It’s just an economics editor in need of some modern undergraduate coursework, people (a fast and frugal history of recent economic theorizing)

Ross Gittins, the economics editor of the Sydney Morning Herald, yesterday threw a fit; you can read it here. Basically arguing that economists are hopelessly committed to something he labels the “’neo-classical’ model”, he claims that

“This conventional economics reduces all economic activity to that which happens within markets. It further narrows the operation of markets to the setting of prices, assuming movements in relative prices are the primary thing influencing the behaviour of producers and consumers.

It thus abstracts from the role of ‘institutions’ – be they organisations, laws or conventions – in influencing market behaviour, so often leads economists to make policy recommendations that prove seriously misguided.”

These are astonishing claims; somehow Gittins seems to have missed the emergence of (non-cooperative) game theory of the eductive and evolutive kind, modern Industrial Organization (including organizational economics and contract theory as well as corporate finance as encoded in Tirole’s 2006 book), the law and economics movement, modern institutional economics, (market and mechanism) design economics, experimental economics, and behavioural economics. As a matter of fact, there are literally thousands of published articles, and consulting reports for governments and various government bodies, that have been written on various economic aspects of organizations, laws, regulations, and, yes, conventions. There are now even high-quality journals dedicated explicitly – qua title – to those areas of research. In fact, most of these topics are being taught at better Australian universities in their undergraduate program. That’s because the subtle influence of institutional details – for example in various matching mechanism and other market and mechanism design problems (e.g., here for an example of a prominent contributor and likely future Nobel Prize laureate and his work and here for an example of another prominent contributor who should, arguably, have received the Nobel Prize together with Smith and Kahneman a few years back already and still might) — is widely acknowledged.

That’s also why social, and anti-social, preferences have become a veritable cottage industry, as has a related literature on altruistic punishment (Google currently lists under “altruistic punishment” more than 3,500 scholarly articles.)

And, of course, economists have for a long time, and famously, been attacked for their “imperialism”, i.e., their attempts to analyze other than market phenomena. (“Economics imperialism” features 500 Google hits.)

The “’neo-classical’ model”, truth be told, has long been superseded by a wide and ever increasing variety, and diversity, of methods and models.

Yet, it does not mean that more standard game-theoretic models (probably to Gittins’s mind part of the neo-classical model world) are not useful. Somewhat ironically, his discussion of Ostroem’s work, and the claims that Gittins makes about the originality of her work, illustrates that point.

Says Gittins:
“For a good example of the way different analytical models can draw different conclusions about the same problem, consider an old economists’ favourite: the ’tragedy of the commons’.

Because no one owned the common area, no one had an economic incentive to look after it. Indeed, each individual had an incentive to get in and use as much of it as possible, as quickly as possible, before other individuals used it up. So what was everyone’s property was actually no one’s property – and that was the essence of the problem.

Many economists thought it obvious that the solution was to allocate private property rights over the commons.

Neat, eh? Of course, there were also some who saw the solution as having the government take over the common property, maintain it and allocate its use on some fair basis.”

Gittins then goes on saying that recent Nobel prize laureate Elinor Ostrom
“devoted much of her career to combing the world looking for examples where people had developed ways of regulating their use of common resources without resort to either private property rights or government intervention.”

Her excursions were indeed successful, something that would not even have surprised Adam Smith who wrote, after all, extensively about the emergence of languages, moral sentiments, and institutional regulations (and their abuse) .

Ostrom found, that “(i)n all these cases people drew up sensible rules for sharing the use of the resource and combined to perform regular repairs. People who broke the rules were fined or eventually excluded.”

Well, that is exactly what standard “neo-classical” game theory, with its heroic common knowledge and rationality assumptions, would suggest, no? The people living in mountain villages in Switzerland and Japan, and fisheries in Maine and Indonesia, and similar repeated-game situations might be able to reach other equilibria in social-dilemma situations than those in one-off situations exactly because they have punishment options of various kinds. That’s the kind of stuff – the issue of “reputational enforcement” (Google lists more than 1,500 scholarly articles on it) — now routinely taught in undergraduate courses. And, yes, Adam Smith understood reputational enforcement exceedingly well, too.

It is simply nonsense to argue:

“Few economists had heard of [Ostrom], or her model-busting work.Why had this solution to the problem never been considered by economists? Because of their model’s implicit assumption that we only ever act as individuals, never collectively. We compete against each other, but we never co-operate to solve mutual problems.”

