The Problem With Nonprofits (October 2024)

I put off writing this post because it felt like a betrayal after spending 15 years in the nonprofit sector. I worked in Haiti, served in the Peace Corps, and started two nonprofit startups. During that time, I worked alongside extremely kind and generous people whose hard work and sacrifice made the world a better place. I also ran into systemic challenges that made it feel like I was swimming against the tide of human nature.

Nonprofits suffer from the principal agent problem. The sector relies on donors and nonprofits deciding what's best for other people by deciding what to fund and work on, instead of empowering people to decide what's best for themselves. This is similar to how communism empowers the state with the impossible task of central planning instead of distributing decision-making power to citizens via the freedom to transact in a market or vote in a democracy.

If I had to describe my personal politics with a quote, it would be, "Communism with family, socialism with friends, liberal with state, conservative with country, and libertarian with the world." I believe this applies to nonprofits too. At a small scale, nonprofits work wonders because human relationships keep everything in check. It's only at scale that things break down, which is why it's frustrating so many people are obsessed with growth.

Nonprofits get big by raising money, which requires focusing on fundraising at the expense of helping people. Organizations can't do everything at once, and if the CEO and leadership is focused on raising money, which is often required to survive as an organization, that's time, attention and resources that aren't spent on other efforts. Compare this to a business where at the end of the day the only way to get and stay big is to make your customers so happy that they decide to keep buying your product.

Nonprofits often rationalize their diseconomies of scale by saying, "at least we're still helping some people, even if we're not doing it as efficiently as possible. If we didn't help, no one would!" Unfortunately, the end doesn't always justify the means, especially with nonprofit economics.
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Giving is sadly a zero sum game, at least for now. Donations have been 2% of US GDP for the past 50 years. Capitalism grows the economic pie but nonprofits that rely on donations keep getting the same small cut of it. When a big nonprofit sells out in order to raise more money, they cut off a bigger piece of the pie, leaving less money for smaller, better nonprofits that don't spend as much effort fundraising. It's a race to the bottom that is exacerbated by the fact that people donate for various reasons.

Many people donate because they truly want to help others, and helping to elicit this trait is one of the most impactful things nonprofits do. But humans are complex and there can be other motivations at play. Sometimes donors want to offset guilt, show off, set an example for their family, get their kid a job, market their business or have a good time at a gala. This isn't bad, per se. If you're going to donate why not get a little extra on the side? But it creates a situation where the nonprofits that raise the most money often do so by shifting their focus from helping people to appealing to these extra benefits.

Inefficient organizations rarely get called out. Beneficiaries don't complain because $1 of free stuff is better than no free stuff, nonprofits don't say anything because jobs are on the line, and donors don't ask hard questions because who wants to invest time and effort to find out they made a bad giving decision?

I'm not accusing nonprofits of being frauds that don't do any good - there are tons of great nonprofits out there! I'm arguing that incentives push nonprofits to be less efficient than they could be. All nonprofits help enough people to get testimonials and photos for their annual report and the best ones help many more than that. The issue is that the worst ones, like the Red Cross, which raised $500M for Haiti and built 6 homes, are not held accountable and continue to raise tons of money.

Nonprofits are audited but auditors are paid by the nonprofits they audit, similar to how the banks responsible for the 2008 crisis paid the ratings agencies that gave them good scores. Plus, auditors are searching for fraud, not inefficiency. Many of the most expensive auditors are actually known for helping nonprofits massage their numbers to look more efficient than they are. For example, calculating vanity metrics for a fundraising proposal might get categorized as a program expense instead of a fundraising expense, which is only half true at best.

Even if all donors were focused on nonprofit impact, as Effective Altruists attempt to do, it would be suboptimal because nonprofit donors and executives have experiences and opinions that are often different than the people they aim to help. Having donors or the PhDs they employ, no matter how smart, try to measure which nonprofits are most impactful is like hiring a grad student to create a formula to determine whether a McDonalds's cheeseburger is better than a Burger King cheeseburger. Measuring impact is better than nothing but it's a subjective, complex, and constantly evolving thing and it's better to let customers (or in the case of nonprofits the people they aim to help) make that calculation themselves by choosing services based on their own complex priorities. And if beneficiaries choose to pay Effective Altruists millions of dollars to crunch numbers in their $15M colonial-era castle in Oxford to assess the quality of the services they receive instead of using that money to do something like buying food or medicine, they should absolutely be free to do so.

