One of the most basic financial tools is the concept of present value. The present value concept simply assumes that value received in the future is worth less than the same value received today.
You can see this dynamic working if you think about whether you would rather be given $100 today or be given it in one year. The difference in the value of the present and the future is called the “discount rate”. In all likelihood you would probably prefer to get $100 in one year rather than $10 today. But there is some point at which you become indifferent. If you are indifferent between receiving $90 today or $100 in a year, then you are using a 10% discount rate (approximately).
However, for some time I’ve been wondering about how this fundamental tool for financial decision making works when it comes to philanthropic decision making.
Which would you rather have, a crime free society and clean environment today or in the future? Clearly, sooner is better. But what if it is either/or? Anyone with a child is going to tell you they’d rather their children live in that better world than that they receive the benefit of it. This preference for the future is hardwired into our species as becomes evident any time a parent puts their children’s needs ahead of their own. It is so hardwired into our neurological makeup that adult humans will often choose to put themselves in physical danger if needed to protect the physical health of any child, let alone their own.
Why does this matter? Because positive discount rates erode the value of investments. If I offer you an investment which promises you a 10% return on your money, you’ll be indifferent if you have a discount rate of 10%. The lower your discount rate, the more attractive any given investment is. The higher the rate, the higher the prospective returns need to be to attract your attention.
But if humans have a preference for social good to occur in the future or to benefit our children rather than us, then it means we have a negative discount rate. It means, we’d rather $100 of social value occur in the future rather then $110 of social value occur today.
If this is true, it means that social returns on investment are radically higher than we might otherwise suppose because, unlike financial investments, we actual prefer that social impact accrue to our children and their children.
But this concept can’t be entirely correct. Many forms of social good are not discrete events, but rather conditions within which life occurs. Wiping out polio, as Bill Gates is urging the world to join him in focusing on, is not a discrete event. If it is wiped out now, more lives will be saved and less suffering will occur than if it is wiped out later.
This means that maximizing the value of philanthropy rests on three elements 1) we should seek to create long lasting positive conditions rather than just discrete, socially good events (which is one way to express a preference for correcting the root cause of a problem rather than treating the symptoms), because doing so will create social value that accrues to more people, 2) we should seek to achieve those conditions as quickly as possible because doing so will allow the benefits to accrue to the maximum number of people but, 3) when forced to make a trade off between activities that create benefits in the future vs. benefits today, we should prioritize the future given the hardwired negative discount rates that we use to value the future vs. the present when it comes to social impact.
There are probably a number of ways to reconcile these three elements. There certainly are some creative tensions between them and so different people may choose different approaches. But for me, they suggest that as a general rule, philanthropy should focus on creating impact that:
- Is lasting rather than fleeting (working on causes rather than symptoms), but;
- Is implemented as quickly as possible, but;
- Prioritizes the needs of the future over the present.
In other words, donors and foundations should: Act quickly to create lasting solutions that prioritize the needs of the future.
To my way of thinking, the best way to get that done is for donors to make rapid grantmaking decisions in support of nonprofit organizations that seek to tackle the underlying causes of social problems, using grants which build the long term sustainability of their grantees while recognizing that truly effective interventions take time to achieve success.
Sean, while these guidelines make sense to me on a theoretical level, I’m having difficulty imagining what they look like from a practical perspective. Can you give an example where philanthropy is focused on lasting impact and is implemented quickly, but prioritizes the needs of the present over the future? My intuition is that the third criterion is only relevant if the first is not met, i.e., present vs. future only comes into play if the impact is fleeting rather than lasting.
Also, I’m not sure I agree with the suggestion that we should use a negative discount rate when considering social return on investment. Yes, given your example of preferring benefits be accrued by our children rather than the current generation, we do imply that preference, but is it really logical? If we hold that all life has equal value, this preference for the future is actually illogical; unlike money, a life today is worth the same as a life tomorrow or 20 years from now or 200 years from now.
I certainly agree with the idea of getting at the root causes of social problems as soon as possible. But valuing the future over the present? Only sometimes. If polio is cured now, it lessens the chance that my child will get polio now or in the future. Granted, some solutions take time to come to fruition. In that case, yes, funding the future may mean you don’t fund some current project.
This is a very interesting post. I have a donor-advised fund at a community foundation, and my area of focus for grantmaking has been animal welfare — specifically, trying to reduce the number of dogs killed in shelters/pounds across the country. It seems to me that I have been placing a greater value on helping dogs today (e.g. by funding either life-saving medical treatments or transports to rescue groups) than on saving lives in the future (e.g. funding spay/neuter surgeries to reduce the future population). My rationale for this has been 1) by funding immediate assistance, I can better track the number — and sometimes even the names — of dogs our funding helps save, whereas when funding s/n surgeries, there is no way to know exactly how many births we would be preventing and how many of those dogs would end up being killed in shelters; and 2) there are other (much larger) foundations which are funding the development of new non-surgical s/n technologies that will revolutionize how s/n is done, possibly saving millions of future lives at a fraction of the cost of conventional surgery. Do you have any thoughts on whether I should reevaluate my funding approach and either fund s/n surgeries now, or alternatively join with the larger foundations to fund the development of the new non-surgical technologies? Part of my hesitation in joining with the larger foundations is that my resources are limited and I don’t feel as though my funding would make an incremental difference in the overall future effort.
Thanks for the comments all, I’ll take them in order.
Dan, my post was meant to offer a mental framework rather than a practical set of suggestions, but let me see if I can’t make the three part conclusion more practical. It seems to me that philanthropy as a field tends to focus primarily on lasting impact. We all want to make that big, historical change. End Poverty! My post is suggesting that this is a good goal, but it must be reconciled with a need to act quickly. In addition, I’m suggesting that the fact we value our children more than ourselves as a culture means that the payoff from successful philanthropy is likely larger than we normally think.
Regarding your last point, I’m suggesting that as a culture , we actually do value children’s lives more than adults. I think that’s correct at a biological level. And so it gives us permission to focus on the long term outcomes of our efforts.
Geri, you are absolutely correct in your example. I tried to make that clear when I used the polio example as a counterargument to show that when an outcome was lasting in nature a different analysis was needed.
Simone, I tend to think that the all philanthropic action should be viewed through your own personal value set. So there’s no “right” answer to your question. I would say that an approach being easier to track is nice, but not always a good reason to fund it. My friend George Overholser often tells the story of someone who loses their keys at night and looks for them under the streetlight on the opposite side of the street from where they lost them because “the light is so much better”.
If you think that the longer term approach has a better total payoff, I’d suggest joining with the larger foundations. It might feel more incremental, but it isn’t really. If you directly fund a program that treats five dogs or you add funding to a program such that your funding means they can treat 1,000,005 dogs instead of 1,000,000, you’ve had the same incremental impact. It just doesn’t feel as tangible. But if the larger program is better, that’s the one to fund.
Sean, it seems like the crux of your argument rests on this statement:
This may be true in certain specific circumstances, but I think if you look at people’s actual behavior, most people choose to take the good stuff now and push the costs onto the next generation. Examples abound throughout history, but in our present era the best examples are public and private debt, unfunded pensions and social security schemes, and deferred maintenance on infrastructure.
Individually people may be willing to make sacrifices for their children, but collectively it seems far more common to me to take the good now at the expense of the future.
People as a group push things off, but individual parents put their children first. It is a tragedy of the commons issue.
But I’ll admit that this concept is pretty theoretical. I just find it interesting that when thinking about valuing items that accrue to us vs to other people, there are real differences.