The Economics of Nonprofits

By: Leo Wang

The modern, capitalist economy that we know of today is predominantly driven by private, for-profit firms. It is based on transactional, self-interested relationships between consumers and producers who seek no other goal other than to fulfill their own selfish needs. While this objective and traditional characterization is indeed accurate, it neglects the expanding role of an increasingly influential group of firms: non-profit organizations. Not only do nonprofits like Amnesty International, Red Cross, UNICEF, and Covenant House further virtuous societal goals, but also benefit the economy in unique ways researchers far too often overlook. How do these entities operate differently? What economic roles do they serve?

Driving Growth

One trend has become strikingly obvious: nonprofits are growing and becoming more indispensable to the areas they serve. Although specific organizations and sectors differ in their operations, they all seem to 1) provide millions of attractive job opportunities and 2) inject significant spendings into local economies.

In the latest 2016 data, the nonprofit sector accounted for a remarkable 12.3 million jobs and 10.2 percent of private-sector employment. This makes them the third-largest employer in the US, behind only retail trade and food services. In the Northeast and Mid-Atlantic regions — where most nonprofits are concentrated — the sector controls as much as 26 and 17.7 percent of private employment in Washington DC and New York, respectively. However, beyond the quantity of opportunities provided, the nonprofit sector also prides itself on the quality of them. According to research conducted by John Hopkins University, nonprofit organizations, on average, pay higher wages than their for-profit counterparts. For example, across the three most popular nonprofit fields — health care, social assistance, and education — employees are, respectively, paid 24, 55, and 45 percent more than those working at a for-profit firm. While these findings will differentiate based on other external factors like region and field, they represent a trend across nonprofits that should be applauded. Moreover, considering how essential the aforementioned fields are, we can reasonably expect the employment share and payroll of nonprofits to further expand in the foreseeable future.

Nonprofit organizations’ spending also generates valuable economic activity. According to the National Council of Nonprofits, the sector spends an impressive $1 trillion annually on a variety of goods and services. This provides a positive externality to local economies — a phenomenon that persists even during recessions like the 2008 housing crisis when many for-profit firms went bankrupt, but nonprofits remained financially resilient thanks to accessible subsidies and favorable unemployment benefits. Lastly, with recent indicators reflecting the total number of registered nonprofits and overall hours volunteered still growing at a remarkably consistent 1–2% every year, communities can stay optimistic about their long term economic outlook.

Causes of Success

What is equally important to identifying nonprofits’ success is grasping the precise causes. Economic theories regarding nonprofits have emerged from as early as the 1970s. Yet, there is rarely a consensus on why these humanitarian organizations prevail. Here are three digestible academic analyses explaining the trend:

1. The first reason for the sector’s visible success is attributed to favorable public policy. Thanks to both consistent public support for philanthropy as well as historically being a bipartisan issue, nonprofits can easily achieve federal tax-exempt status by applying to the Internal Revenue Service (IRS). Depending on the state and county, organizations can also potentially seek exemptions from sales or property taxes. Even during economic downturns, these rules rarely suffer from political volatility. At times, they allow organizations to outperform for-profit firms on traditional growth and impact metrics.
2. A second (and more intrinsic) cause to the sector’s success has to do with Weisbrod’s public good theory, which views nonprofits like the American YMCA, Salvation Army, and United Way as “private producers of public goods.” Thus, because the services and goods they provide typically are price inelastic, non-profit organizations can usually perform well in the long-run. This is in addition to 1) their ability to run more efficiently than government services and 2) serve the “residual unsatisfied demand for [citizens] whose taste for such [public] goods is greater than the median.”
3. However, Weisbrod’s theory fails to answer two questions: 1) what about (most) nonprofits who provide private goods, and 2) why can’t for-profits satisfy the residual demand? This leads to another popular economic theory known as the contract failure theory, which, in short, suggests that nonprofits are trusted by citizens more so than proprietary firms due to the latter’s image as profit-driven, and therefore, exploitative. This also explains why nonprofits tend to primarily succeed in fields like healthcare, education, and social assistance, where there are issues of information asymmetry that lead to distrust among consumers.

In a society where citizens are becoming more socially conscious than ever before, the nonprofit sector will continue to grow at unprecedented rates. As a result, the importance of insightful research on the nonprofit scene and its future will also be more important than ever before. Moving forward, additional discussion and research is, without a doubt, required to predict the economy of the future.