more thoughts on social enterprises

There are four things that at root explain the persistent poverty that social enterprises seek to address: (1) loss aversion (2) credit constraints (3) what I refer to as contigent profitability and (4) high transactions costs. Poverty is both the cause and a consquences of each one of these. Consider first loss aversion. However much a gain in earnings might mean to a poor family, the fact of the matter is that if potential losses are substantial this family, because of its poverty, cannot afford to gamble. Loss aversion means that even if such a family were able to experiment (or even if the family concerned were otherwise quite comfortable with the notion of gambling) they would still sit back and wait, “leaving well enough alone”. Of course, the poverty of poor families also sharply limits their ability to act. By definition, one’s own resources are limited if one is poor and credit is not easily had as the fears of the poor are compounded by creditor's lack of faith in their ability to honor obligations. Contigent profitability is simply a term I have created that is meant to capture the fact that the expected payoffs of any undertaking are often dependent on a number of significant factors outside the invididual family’s control. For example, the less faith poor families have in job opportunities appearing after investing in education or the less confident they might be that a reliable supply of inputs would be available to continue to operate one's own business the less beneficial activity will take place. Even if the poor had no real reason to be particularly loss averse and even if credit were readily available on reasonable terms this would be true. Paul Polak in his book Out of Poverty discusses his organization IDE's (International Development Enterprises) first project. This project involved helping refugee blacksmiths in Somalia build and sell donkey carts to other Somali refugees. Absent Polak’s realizing that tires would frequently be in need of repair and his efforts to bring tire patch kits and lug wrenches (inexpensive lower quality ones) all the way from Nairobi back to Somalia , the initial efforts of blacksmiths would have been far less successful. (Polak, p. 65) In essence the complementary investment and activity of others, as it limits the size of potential losses and raises the potential payoff of any investment, tips the scales in favor of action rather than inaction. There is finally a myriad of things that together combine to create the fourth factor contributing to persistent poverty: high transaction costs. To begin with, individual transactions the poor carry out are small . This means that if, for some reason, a given trade is unsatisfactory there is a high chance that the costs to an injured party of making a legal case against the offender will often far outweigh the benefits. Also the very contingent nature of economic activity just discussed and the large number of individuals involved means that not only is the enforcment of contracts costly but so too would be writing-up such contracts . Add to all of this low levels of education and poor infrastructure and it should be easy to understand that high trasanction costs serve as barriers to the identification as well as the pursuit of opportunities. In essence social entrepreneurs are involved in trying to break the vicious circle that the preceding four factors create. This of course begs the question as to how social entrepreneurs addressing such questions differ from other non-profits or government agencies devoted to attacking the same problems. Some see the key difference as being due to better organization and the sharper focus on results that social entrepreneurs have. Some equate social entrepreneurship with being for-benefit organizations that are completely self-sufficient. What is curious about the field of social entrepreneurship is how wide the range of definitions in use is. This then means that what might pass muster as a social enterprise to some may not at all qualify if an alternative definition were to be employed. What one might consider social enterprise is to another a nonprofit or what is labelled by one person a for-profit with a charitable bent becomes in the eyes of another a social entrepreneur. An attempt at a definition: The word entrepreneur comes from the French entrependre meaning to undertake (as in to undertake a challenging task). A social entrepreneur then is an individual willing and able to undertake challenges (either the challenge of pursuing advantages of opportunities as they appear or warding off threats such as finding and continuing to attract resources and funding) with her principal goal being not her own gain but rather the benefits her efforts generate for others. In turn, broadly what seems to distinguish social enterprises from other non-profits are two things: While many other non-profits are focused on helping others they rely heavily on charitable donations and grants and operate in a very nonbusiness-like manner social enterprises are run more professionally and to some degree have the ability to generate earnings that defray operating expenses, help pay suppliers and help attract and retain qualified staff. Discussing an obviously important part of the social enterprise movement, microfinance institutions (MFIs), Jonathan Murdoch notes that while a substantial proportion of MFIs are self-sufficient in this sense (what he refers to as operationally sustainable) far fewer are financially sustainable. While operationally sustainable MFIs generate enough to revenues to cover their operating expenses they fail to generate enough revenue to act entirely independently. It is only the much rarer financially sustainable MFIs that could survive if they had to "...obtain all inputs (especially capital) at market, rather than concessional, rates (Murdoch, 1999, p. 1588) While the goal of financial sustainability is laudible as Wei-Skillern et al point out while in commerical capital markets "...the key motivation for all players involved is most often to build a profitable company and to earn an attractive return on investment" the motivation is varied in the case of those funding social enterprises (Wei-Skillern et al, p. 13) They go on to note social enterprises "...rarely, if ever, atain breakeven without some form of donor support" (p. 13) It is enough to be business-like in managing operations and to be, if possible, concerned with operational sustainablity. It is often nothing short of impossible to pay staff competitive salaries and benefits and at the same time pay investors an adequate return on their investment and remain at the same time true to the social enterprise's orginal mission.

Nonetheless, Boschee and McClurg define social enterprises and social entrepreneurship in terms of self-sufficiency. As they put it self-sufficiency "...can be achieved only by relying completely on earned income, and is the ultimate goal of the most ambitious social entrepreneurs" (Boschee and McClurg, 2003, p. 3, emphasis added) As Murdoch suggests however by such a definition it is well nigh impossible to find real world examples of social enterprises. It sets a standard that few social enterprises will ever be able to attain.

On its website the Social Enterprise Alliance notes that in 2002 commercial revenue ("service fees, registratrions, dues and subscriptions, and other program fees, as well as income from special events and sales of products") has risen from 48.1% of nonprofit revenue overall in 1982 to 57.6% in 2002. These figures are not adjusted for inflation where inflation eats away over half of the seemingly impressive 219% growth in nonprofit revenues. And when adjusted for inflation the figures represent at most decent growth in earned income. This growth has taken place alongside relatively weak growth in the total earnings of nonprofits. While the U.S. economy grew at an average annual rate of 3.36% in real terms between 1982 and 2002 the total revenue of nonprofits grew only 2.75% a year in real terms while earned income (if commercial revenue and earned income are synonmous which is not entirely clear from the SEA's website) grew at an average annual rate of 3.68%. In short, as overall funding for nonprofits lagged behind the general growth of the U.S. economy a few additional scraps were thrown in the direction of nonprofits in general to make up for the significantly lower growth in government support for nonprofits (1.72% a year in real terms or put another way a little over half the growth in real incomes overall between 1982 and 2002).

A key catalyst to growth of social enterprises and the increased focus on earned income has therefore been the fact that tighter government budgets have forced many social organizations to become far more self-sufficient than they might otherwise be. It also reflects the sad fact is that more than being a desirable goal for social enterprises the complete self-sufficiency that McClurg and Boschee call for reflects the outsourcing of public service to private sector. Part of the rise of social enterprise is then borne of necessity converting some non-profits into social enterprises simply because of a lack of funding.

All the while the mountain of poverty grows in absolute terms. The many social enterprises that have sprung up are to be admired and applauded for their accomplishments. However what many of these enterprises have been able to accomplish is tantomount to moving small sections of earth from this ever growing mountain of poverty. Looked at from the ground level those who have given so much of their time and effort are justifiably proud. This in no way however means that such undertakings represent a key solution to the dilemma of world poverty. As Jonathan Murdoch in his work on MFIs has suggested in fact the more operationally sustainable MFIs -taken here as a subspecies of social enterprises- have succeeded by addressing not the needs of the poorest of the poor but small merchants and shop keepers who are relatively speaking better off. It is indeed striking to see the Mexican MFI Compartamos frankly admit this and to draw the connection between its move from nonprofit to profit status as in no small degree due to this and that it's mission does not nor can it include addressing the needs of the poorest of Mexico's poor (see the following).

There are, of course, social enterprises that as Alan Folwer notes he would prefer to refer to as integrated complementary organizations. In these the business generates a suplus that then is not plowed back into the original venture nor turned over to shareholders but rather it directed toward a social program of some sort. Staff is hired, funding is raised through bank loans and bonds, advertising is carried out and after all the bills are paid the net revenue goes toward supporting some social program or perhaps a variety of social programs. BRAC through a variety of enterprises such as its retail outlet Aarong provides employment opportunities to the poor, an outlet for their products, and provides revenue that helps fund BRAC's other activities. Newman's Own "shameless exploitation in pursuit of the common good" would be another example of a business that operates at least in a sense at a financially sustainable level and uses the profits earned for social programs rather than to provide a return to shareholders. To their credit the fact that this presents practical difficulties in equity markets is something the Grameen Foundation recognizes.

A brief history of the U.S. housing market

No time to comment much on this but didn't want to lose track of this link. What is incredible and needs to be kept in mind is that between the late 1990s and May 2006 there was a marked run up in housing prices. This report by Robert Krulwich makes that fact abundantly clear.

