Disclaimer: This is adapted from a post on my blog, Empiricism. I’m not an economist and I'm new to EA, so this may overlook prior work that applies market design theory to philanthropy. Comments, suggestions, references, etc. would be very welcome!
Market Design Meets Effective Altruism
There are over 1.5 million nonprofit organizations in the United States alone. Faced with so many choices, how do donors find the “right” nonprofit to support? Might there be better and more efficient ways for donors to identify organizations that are doing great work on causes that they care about? Market design theory provides some insights into how the philanthropy donation market can be improved, and, in particular, how the EA community could shape philanthropy markets to steer more money to the most effective causes.
This is a long-ish post, so here are the take-home messages:
- Viewed through the lens of market design theory, philanthropy markets are very inefficient.
- New marketplaces like GiveWell are more efficient niches within the broader market.
- Individual cause preferences play a huge role in what organizations donors choose to support, but EA focuses on just a few cause areas.
- Organizations in new cause areas (such as education) may be close to meeting rigorous efficacy standards that would allow them to be listed by GiveWell.
- Large donors could adopt a “market shaping” strategy to help more organizations in new cause areas become highly effective.
- Market shaping is a highly leveraged strategy for hits-based giving that could help broaden the appeal of EA and thus grow the EA community.
Here’s an analogy that may be helpful: in the for-profit space, VCs are looking for a liquidity event or an exit to realize return on their investment. An IPO is one such event in which a business goes public and becomes accessible to retail investors. Achieving the highly effective label and being listed by GiveWell is the nonprofit equivalent of an IPO.
The Nobel laureate economist Alvin Roth identifies three key features of properly-functioning markets:
- Thickness: the market needs enough buyers (donors) and sellers (nonprofits) that they can search for matches that work for both parties.
- Safety: both buyers and sellers need to feel confident enough to share relevant and accurate information related to the transaction. In the case of philanthropy, donors are particularly interested in how their contributions are being used and what impact their donations have.
- Lack of congestion: when markets are thick, it can take a lot of time and effort for buyers and sellers to find each other and evaluate each other in order to transact. Congestion makes markets slow and inefficient.
Judged by these features, the overall philanthropy market looks to be thick, not particularly safe, and very congested.
- Thickness: Donors have a plethora of different organizations to choose from.
- Safety: In most cases, it’s impossible for donors to know exactly how their funds are used and what impact those funds have.
- Congestion: Due to high thickness and low safety, donors need to spend a lot of time finding worthy causes and many nonprofits spend heavily on development in order to bring in donations.
A Search Problem: How Donors Navigate the Current Market
Not all donors use the same approach to choose the organizations they support. That said, research and lived experience reveal certain patterns. Donors:
- Narrow their search by focusing on cause areas that they prefer. Personal and demographic traits (such as empathy, gender, age, and income level) influence donors’ cause preferences.
- Prioritize organizations to which they are personally connected. Knowing someone in the organization and volunteering for the organization are both associated with the choice to give.
- Decide to give in order to conform with group norms. Giving is more likely when friends, community members, and family are also involved in the cause.
These seem like reasonable strategies to guide donation choices and many donors are perfectly happy with the organizations they support. However, we can’t conclude that the market is efficient just because some donors are satisfied. The success of organizations like Bridgespan, Charity Navigator, and GiveWell (all of which help donors navigate a low-safety market) suggests that there is room for improvement.
Case Study: The GiveWell Marketplace
GiveWell is a small marketplace that has very different features from the broader philanthropy market. The GiveWell team rigorously evaluates charities to determine how much good they can do with each additional dollar they receive. GiveWell only recommends a handful of nonprofits that are highly effective.
Let’s look at GiveWell in terms of market design features:
- Safety is prioritized, with donors knowing exactly how their money is used and what impact it has.
- Congestion is minimized. Donors have a few highly effective options to choose from. Because GiveWell funnels donors directly to its recommended charities, those nonprofits don’t have to spend a lot of money on fundraising.
- Thickness is not prioritized. In fact the marketplace is quite thin. There aren’t many GiveWell-recommended charities, which means donors interested in other causes still have to search the broader philanthropy market for charities that fit their preferences.
Benefits for Donors
It used to be the case that only the biggest philanthropists (such as the Gates Foundation) had the resources to evaluate nonprofits and determine where to invest to maximize impact. Now that GiveWell exists, even small donors can invest confidently in highly effective charities. By providing market access to many small donors, this frees up large donors to support promising nonprofits that haven’t yet met GiveWell’s high standards. By increasing safety and drastically cutting congestion, GiveWell brings more market-like dynamics into a small segment of the philanthropy market.
The IPO analogy is useful here: VCs have the resources to evaluate small private companies and make high-risk investments. A small fraction of VC-backed startups eventually IPO, at which point retail investors can buy in. In the same sense, venture philanthropists can make many high-risk investments. Only a handful of these investments eventually achieve the highly effective label and become a preferred choice for “retail donors.”
Benefits for Nonprofits
It’s well established that many nonprofits struggle to get funding to support their overhead and operations. To keep the lights on, they are constantly fundraising for the next new initiative. GiveWell breaks this vicious cycle: most of the GiveWell charities focus on executing just one program extremely well. As a result, GiveWell charities behave a bit more like for-profit enterprises: they make a product (lives saved or improved), and additional donations just go toward making more of that product.
This approach is not tractable for most nonprofits. To return to the IPO analogy, most businesses aren’t listed on public markets and never will be. IPOs only make sense for organizations with scalable business models, such as direct-to-consumer tech companies. Aside from Wikipedia, there don’t seem to be many highly scaled tech nonprofits that focus on doing just one thing extremely well. It’s interesting to imagine a future in which tech nonprofits have enough funding to achieve economies of scale comparable to what we see in for-profit tech.
Extending the GiveWell Model
GiveWell provides donors with a limited set of choices and causes: it’s not a particularly thick marketplace. If donors had more highly effective nonprofits to choose from, they’d be more likely to find and donate to organizations that match their cause preferences. This suggests a different strategy for nonprofit growth: funders can seek out projects that have high potential to become recommended by GiveWell but need additional evidence (and programmatic improvements) to make the cut. Even if many of these projects fail, the few that succeed in being listed by GiveWell will have forged a new pathway to sustainability. Charity Entrepreneurship and the GiveWell incubation grants program both look to have this type of market shaping strategy.
Gaps and Predictions
The central premise of this piece is that the philanthropy donation market is rather inefficient (mostly by virtue of its congestion and low safety) and therefore there is significant room for improvement. This premise is disputed and it’s difficult to find robust academic research on the subject. However we can make two testable predictions that would indicate whether this premise is true:
- Some people donate less than they would like to because the market is inefficient. Qualitative research on why people do not donate might provide some evidence for this prediction.
- When they find efficient marketplaces within the broader market, donors give more. Quantitative research (for example, looking at the percentage of income given before and after donors start to use GiveWell) could provide evidence that this is happening.
In other words, improving efficiency in the philanthropy market isn’t a zero-sum game. A better market could catalyze more donations and broader participation without undercutting nonprofits who are doing well in the current system.