Legal Commentary

I've started a few blog posts on non-profits and politics, but it's hard to get far into that swamp before you end up asking the question, "Hey, what's the point of having these non-profits around, anyway?"  So maybe it makes more sense to start at that end.  The classic economic account, per Henry Hansmann, is that some firms must find a device for credibly signaling that they will not shirk.  For example, since no one can tell easily whether health care is of high or low quality, customers will be reluctant to pay for it unless they have some guarantee the hospital won't cut corners in order to maximize revenues.  So non-profit status is a commitment device for providers of credence goods.  Since the pledge makes it hard to raise capital, these goods can only be provided if they come with a subsidy.

Recently, Malani and Posner have cast some doubt on Hansmann's story by pointing out that many non-profits seem uninterested in advertising their non-profit status.  They then leverage this insight into a claim that the subsidy for charitable works should be open to for-profit firms.  One could quibble with Malani & Posner's premise here.  For example, their big example is hospitals, but it may be that hospitals were overwhelmingly non-profit for so long that customers now assume they are for-profit, or that hospitals choose names, like "City Hospital" or "University Hospital" or "St. Jude's" that themselves signal a commitment to health care over profit. 

In any event, there are a couple of other strong economic justifications for the non-profit sector, and I think they both demand that subsidy recipients be non-profits.  Neither would be undermined by the Posner/Malani claim that non-profits do not signal their status.  Both are, like Hansmann, market failure stories.  The first is a coordination problem. 

What do I mean, coordination problem?  Well, as Acemoglu et al. point out in their neat LEO piece from last year, "Incentives in Markets, Firms, and Governments," there are times that a firm would actually prefer that the incentives it offers its employees be low-powered -- that is, produce only weak motivation.  Their key example is the Freakonomics tale of teacher testing -- give teachers strong reasons to improve test scores, and they teach to the test or cheat.   This "bad" effort in response to incentives may crowd out or swamp any beneficial effects from increasing "good" effort.   

Here's the problem (as I see it; Acemoglu et al. are a little sketchy on this part).  It's hard for a firm acting alone to offer only low-powered incentives.  If my rivals can offer a share of profits, I'm likely to be outbid for the best talent; high performers will want to get large rewards for doing better than others, so that my low-powered compensation scheme selects for workers who see themselves as less able.   In order for anyone in the industry to offer low-powered incentives, they all have to commit to that compensation scheme. 

The U.S. scheme for subsidizing and regulating the non-profit sector could be a way of getting to that result: a whole industry committed to low-powered (e.g., not profit-based) compensation.  And, as it turns out, the sectors where this tactic is necessary look a lot like Hansmann's description of what should be a non-profit, because a key component of the "bad" incentives dilemma is that we're trying to produce goods where the quality is hard to measure, so we have to use imperfect incentive schemes.

Is this making sense to anyone so far?