Going Green

The numbers are truly staggering. The world's population has increased over sixfold in the last two hundred years and will grow at least half again as much in the next few decades. By 2050 population is to reach a peak at 9-10 billion. To not only keep real per capita income at its present level but to lift as many of the billions of the world's poor out of poverty, the world economy must continue to for quite some time. Unfortunately, on average each percentage point increase in the rate of growth in gross world product leads to an increase in CO2 emissions of .4%. (For information on how substantial the differences are from country to country, click here.) The two key sources of CO2 emissions are the burning of fossil fuels and deforestation and both are related to population growth and development(For more on the deforestation of tropical forests in places such as Brazil and Indonesia. click here.) The historically unprecedented growth in real income and population is founded first and foremost on the use of natural resources. With the industrial revolution we swapped tools made principally of wood and leather and powered by human and animal muscle for machines. The premodern economy was an organic one limited in its potential by what little of the flow of the sun's energy we could capture each year. Our modern industrialized world is an inorganic one where we draw from the age-old stock of solar energy found in oil, coal, and natural gas. While great strides have been made in limiting the growth in the use of nonrenewable resources since the 1970s, the fact is that the world economy still runs on fossil fuels. Some 80% of power we use comes from fossil fuels, principally oil, coal, and natural gas. Already having exploited the highest quality and most easily accessible ores and fuels implies that, all else equal, we face a future of increasing costs. Part of the current run up of oil prices reflects the impact of increasing demand in the wake of growth and development. Added to this continued growth in population and production means increasing amounts of waste that must either be stored or recycled. One can see that the benefits to "going green" (shifting away from nonrenewables and other forms of pollution control as soon as we can) are great while the potential costs of inaction are to say the least considerable. All of us seek to capture the benefits that, through our activities, we are legitimately entitled to. All of us try to avoid bearing any more of the costs of actions than we are legitimately expected to bear. We are not wrong for doing this. Looking at life as a pyramid, I should hope that we would all agree that at the very base of that pyramid are our family and friends. To give away benefits that rightfully belong to us or to voluntarily bear costs we aren't expected to means giving away what is ours to someone or something far more distant from us, far less connected to us in space and time and denying these things to those within our own circle. The problem we face when thinking about environmental issues begins with the guilt we feel once we have admitted this. Add to this the fact that each one of us is such a small part of the overall picture. Often when we do things that will help the environment we know what we're giving up at the same time we realize that there is little or no guarantee that the additional costs we have taken on or the benefits we have turned over to some one else will really make a difference. This helps to explain why when left to individual initiative not enough tends to get done. When it comes to the environment, we often face a classic coordination game situation in which doing what is best for ourselves and society at large is only really worth our while if we can count on a sufficient number of other people moving forward to do the same thing. It is wasted effort to blame government, what's going on elsewhere in the world and, perhaps, most importantly, feeling too guilty. It is far better to focus on what can be done now because something must be done. The good news in that contrary to the old adage she who hesitates is lost there are increasing numbers of nonprofits, for-profit companies, and individuals, both in private and public life who have broadened the base of their pyramid and coordinated their actions to include people and things far more distant than them in space and time. And the more movement in the right direction that takes place, the easier it is for others to follow, especially once a critical level of forward movement has been reached. Compact fluorescent lights or CFLs are an example of this. While CFLs lights not all that long ago were relatively expensive they are now well within the range of incandescent bulbs. While true they are still more expensive than incandescents they are no longer outlandishly so. And in the long-run they are far cheaper to operate. They last longer and are more energy efficient, using fewer watts of power to generate the same amount of light. (a, b) The drop in price in the U.S. market is arguably in no small part due to actions taken by government in other countries and in anticipation of similar actions soon taking place elsewhere. By stimulating the demand for CFLs two things have happened. One, to the degree scale economies are important, by increasing demand it has become possible for major players to ramp production to a level at which overhead can be covered with a much lower premium charged per bulb. Secondly, more current demand (and more demand still expected in the future) has increased the amount of space available for the number of companies needed to serve this market. Regardless it is evident that the last couple of years we seem to have reached (or are at least close to reaching) the critical level needed to sustain change. Incandescant bulbs have been banned (the Philippines, Australia, Ireland, and Italy), CFLs have been given away for free by the government (Venezuela and Cuba) or made available to the public at a subsidized price (Brazil). (c) With 17% of residential electric consumption in this country for lighting, with say 52 light sockets in the average home at present using incandescent bulbs, and with an average savings of about 45 kwH per bulb installed the potential impact of a switch to CFLs is considerable (d). The savings of 2340 kwH per home is equivalent to a little under 3 months of power consumption for the average home. (e, f). Much like CFLS, government bans or taxes on plastic bags in many key markets (country-wide in Ireland, the U.K., Bangladesh, Taiwan, and Australia and in cities like San Franciso or Mumbai ) have led businesses, one should imagine in anticipation of similar taxes and bans, to introduce reusable plastic bags and encouraged the growth in their production. (For more on this click here or here) Change in other areas such as in heating and transportation is far more problematic Often this is because change requires much higher initial costs or, if financed in some way, much higher fixed costs. To "go green" is in many case a decision to become less liquid or more highly leveraged. Consider first the case of hybrid cars. To many it is surprising to note that that outside the triangle that extends from Boston down to Washington D.C. and from there westward up to Chicago one finds some two-thirds of America's population. This means that fuel efficient cars are an absolute necessity because whatever the benefits of mass transit outside this area, people are by and large too scattered and too sparsely settled for mass transit to be feasible. That something vis-a-vis cars needs to be done soon is borne out by the fact that some one third of CO2 emissions in the U.S. is emitted from cars.

However, hybrid cars are still costly. Even with gas averaging $3.28 a gallon nationally and 3 year new car loan rates at 7.11% given current differentials in terms of price and mpg, a hybrid Honda Civic is just barely less costly to buy and run than a Honda Civic sedan. And a decided disadvantage is that while given superior mileage the operating costs associated with a hybrid are far less than a regular car, the initial outlays and the monthly car payments one is commited to are far higher. To buy a greener car means that one must be willing to become less liquid (i.e. pay a higher amount out of pocket rather than finance the purchase, bring monthly payments down. This means having less cash on hand) or become more highly leveraged (commit to higher fixed expenses in the form of monthly car payments). Given current rates and the price differential on a hybrid versus a regular Honda Civic sedan this commitment boils down to agreeing to spend 50% more a month for the hybrid than the buyer of a regular but reasonably fuel efficient car is committed to pay. Government agencies or non-profits -with the public interest in mind- have shown themselves willing and able to sacrifice liquidity and increase their financial leverage in a way that private families and for-profit businesses understandably have not. (For example the city of Rock Island, Illinois has just purchased a fleet of twenty-one Honda Civic hybrids. Click here for more details.) Being greener in the case of hybrids means being drier (less liquid) or more precariously positioned (more highly leveraged)

