First it was shoes, then shirts. I don’t have much to add on questions like “Are supplies in fact clogging the roads?” and “Are there in fact people in Africa who don’t wear shirts because they can’t find/afford them?” But to me, the argument against in-kind donations is both simple and general (i.e., it doesn’t depend much on the specifics of the goods):

1. It seems nearly always preferable to sell your unwanted belongings and give the proceeds to charity.

I’m not sure how many (if any) people are “desperate for shirts.” But it does seem that an easy test of whether your old shirt is worth anything to anyone is to ask, “Will someone pay for it?”

This makes it likely that your shirt itself will not get to the poorest people - it will get to whoever pays the most for your shirt. But as long as you give to the proceeds to the best charity you can find, this seems like a good outcome. Imagine that a less-poor person is willing to pay $3 for your shirt; a poorer person wants your shirt but can’t (or won’t) pay $3 for it. That implies that the latter person is better off with the actual $3 (or $3 worth of the best charitable services you can find) than with the shirt.

Of course, if you sell, someone has to pay enough not only for the shirt, but for the costs of shipping and logistics. But that’s part of the point. If there’s no one in the world who will pay enough for your shirt to cover shipping costs, that’s a red flag that you’re looking at a wasteful transaction. Throw out the shirt and give cash. (Again: if someone in Africa is not willing or able to pay the shipping costs to get your shirt, that implies that giving them cash or charitable services equivalent to those shipping costs would be more valued than the shirt.)

The 1 Million Shirts campaign has asked for alternative ways to help people. I think “collect the million shirts, sell them off and give the proceeds to an outstanding charity” is a reasonable proposal.

This is also my understanding of how Goodwill works.

It seems that this argument holds for nearly all in-kind donations. There will be exceptions,* especially where a gift is driven by an acute local need for a particular good. But I would guess that such situations are the exception, rather than the rule, because I don’t think most in-kind donations are driven by the needs of the recipients. That brings me to the next point.

2. Just because your gifts are accepted doesn’t mean they’re wanted.

Good Intentions are Not Enough points to a USAID statement on gifts in kind (PDF). I think it’s an eye-opener, particularly this part:

The American public often … attempts to collect and donate commodities, also referred to as “gifts-in-kind” (GIK). GIK are most often inappropriate for relief programs and harmful to the environment and the local culture. They are expensive to transport, relative to the cost of procuring the same commodities locally. GIK use up scarce resources such as transportation routes, warehouse space, and staff time. They can adversely affect the regional economy by competing with similar commodities available locally. And GIK can contribute to negative images of the United States and its disaster response activities. Despite these problems, USAID often faces significant pressure to assist with or fund shipments of GIK to disaster settings. (Emphasis mine)

I think there is a possible analogy to volunteering. Charities have an incentive - and perhaps also pressure - to accommodate people asking them to give in-kind donations. (We’ve even seen a little of it ourselves; despite the abstractness of our own activities, people come to us asking where to donate leftover drugs or equipment, and it’s never fun to reply with “tough luck.”)

Giving away your goods feels better than taking my above suggestion, because it doesn’t force you to confront the difference between what you paid for the goods and what they’re now worth. (Giving away an old shirt feels better than selling it for $1.) And plenty of organizations are interested in delivering these good feelings. There may also be organizations that simply deliver gifts-in-kind without carefully weighing the shipping costs, logistics issues, etc.

We’ve noted before that much of charity seems set up to serve the donor rather than the recipient. Consider this next time you’re about to give old clothes to people who may not have asked for them (even if it’s through a charity that’s claiming they have).

*For example:

• Companies/producers can have reasons, relating to price discrimination, to donate the the things they produce. These reasons can apply to a drug company donating drugs, but not to an individual giving away old belongings, so I won’t elaborate on this point here.
• Sometimes there is an excellent match between what you have to offer and what someone else needs, to the point where (a) the person in need would be close to the highest bidder to buy it; (b) selling rather than donating would create unnecessary middleman/friction costs. (Analogy: if a friend is willing to pay $250 for an old computer that’s worth $300, I’ll take the friend’s offer instead of going through the hassle of selling. On the other hand, if the friend is only willing to pay $50, I’ll sell the computer.)
• There can be tax advantages to in-kind donations.

I’m very interested in the recent debate over microfinance interest rates (see our response to the NYT article, as well as Te-Ping Chen’s comments at Change.org).