No, no, no. This is what game theory is all about: individual actors inter-acting (or, acting collectively). There are well defined conditions, well understood by most modern economists, under which interacting optimizing individual actors co-operate. There are also good reasons why proponents of the Nash program (which postulated, for the sake of robust implementation, that cooperative solutions be grounded in non-cooperative assumptions) have belaboured for the last five decades that very point, with considerable success since non-cooperative game theory today is the only game in town that matters and that, incidentally, is the heart and soul of theorizing about reputational enforcement. And has been that for at least three decades, as demonstrated by the classic work in the early 1980’s by people such as Klein and Leffler and Shapiro.

That the economics editor of one of Australia’s finer newspapers is that uninformed about modern economic theory is bad enough. That he has no qualms to regurgitate the same old tired misperceptions about economists, and the alleged false policy advice they give, is appalling. For all I can see, Gittins’s poorly informed opinion piece reflects more on his ignorance than the stupidity of economists currently working in Australia. At least not economists working in academia.

The Economist can’t be wrong (or PERHAPS it can …)

A famous saying has it that, if we were to ask “n” economists for their opinion, we would be assured of at least “n+1” opinions because one of them would surely have two opinions all by himself.

So when 172 economists (professors all and by and far German, to boot!), motivated by the outcomes of the recent EU summit (specifically the politically agreed-on direct recapitalization of troubled banks through the European Financial Stability Facility, and its planned future replacement, the Europen Stability Meachnisms, or ESM), … when these 172 economists sign off on one statement, something extraordinary must be happening. Indeed it is.

Germany’s chancellor, Angela Merkel, already losing fast her domestic political support (see here), now also faces considerable public opposition in the form of a letter to the public (see here) that those 172 professors – many of them quite prominent – have signed. (Here is The Economist’s take on things ). The letter of the 172 profs is quite a challenge. Nevermind the multiple legal challenges that are on the way (see here) and that already led Germany’s president, Joachim Gauck, upon request of the country’s High Court, to postpone his signature on documents initiating the European fiscal pact and the ESM.

The letter of the 172 profs drew immediate reactions from Merkel and Schaeuble (her minister of finance) as well as the popular press which has supported Merkel for years in a fairly uncritical manner. (Indeed, Merkel’s public approval ratings until recently were almost those of Gillard and Abbott together.) The 172 profs were called everything from “unknowns outside of their university” (clearly wrong) to “Stammtisch economists” to “irresponsible” by various partisan commentators including two groups of economists: one spearheaded by alleged “heavyweight” Bofinger and the other by a group of economists connected to the Frankfurt Center of Financial Studies. It is noteworthy that the first group consists of a handful of economists while the second group of about 15. Hardly a strong counterattack, to go by the numbers.

Most recently, a couple of prominent Swiss economists (Monika Bütler, Urs Birchler, B&B from here on) have commented for Swiss newspaper Der Tagesanzeiger on this developing story (see here). Coming from well-informed outsiders, what they have to say strikes me as about right. What follows below is a summary (and partial translation of key passages) of their commentary.

B&B start out by stating that the 172 profs see the proposed European banking union as a means to have tax payers ultimately pay for bank debts (and private profiteering gone awry). They stress that the signatories swim against a current that got stronger in recent weeks and months, with even The Economist, which they call “otherwise reliably market-oriented”, now suggesting to Germany: Pay already! And even though Merkel already has a worldwide reputation as a spoilsport, due to her resistance to the socialization of European debt, the 172 economists argue that she has gone way too far with her agreement to the plans hammered out at the recent EU summit.

B&B summarily dismiss the critique of Bofinger et al. as high in rhetoric and low in substance. B&B then argue that, in contrast, the critique of the 15 economists from the Center for Financial Studies (CFS) in Frankfurt, including Jan Krahnen and Martin Hellwig, ought not to be dismissed. They note that these economists see the ESM as a suitable mechanism to recapitalize banks directly, in return for various suitable conditions.

B&B next ask who is right in their assessment of the EU summit agreements (and in particular the ESM): the 172 economists who wrote the public letter or the 15 CFS economists? B&B conclude that the assessment in the latter case is based on the idea as such (no socialization of European debt), while in the former case the assessment is based on the likely reality (money today for promises to be enacted tomorrow but promises that will not be kept).

B&B then offer an “anatomy of the crisis” stressing that there are really three separate crises (the Euro-crisis which has to do with the diverging competitiveness of the countries in the Euro-zone, which seems to necessitate the exit of some of the countries from the Euro-zone or tremdous efforts by Germany and others able to provide such effort; the national debt crisis, which puts many governments at the mercy of the vagueries of international financial markets; and the bank debt crisis, which has European banks suffering the consequences of the financial crisis, the real estate bubble and the high stock of government bonds with many undercapitalized still distributing huge amounts of dividends and bonuses.)

