The Economics of Giving

Posted: 3rd October 2016

By: Henry Chen

Welfare is what we get when our parents, by less than fortunate circumstances, pass on to the government the burden of splashing us with pocket money. To understand what would happen if our government turned off the taps, which I assure you might not be as detrimental as you may think, we must first understand why they have been turned on in the first place.

Dictator Game

Let’s play the Dictator Game. The rules are as follows:

  1. You are in a room with a stranger.
  2. You are offered $10 but are given the option to share it with the stranger.
  3. The stranger will be informed of your decision and the $10 will be distributed accordingly.

If the assumption holds that all market participants are purely rational and prefer more wealth to less; we would all take the $10 for ourselves. Obviously, this would rarely occur in reality and a 50-50 split is a popular choice as shown below.

Source: http://www.sciencedirect.com/science/article/pii/S0167268111002332

Let’s now consider the Dictator Game being played in a few different scenarios. Would your answer change if:

  1. You are being offered the $10 by the government
  2. You are being offered the $10 by your parents
  3. You earnt that $10
  4. The stranger is attractive
  5. You never expect to see the stranger again
  6. The stranger will not know of your choice and is unaware of the game

Pure altruism

If the assumption holds that altruism exists in its pure form (i.e. acting in the consideration of others without ulterior motives), then an initial choice to give the stranger a certain share of the $10 should be unchanged. Again, this is rarely the case in reality where ulterior motives do exist and can be beneficial for economic reasons.

Under assumptions of pure altruism, you are only concerned about the satisfaction or joy arising from seeing another person receiving a gift. However, this gift could be provided by others and you would still experience an identical level of satisfaction. This results in the following two implications:

  1. You would prefer others to give to maximise your net satisfaction
  2. The act of giving can be effectively crowded out by others (e.g. the government)

Essentially, it’s like a group assignment that doesn’t count towards your final grade – you will not only be frustrated and disappointed if you expect everyone to pull an equal weight; the assignment itself will probably never be finished. If pure altruistic values are promoted by society, it will inevitably result in a functional government assuming responsibility for providing for the needy. This may be the reason why in Australia, welfare and healthcare spending makes up a large portion of the fiscal budget.

Impure Altruism

Certainly, there may be reasons why you may contribute to that group assignment such as self-expectations and the desire to demonstrate your competency or expertise. These are examples of ulterior motives or impure altruism which may indeed overcome the above two issues of pure altruism. American society actively promotes impure altruism (i.e. giving is a symbol of wealth) and a greater emphasis is placed on the private sector in providing for the needy. Consequently, America is estimated to have a greater portion charitable donations as a % of GDP than Australia. Yet Australia has had a lower Gini-coefficient as shown below.

Data extracted from OECD http://stats.oecd.org/index.aspx?queryid=66670# . Note that certain data points for Australian were unknown and thus extrapolated to form a line graph.

Limitations of the private sector

Encouraging the private sector to assume responsibility for the needy can have its pitfalls too.

Firstly, there is the allocation of donations. Individuals are more likely to donate to groups of individuals that they connect with either personally or through awareness campaigns. A very successful example of this was the ALS Ice Bucket Challenge which raised $100.9m in 2014 compared to $2.8m during the same period of the previous year. However, similar levels of compassion and altruism may not be given to other groups, such as former convicts, who may also require financial assistance to become functional members of society. Thus, further marginalisation of groups may arise.

Secondly, charitable donations have the economic characteristics of a normal good. During booms, donations are expected to be pleasantly higher. However, low income earners are generally hit the hardest in terms of the percentage change in income and wealth during recessions. Thus, when donations are needed the most, they are supplied the least.

Thirdly, there is the concern of fraud committed by intermediary institutions that accept donations and “pass them on” to the needy. In 2015, a US Federal Trade Commission investigation revealed that four major cancer charities had passed on an appalling 3% of the $187m in donations to victims. Certainly, the implications are not to cease donating to charities all together, but to ensure that there is adequate public oversight.

In reality, providing for the needy is rightfully a shared responsibility between the private and public sector. If the objective is to maximise life expectancy and living standards across society, then impure altruistic motives should be advocated but the government must play an essential role in the provision of welfare and health care. Simply put, if everyone wants to see the homeless person pick themselves off the street but no one does anything to help, we would all be rational but slightly disheartened members of society.