Because of the absolute costs , it is unlikely we shall anything like what has happened with CFLs, that might tip the scales decidedly in favor of hybrids, any time soon. In short, we will not see a ban on regular gas powered cars or say subsidies to reduce individuals' initial outlays on hybrids. For example, consider the cost of government subsidizing the purchase of hybrids. In 2004 over 7 million passenger vehicles were sold in the U.S. Assume that government tried to encourage everyone buying new cars to buy hybrids by covering the gap between the price of a hybrid and its less energy efficient counterpart. Further assume that the average subsidy would have to be $7,590 (the current gap between a Honda Civic hybrid and a regular sedan). If all accepted the offer the cost would be a total of $53 billion. Here what we face is a classic example of what is referred to as a lock-in effect (and what Environment Illlinois recently referred to as "a chicken and egg problem".) Until demand is high enough and therefore the production of hybrids has increased to a point that scale economies can be realized and market share increased in order to close the gap between hybrids and gas-powered cars, we are trapped in a situation in which the purchase of a hybrid will require both a sense of commitment to the environment and the financial resources necessary. No matter how little gas a hybrid uses, as long as the initial outlay is greater than a fuel powered car, concern over loss of liquidity or leverage can be expected to remain obstacles to a significant shift. (There is also a question of how much can be gained by simply driving better maintained gas-powered cars more slowly.) There is another problem that arises with hybrids and other big ticket items. New ideas are constantly coming up. The X prize competition slated for next year is paying $10 million to the first team that develops a working model of a car that gets at least 100 mpg and can be brought into production at a competitive price. Motor Development International, a French company has developed vehicles that run on compressed air that takes only a matter of minutes to re-fuel. There is a three-wheeled hybrid that while it only seats two passengers, the Aptera, gets 330 miles to the gallon. Logically one must ask which alternative will ultimately win out and will there be significant disadvantages to having committed to one alternative too soon? For example, a firm that buys a fleet of vans from Motor Development International may find that in ten years time there are few if any technicians who can service an air car because hydrogen fuel cell or solar powered cars have come to dominate the market. The value to all of us as individuals of waiting means that movement in any one direction is of necessity far slower.* (While Steven DeCanio in his 1998 paper, "The efficiency paradox: bureacratic and organizational barriers to profitable energy-saving investments" Energy Policy, April 1998, argues that often organizational inertia rather than economic considerations impede the adoption of greener technologies, he also finds statistical results that indicate that the later firms entered the EPA's Green Light Program the less time that was required to recoup initial costs, i.e. the shorter the payback period. He admits that this was possibly due to "...continuing technological progress over time, or to declining costs of the equipment as the market for it has grown" , p. 451. This is consistent with the argument put forward by van Soest and Bulte that with the variety of alternatives available, the direction of technological change so unpredicatable, and the commitment that investment in any one particular technology entails, there is a real value to waiting. See van Soest and Bolte, "Does the Energy-Efficiency Paradox Exist? Technological Progress and Uncertainty" Environmental and Resource Economics, 2001. This is remiscent of the Christine Romer's irreversibility hypothesis. ) The same problems associated with cars applies to power and heating technologies as well. Wessel and Jones in their book _Prosperity_ write beautifully about how important the introduction of electricity was in the development of the world economy. Here in the U.S. a large share of our electricity comes from coal-fired plants and some 40% of our CO2 emissions comes from generating electrical power because nationwide a large share of the power generated is from coal-fired plants. According to Environment Illinois's recent report "The Power of Efficiency" only 31% of the demand for electricity in the midwest is residential demand. Commercial businesses and industry therefore account for the rest of the overall demand for electrical power in the midwest (as well as over half of the demand for natural gas). This leads to the question of alternative power sources such as wind and solar. Unfortunately we are a long way off from either solar or wind being a viable alternative to typical large scale power plants. (i). High quality wind sites generate about 30 to 40 percent of their rated capability on average (this is because of wind speed variations) h and given the considerable scale economies involved in wind power(evident in h above) the feasibility of installing and using our own wind turbines to generate much power seems foolish. Solar panels in this regard hold out far more promise. However, solar panels face the same obstable that more fuel efficient cars face. However much cheaper they are to use once installed, the upfront costs of solar power, like fuel efficient cars. are considerable. An added problem is the use of silicon to make PV cells and the capacity of the system to supply the solar industry with a sufficient quantity and quality of silicon if there is a substantial increase in demand. Citizenre is attempting to significantly reduce the initial outlay required of consumers. However there are serious questions about what might happen to the solar power industry in the U.S. if Citizenre fails and serious questions about their ability to fulfill the promises that are being made.g Regardless, solar plants on average generate even less production than wind-farms do, usually less than 25 percent of their rated capacity. This is due to generators not producing electricity during the nighttime or during cloudy days. Finally, it is indeed sobering to consider the fact that currently all the solar panels with a connection to the power grid provide no more power than one medium coal-fired plant. And again the range of alternative new technologies increases the value of waiting. For example, great strides in micro combined heat and power systems (micro CHPs), the residential equivalent of CHPs used in commercial and industrial buildings represent yet another alternative to coal-fired plants and to central power stations. Although CHPs run on natural gas 90% of the heat and power generated is used versus 30-40% for power transmitted from a central power station. Here too however, unless subsidies are added at present the initial costs of installing such a system is far greater than that of installing a new high-efficiency hot-air furnace (according to one source $6,000 more even after gas company rebates). Michael Porter and Claas van der Linde in their paper "Toward a New Coneption of the Environment-Competitiveness Relationship" (Journal of Economic Perspectives, Fall 1995) argue that rather than environmental regulation always hurting businesses' profit there are instances, many they would argue, where regulation has raised businesses' profits and increased their competitiveness. Although they do not quite develop their argument along these lines they nevertheless hint that one one the principal advantages created by regulation is that it closes off some of the "numerous avenues for technological improvement" which therefore no longer vie for executives "limited attention" (p. 99). The relatively new branch of economic theory called behavioral economics draws our attention to the marked tendency we have to prefer the status quo, especially when the alternative choices that confront us are so numerous that they are overwhelming. If there is truly any merit to Porter and van der Linde's argument it is perhaps due to nothing more than simply our preference for the known (i.e. the status quo) and our subsequent fear or discomfort with the unknown together with our realization that individual efforts will only matter if done on a large enough scale, by a sufficiently large number of businesses and individuals. Whether it takes the form of government regulation or it is self-imposed, pressures to change, actions to limit choices, and measures to guarantee enough broad effort to make the individual cost and discomfort worthwhile are all required. As the International Labor Organization argues given the simultaneous goals of reducing global poverty and control damage to the environment, the impact of greener technologies on employment has to be considered. The good news is that there is no real conflict between jobs and green technologies. At the same, the research suggests that the direct impact of "going green" is slight. (see the ILO's "Green jobs: Facing up to an "inconvenient truth") For example, an increase in recycling creates an increased demand for labor (to drive recycling trucks and sort through recylables) however it will reduce the amount of garbage that ends up in landfills and therefore reduces the need for labor there. Or as the ILO report notes, increased use of mass-transit creates more jobs for bus drivers but reduces the demand for gas station attendants and auto mechanics). Perhaps the most promising area is in construction. It is noted in the ILO report that one of the most significant areas for reducing CO2 emissions (possibly as much as 20-30% in both industrialized and developing economies) is in increasing the energy efficiency of buildings, mostly in the form of increased insulation. Germany's Alliance for Work and the Environment is given as an example. As described in the ILO report, the Alliance is a joint iniative of government, builders, environmental groups, and trade unions that with a $1.8 billion initial investment has improved the insulation of 265,000 apartments, created 190,000 jobs and, via reduced unemployment, reduced heating bills, and the increased tax revenues from higher incomes and such has generated benefits of some $4 billion. Based on the success of the initial $1.8 billion, the German government has committed itself to spending $8 billion more between 2006-2009. Although I am not aware of any direct way of measuring this, it is remarkable how much more attention the environment has received, especially in the last year or two. There is really no other issue that is of more importance than that of the environment. Through economic and population growth we have come to a point where we now are pushing uncomfortably close to the constraints imposed by the planet. Let us hope that we have shifted our focus in this direction at a point in time where it is possible for us to change course.

Thoughts on social entrepreneurship

At the end of this month, the University of Baltimore will be holding a day long symposium 'Love and Money' in which participants consider the growing power and influence of social entrepreneurship. Referring to social entrepreneurship as the fourth sector (the other three being for-profits, not- for-profits, and government) the announcement for this symposium describes social entrepreneurs as : "leveraging the potential to realize lasting change on a worldwide scale, addressing millennia-old issues like hunger, poverty and social inequality in ways never before seen in history. Their "for benefit" model—prompted by a social purpose, self-sustaining, and creating and distributing products and services that improve quality of life, add jobs and stimulate the economy—calls for market generated profits that are then turned back to be invested to advance a social mission. These entrepreneurs are determined to put all of their energies into resolving entrenched social issues while reducing dependence on traditional grant and gift funding methods". What I would like to consider in what follows is the question of how profitable "for benefit" entrepreneurship can be as well as the question of how effective the untold number of small organizations (working more or less independently ) can be in protecting the environment, reducing poverty, and promoting the general welfare . Furthermore -assuming that the popular press is correct and that social entrepreneurship is is growing- a third question is what are the forces that are at play in promoting this growth. Finally, returning to the question of effectiveness, the issue of how much of what social entrepreneurs are trying to accomplish ideally should be done by the state? In a democracy is it not true that the state's main goal to promote the public's interest? Is it not equally true that , by virtue of its size, the state has far more power to organize resources on a large scale to promote general welfare than individual businesses ever will? Does the rise of social entrepreneurship reflect acceptance of the fact that real world governments are unwieldy and often unable or unwilling to address pressing social issues effectively?

How profitable can for-benefit companies be? It is a matter of basic microeconomic theory that any organization that on the one hand seeks to earn profits but on the other is focused on not only its own profits but is also concerned with the impact of its actions on other people and the planet will tend to either earn less profit than it would otherwise enjoy or it has to pay its staff less than they could make elsewhere. Why? Concerned with a "triple bottom line" such a company is trying to internalize benefits that it will not be compensated for or is trying to internalize costs that it would not otherwise have to bear. It can be shown that either way profits earned will be less than what they would be if the company were instead concerned only with its own profits.

In a market in which funding will only flow to such a company if it pays a competitive rate of return this means that it will have to rely on its staff willingly taking a cut in pay or relying on volunteers to help. Barring this the fact is that investors in a social enterprise will have to be willing to accept less return with greater risk than they would have to elsewhere. In reality of course what we increasingly see is a combination of all three of these things, also included in this mix are grants and subsidized credit that brings the average cost of capital down while appearing to pay private investors a favorable return. By bringing together dedicated staff ,volunteers, and investors social enterprises can reduce their dependence on grants, gifts, and subsidized credit from chariable organizations and governments but in reality dedication and commitment are both necessary ingredients in the process.

For example consider the following scenario. Management realizes that the more labor it employs and the higher its scale of operations the better it will be for other businesses in its area. This could be because of the knowledge that spillovers from its workers to employees of other companies operating in the area. This could be because this company supplies an input that will then be regularly supplied in the local market. The point is that with a view toward the social benefits of its actions this firm will push its level of operations well beyond the level it would if only concerned with short-run maximization of its own profits. Arguably, the long-run profitability of this firm may be increased if the productivity of labor employed by other firms is increased significantly but the fact remains that this social enterprise's short-term profits will suffer.