B&B argue that the EU has been responding to these three crises without any recognizable concept but with ever larger amounts and with ever emptier slogans through which subsets of the crises were linked (“If the euro fails, Europe fails”) and which were then used to dismiss previously adopted rules. B&B argue that the increasing amounts of funds invested in rescue operations and emergency pots have helped neither the Euro nor the indebted countries, and that the Euro can only be saved with economic adjustments in the afflicted countries. Whatever help is currently being given out ends up in the hands of the banks’ creditors, i.e., internationally active banks.

The concluding paragraphs seem worth translating:

“Rescued Banks – Shattered state institutions

With the bailout of Spain, the facade has now fallen. Money goes directly from the printing presses of the ECB to ailing commercial banks. You have to imagine such transactions five years ago. The financial press would have raised hell: A central bank finances troubled commercial banks! By abandoning the commercial banks’ (and their owners’) responsibility for losses and by abandoning its abstinence from handing out selective benefits, the ECB destroys two pillars of the financial architecture.

It seems that no one bothers – except those 172 economists from German-speaking countries through their, in light of the circumstances rather tame, letter. Admittedly, the letter simplifies much, but in its essence it is right on target. The results of the attempts to rescue the Euro and the Euro-zone come to this: on the one hand the far-reaching bailout of banks, on the other hand a shattered European monetary system, broken public finances, and a shattered confidence in European institutions.
This time no one will be able to say: The economists did not warn us.“

So much for B&B.

The subject matter is, of couse, complicated and reasonable people can have differing opinions on some of the matters. The letter of the 172 profs has created new realities in the current debate and certainly will make it more difficult for Merkel and her government to push things through without proper examination of what she commits Germany to.

At the minimum, the 172 profs have invigorated a debate that so far was mostly conducted by professional politicians (i.e., the same people who are majorly responsible for the current malaise of Europe and the Euro). That has to be a good thing. As Germany’s influential weekly Der Spiegel noted (see here), the discussion has become one about ideas rather than ideologies and that has to be a good thing, too.

Will developments in Europe have an effect on Australia? The local experts seem for the most part to think it won’t (see here) but they diverge widely in their forecasts. As one might expect in such a complex matter.

Women and children first! Not!

In a recently published working paper (see here), Swedish economists Elinder & Erixson revisit the issue of gender, social norms, and survival in maritime disasters. This topic has attracted some attention through the controversial work of Frey et al. (e.g., here; see also here) which made much of the alleged bravery of male passengers on the Titanic who allegedly sacrificed themselves so that women and children might be saved, seemingly providing further evidence for a “women and children first” social norm. Specifically, Frey et al. argued that “even though the two vessels and the composition of their passengers were quite similar, the behavior of the individuals on board was dramatically different. On the Lusitania, selfish behavior dominated (which corresponds to the classical homo economicus); on the Titanic, social norms and social status (class) dominated, which contradicts standard economics. This difference could be attributed to the fact that the Lusitania sank in 18 min, creating a situation in which the short-run flight impulse dominated behavior. On the slowly sinkingTitanic (2 h, 40 min), there was time for socially determined behavioral patterns to reemerge.“ (from their abstract)

There was much wrong with the Frey et al paper (an earlier version of which I reviewed for another journal). The authors’ assumption that these two “treatments” differed only in the speed of sinking was unwarranted, as speed of sinking, and time pressure, were confounded along multiple dimensions. For example, the knowledge conditions were quite different across the two “treatments”. The Titanic sank three years earlier than the Lusitania; it also had a reputation for being ‘unsinkable’ that made it easy to seemingly accept the “women-and-children-first” social norm. Indeed, the first life boat was launched only one hour after the Titanic struck an iceberg and was populated only by a fraction of the passengers it could carry. In essence, chivalry seemed rather inexpensive on the Titanic. At least during the first couple of hours. In contrast, the passengers on the Lusitania almost certainly knew about the sinking of the Titanic. They also knew that their ship was likely to be targeted by the German Imperial fleet. Thus the passengers on the Lusitania surely had no doubt what happened, and what their likely fate would be, when the Lusitania was hit by a torpedo. That very moment chivalry had become rather expensive.

Elinder & Erixson analyse a database of 18 maritime disasters spanning three centuries, and covering the fate of over 15,000 individuals of more than 30 nationalities. Taking their cue from the work of Frey and his collaborators, they test six hypotheses.

