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A Social (Entrepreneurship) Dilemma

October 25, 2011

Partnerships.org.au begins to discuss an important problem for social enterprises. The article explains: markets “work reasonably well as a test of private value creation, especially for those who are willing and able to pay” but “do not do a good job of valuing social improvements, public goods and harms, and benefits for people who cannot afford to pay.”

This may best be demonstrated with a quick economics lesson and the graph below.

Let’s say the above graph represents a cost-benefit analysis for a public good, say, the clean-up of a polluted waterway. A move along the x-axis represents more or fewer “units” of clean-up, while points on the y-axis represent “units” of price or value. Because the lines represent Marginal costs and benefits, the cost of cleaning up is initially low, maybe the first units of pollution are floating on the top and are easiest to access. The marginal cost of cleaning up increases as more units are cleaned because the pollution becomes harder to access or find. Likewise, the marginal benefit of cleaning up the first units of pollution is much higher than the marginal benefit of cleaning up the last few units. Maybe the first units of pollution are just unsightly, or are most dangerous. Subsequent units of pollution may be less necessary to clean, because pollution in small quantities poses less of a health risk and may be acceptable or even normal. The most efficient amount of clean-up, then, is demonstrated by the point at which the marginal cost of a certain quantity of clean-up matches the marginal benefit afforded by that quantity (the point MC=MB). Based on the position of this point, one can deduce the proper quantity and the price per unit of that quantity, respective points on the x- and y-axes.

Now let’s complicate the graph slightly.

The above graph still represents marginal costs and benefits, but now we distinguish between “Marginal Public Benefit,” “Marginal Social Benefit,” and “Marginal Social Cost.” Following with the above example, this graph represents that in many cases, including ours, the benefit of an action to society may be greater than its benefit to a specific individual or group of individuals. In general, individuals will perceive less benefit from the cleaning-up of the waterway, but society in general will certainly benefit from the cleaning-up of the waterway. Maybe pollution in the waterway was killing populations of fish caught for food, and continued pollution would harm the local fishing economy. Individuals may only think cleaning-up the waterway gives them a place to swim and a lovelier sight, not being able to calculate the impacts of a potentially damaged economy on their lives. This difference between marginal social costs/benefits and marginal private costs/benefits is called an externality. The result of externalities are conflicting points of equilibrium: here, a different conclusion as to the most efficient amount of clean-up (MC=MPB vs MC=MSB).

Economic models typically assume individuals are acting in their own self-interest. Individuals see only how policies directly benefit them, mostly because they are not immediately able to calculate the complex implications of actions. Thus, most basic models would direct us towards the quantity “Q” of clean-up in the above graph, even though the optimal quantity for society would be “Q opt.”

Situations that involve negative externalities can be described as Social Dilemmas. Pollution is a good example of a social dilemma because usually the cost of polluting is relative low to an individual or corporation, but that pollution affects others around it. While the corporation will make decisions based on its personal costs and benefits, usually the cost or benefit to society will be ignored. i.e. the corporation pollutes with general disregard for its negative impacts on society.

This question of individuals’ self-interest defines the dilemma stated at the beginning of this post. As individuals attribute value to marginal units based on their perceptions of benefit to themselves, they act based on those perceptions, rather than the reality of the benefit (or lack thereof) to society as a whole (“It is inherently difficult to measure social value creation.”). Social enterprises must appeal to individual consumers, even though they are trying to achieve a different equilibrium (MC=MSB) than a group of individual consumers (MC=MPB).

“Many social-purpose organizations charge fees for some of their services. They also compete for donations, volunteers, and other kinds of support. But the discipline of these ‘markets’ is frequently not closely aligned with the social entrepreneur’s mission. It depends on who is paying the fees or providing the resources, what their motivations are, and how well they can assess the social value created by the venture…Even when improvements can be measured and attributed to a given intervention, social entrepreneurs often cannot capture the value they have created in an economic form to pay for the resources they use…To offset this value-capture problem, social entrepreneurs rely on subsidies, donations, and volunteers, but this further muddies the waters of market discipline” (Partnerships.org.au).

In short, social enterprises operate within markets – using markets to more effectively accomplish their goals – but these organizations, by definition oriented towards benefitting society, are thus frequently unfit to compete within these markets where self-interest rules.

This may mean that consumers demand the goods and services of a social enterprise at  the price “P,” even though the social enterprise most likely needs to sell such goods at the price “P opt” in order to cover the costs it incurs. It also suggests that the social enterprise is producing (or wants to produce) more of the good “Q opt” than is demanded by consumers “Q.” It should be noted that this model applies best to organizations that directly produce a public good, such as an environmental group that protects endangered species. One can see, then, that it is difficult for an individual to estimate how much benefit will be created by his donation that may save “n” number of bald eagles, and the specific private benefit of such an action is equally elusive.

Partnerships.org.au concludes, then, that often only weak correlations exist between a social enterprise’s ability to attract donations and profits, and the amount of “good” it creates. The most successful social enterprises may simply be those that more closely resemble businesses and/or provide social benefits as more of an afterthought. Or, perhaps some of the most successful social enterprises are those that best utilize advertising and other competitive techniques. And how competitive ought social enterprises to be, especially if their competition consists of other social enterprises?

The site also conclude that the failure of individuals to align social benefit with their own private benefit creates a gap in revenue for many social enterprises. This gap is usually filled by government grants or philanthropy, explaining why most social enterprises cannot be self-sufficient. Although, the most successful social enterprises find creative ways around this problem.

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