with market information. It is assumed that every market participant has perfect knowledge of price and quality. However, this knowledge is not always easy to acquire. Individuals are not capable of determining the dollar value of certain goods, such as child and nursing home care. Due to the nature of these services and the clients they serve, consumers gravitate to organizations which have little incentive to cut expenses in order to maximize profit. Since nonprofits are not permitted to make profits, they appear to be the natural choice for consumers demanding these services. The reliance on nonprofits in these industries is called “contract failure” or “market failure” (O’Neill, 2003, 49). Because consumers do not posses full market information about the value of these goods and services, market equilibrium cannot be met.
Nonprofits are created for purposes not seen as traditionally “economic”, yet their activities affect the economy in ways other than simply the fact that they use up real resources in producing output. Neoclassical theory has an information gap concerning the source of the assumptions economists tend to hold constant. Human behavior is not as constant or perfect as neoclassical theorists would like to believe. The neoclassical assumption that man is a rational, selfish actor seeking to maximize profit defies the nature of nonprofit existence.
The “rational, selfish man” is based on the assumption that an individual or firm will choose from among scarce resources to maximize utility, or pleasure. This assumption, according to feminist economists, is “divested of those traits and uninvolved in those activities traditionally associated with woman” (Hewitson, 1999, 70). The feminine caring, nurturing traits that are neoclassically associated with weakness can be applied to the work of nonprofits. The neoclassical masculine traits of selfishness and autonomy are ingrained into the rigid “production-at-any-cost” (Gunn, 2004, 54) philosophies of for-profit firms. The structure derived from this “androcentric” (Hewitson, 1999, 72) neoclassical assumption tends to devalue the work of woman in the third sector while commending the achievements of men in the private sector. This is apparently because the assumptions were created and have thus far been constrained in a male-dominated and profit-seeking society. Until we can measure the value of nonprofits’ work in dollars and cents, neoclassical theory will continue to consider it insignificant. It is ironic however, that the operations of the private sector depend so heavily on the third sector to operate efficiently.
Feminist economists have developed several versions of a “gender-value-compass” (see table 1.3) that could give value to a sector of the economy that has been considered “unproductive labor” since Adam Smith coined the phrase in 1776 (O’Neill, 2002, 48). This compass balances the male (private-sector) and female (nonprofit sector) characteristics, noting negative and positive traits for each. Nonprofit organizations can adopt the gender-value perspective to give their organization worth and meaning.
“Including both masculine- and feminine-identified positive qualities…makes possible a practice that is flexible, attentive to context, humanistic, and rich as well as strong, logical, scientific and precise” (Nelson 1995, 139 in Dolfsma and Hoppe, 2003, 120)
The gender-value-compass (Table 1.3) shows that feminine, while typically thought by neoclassical economists to be incompetently weak, has the positive capability of allowing flexibility. Nonprofits are able to have far more flexible practices than large for-profit firms because they are smaller and are not constrained by profit maximization. Table 1.3 also shows that the strong, masculine characteristics can have negative connotations. Large firms, although they have a position of power and strength in our economy, can miss out on entrepreneurial opportunities due to the confinement in rigid operating practices. The ultimate goal of any organization is to “capture both the value of the for-profit model and the value system of nonprofits” (Arsenault, 1998, xiii). The gender-vale-compass makes that process slightly easier.
1 The economic role of nonprofit section is largely based on the theories presented by Robert Gassler in his 1986 book on the economics of nonprofit enterprise.