Assuming that it would have only earned normal profits as a for-profit then by producing more than the profit maximizing level of output it generates negative economic profits. In an accounting sense the books may more than balance, the firm may appear to be profitable but this is only because either stakeholders or staff are willing to accept a lower return (in exchange for knowing that what they have done is of benefit to others) or because grants, subsidized credit, gifts, or volunteers are able to make-up the difference between the accounting profits realized and the economic profits required of a for-profit enterprise.

The Grameen Bank is an example of such an organization. Working with a dedicated staff that could be earning far more elsewhere 22% of every dollar lent comes from donations or the Central Bank of Bangladesh. This is not to be viewed as a failing of the Grameen Bank but rather simple comfirmation of the fact that it is impossible for a firm to either consider costs that it would not otherwise have to bear or consider benefits in making its decisions that it will not receive any direct or immediate compensation for without seeing its short-run profits fall*.

*In the late 1990s Richard Sandor helped to establish the Chicago Climate Exchange (the CCX) in which CO2 emission rights are traded on the private market. The CCX also manages the much more important ECX (the European Climate Exchange). Although enormously profitable at this point the CCX was formed in the late 1990s with the help of a $1.1 million grant from the Joyce Foundation. Sandor is also the father of the interest rate futures market. A question naturally arises as to how much grant money had to be provided to form interest rate futures trading in the 1970s compared to the $1.1 million used to organize the CCX.

The catalysts to growth in social enterprises.

Imagine a Venn diagram with three circles drawn on it. The first is labeled need, the second staffing, and the third, financing. Given growing population and the push worldwide toward industrialization the need circle is growing ever larger each year. The growth in population corresponds to a rising number of people living in absolute poverty while rising population and industrialization together mean growing pressure on the environment. Growth in accumulated wealth, in the stock of human capital, and in the supply of labor mean that the staffing and funding circles are growing as well. This growth in all three circles means that inevitably the degree of overlap should grow over time but there is also at play a shifting of the staffing and funding circles toward the much larger and faster growing need circle as attitudes change and more people become aware of the extent and severity of problems the world's poor and, via the environment, future generations face.

There was serious flooding toward the end of summer of 2007 in Bangladesh, India and Nepal. Former President Bill Clinton appeared on the Oprah Winfrey show early last fall to promote his book Giving and featured the microfinance institution Kiva. In response to the crisis in South Asia one could easily go online and donate money to aid flood victims in South Asia. After hearing of Kiva on the Oprah Winfrey show anyone interested in becoming a lender to someone in any number of developing countries could do so with only a bit of time, a bit of money, an internet connection, and a valid credit card. Computer technology has made it easier to not only learn of problems around the world but also to act on such problems. One hears of the Skoll Foundation on social enterpreneurship, One World Health, Living Goods, Better World Books, Vikram Akula's microfinance organization SKS and within minutes finds the home pages for these organizations, praise and criticism, and discussion of related organization. There is no question that a large part of the growth in activity, refered to above the shifting of staffing and funding circles toward the needs circle as all three grow ever larger, is in part due to the ease with which information can be obtained and action taken. In particular, the flow of funding that as Wei-Skillern et al in their book Entrepreneurship in the Social Sector characterize as highly fragmented (p. 13) has become far less so thanks to the internet.

Arguably another factor in addition to the ease of funding is that both in terms of funding and staffing there are a growing number of upper-middle class and wealthy people whose knowledge of the world is quite a bit broader than their parents and grandparents. They also increasingly are searching for some meaning in their own lives, are conscious at some level of their good fortune and wish to share it rather than hoard it. The growth of modern cities allowed a shift from the street-alley segregation (where although separate the wealthy and the poor lived in proximity to each other) that Stuart M Blumen refers to in his book the Emergence of the Middle Class to areal segregation (where the middle class and wealthier segments of society could and do live largely separate lives). In a very interesting way perhaps modern media has created a virtual world where it is far more difficult to grow up shielded and largely unaware of the problems of others and the environment and has helped move us back toward a time where it was harder to ignore the plight and misfortune of others.

The need for social enterprises.

As laudible as social enterprises are it is an important question whether or not these needs couldn't be far better served by government. Herman Daly has long advocated that government set the stage for the private sector by insuring, prior to market activity, that what he refers to as intragenerational equity and intergenerational equity are taken into account. In a world in which historical accident is relevant (such as England's endowments of coal, iron ore, and water transport in the age of coal and steam or our own endowments in the U.S. of coal, iron-ore, oil, and water transport in the age of steel) and in which the scale of activity has risen so much relative to its resource base (as in populous areas throughout the premodern period or the industrialized world now) attention must be paid not only to efficiency but to justice as well. The faster a society pushes use of renewable resources beyond their sustainable limits and the faster it depletes its stock of nonrenewable resources the more future generations are liable to suffer and the less equitable the allocation of natural resources will be over time. The more economies allocate resources of all sorts to the satisfaction of the relatively trivial needs of economically better off consumers and businesses rather than the abolutely basic needs of the poor the less equitable the allocation of resources will be at the present time. Social entrepreneurs, by definition, seek to promote a more equitable allocation of effort both now and in the future or in short, doing what Daly has long advocated sovereign governments should be doing. The question therefore arises whether or not social enterprises are not only growing because it has become easier to become informed of where needs are and to organize the resources needed to affect change but also because of an increasing awareness of how far short of the mark governments have been in taking the initiative and following through. Indeed Kaushik Basu in his Prelude to Political Economy identifies clearly how easily recommendations given to politicians by experts can be expected to be completely ignored (see chapter 7 of Basu's Prelude pp. 169-173).

Because of their ability to act without having to navigate choppy political waters, to act without having to divine the preferences of politicians, to act without having to try to persuade them of the value of a given program, or to act without having to enlist the support of others to persuade policy makers, social enterprises are far better at initiating change than governments can be. Ironically they are inherently inferior to government in being able to sustain a certain level of activity or to achieve a sufficiently high enough scale. No small part of the limited ability to sustain effort over time is because it is difficult for social enterprises to capture the benefits generated by programs they've initiated as easily as governments can. For example, one might envision a social enterprise in which schooling is provided to elementary age students along with a stipend to cover the loss of income the family suffers as their children attend school rather than work. If this important work was carried out on a wide enough scale by the state the stock of human capital might grow. In turn, the level of output per worker would grow, and given current capital labor ratios, the expanded real per capita income would generate increased tax revenues and therefore be a self-liquidating investment. In contrast it is hard to imagine a patch work of social enterprises working independently that could offer similar opportunities on a wide enough scale to make much of a dent in the problem in a short enough period of time. It is equally hard to imagine their capturing the benefits that accrue only with a lag to other businesses in terms of more easily trained, more flexible, and therefore more productive workers. In short, there are places where social enterpreneurs will be able to step in but many others where benefits are either delayed or shared by the community at large in which they will not be able to step in as easily.

The other major drawback to social entrepreneurship is that it is difficult for social enterprises to achieve the sort of scale needed to really bring about change. Primarily this is due to the continual need to find staff and those willing to provide financial support who will readily take on added risk or responsibility for lower returns in the numbers required to keep up with the growing needs of the world economy for help.

All true but largely beside the point.