Their results suggests that there is little place for chivalry during maritime disasters: Women have a substantially lower survival rate than men. Contradicting the adage that captains (and crews) go last in these kind of situations, Elinder & Erixson find that crews, and captains, do significantly better than passengers (whether female or male); see Figure 1 in their paper. (Yes, Francesco Schettino, you are not alone.) Predictably, children fare worst. Importantly, the authors also find that duration of a disaster has no effect on the survival probability of social norms. The one thing that seems to give the “women-and-children-first” social norm a chance is an explicit policy of the captain. Essentially this finding demonstrates that the potential for punishment has some sway. Elinder & Erixson (2012, p. 8) also show “that women fare worse, rather than better, in maritime disasters involving British ships. This contrasts with the notion of British men being more gallant than men of other nationalities.”

Three Cups of Tea, the sequel

A while ago, I related to this forum a “developing story” in the USA (see here) involving the Central Asia Institute and its founder Greg Mortenson; the multiple allegations (of fraud, deceit, breach of contract, racketeering, and unjust enrichment on the part of Mortensen and CAI) were significant and posed, once again, serious questions about the accountability and transparency of the not-for-profit sector in the USA as well as the enforcement mechanisms that are in place over there. I also argued that similar questions could be asked about accountability and transparency of the not-for-profit sector here in Australia. I did so already in earlier contributions (see here and here.)

Last week the Montana Attorney General, Steve Bullock, issued a report of his office’s investigation into CAI and Mortenson. You can find it, in all its depressing glory, here. It is likely to become a classic case study of what goes for accountability and transparency and enforcement in some quarters. It poses more questions than it answers.

The AG’s report essentially confirms many of the allegations. Arguing that CAI/Mortensen have accomplished some good, and – given a chance — might do some more, the AG has put in place a “settlement” that allows CAI/Mortenson to get things right in the future. Or at least right enough for the Montana Attorney General not to bother them. Essentially, more than a decade of flaunting accountability and transparency, and more than a decade of questionable spending of literally tens of millions of dollars, will be forgiven as part of the settlement. In the words of the AG:

“We concluded that the board of directors failed to fulfill some of its important responsibilities in governing the nonprofit charity. Further, Mortenson failed to fulfill his responsibilities as executive director and as a member of the board.
Despite policies that committed him to do so, Mortenson failed to make contributions to CAI equal to the royalties he earned on the books the organization purchased. Nor did he and CAI devise an equitable way to split the costs to advertise and promote the book, which was required by his 2008 employment agreement. Mortenson also accepted travel fees from event sponsors at the same time that CAI was paying his travel costs. Moreover, he had significant lapses in judgment resulting in money donated to CAI being spent on personal items such as charter flights for family vacations, clothing and internet downloads.
Despite consistent and repeated warnings about a lack of financial controls for the money CAI spent abroad and here at home, the board of directors failed to close those gaps over a period of nearly ten years.”

This strikes me as way too gentle a way of putting it, given that in 2002 Mortenson essentially forced out three members of the supervisory board that demanded accountability and transparency. And that a couple of years later the CFO resigned in response to Mortenson’s continued refusal to do what ought to be done. Lapses in judgment? Oh, please … Again, in the words of the AG:

“Between 2001 and 2011, CAI had three independent audits of its financials. The audits performed for the 2003, 2009 and 2010 fiscal years revealed material weaknesses in CAI’s financial and internal controls. Rather than address the deficiencies found in the 2003 audit, the board discontinued auditing its finances. The same material weaknesses appeared in the later audits. The CAI board also was expressly told of financial deficiencies and problems with internal controls by its former chief financial officer during the CFO’s employment with the charity. Those problems were further detailed and reiterated in a memorandum supplied to the board when the CFO resigned in 2004.”

It ultimately took The American Institute of Philanthropy, an independent charity watchdog, and a CBS program, “60 minutes”, to raise public and effective concerns about CAI’s lack of accountability and the dubious role that Mortenson played in it all. The “60 Minutes” program, apart from alleging mismanagement of funds, also alleged that Mortenson fabricated some of the stories in his books including “Three Cups of Tea”.

It is noteworthy that these allegations — which continue to stand — were not investigated by the Montana Attorney General, as were issues that are within the domain of the taxing authorities.

Three comments come to mind immediately:

First, why did it take an independent charity watchdog and a CBS program to finally (well, let’ s hope) put a stop to years of mismanagement and material weaknesses in financial and internal controls? And, by all accounts, millions of misappropriated funds on the part of Mortenson? Where was the Montana Attorney General during the past decade?

