The Economics of Philanthropy

Michael Spence
Michael Spence, a Nobel laureate in economics, is Emeritus Professor of Economics and a former dean of the Graduate School of Business at Stanford University and a co-author (with Mohamed A. El-Erian, Gordon Brown, and Reid Lidow) of Permacrisis: A Plan to Fix a Fractured World (Simon & Schuster, 2023).

FORT LAUDERDALE – The biggest election year in history is unfolding at a time when rising wealth and income inequality are fueling polarization and undermining social cohesion in many countries. Average income levels and overall economic performance seem to make little difference; widening gaps between haves and have-nots are becoming a practically universal phenomenon, and they increasingly translate into sharply divergent visions of what constitutes economic and social progress. This makes governance difficult, at best.

If formal governance mechanisms are impaired by seemingly intractable political polarization, how can we address important challenges, like improving equality of opportunity, building sustainable economies, and delivering critical public goods? One answer is philanthropy.

Once considered a preserve of the wealthiest few, philanthropy today is a mass phenomenon. Crowdfunding platforms enable small donors to support all kinds of people and projects, and volunteers of all income levels devote their time and energy to charitable organizations. But if wealth is accumulating rapidly at the top of the distribution, it would make sense to tap the wealthiest cohort to fund universally beneficial projects.

Microsoft founder Bill Gates offers one model of such philanthropy: the Bill & Melinda Gates Foundation, of which he is co-chair, has had a far-reaching impact in a range of areas, from global health to sustainability. Large investors are also playing an increasingly important role in basic research, which can also be considered a kind of philanthropy, depending on how the results are shared and used.

In the 1970s, more than 70% of funding for basic, non-proprietary research came from government. That number has declined steadily as business and philanthropic funding has expanded. But when it comes to research into digital technologies, especially artificial intelligence in the United States, government accounts for just one-third of funding. The rest comes from tech giants like Microsoft and Google (one-third) and philanthropists and philanthropic organizations (the remaining third).

In other words, the private sector now accounts for two-thirds of funding for basic research – most of which is open-source and open-access – into transformative technologies like AI. There is precedent for such corporate involvement in basic research. AT&T’s Bell Laboratories was responsible for a range of critical innovations, from transistors to photovoltaic cells, before antitrust action dismembered its parent company. At a time when regulators are attempting to determine how best to regulate Big Tech, the fate of Bell Labs is worth remembering.

Philanthropy is often viewed as an expression of individual empathy, but it is more complex than that. In fact, philanthropy is a complex social phenomenon shaped by a range of considerations and incentives, including direct financial incentives. In the US and elsewhere, charitable giving is encouraged by making donations tax-deductible. But other benefits – say, to the philanthropists’ reputations – also carry considerable weight.

As Jonathan K. Nelson and Richard J. Zeckhauser show in their 2008 book The Patron’s Payoff: Conspicuous Commissions in Italian Renaissance Art, this was as true in the fifteenth century as it is today. At the time, Italy’s wealthy wished to advance the arts and, to a lesser extent, science; signal their wealth and the achievements that created it; and demonstrate their piety in a society dominated by the Catholic Church.

The Church provided a way for the wealthy to achieve all of these goals: it built cathedrals with numerous chapels around the central nave, and then sold rights to decorate and name the chapels to wealthy families, who would commission great artists to produce paintings, frescoes, and sculptures. With that, the Church was funded, art flourished, and the wealthy advanced their philanthropic agendas, enhanced their reputations, and even gained a degree of immortality.

This experience highlights the importance of signaling mechanisms, networks, and recognition not only in encouraging but also in directing philanthropic activity. There is a reason why major donors to top universities, for example, get their names emblazoned on buildings and attached to major research initiatives: like the art patrons of the Renaissance, they want to support human advancement and enhance their personal status, especially in a network they care about. As philosophers from Aristotle to Hegel have argued, recognition – especially for helping others – is a fundamental human desire.

Like universities, other elite institutions – such as art galleries, libraries, museums, orchestras, and opera houses – attract philanthropic giving partly by ensuring that donors get the recognition they crave. But many vital causes, including support for those who are struggling to make ends meet and to create opportunities for their children, lack similarly powerful mechanisms for attracting donor funding.

While philanthropy is not a substitute for government action in areas like health, education, and the distribution of income and wealth, it can certainly help – if the right incentives are put in place. To this end, we must design institutions that deliver reputational and network benefits to donors supporting causes like poverty reduction and public health. The key missing ingredient appears to be an intermediary that acts as a respected impact investor and forms the core of the signaling mechanism.

More fundamentally, we need to stop applauding wealth for its own sake. While wealth can signal certain kinds of achievement, it becomes worth celebrating only when it is deployed in the service of human well-being.

Michael Spence, a Nobel laureate in economics, is Emeritus Professor of Economics and a former dean of the Graduate School of Business at Stanford University and a co-author (with Mohamed A. El-Erian, Gordon Brown, and Reid Lidow) of Permacrisis: A Plan to Fix a Fractured World (Simon & Schuster, 2023).