Thanks to the weather (an ice storm), I woke today to find that that I had a bit of extra time. So I sat with a cup of coffee and yesterday's NYT (December 10th 2007) and saw on the front page Lydia Polgreen's "Congo Republic Awash in Oil and Poverty". I readily admit that I expect to see certain things in any article on Africa. Ms. Polgreen's article did not in any way, shape, or form surprise me. In it (1) I found a naive notion that mineral wealth, overall wealth, and income are synonymous and found no mention of environmental issues, (2) I found too much focus on corruption, and (3) I found a careless use of numbers. One walks away from a piece such as Polgreen's confident that if they were given a month or two to run the show all would be well. Implicit in this is the ugly attitude that the people actually involved are so inherently bad, stupid or both that they cannot manage their own affairs. (1) RESOURCES: After having described the deplorable conditions at Brazzaville's main teaching hospital, Polgreen poses the following question "... why is the hospital, like so much of the Congo Republic, so tattered when the country sells billions of dollars of oil each year?" The answer is actually simple. Oil and willing workers it may have but the Congo Republic lacks human capital, tools and machinery and natural resources. The skilled labor to fix plumbing, repair light fixtures and electrical connections is in short supply. Also the capital it needs, real capital, both public (roads, well developed harbors, airports) and private (tools and machinery) is scarce in the Congo Republic. Finally, as green and lush as it may appear the Congo Republic's environment is very fragile indeed. As population has increased and farmers have been forced to change from traditional slash and burn techniques to more settled agricultural techniques, nutrient mining (the depletion of minerals in the soil and hence fertility) has been very high (1). This coupled with the Congo river (an annual river which goes from a trickle to rapids and back again) means that overall the country's natural resource base is quite poor. Nobody who takes a moment to consider how important natural resources, physical capital, and skilled labor to economic development will be at all surprised that the Congo Republic is so poor. Perhaps a better question would be how well those of us from economically richer areas -used to the advantages we enjoy-would cope with the obstacles found in the Congo Republic. _________________________________________________________ Of course, the preceding raises the question as to why the stock of skilled labor, tools and machinery and infrastructure is so poorly developed. Consider investment in public capital or infrastructural investment first. The Congo like most of SubSaharan Africa is sparsely settled. Therefore the cost of building and maintaining infrastructure is spread over relatively fewer people and people who are poor. As a result, the cost per person is by definition far higher than it would be in a more densely settled area. There is therefore in turn a lower chance that individual benefits will outweigh the costs. Because of this, as Ester Boserup argued a long time ago, poor and sparsely settled areas are caught in a trap that is difficult to escape. The publicly provided capital, the infrastructure, that the country needs to carry out economic activity such a producing and then transporting new light fixtures, paint, and plumbing fixtures to fix hospitals is far from developed to the degree that it should be. Without a great deal of extra effort this is unlikely to change. And low levels of investment in education, training, or in business is a chicken and egg problem. Take for example education. The benefits from the investment in education are contingent on what we expect others to do. If somehow a poor family could afford to give up the income that their children help to provide them*(see * below), it would all be worth it if that child in turn could find work that would make use of this education. However, this will only be true if the structure of the economy changes and this the family has no direct control over. Stuck at the bottom of a very deep hole individuals trying to climb up to the top on their own are unlikely to make it. Only if they were to cooperate, standing on one another's shoulders, might it be possible to escape. And this is not possible without a great deal of trust. While life at the bottom of the deep hole may not be too pleasant you know what you must face and know you can cope. What if a family helps others climb out only to find that when they have reached the top they have forgotten their obligation to help the rest escape? What of the risks of injury if this human ladder collapses means? It perhaps is better to leave well enough alone. Poor laborers, farmers, and business people are -because of their poverty-risk averse. (2) CORRUPTION: Even if one had the most dedicated and well-financed government in the world it is difficult to overcome these obstacles, especially when the environment is such that it lacks skilled labor and capital and the country's coastline has few natural harbors, its rivers are not navigable, rainfall is highly variable, and soil is poor. In short, when the hole is especially deep and the edges particularly slippery it will require far more effort and far more help than the help those in shallower holes required. Corruption does not help make it any easier for a poor country to climb out of the hole it is in. However, for every twenty pieces written on the political and economic obstacles African countries face that focus on corruption there may be one that mentions the problems of poor natural resources, low private investment and poorly developed infrastructure. A change in political culture will not make the Congo River more navigable. It will not change the speed with which the costs of increased population and density emerge (urban overcrowding, nutrient mining, and so on) versus the speed at which the benefits appear (a wider base to spread infrastructural investment over only works if the level of real per capita income remains constant or increases.) It can of course alter the payoffs from private investment in such a way that it lessens the risks to any one family or business taking the first steps to educate, train, or invest in their own business or farm. However, a less corrupt government does not alter the contingent nature of these investments. What I referred to as the chicken and egg problem remains. Blessed with natural harbors, timber, coal, iron ore, fertile land, labor (first brought in chains and the driven here by poverty) the U.S. has prospered despite Tammany Hall, McCarthyism, Watergate, or Enron. Although India's shining is more an example of how all that glitters is not gold (see Mira Nair's Planet India for example) its growth is high despite widespread corruption. To blame poor performance on corruption is cruel when no matter how well run things might be or how selfless public servants could be, the hole is so deep and so hard as to be almost impossible to climb out of. (3) PROPORTION: My last criticism of Polgreen's piece involves simply taking the numbers she had reported and asking a few relatively straightforward questions. For example, Polgreen states that the Congo Republic churns out 250,000 barrels of oil a day. At $90 a barrel this means that that the Congo would earn $22,500,000 a day or $8,212,500,000 a year. This sounds like an awful lot of money. However even with a population of only 3.8 million people this then represents only $2,161.18 a year available per person. Say that actually only half of this (about $1100 per person) could be turned back over to development because the rest is needed to cover costs of production and that none of this money was wasted. It is without a doubt true that a great deal could be done with this in such a poor country as the Congo. It is equally true that the average American would need to pay only about $14 a year and that the burden would be even less (far far less than what the average American family spends eating out or on entertainment each year, about $5,000 per family) if all the economically more developed parts of the world were to ask its citizens to put money into what might be called something like a Help Africa Compensate for Corruption Fund. In sum, we could help those most in need if we were to actually go out and buy a ladder rather than standing at the edge of this deep hole criticizing the behavior of the leaders on the bottom. The money wasted by government officials on travel, lobbying, and such is not confined to just countries like the Congo Republic. *(See above) Stephan Thernstrom in _Poverty and Progress_ wrote eloquently of the problem that the families of unskilled workers in Newburyport, Massachusetts faced. "The relentless pressure of poverty -stemming from the depressed wage level for common labor and from sharp seasonal fluctuations in employment opportunities -forced the children of Newburyport's laborers into the job market at an early age. Sometimes a laborer went several weeks without earning a cent; then the four dollars a week that his twelve year-old son earned as a bobbin boy was the family's sole source of support. Opportunities for formal education past the age of eleven or twelve were effectively nil for working class children" (Thernstrom, 1971, pp. 22-23) For more on geography as a barrier to trade see Hummels "Time to Trade"

Taking stock of financial markets and the FED

Before mid September when the FED shaved off 50 bp from its fed funds target the DOW stood at 13404.42 (9/17/2007). After its September meeting, and as one would expect, stock prices began to climb. They in fact rose quite rapidly, reaching a peak in early October when the DOW hit 14164.53 (10/9/2007). The situation just as quickly changed however. Between the 9th and the 19th some 85% of the 5.7% climb in stock prices was lost. In short, on the 19th the DOW was only a fraction of a percentage point above where it had been prior to September 18th. The only thing that changed this was the growing anticipation of the .25% rate cut in the fed funds rate. As a result of this we have seen a healthy increase in stock prices in the last few weeks. (To see what has happened to the DOW over the last six months click here and choose zoom 6m) However, with the actual announcement on Wednesday that this was indeed what the FED was going to do we see a drop in prices rather than the sort of dramatic increase in stock prices that took place between September 18th and October 9th. Two questions immediately present themselves: (1) what accounts for the very different reaction to Fed rate cuts and (2) what can or should the Fed do about it? As the late John Kenneth Galbraith in his book the Great Crash "Of all the weapons in the Federal Reserve Arsenal, words were the most unpredicatable in their consequences" (JKG, The Great Crash, p. 38). Along with their announced cut the Fed pointedly noted that they now regarded the risks of inflation to be as important as the risks of recession. One interpretation of this, don't expect further rate cuts any time soon. One might charitably think that this was a more than reasonable statement to make, especially in light of what the figures for real income growth (the real GDP stats) for the third quarter of 2007 indicated. They showed a very robust economy, despite weakness in the housing sector with the demand for our exports growing at a much faster clip in the third quarter than in the second (16.2% versus 7.5), federal government spending growing at a slightly faster rate, investment in equipment and software continuing to grow, consumer spending growing at over twice the rate that it had in the second quarter and so on. However the weakness in housing is very real, with residential fixed investment falling 20.1% after already having dropped by 11.9% in the second quarter. Perhaps more significant is that nonresidential fixed investment grew at a slower pace than it had in the second quarter. Also over a third of a percentage point in the 3.9% growth in real income and production last quarter was due to a substantial build up in inventories. Part of this build up must be in anticipation of growing demand. As a result, continued growth in demand is a necessity if this build up of inventories is to be justified. Of course, another part of the build up could be due (and probably is due) to the weakness in housing and the softening of nonresidential fixed investment. In hindsight, it might have been better if the Fed had reported that it was still more concerned about economic weakness than inflation because as Galbraith suggested what the Fed says has very unpredicatable effects. All it took were the words that it was as concerned about inflation as it was about recession to short-circuit what arguably was one of its chief reason for cutting interest rates, to soothe financial investors' fears. Whether you believe that the Fed will have any reason to raise rates some time in the near future does not mean that you will continue to hold stock. The fundamentals matter far less than what you believe others -rightly or wrongly- think and how they will react. If you think a sufficiently large number of your fellow traders are likely to be bears then you have no choice but to follow suit (unless you can wait things out a bit) It did not help matters at all that the price of oil went higher as buyers in the oil market factored in growth in overall demand in the U.S. market. (They of course failed to factor in the impact in turn of significant oil price increases on that growth.) This undoubtedly added fuel to the speculation that either the Fed would indeed refrain from further rate cuts (and possibly in fact raise rates) or at least to an increasing belief that others trading stocks felt this way. Others then would be less inclined to hold stock, penalize those who failed to follow suit, and thus depressed the market still further What has been encouraging and characteristic of the fed funds futures market is that until this morning's jobs report traders were still betting strongly on another quarter percentage point rate cut in December and more than even odds of yet another cut of .25% in the targeted rate in January. However with the jobs report, an unemployment rate still at 4.7% but growth in payroll double the consensus estimate, these estimates have changed, especially in the case of another 25 bp cut in December. The probability of a .25% cut in the targeted rate implied by the price of these contracts has fallen from a 84% probability to only a 68% chance. (for more on this market click here.) Still I think the point to emphasize is that as of now it remains true that the majority in this market still believe that it is more than likely the Fed is going to be cutting another .25% off the fed funds target by mid December and still more than even odds that it will target still lower rates in January. This is regardless of what the Fed might have wished to suggest on Wednesday The added liquidity to help struggling banks that recklessly overextended themselves is there but the Fed must also take the reaction of financial markets into account. The simple fact is that if banks fail or capital markets seize up then the final quarter of 2007 and the first quarter of 2008 will not be as strong as they could be, whatever strengths we saw in the U.S. economy during the third quarter. One might argue that the credibility of the Fed -having suggested that further rate cuts should not be expected- is in danger if it does indeed cut rates further. The Fed did not however categorically state that it was not going to further cut rates. Also, it is fortunate that most involved are wise enough to realize that even if the Fed had made such a foolish and categorical statement at the end of October concerning its plans a month and half later that this is subject to change.