Second, while it is somewhat understandable that the Montana Attorney General now tries to right things (at the expense of getting things right), it sends a devastating signal to the not-for-profit sector in the USA as a whole. Essentially he invites every not-for-profit, and for-profit-in-disguise to follow the example of CAI/Mortenson. Predictably, the Montana Attorney General’s report, and decision, will become a template for those not-for-profits trying to avoid proper accountability and transparency.

Third, the CAI/Mortenson story is an ideal test case for the Australian Charities and Not-for-Profit Commission (ACNC) Implementation Taskforce (for its website see here) to understand whether its intended (enforcement) model has bite. It now seems obvious that the ACNC will be little but a variant of the Charity Commission for England and Wales. I have argued elsewhere (see the references above to my earlier CET contributions) why this model is flawed and can, and should be, improved on. I do see nothing in what is currently known about the ACNC that convinces me that something like Mortenson/CAI could not, or is not already, happening here. The recent series of investigative reports of The Daily Telegraph (See here and here and here and here and here) and the responses of advocates (see, for example, here) are not reassuring.

As is a recent submission to the Treasury of the Community Council of Australia (for its website see here). Its ”informing principles for new fundraising regulation” say, among other things, this:

“2. While increasing the transparency of charities is desirable, no evidence has been presented to indicate the Australian public lack trust in charities or are concerned about information asymmetry. The goal of any new regulation should not be seen as addressing a market failure, but of promoting more charitable giving.”

I am not sure in what reality the authors of that principle live. Surely it is a parallel universe to the one described in the Daily Telegraph investigative reports. Or, for that matter this study of fraud in Australian nfps: BDO study. And, surely, it does not match my own experiences last year when I tried to identify, on a very happy occasion, deserving not-for-profits.

It is discouraging, and from my perspective very short-sighted indeed, for the Community Council of Australia to dismiss the serious lack of accountability and transparency that does afflict the Australian not-for-profit sector, and the lack of public trust that begets.

An update on the Australian carbon pricing mechanism

On Friday last week (February 3), the Department of Climate Change and Energy Efficiency (DCCEE) published a position paper (see here) that will inform the development of a legislative instrument for auctioning carbon units that will specify the detailed policies, procedures and rules for auctioning carbon units; the DCCEE is now seeking public comment on that position paper. The deadline: 24 February 2012; yes, a couple of weeks away. There will also be two technical working groups in Sydney on Thursday, (16 February) and Melbourne (17 February) but apparently they are by invitation only.

Also last week, the DCCEE released a consultation paper which you can find here; that consultation paper provides an experimental test of possible designs for the Australian carbon pricing mechanism.
While I welcome the fact that policy decisions of that kind are tested experimentally (Disclosure: I am one of the authors and a peer reviewer of select chapters of that study), it is incomprehensible to me that a report that was written in late 2009/early 2010 (and submitted in May 2010) is only now being released.

I also wonder how someone can reasonably expect that a couple of weeks are enough for serious commentary (especially given the fact that whoever comments on the position paper and its positions probably ought to have read at least sections of the consultation paper); makes me wonder how serious the DCCEE is about seeking public comment on the position paper.

I, for one, will now go back to writing my Discovery grant proposal which is on evidence-based policy making. Oh, wait …

An update on the regulatory reform of the not-for-profit sector

To recall: On 10 May 2011, following preparatory steps such as a Productivity Commission report on its status (see here), and a Consultation paper based on it (see here), the government announced its intention to reform the Not-for-Profit (NfP) sector in Australia (see here for a quick overview of that sector, one of the largest service sectors in Australia and one that has outstanding importance for the social fabric of the country). I have previously blogged on these and related developments (see here and here). There is no doubt in my mind that the Gillard government ought to be lauded for its initiative. It was overdue.

Putting its money where its mouth is, the government has budgeted more than $ 50 million over four years for a range of measures which prominently include the establishment of an Australian Charities and Not-for-Profits Commission (ACNC, see here). The government also established the ACNC Implementation Taskforce (see here) which is charged, during the current start-up year, to build the foundation of the ACNC (including making many of the key personnel decisions).

The ACNC Implementation Taskforce, headed by Susan Pascoe AM (see here) and assisted by David Locke (see here), who is on secondment from the Charity Commission of England and Wales, started its work soon after Shorten’s announcement and has initiated a process now well on its way: four by-invitation-only roundtables towards the end of last year, as well as two discussion papers in November (on the functions and operations of the ACNC, see here) and December (on governance arrangements, see here), will in early February be followed by an ACNC road-show through capital cities (see here for the schedule) before the actual set-up will be finalized in March through June of this year (see here).