It seems that realizing how high interest rates can be has been a wake-up call to many that microfinance can easily be doing damage as well as good. If someone is paying 150% interest a year, all it takes is some accounting errors for them to end up losing money and getting stuck in debt rather than helping themselves as intended.

But isn’t this concern equally valid for lower interest rates? The same people complaining about excessive interest rates imply that rates 10-30% above the cost of raising capital can be considered reasonable. 10-30% above the cost of raising capital is still significant - it’s more than most Americans pay on their credit card debt - and small losses could be especially risky and damaging to the very poor.

In my view, there is no substitute for asking tough questions about social impact and no excuse for donating to a microfinance charity that can’t answer them.

We’ve previously argued that the “headline program” a charity uses to raise money may not be the one you’re effectively funding with donations - even if your donations are formally restricted to that program. (See our full series on the topic).

Now the Chronicle of Philanthropy quotes a fundraiser saying exactly the same thing, as a suggestion for charities rather than a warning for donors.

Nonprofit organizations’ biggest concern with the approach Kiva and DonorsChoose take is that it brings in donations that must be used for a specific purpose, rather than undesignated gifts that can finance anything, including overhead expenses.

But that’s an accounting issue, not a fund-raising issue, argues Michael Cervino, vice president of Beaconfire Consulting, in Arlington, Va.

“If you’re already planning as an organization to spend money on A, B, and C programs at a certain level, then there is no reason not to use that program as a poster child for your fund-raising efforts,” he says. “Go ahead and raise that money. You’re going to spend it there.”

Note: I posted most of this post last night as a comment.

There has been some interesting back-and-forth in the comments lately between Laura Deaton and me (see the Should Charity Evaluation be “fair”? thread). Laura seems worried that by issuing ratings and a list of “top” charities, we are implying a level of objectivity and reliability that “overpromises” and can mislead donors. I believe it is a somewhat common concern behind many people’s uncomfortability with the growing interest in charity evaluation.

I think it is helpful to think about how reviews, “top” lists, and evaluations are seen in other domains. For example, movies:

• Movie reviewers share both quantified, judgmental “ratings” and (some of) the reasoning behind their ratings.
• Reviews involve substantial judgment calls.
• Some people read the reviews to get a sense of the reviewers’ values, biases, etc. and decide for themselves how much to weigh them. Some people just look at the ratings.
• Movie reviewers will sometimes put out a “X best movies of the year” list, even though they haven’t even seen all (or even a substantial portion of) the movies made in a year.
• Large information providers, including both newspapers and aggregators such as Metacritic/Rotten Tomatoes, will collect the opinions of many movie reviewers in one place and offer them up as a service to people deciding which movies to watch. They will put their name behind the reviews even though they don’t endorse every word of them.
• The whole system seems to be valuable to a lot of people and to be clearly superior to alternatives such as (a) ratings provided without any reasoning; (b) ratings based on purely objective criteria such as “percent of film budget spent on actors’ salaries”; (c) ratings withheld entirely out of concern for misleading overly impressionable viewers.

Similar systems exist for a lot of consumer decisions.

Any metaphor breaks down and I wouldn’t want this one taken too far. But it seems appropriate for the question at hand, which is whether we are “overpromising” by issuing ratings, evaluations and “top charities” lists. Based on what these terms mean in other domains, I think we are closer to overdelivering.

Added 4/21/2010: I realized after writing this that Tactical Philanthropy made a similar argument in 2007.

Recent coverage of microfinance has had a sharp focus on interest rates, implying some line between “reasonable” interest (associated with “social investment”) and “excessive” interest (associated with “loan sharking”).

In Nicaragua, President Daniel Ortega, outraged that interest rates there were hovering around 35 percent in 2008, announced that he would back a microfinance institution that would charge 8 to 10 percent, using Venezuelan money …

Damian von Stauffenberg, who founded an independent rating agency called Microrate, said that local conditions had to be taken into account, but that any firm charging 20 to 30 percent above the market was “unconscionable” and that profit rates above 30 percent should be considered high.

Mr. Yunus says interest rates should be 10 to 15 percent above the cost of raising the money, with anything beyond a “red zone” of loan sharking. “We need to draw a line between genuine and abuse,” he said. “You will never see the situation of poor people if you look at it through the glasses of profit-making.”