Inequality Rises in the U.S.

This report (click her) ran a while back on NPR's Morning Edition. (For the numbers the report was based on click here.) The bounty going to the top 1% of Americans has pushed past that of even the 1990s. What was offered as an explanation was the simplistic notion that the demand for services of highly skilled labor was rising faster than the economy overall was growing. However with even a basic background in economic theory it should be apparent that higher returns in a competitive market invites entry. (In point of fact, one definition of competitive market is that free and easy entry into a market is possible) All else equal, as suppliers exit the market with lower returns and enter the market with higher returns the value of the former should rise and the latter should fall. Persistent inequality is a sign of failure of the market system rather than the price to be paid for all the very real benefits markets provide. Skills mean in essence education and so the issue of persistent inequality begs the question of why access to quality education is so inequitably distributed. To focus on the competition that unskilled labor faces from technological change or from abroad diverts our attention from this much more awkward question. The poor cannot afford to live in areas where the property tax base is high enough to support good public schools. It is even less likely that the poor can afford to send their children to private schools. And most importantly, despite whatever unrealized potential a given student might ultimately have, the poor cannot hope to leverage this potential into the sorts of loans that would fund that child's education and lift that child and her family out of poverty. Given the imperfections that exist in credit markets this is out of the question. Add to these financial constraints families at the top end of the income distribution have accumulated many advantages over the years . These advantages include the skills required to negotiate the educational system to our childrens' advantage and you have a fairly complete explanation of why inequality is so persistent in America. (See Annette Lareau's Unequal Childhoods or her earlier book Home Advantage) It is important to note that despite the very real problem that persistent inequality presents, the IRS numbers overstate the degree of inequality. Many students and other young adults from middle class and wealthier families file returns. The adjusted gross income of a graduate student with a tuition fee waiver and a monthly salary for working as a teaching assistant or research assistant or, more importantly, the college student who works part time as kitchen help or as janitor will be pitifully small. However, their poverty is only temporary and not very real. As they go to school or work part time and try to find some direction in their lives they live comfortably and securely.

on market falure, game theory, and government policy

Markets are efficient when they are able to communicate information at the lowest cost possible. Therefore one way of characterizing market failure is to describe it as a situation in which markets do not or cannot communicate information effectively. When markets fail there is possibly some benefit to government intervention. However, to the degree that markets communicate information, one should be leery of government intervention. Goverment intervention may disturb the delicate process of communicating information between buyers and sellers. There is also the very real potential of policy makers acting in their own self-interest rather than working for the general good. Communication failures 1: Unable to communicate, negative externalities. In the case of negative externalities, such as pollution, markets fail because prices do not convey full information of the costs of their activities to buyers and sellers. Polluters and their customers consider only the costs they have to bear. Why do they fail to take into account the total cost of their actions ? The principle reason is that other parties cannot accurately express what share of the resources harmed by pollution are theirs. And it is often too costly for individuals hurt by pollution to form a block that could effectively communicate to the polluting company the total costs of its activities. (For more on these problems click here.) Government steps in to supply this information to polluters, most commonly through emissions taxes. Communication Failures 2: Unable to communicate, missing information. There are many instances where markets not only do not communicate information efficiently but in which they cannot. The facts are simply not there to be uncovered. What happens as a result of one’s own actions are contingent on what everyone else does. In turn, what others plan is contingent on their expectations of what still others will do. There is absolute ignorance of what the future will bring. The future is not something to be uncovered through careful study but rather it is something we create. From an individual perspective, this lack of information means that often it is far better to wait than to act. Economists have experimented with all sorts of terms to capture this: for example, linkages (Hirschman), circular and cumulative causation (Myrdal), and most recently, complementarities (development economist), reciprocal externalities (public choice theorists), and network externalities where you capture benefits being part of the same group or network; investing businesses, educated workers, and so on (economists working in the field of industrial organization).

Why better safe than sorry rather than nothing ventured nothing gained? There are of course many transactions which are small and routine and the potential costs of mistakes are therefore small. Here one can experiment. One needn't rely on trust or extensive experience. Say that I spend $1 to buy new brand of cola rather than Coke. I discover that I don’t like it nearly as much as I do Coke. The next opportunity I have I will simply remember to buy Coke rather than the new brand and my loss, the cost of my mistake, is at most the $1 spent. However, there are many transactions that are infrequent and that are far from routine. Basically whenever it is the case that a transaction is large (large from the perspective of the individual involved) and, at least at first, the transaction is far from routine the costs of making a mistake are quite high. We see people hesitate for this reason. Whether a given choice has been a wise or a foolish choice hinges crucially on what others do. Your assessment of the wisdom or folly of a particular decision then hinges crucially on what you think others will do. Before deciding to reenter the bond and stock market (and to therefore begin to take greater risks again) in the wake of a bear market, a financial investor must be confident that others will soon begin to feel bullish as well . In an economy where, even with education, jobs opportunities are scarce, a poor family sending their children to school (and in the process foregoing the income they would otherwise help bring in depends on) hinges on being confident that jobs will be there. Residents living in the vast slum of Dharavi in Mumbai agreeing to move into smaller living spaces, doing their handicraft work in the centralized location promised, hinges crucially on their being confident that the promised work space will materialize. In all of these cases resistance to change is far from irrational. The costs of mistakes are so great and the decision to heavily invest in bonds, to take years out of one’s earning life for education , or to agree to move if markets remain bearish, job opportunities scarce, or promises are not kept impose costs too great to absorb. Game theory. Game theory focuses on such situations.* In the classic prisoner’s dilemma criminals face potentially tremendous costs. To minimize the damage that might occur to them individually they confess rather than stay quiet. A socially efficient decision (from the standpoint of this society of two criminals at least) would be to keep quiet. However not knowing what the other prisoner is doing to do, the equilibrium solution is to confess. Both do so and both are far worse off than they would have been if they had just kept quiet. The reason they don’t is in part because they do not know what the other will do. However, the choice made is more importantly due to the fact that they make this decision only once, and that the costs of mistakes are very high indeed. Contrary to the typical examples of market efficiency in a prisoner's dilemma rational self-interest leads to socially poor results. If you keep the same fundamental structure of a prisoner’s dilemma (choices/decisions are not small routine ones and where mistakes are relatively expensive and are not quickly or easily corrected) but alter the payoffs in such a way that the actions of decision makers (players of the game) are complementary you move from a prisoner’s dilemma to what are called coordination games.** To say that the payoffs are complementary means that they are very much contingent on what others do. Good or bad, decisions reinforce one another. If we are able and willing to take risks and are fairly confident that others will act in such a way that their choices positively reinforce our actions then we will go ahead. If we are not confident of this, it is better to wait.