There are interesting questions to be asked, also for economists, about the incentive-compatible design of this new organization, as well as the whole design and implementation process itself. It is an interesting question, for example, to determine which interests are to be taken into account. That of NfPs, and/or that of their peak bodies, and/or that of those working in NfPs, and/or that of the government, and/or that of consumers’ of NFP services, or that of the country at large? It is also an interesting question how to take them into account.

The “MudMap” to be found on the ACNC site (see here) illustrates a fraction of the myriad interests that have to be negotiated in the process. My first reaction to this map was, too many cooks have to spoil the broth. Having followed the process over the last few months (and having participated in one of the roundtables), it seems that the process is well managed and reasonably transparent although it is not clear that to me that it will lead to the optimal outcome, or even a good one. Consumers, for example, seem awfully under-represented. And from what I have observed so far, way too many lawyers and lobbyists seem to get their say too often. It will be interesting to see whether the crew that will be on board in mid-year (when the ACNC is taking over from the Implementation Taskforce) is really independent of ATO and other parties with very vested interests that currently seem to have a prominent voice.

As mentioned, the government has issued two working papers (on the functions and operations of the ACNC and on governance arrangements), with consultation deadlines set for Feb 27 for the former and January 27 (yes, coming very soon indeed ? ) for the latter. By and far it seems fair to say that many of insights reflected in the discussion paper are informed by the experience of the Charity Commission of England and New Wales (no surprise here, given David Locke’s prominent role); I am on record having my doubts about this model (see my comment on the Productivity Commission report here). I continue to believe that a hybrid model of compliance – the kind of things that the ACNC Implementation Taskforce is considering implementing and on top of it certification for the few hundred nationally acting not-for-profits – is a better way to go. As detailed in my comment on the Productivity Commission report, there is certainly considerable evidence on the efficacy of some such model.

In the discussion papers that the ACNC Implementation Taskforce has issued, I have read many things that sound right. Yes, it’d be wonderful to have “validated data” (p. 7, discussion paper on Implementation Design) but how do we validate them when the data apparently will be self-reported? And, yes, I like to have an “open data” facility so that researchers can develop their own analytical material (p. 18, discussion paper on Implementation Design). As a matter of fact, that kind of data base would be an effective means for researchers and press and other interested parties to smoke out those that have an insufficient understanding of the fiduciary duty that comes with public monies. It will be interesting to see what exactly this data base will contain. Whatever it is; it will be undoubtedly be self-reported data which are notoriously problematic (see here).

Nevermind that it is currently unclear to what extent this reporting will indeed reduce red tape, and reporting required by other entities. It will take a lot of persistence and negotiation for this data collection to be allowed to substitute for other such efforts. Both the Implementation Taskforce, and its successor, have their work cut out for them.

It is encouraging that the ACNC Implementation Taskforce acknowledges that there is considerable potential for various forms of corruption (e.g., false acquittal of a government grant, or its expenditure on purposes it was not intended for), fraud, mission drift, and so on (see pp. 9 – 10 dp on Governance Arrangements). But again, here, too, the devil is in the detail and it will be interesting to see what effective means the ACNC will end up having and implementing.

The ACNC Implementation Taskforce provides a useful discussion of principles that ought to guide the implementation of appropriate governance mechanisms (pp. 15 – 29). It is heartening to see that it realizes that not-for-profits have multiple stakeholders of which many are unlikely to be properly represented and that therefore “responsible individuals must exercise at least the same degree of care, diligence and skill that a prudent individual would exercise in managing the affairs of others.” (p. 16, no. 87, see also no. 89). All that is fine and dandy, as is the lengthy discussion (and as are the consultation questions) regarding conflict of interest; nevermind the question what exactly constitutes material personal interests, I have to wonder though what the consequences of violations of some such requirement are. My experience in Australia (e.g., being the Treasurer of an owners’ corporation) is that there are lots of well-intentioned laws and regulations and guidelines but they can, more often than not, be violated with impunity because consequences are either not attached to start with, or not imposed, if indeed they exist.

Overall, I fear that we might end up with a lot of new wordage and reporting requirements that will have little bite when all is said and done.

I would not mind being wrong on this one.


Three cups of tea and other nasty habits

The philanthropic press in the USA (e.g., here) — and not only it (e.g., here) — is currently abuzz about accusations levelled against Greg Mortenson, former mountaineer turned successful book author turned philanthropic entrepreneur and co-founder of the Central Asia Institute (CAI).