Walk into the offices of the largest nonprofits that rely on donations as their primary source of revenue and it's soul sucking. These are places where the walls are covered in photos of impact but 90% of the work they do is ultimately focused on fundraising. Then walk into a small, broke nonprofit office that barely has time to fundraise because everyone is so focused on helping other people and it's hard not to be inspired. Most regular small-dollar donors, who fortunately make up the bulk of giving, intuitively know this and instinctually support small nonprofits where they have personal connections.

I'd take the contrarian position that your average individual donor who gives $100 a year creates more impact per dollar than the big foundations that allocate tens of millions. Big foundations often waste lots of money on unnecessary overhead to overthink giving and incorrectly draw analogies between nonprofits and businesses. They also push the organizations they fund to grow (often too fast), partially to make their portfolio look more successful, at the expense of the boring but important work of efficiently helping people at a modest and sustainable scale. Some well-respected foundations spend more money on overhead to decide what to donate to than they donate to nonprofits (and of course, there are a select few that are super efficient and still make good decisions).

I believe this happens because people who build successful business empires have the means to start big foundations and those foundations, in turn, fund nonprofits that model the behavior of the foundation's founder. This leads to a phenomenon where what's hot in the nonprofit sector is somewhat a projection of the culture of the most recent boom industry. When everyone on Wall Street got incredibly rich and started donating, microfinance nonprofits received more donations than they knew what to do with because Wall Street executives believed finance could help save the world. Now that tech is hot, Effective Altruism and tech nonprofits get funded, because startup founders believe data and entrepreneurship can help save the world.

I'm not trying to pick on foundations here, many do good work. But it's one of the industries that is the most insulated from criticism, which breeds complacency and results in less impact that would otherwise be possible. In a sense, the more important someone's work is the more they should be hunting for constructive criticism.

When I ran nonprofits I tried my best to balance the very real need to fundraise with what I believed was best for the people we aimed to help. Looking back, I'm proud of how hard we worked and the impact we had, despite making many mistakes and learning along the way. In the end, I left the sector because I realized that growth was often at odds with serving customers. I felt stuck, like the only way to grow was to spend more time fundraising, but I didn't want to spend all day fundraising only to grow our budget and have to fundraise twice as much the next year in order to avoid layoffs and letting down the patients who relied on us. Scaling a nonprofit felt more like digging a hole than building an airplane that could one day fly on its own.

Of course, Capitalism can't solve all problems but it does a pretty good job of helping to efficiently scale things that work. You help people, they give you money, and you grow to help more. It's a powerful concept. It can go off the rails if you let it, but that's a fairly good problem to have - very few businesses ever survive to reach the point that their externalities do more harm than good, and for me personally, I would much rather be in a position of having to tap the brakes than making a car go faster without gas in the tank. If I was 20 again and thinking of going into nonprofits, here's how I'd do it differently.

If I wanted to solve a big problem, I'd start or invest in a business. If a business wouldn't work, I'd do it through the state, either by working for the government or by voting and lobbying for the government to use my tax dollars to solve the problem. If neither of those strategies worked, I'd start or donate to a nonprofit, and I'd make sure that the nonprofit empowered beneficiaries to increase accountability to the people they aimed to help instead of whoever pays the salaries. For example, they could add beneficiaries to the board, charge something for their services to generate signal on the value they deliver, and/or commit to transparency.

Most importantly, if I started another nonprofit that relied on donations, I would acknowledge the tradeoff between scale and impact earlier on instead of trying to brute force my way through it. Other people may have better luck than me, but no matter how hard I worked, incentives ultimately won (in my experience, very few people wake up in the morning and think "I'd love to donate some money today!"). It took a long time to realize that sometimes, instead of simply swimming harder, it's smarter to swim with the current of human nature, albeit maybe a little sideways at times, instead of directly against it.

Philanthropy is a tiny part of the economy at just 2% of GDP (and the largest nonprofits are de-facto businesses like universities and hospitals with clear revenue models so the true % is lower), while government is ~23% and business is ~75%. Despite constituting the vast majority of GDP, capitalism and democracy are not perfect, and nonprofits are well-positioned to help people who fall through the cracks, along with testing and advocating for important ideas those larger systems have yet to adopt, as has happened with countless positive social movements and technological innovations throughout history.

When I zoom in and talk to someone whose life was saved via philanthropy, it's hard not to think that nonprofits do the most important work in the world, which is why I still support some small nonprofits that I believe in and maintain personal relationships with. And yet, contrary to popular nonprofit mission statements of the, "We're going to end poverty" variety, when I zoom out, it's equally clear that nonprofits should remain a small part of the solution to the world's biggest problems.