In classic examples of market efficiency, no one need think strategically at all and the environment is truly a competitive one in which the gains of some are offset by the losses of others. We do not have to think strategically because the costs of mistakes are so small. In a prisoner’s dilemma we think strategically at first but ultimately decide that regardless of what others might do it is best for us to protect ourselves whatever might be the long-run costs to society and to ourselves. In a coordination game , we think strategically throughout and must trust others to act in a certain way before we are willing to move in a positive direction. Unless confident of what others may do, their actions materially altering the payoffs of our taking on greater risks, we are better safe than sorry. Nothing ventured nothing gained is too dangerous a philosophy for us to follow. Understanding the obstacles to forward movement government can act as a catalyst to decisions taken by private citizens and businesses and can improve on market outcomes. In the process the payoffs change in such a way that sellers’ costs, the prices buyers must pay, the uncertainty of markets materializing and the contingency of individual decisions are reduced. President Clinton’s Aids/HIV initiative can be viewed in this light. With private donations and government grants he provided a guarantee to drug companies that if they were to ramp up production and, in so doing, realize large enough economies of scale to lower costs demand would be sufficient to absorb the added production. The guaranteed demand was made possible though the Clinton foundation support that supplemented recipient countries’ funding. By guaranteeing a market President Clinton broke the deadlock that otherwise would have gone on for far longer. *The late British economist G.L.S. Shackle wrote of "crucial experiments" which by their very nature are nonroutine and potentially very costly if they fail. Although I am not aware of anyone doing so, one might draw a direct link between Shackle's crucial experiments and nonrepeated games. Also, in mainstream economic theory, there is Christina Romer's irreversibility hypothesis -that decision makers confronted with uncertain situations rationally will delay committing to making any decision and spending when such commitments are costly to reverse. (see " Irreversibility, Uncertainty, and Investment" Pindyck,Robert S., Journal of Economic Literature, 1991, 29, 3, 1110-1148 and "Uncertainty as a Propagating Force in The Great Depression" Ferderer,J.Peter; Zalewski,David A., The Journal of Economic History, 1994, 54, 4, 825-849) For more on coordination games see "Coordination" by C. Monica Capra and Charles A. Holt Southern Economic Journal, Vol. 65, No. 3 (Jan., 1999), pp. 630-636 or Debraj Ray, Development Economics, Princeton University Press.

sanitation in india

For anyone travelling to India the question of public sanitation naturally arises. Garbage collects on the streets alongside animal waste. Men stop on the side of the road to relieve themselves. Toddlers squat right out in the open to defecate. The extremely naive notion is that it is culture that explains why Indians of all walks of life accept this . (India of course is far from alone in the developing world in struggling with these issues. Click here for more.) A historical perspective. In _Conditions of the Working Class in England_ Engels describes 19th century urban England. It matches what one sees in urban India today: Every great city has one or more slums, where the working-class is crowded together. True, poverty often dwells in hidden alleys close to the palaces of the rich; but, in general, a separate territory has been assigned to it, where, removed from the sight of the happier classes, it may struggle along as it can. These slums are pretty equally arranged in all the great towns of England, the worst houses in the worst quarters of the towns; usually one- or two-storied cottages in long rows, perhaps with cellars used as dwellings, almost always irregularly built. These houses of three or four rooms and a kitchens form, throughout England, some parts of London excepted, the general dwellings of the working-class. The streets are generally unpaved, rough, dirty, filled with vegetable and animal refuse, without sewers or gutters, but supplied with foul, stagnant pools instead. Moreover, ventilation is impeded by the bad, confused method of building of the whole quarter, and since many human beings here live crowded into a small space, the atmosphere that prevails in these working-men's quarters may readily be imagined. Further, the streets serve as drying grounds in fine weather; lines are stretched across from house to house, and hung with wet clothing. (For reference click here.) Stuart Blumin in his book _The Emergence of the American Middle Class_ describes the same transition taking place between late 18th century urban America and the post-bellum period. Urban America moved from "street-alley segregation" of classes to "areal" segregation. Street-alley segregation meant wealthier families lived on the broader, better maintained streets while poorer families lived nearby, down narrower and more crowded alleys. Areal segregation means different social classes living in distinct neighborhoods. Advances in transportation made it possible for more affluent city dwellers to in one way or another to remove themselves from direct contact with what Engels describes above. And something similar is happening today in modern India. Slums are being cleared and slum families relocated. In the place of slums multi-storied apartments are built for the middle class and wealthier families. Those able to separate themselves from the less fortunate do so. It means that the illnesses and the other problems of the poor become less and less of an immediate threat to their own family's well-being. With this, the more affluent need worry far less about the poor's welfare. The poor continue to live their lives, removed from the sight of the "happier" classes . No Other Choice: Enduring open sewers and refuse of all kinds is not a cultural choice. Access to running water and toilets is obscenely small in India. With considerable variation state by state, according to the 2001 census fewer than 30% of homes in India have toilets (with a sizeable percentage of these being pit latrines or pit toilets. For a break down I've compiled state by state click here). This begs the question as to why investment in water and sewer systems are not given priority, especially given the seriousness of the diseases caued by improper sanitation.

Two important differences between modern India and urban 19th century America and western Europe:

The provision of clean water and sewer connections was not remarkably fast in the now indistrialized world (see for example, Martin Melosi's _The Sanitary City_) There are two things that make India's current situation different from western Europe or America's in the 19th century however that have made progress even slower in India and in other economically developing countries. The first has to do with the medical advances that have taken place between the 19th century and now. The second is the sheer size of the problem India faces now now versus what America and western Europe had to deal with a century and a half ago.

Modern medicine has made it possible for economically privileged families to protect themselves without having to worry as much about the poor and their situation. In contrast to 19th century America and western Europe, middle class and wealthier families can insulate themselves fairly effectively against diseases such as cholera and dysentary. Abram De Swaan in his book _In the Care of the State_ details how even as more properous families located in suburban areas with new construction and water and sewer lines they could not completely protect themselves from diseases spread from the poorer sections of 19th century America and Europe. Also with greater numbers of poor people crowded into urban areas it was more and more likely that dieseases such as cholera would break out and spread from poorer areas to wealthier ones. Before antibiotics, other advances in medical care, and insecticides weighing the threat of diseases spreading to wealthier neighborhoods against the added costs of extending water and sewer lines to poor neighborhoods, the calculus of enlightened self-interest tipped the scales in favor of the poor (see Abram De Swaan, pp. 137-142). In modern India the costs and the benefits have changed radically. Poor areas are incredibly congested and therefore very difficult (i.e. costly) to connect to existing water and sewer lines. At the same time and more importantly, the direct benefits to wealthier families of such measures are far less thanks to modern medicine which better protects them against the threat of diseases originating in poorer areas.* *Susan Chaplin in her article "Cities, Sewers and Poverty: India's Politics of Sanitation" (environment and Urbanization, 1999, pp. 145-158) clearly notes this "...the very developlements in modern medicine and civil engineering that contributed to the success of sanitation/ public health in nineteenth century Britain have enabled the middle class to largely ignore environmental problems and the resulting diseases. The use of antibiotics and insecticides have generally contained potential epidemics in slum areas, and hence have not generated a mutual awareness amoung the middle-class that it would be in the interests of society as a whole if the poor were provided with decent living conditions" (Chaplin, p. 151) The congestion and the resultant costs of dealing with sanitation issues are in part a function of much higher rates of increase in numbers and therefore a much larger scale problem to be dealt with. Mira Kamdar in _Planet India_ notes that urban India grows by 10 million people a year. and in Calcutta, The Living City, volume 2 it is noted that Mumbai saw its population increase by 1000 people per day through migration. (Although these numbers are out of date one can imagine the problem is even worse today). America and western Europe had much smaller numbers to deal with during their periods of substantial urban growth. Other factors: A great degree of India's failure to conquer the problems of sanitation and clean water are therefore arguably due to the these two factors. Other factors of course are at play as well. There is the fear on the part of municipal authorities that if in they take measures to improve the living conditions of the poor that this will simply attract more poor migrants to them. There is a Harris-Todaro like argument implicit in this that therefore improvements will be short-lived. As conditions in city A improve a larger fraction of those migrants who might have moved to city B will move instead to A, overtaxing its capacity to serve them and pushing living conditions back to where they were before. The initially cleaner city is ultimately no better off than it was before. One conclusion to be drawn from this is that piecemeal efforts to effect change are far less likely to achieve success than coordinated concerted effort on at least a regional if not national front. There is also the fact that many slum areas are occupied by squatters. The fear is that extending proper water and sanitation will legitimize squatters' claims to these lands. Often large slums are located in what are considered areas of prime real estate (currently Dharavi in Mumbai and the Salt Lake area in Kolkata years ago as well.). As an area becomes more and more settled real estate developers must realize that it will be far more difficult for the state to remove and relocate slum dwellers from these areas on their behalf. (see pages 14-15 of Burra, Patel and Kerr, "Community Designed, built and Managed Toilet Blocks in Indian Cities" Environment and Urbanization, 2003, pp. 11-32) The great predicament is that if the Alliance (SPARC, the National Slum Dwellers Federation, and Mahila Milan) estimates are correct and a 10 seat toilet block will serve 500 people in an area are realtively low cost ($800 U.S. to build a well-designed 10 seat toilet block with pour-flush systems) the fact remains that to tackle this problem requires massive expenditures. For example, in Mumbai almost 2000 such blocks would need to be built to cover slum dwellers who, as of now, haven't access to proper facilities at all. Using the official exchange rate, the total costs would therefore be over one and a half million dollars U.S. (and in terms of purchasing power parity almost $8 million U.S.). Regardless of the cost, management of various charities and NGOs of 2000 such projects along with the competition for money as these organizations work independently of one another implies a high degree of inefficiency. Yet along with the decided apathy that exists due to government focusing mostly on the interests of the well-to-do and the powerful there is the issue of government inefficiency. Burra, Patel, and Kerr make a strong case for being more than a bit skeptical about the ability of municipal governments being at all efficient. One Alliance study cited in their article shows that contractors have routinely built substandard toilet blocks.** Inadequate water supplies in particular mean that often in as little as three months latrines become so blocked and dirty that they become unusable. This couple with builders asking community members for more money as toilet blocks are being built in their neighborhoods and the city charging unrealistically high fees for access (Rs150 for a family of five would allow each family member to use the facilities once a day) suggests that perhaps community based initiatives, given political realities, are on balance a better alternative. ** See Robert Wade_Governing the Market_ pages 288-289. Contrasting corruption in Taiwan to corruption in India he notes that in East Asia: "Most rumored or reported corruption takes place at the local and provincial government levels where nothing major for the national development effort is at stake ... In all these ways corruption contrasts with corruption in many other countries in South and Southeast Asia. Corruption on public works projects, for example, occurs mainly through overcharging for correctly built structures. In India it occurs mainly by substandard construction of correctly priced structures, which are much more likely to wash out in the next monsoon. Taiwan's mode is probably less damaging to economic development than India's".