For a quick primer, see here.

The CAI has raised tens of millions of dollars and claims that it has built and/or supported over 170+ schools and school library projects and provided education to over 68,000 children, including 52,000 girls, in the remote regions of Pakistan and Afghanistan where few education opportunities existed before CAI did all the good deeds it reports having done (see here.) But did it? And did Mortensen benefit in unseemly ways from the considerable donations that CAI managed to attract?

It is not clear at this point what exactly the truth is but a class-action suit has been filed that alleges fraud, deceit, breach of contract, racketeering, and unjust enrichment on the part of Mortensen and CAI. See here for the gory details. The evidence that has emerged so far suggests that there is something to the accusations and that, at the minimum, Mortenson and CAI played fast and loose with the facts.

Whatever the evidence turns out to be, this affair is of the high-visibility kind and hence very likely to have already damaged the reputation of the not-for-profit sector in the USA as such; it has rightly generated more questions about the efficacy of the monitoring solutions that the not-for-profit sector in the USA adopted a few years back under the threat of legislative action. See here. I would be very surprised indeed if Senator Grassley — who back then single-handedly prodded the not-for-profit sector in the USA to take action — will not have some further questions to ask about this latest indication of the not-for-profit sector’s inability to monitor itself. And I am sure he will ask them very publicly.

It is, of course, an interesting question whether a similar development could take place in Australia. The Mercy Ministeries, albeit on a much smaller scale, is an example that, yes, it could. See here.

A set of recent experiments of colleagues in Australia further illustrates the potential for abuse well. In “Economic and Intrinsic Motivations for Dishonesty: An Experimental Study”, Friesen & Gangadharan, senior lecturer at the University of Queensland and professor at Monash University, respectively, conducted two incentivized lab experiments
with students. In their “Theft experiment”, their subjects were asked to find in given tables pairs of two-digit numbers that would add up to 100 and to then report anonymously how many of the 20 matrices they had been able to “solve” this way; their pay was the self-reported number of correct decisions and the pay was real cash provided by the experimenter. In their “Reporting experiment”, subjects were asked to make potentially hazardous “production decisions”. The probability of hazards could be reduced at a cost to the “producer” under conditions of compulsory and voluntary reporting of “accidents”.

(Before you read what the results were of those experiments, you might want to predict them.)

In the Theft experiment, one third of subjects took more money than they were entitled to; of that third, one quarter took all. In the Reporting experiment, nearly everybody was dishonest at some point. (Note that in the compulsory treatment that requires outright lies.) Less than ten percent of the subjects always reported an accident! Reporting occurred more often in the compulsory treatment than in the voluntary.

Dependent on your belief in human nature, these results may be surprising but they should, in any case, provide some food for thought: If in an environment where relatively little is at stake you see such massive cheating, what can you reasonably expect in an environment where lots is at stake and hence the temptation to misbehave is correspondingly so much greater?

Another interesting “experiment” was recently reported by the IRS of the USA which on June 2008 revoked summarily the tax-exempt status of no less than 275,000 nonprofits that failed to file reports for three years in a row. In numbers of existent entities that action shrunk the US Third Sector overnight by more than 20 percent. See here. These numbers are truly stunning and illustrate the utter lack of accountability and transparency of the sector in the USA. I am almost certain that Senator Grassley will have many a question to ask about these developments. As well he should.

These developments also suggest that how important it is for the nonprofit, or third sector in the USA and Australia, to catch up with its attempts to become accountable and transparent so that developments like the ones mentioned at the outset cannot possibly happen again. The Australian Third Sector is not accountable and transparent and current discussions on how to change that sorry state of affairs are curiously uninformed by discussions and events elsewhere; it is particularly noteworthy that the changes currently discussed in Australia have quite some similarities with the failed US system of self-reporting and self-monitoring.

I have written about the problem of the lack of accountability and transparency of the not-for-profit sector in Australia, and the insufficient current attempts to reform it, elsewhere (e.g., here), so simply leave it at that for here and now.

Addressing Not-For-Profit Sector accountability and transparency

The Australian Third, or Civil Sector, is one of the largest industries in the country. According to a 2010 Productivity Commission (PC) report (see here) it consists currently of 600 000 not-for-profit organizations, of which the Australian Bureau of Statistics considers about 60 000 economically significant (e.g., employing paid staff, or otherwise a candidate for taxation). Over the past decade the sector’s contribution to GDP has doubled and it is currently estimated to be at least 4 percent per annum, i.e., well in excess of $40 billion. Nearly 5 million volunteers add an estimated $15 billion in unpaid work. The Third Sector is a key ingredient of civil society.