It seems very important that interest rates be transparent, i.e., clearly communicated to and understood by clients. It also is clearly important that there be no coercion, i.e., that clients not be pressured to take loans they don’t want to take. More debatable, but something that we support strongly, are additional measures to assess and improve the client experience, including monitoring overindebtedness, examining dropout rates, etc.

But if/when such things are in place, it is unclear to me on what grounds anyone can complain about interest rates being “too high.” If the terms of loans are clearly communicated, then I see no explanation for why clients would take out loans - unless they feel they have no better alternatives.

What objection can be raised to a 100% interest rate, if the next-best alternative is a 500% interest rate (as I have been told some informal moneylenders charge)? What objection can be raised to a 500% interest rate, if there is no other way for people to get credit? When a loan could result in a sick child’s being treated, or a profitable micro-business, what fee is too high for that benefit?

When MFIs charge more than they need to in order to make a profit, that’s an opportunity for someone else to come in and undercut them. If no one else is coming in, that implies that the costs and difficulty of providing credit in an area may be higher than they appear to an outsider. For an outsider to declare profit margins “too high” strikes me as ungrounded and unproductive, especially when that outsider has not tried to provide credit for less in the same area.

Microfinance exists to improve the lives of the poor. Ideally, then, microfinance institutions would be judged by their effects on people’s lives. Instead, they’re being judged by simplistic financial metrics that crudely attempt to get at the moral uprightness of the organizations. To me that’s a very familiar situation.

I believe the ideal way to evaluate an MFI is to look directly at its impact. When this isn’t possible, proxies for client participation and satisfaction may (debatably) be appropriate. I don’t see any place for universal rules about how much interest can be charged.

One of the goals we do not have is the goal of being “fair” to charities, in the sense expressed in this comment:

You are right on in your focus on provable results, but some areas are much easier to evaluate than others … A bad charity to me is one that is misleading, not transparent, or ineffective in comparison to its peers.

It seems common that people wish to be “fair” to charities, focusing on merit (how well they do what they do) rather than results. (Objections that our process favors large charities often come from a similar place.) How do people trade off merit vs. results in other domains?

• Investing: if company A looks more likely to be profitable than company B, most people will invest in company A. They won’t give a second’s thought to considerations like “But company B is in a more difficult sector.”
• Consuming. If you’re buying an iPad, I doubt you’ve worried much about how unfortunate Notion Ink is for not having the brand name, marketing budget and sheer size to compete for your dollars.
• Sports. Here we take significant steps to “level the playing field.” We are very careful about which advantages (strength, speed) we allow and which (equipment, performance-enhancing drugs) we do not.

We feel strongly that charity evaluation should not be seen as a contest, bringing glory to meritorious charities and dishonor to scams. Instead, it should be seen as a pragmatic way to get money to where it can do as much good as possible. “Merit,” “A good attempt given the difficulty of the problem,” etc. should be left out of the picture.

That’s why we’ve always taken more care to eliminate “false positives” than “false negatives” in our recommendations. If there’s an ineffective charity we recommend, that’s a real problem. If there’s a good one that our process has failed to identify, that may be bad from a “fairness” perspective, but it’s not nearly so problematic for the goal of helping donors accomplish good. Evaluators that are more inclined to give charities the benefit of the doubt probably “wrong,” and anger, fewer charities - but they’re less effective in directing funding to where it will accomplish a great deal of good.

And that’s why we’re unapologetic about our bias toward charities working on tangible, measurable goals. Health is an “easier” sector than economic empowerment for clearly defining goals, tracking progress toward them, learning from mistakes, and ultimately making a positive difference. That’s a reason to prefer health charities, not a reason to “handicap” them. (Note that we do think there can be good reasons to give to “less measurable” causes, including philosophical preferences; more on this in a future post.)

When we spend money on ourselves (investing or consuming), we think exclusively about meeting our own needs and wants. It’s only fair that when we spend money on others (charity), we should think exclusively about meeting theirs.

One of the more difficult things to understand about the microfinance institutions we’ve investigated is the “true” interest rate they’re charging their borrowers. In July 2009, David Roodman of the Center for Global Development wrote:

It appears that many MFIs impose subtle fees that effectively raise interest rates. Some charge one-time loan origination fees. Some require borrowers to deposit a percentage of each loan amount with the MFI in a savings account that pays interest at a rate lower than that on the loan. Some overcharge for credit-life insurance bundled with the loan. Another criticized practice is to charge interest on the full loan amount even as the outstanding balance declines over the repayment cycle. Such “flat-rate” interest effectively doubles the interest rate compared to “declining-balance” interest since the average balance over the cycle is half the starting amount. Also, MFIs may also prefer to quote their rates on a monthly basis, hoping to exploit borrowers’ ignorance of how a seemingly modest 6 percent per month compounds into 100 percent per year.