More public support for higher education

A story on Congressman Jim Webb's proposal to more completely fund veterans college education ran this morning on NPR's Morning Edition. More specifics on Congressman Webb's proposal is to found here on his website. Another related story ran on Marketplace Morning Report. On October 1st a new law comes into effect that changes how students loans are distributed and the rates of interest charged. For more on this click here. The impetus for this new law comes from the Campaign for America's Future .

The G.I. Bill

One way of describing what college professors do is to say that we perpetuate middle class privilege. We could also say that we help to protect the economic gains many families and the American economy overall enjoyed as a result of the G.I. Bill. For more on the G.I. Bill and its impact on American society click here.

socioeconomic standing and access to higher education

Over the last several days I have been struggling with some numbers I had seen reported. These numbers are statistics on minority enrollments and the persistence of enrollment gaps between African-Americans, Hispanic Americans, Non-Hispanic White Americans and Asian Americans. A study by Carnavale and Fry for ETS "Crossing the Great Divide: Can we Achieve Equity When Generation Y Goes to College?" notes that, although the total number of minority students (African-American and Hispanic American) enrolled in college is projected to rise as is the percentage of total enrollments, a significant gap between the share of 18-24 year olds in these groups and the number of African American and Hispanic American 18-24 year olds enrolled as students will grow. (By 2015, 550,000 fewer young Hispanic-Americans enrolled than one would expect given projected population and over 200,000 fewer young African-Americans.) This is a very funny number. The projected population totals are based sensibly on current trends in the growth of different groups (presumably it is based firstly on the number of children born between 1991 and 1997 and then with adjustments made for complicating factors such as immigration, deaths, and so on). However, the appendix to "Crossing" explains that projected enrollments are based on the assumption that current enrollment rates (obscenely lower for African-American and Hispanic Americans 18-24 year olds) will continue. (see Projection Methodology p. 55 of "Crossing"). So numbers such as those for Fall 2005 from the Census Bureau were used. These numbers show that while 40% of non-Hispanic White Americans 18-24 years old were enrolled full time or part time in four year colleges and 50% of Asian Americans only 29% of African Americans 18-24 years old were enrolled part time or full time in four year colleges and only 24% of Hispanic Americans of this age group were. Given the age range reported (18 year olds to 24 year olds) one would expect to see a fraction of 18-24 year olds who have completed their undergraduate degrees. And indeed you do see this. According to the Census Bureau the numbers were 4% for White-Americans, 3.5% for African Americans, only 1.82% for Hispanic Americans, and almost 9% for Asian Americans in October 2005. More importantly and my main reason for looking at these numbers are that regardless of ethnicity there are significant differences in enrollment rates -in either two year or four year colleges or in four year colleges- according to SES (socioeconomic standing). Haveman and Smeeding( "The Role of Higher Education in Social Mobility", The Future of Children, vol. 16, no. 2., Fall 2006, pp. 125-150) note that 90% percent of students from families with incomes in the top quartile of earnings were enrolled in college twenty months after graduation (73% in four year colleges) only 60% of students from the bottom quartile were enrolled in college twenty months after graduation (with fewer than half enrolled in four year colleges, 37% in two year colleges, and 17% enrolled in vocational/technical schools.) To assume that low enrollment rates will persist -as Carnavale and Fry implicitly do- is not very helpful. Similarly, while racial discrimination is in part the cause of lower SES, it is much more important to focus attention on social class as an obstacle to higher education and success. To focus on race seems to invite substantive versus formalist interpretations of the achievment gap. In other words, that the differences in achievment are in large part due to cultural factors. However, controlling for race, there is a strong statistically significant relationship between family income levels and enrollment in college (in either two or four year schools or in four year schools). Using data for October 2005, I find that enrollment rates were about 23% points higher for 18-24 year olds students from families with incomes in the $100,000 to $150,000 range than they were for 18-24 year olds whose families earned between $30,000-$40,000 for example. (These numbers are derived from regression I have run using Census Bureau data on fall enrollments for Fall of 2005.) I am incredibly impressed with a paper entitled "Reducing Inequality in Higher Education: Where Do We Go From Here?" by Cornell University's Ronald Ehrenberg . I am impressed first because of its focus on SES and the inequalities that are perpetuated by both the differences in access to higher education as well as differences in levels of success after a student enters colleges. I am also impressed because of its focus on an analysis of what possibly can be done -in terms of financial aid, education policy at the primary and secondary levels, and within college itself- to assist students from economically disadvantaged backgrounds . For good measure there is a thoughtful discussion of the direct and indirect financial pressures colleges and universities face and how these pressures have led them to worry far less about their role in perpetuating inequality. The paper was presented at the Conference on Economic Inequality and Higher Education: Access, Persistence, and Success, Syracuse University, September 23-24, 2005). Ehrenberg's main points are (1) that little advance has been made in enrollments of students from low income families since the 1970s, (2) that states have increasingly faced tight budgets and, as a result, have kept state spending per student at more or less constant levels since the 1970s, (3) that increased spending per student has therefore been funded largely by tuition increases, (4) that , perversely, as the private returns to college have grown and the gap in earnings between the college educated and those without college degrees has increased, the tuition increases have been more or less tolerated by middle class families. The increases are regarded as the price to be paid for protecting their position. (5) that the increase in tution at four year colleges has shifted proportionately more and more low income students into two year colleges, (6) that given the difficulty of transitioning from two year to four year colleges, especially to those schools where transfers from two year colleges are relatively rare -persistence- the ability of transfer students to complete their undergraduate degrees has fallen.

He outlines several very recent programs at flagship public universities such as UVA, the University of Texas, and UNC-Chapel Hill to increase enrollment of students from low-income families as well as very recent efforts by Princeton (1998), Harvard (2005), and Yale (2006) to increase enrollment rates and graduation rates of students from low-income families. Very selective schools by definition admit and graduate mostly students from wealthier families. Hill, Winston, and Boyd ("Affordability: Family Incomes and Net Prices at Highly Selective Private Colleges and Universities" Journal of Human Resources, 40 (fall 2005)) note that 108,721 students earned undergraduate degrees at the 28 highly selective private colleges and universities in their study. This implies that well under 10% of all the students earning bachelor's degrees in spring of 2002 received their degrees from such schools. Given the cost of attending such institutions, one can safely assume that families of relatively modest means were receiving some sort of financial aid. Assuming that all middle class and low-income families attending these schools received some kind of aid, students from families earning less than $51,000 a year represented only 17% of students graduating from such schools.

To make these very exclusive schools more inclusive is fine. However, students from wealthy families are disproportionately represented in these schools and always will be. Besides this, as noted above only a small percent of college graduates in a given year earn their degrees from such institutions. Therefore changes here cannot be expected to create more than a ripple overall. What is needed are similar programs at the colleges and universities where the majority of students pursue their education. However as Ehrenberg points out there is a danger in such institutions being more inclusive because these "lesser" colleges and universities face even more risk -both financially and politically- if they follow suit.

The financial resources of such schools are far more limited. As Hill,Winston, and Boyd (in the study of highly selective private colleges and universities already mentioned above) note there is a statistically significant inverse relationship between the net price students from low-income families are asked to pay for their schooling and the size of the endowment per student a particular school has. In the case of schools with much lower endowments per student Ehrenberg notes that they "...do not have the large flow of annual giving and the large endowments that the University of Virginia or the University of Chapel Hill have and thus it will be more difficult for them to develop the resources necessary to support programs such as Access UVA or the Carolina Covenant."

He goes on to point out that "If these flagship institutions are successful in diversifying their student bodies along racial/ethnic and socioeconomic lines, they run the risk of alienating the traditional supporters of their institutions; the upper and middle class families whose children attend high school that have been large feeders schools for them. This may translate into political pressure to reverse policies that led to the diversification, or a further loss of financial support for the public institutions." (Ehrenberg, p. 14). Other schools face the same political problem if students from the families that have typically supported these schools have a more difficult time being admitted into these schools because equally or more deserving students from poorer families have taken their place.

Therefore the current efforts that are being made to make access to higher education more equitable are likely to have less impact than one would hope for or what is needed to really change the way opportunity is distributed. A few cards in the deck are being moved around and most of the aces are still at the top. The entire deck needs to be reshuffled.