The Australian Third Sector is also covered by a pathetic hodgepodge of regulation. In the words of the PC, “the current regulatory framework for the sector is complex, lacks coherence, sufficient transparency, and is costly to NFPs [Not-for-Profits]” (PC 2010, XXIII) yet, the Australia does not have standards of recommended practices for charity accounting such as England or Wales, or New Zealand, or the USA and Western European countries for that matter. Fundraising is de facto unregulated. Essentially, donors and state have little idea what happens to the considerable amount of private or government donations (concessions). That’s not a way to instill public trust and confidence in a sector whose livelihood depends on it.

The problem has long been known and a sizable cottage industry has documented the lack of accountability and transparency of the Third Sector in Australia. Over the last 15 years (starting with the 1995 Industry Commission report) five significant federal inquiries have addressed the regulatory mess that the Third Sector represents, and dozens of talking heads — mostly lawyers, advocates, and bureaucrats — have given their opinion on literally thousands of pages of final and draft reports, thousands of submissions on the draft reports, transcripts of hearings, scoping reports (the latest one, drawing on the PC 2010 report, issued in January 2011, see here.

Apparently, to judge from a clip in the SMH this past weekend, the federal government is now determined to install a national not-for-profit regulator to cut the red tape in the sector: Labor, we learn, “will reportedly put aside $53.8 million over four years in Tuesday’s budget to establish the independent Australian Charities and Not-for-profits Commission from July 1 next year.” (see here)

Welcome news that is on the one hand. One the other hand, I fear the problem of accountability and transparency of the Not-For-Profit Sector will not be solved this way. If other countries’ history is any guide, it will take some big scandals to focus the government and the sector on what it means to be accountable and transparent.

I see two key problems:

First, few seem to have a good understanding what exactly the purpose of regulatory reform in this area ought to be, and can be. A couple of weeks ago I attended yet another workshop organized by the Australian Centre for Philanthropy and Nonprofit Studies at QUT. It was telling that in the last of two days of sessions, the participants were scrambling to answer what seemed a naive, and maybe was meant to be a devilishly simple, question: why do we need regulation in the first place? It took a while for the – in other countries widely accepted
— answers to come forth: to promote public trust and confidence in the charitable sector, which requires that fundraising is done properly, that money is going to cause, that accountability and transparency are such that donors (private and public) can verify that money will be spend the way NFPs say it would be spent. The problem is, none of these things can be easily regulated. Partially because regulation that tries to ensure these kind of things needs enforcement which is expensive. Very expensive indeed.

Second, few — specifically the dozens of talking heads that dominate the debate currently — seem to have a good understanding of available working models. Much of the focus seems to be on the Anglo-American model but this model — based as it is on obligatory annual (self-) reporting — is known to have its share of problems and will, in any case, take years to be implemented here. What, unfortunately, continues to be ignored in the Australian discussion are the very effective certification agencies that exist in a number of West-European countries such as Germany, the Netherlands, Switzerland, or Austria. In all these countries,
(self-) reporting requirements are way behind those in, say, the England, or the USA. Yet, these certification agencies have been rather successful in generating public trust and confidence in the sector, or at least its nationally working flagships (which albeit representing typically 5 percent of the sectoral firms account for more than 8o percent of assets and revenues. Importantly, most of these certification agencies make due with surprisingly small budgets. Shoe-string budgets indeed of a couple of millions at most of which typically at most a third comes from Public subsidies. Yet another interesting example is the New Zealand Charities Commission which — having been established only in mid-2005 — has within a couple of years managed to establish a Charities Register which has 24/7 up-to-date information on more than 25,500 registered charities (see and which is moving towards a model that through its actions (e.g., complaints forms on its website) quickly towards a model that seems to draw on some of the lessons that can be learned from the certification agencies in Europe.

So, while it is commendable that the federal government does something, the way it apparently wants to go about reforming the Not-For-Profit Sector seems ill-advised, wasteful, and predictably ineffective. It is a policy that seems not based on the considerable evidence that is out there on available alternatives, and ultimately insights from economics about the incentive incompatibility of self-report mechanisms.

The Wallis Report, the Cooper Review, and the limitations of Behavioral Economics

In a recent special session on Superannuation at the Australian Conference of Economists, David Gruen — an economist working for the Australian Treasury and one of the authors of the Cooper Review (see here) reflected on the intellectual paradigm shift that informed its deliberations and recommendations (see here). Continue reading “The Wallis Report, the Cooper Review, and the limitations of Behavioral Economics”