Our experience with the microfinance organizations we have investigated to date suggests that these are real issues that donors should be aware of when interpreting interest rate data.

To be clear, we don’t think charging a high interest rate signifies wrongdoing on the part of a microfinance bank. High interest rates may be the best way to minimize losses and serve more people, and client participation at high interest rates may be an indicator that they are getting a service they value. We just want to note how striking the difference is between the initial “cited” interest rate donors often hear about and the “effective” interest rate taking all factors into account.

We recently evaluated a microfinance institution (MFI) in Malawi, the Microloan Foundation, as part of our process for distributing a grant to an economic empowerment charity in Sub-Saharan Africa. Its stated interest rate for its most popular loan type is 20%, but:

• 20% is the rate over the course of the 4-month loan. The “nominal Annual Percentage Rate (APR)” (a common way of stating interest rates in standardized terms and the rate which U.S. lenders are required to provide to borrowers) of this loan, with no other costs, would therefore be 60%.
• Interest is calculated as a flat rate. 20% of the whole loan amount is charged each payment, instead of 20% of the remaining loan balance. This method raises the nominal APR from 60% to 93%. On a $100 loan of this type, a borrower would pay $20 in interest compared with only $12.80 on a loan with declining balance interest.
• Payments are due every two weeks, instead of every month, so that the first payment is due only two weeks after the loan is made. Requiring 8 payments instead of 4 raises the nominal APR from 93% to 102%.
• The Microloan Foundation requires borrowers to hold 20% of the loan amount in a savings account which cannot be accessed until the loan is repaid. On a loan of $100, this requirement reduces the effective size of the loan to $80, while decreasing the effective size of the last payment due by $20 (because savings are then accessible). The savings requirement raises the APR from 102% to 149%.
• Arguably, the APR used above (i.e. the “nominal APR”) understates the interest rate people are paying because it does not take into account the compound value of interest. (Wikipedia’s entry on APR has a discussion of the relevant issues.) At relatively low interest rates, such as the interest rates we’re used to in the U.S., the “nominal APR” (what is usually reported) and the “effective APR” (the “mathematically true” interest rate) are usually very close to each other - but at the much higher interest rates charged by microfinance institutions, the “effective APR” can be considerably higher, raising the question of which one should be quoted to give Americans the best picture of what people are being charged. The Microloan Foundation’s nominal APR of 149% is equivalent to an effective APR of 326%.

Not only are these final “effective” interest rates many times bigger than the initial “20%” figure, they’re also significantly higher than would be implied by looking at MLF’s nominal gross portfolio yield according to MixMarket (93% for 2008; Mix Market defines this as interest and fees divided by the gross average loan portfolio ).

MLF doesn’t charge fees on its loans, but other microfinance institutions do, and these can cause further significant increases in the effective interest rate. (For example, adding a 5% fee to the beginning of a loan that without fees would have a nominal APR of 40% raises its nominal APR to 66%.)

From what we’ve seen, fees, compulsory savings, and the flat interest rate method seem to be fairly common among microfinance institutions. Of the 65 MFIs who had submitted a Social Performance Standards Report to Mix Market as of late 2009, 42% use the flat interest rate exclusively, 29% held compulsory savings accounts, and 72% collected fees on at least some loan products (according to their Mix Market profiles).

Understanding the true cost of credit for a borrower is important for reasons discussed previously:

• High interest rates (combined with high rates of repayment and low drop out rates) show that borrowers are willing to pay a high price for the loan, arguably implying that they value this service.
• If interest rates are low, microfinance institutions may be effectively giving cash transfers, at which point the mere fact of participation becomes less meaningful, and it becomes more important to ask whom the handouts are going to.
• On the other hand, the higher the interest rate, the more we worry about whether borrowing is good for the borrowers (and about anecdotes like this one).

A fairly new initiative (started in 2008), MFTransparency, is working to create a more open discussion about microloan pricing, and has compiled and published interest rate data for two countries, Bosnia and Cambodia. We look forward to following the progress of this initiative and to drawing on its data to inform our investigations of microfinance organizations.