Tackling the Theory of Displacement

If you read the title of this post, don’t worry. This post isn’t about an old man in a bathtub, quantum physics, or floating continents.

It’s about a different kind of displacement.

There has been a building level of awareness and literacy on impact investing in the past few weeks, given increasing news coverage from outlets from the New York Times to Raleigh, Durham and Chapel Hill’s News and Observer.  [We’re still waiting for front page coverage in the Financial Post, or the Globe/Toronto Star’s Business section.]

As we increase awareness, we need to tackle some early concerns right away as we begin to build interest in this space.  One of these concerns is outlined in what could be called the theory of displacement.  Roughly conceived, this theory postulates that:

Individuals and institutions with available funds and an interest in achieving social or environmental improvement will choose profit-generating enterprises over charitable organizations.

Simply put, all things being equal, if someone has the choice between making money and losing money with similar “good” outcomes, they will choose to make money.  So, even if we have a social conscience, we’d still be the good children of Adam Smith and maximize our profits.  I’ve had conversations with folks who share this belief.  They worry that a movement in this direction will only take money away from charitable causes.

But there are many reasons this theory cannot hold water.

1. Strong connections. Canadians will always direct funds to charities because of personal and religious connections to particular issues and causes.  The motivation to give is often founded in a fundamental system of beliefs, or direct personal experience with something that has touched their lives.

The primary target of funding to charities in Canada proves this point.  Over two thirds (70 per cent) of these funds are directed to religious, social services, or health related organizations.  The bonds or requirements of religion, the impact of an illness on a family member, or the experience of a job loss are deeply personal connections that compel Canadians to give.  These connections are extremely resilient and are unlikely to be broken by the potential for a financial return.

2. Practicality. There are very practical reasons that we support charities – they are the only vehicle for some forms of civic activity.  Canadians, and indeed, citizens around the world, direct money to charitable institutions like churches, shelters, humanitarian relief and human rights organizations because they are the only means of providing necessary support to achieve certain social aims.

We simply cannot achieve necessary social and environmental progress solely through enterprise or innovation.  Our aims can only be achieved through effective and progressive public policy and a well-functioning charitable sector functioning in concert with enterprises with a social mission.  Each of these is necessary, but they are not independently sufficient conditions for achieving social and environmental progress.

For example, if we were to examine poverty reduction as a desired social outcome, it requires the combination of good public policy (ie. economic and income security measures, labour protections, and fair wage policies), social enterprise activities (ie. social hiring practices, and enterprises that employ at-risk youth), and charitable endeavours (ie. food banks, employment programs, and shelters).

Arguably, this is a reason that displacement cannot happen, as well as a reason that it will not happen.  It is simply not practical.

3. Finances. There are powerful financial incentives in place for Canadians to donate to charitable organizations and causes.  For many Canadians, it makes financial sense to donate a small portion of their income to charity.

The tax incentives to donate are substantial.   (In particular, there are significant incentives for the donation of securities.  So if you haven’t heard about this yet, ask your financial advisor).  If you don’t believe this, then please learn more from the good folks at TD Canada Trust, the Canada Revenue Agency, Deloitte, or KPMG. For example, the actual after tax cost of a $1,000 donation of securities for an individual in the highest tax bracket (marginal tax rate of 46 per cent) is $536.   Although it does not deliver the potential for a financial return, a donation does not represent a total loss for an individual or institution.

Arguably, it is still not financially profitable, but the first two features (connections and practicality) coupled with these financial incentives will continue to ensure that funds are directed towards charitable causes.  

4. Lack of evidence. The reason that displacement is a theory is because it is just that; a theory.  There is no statistical proof that displacement takes place.

In countries that have witnessed a significant development in their social enterprise and innovation sector, there has not been a commensurate decline in charitable gifts.  In nations with a well-developed and rapidly growing social enterprise sector such as the United Kingdom, there has not been a displacement of funds.  In fact, more Britons make financial donations to charity than Canadians.  According to a recent study, 95 per cent of all UK residents made a financial donation to a charity in the past year.  In Canada, 84 per cent of citizens make some form of financial donation to a charitable or non-profit organization on an annual basis.  [Note that many do not apply for a tax receipt, as they may contribute to a raffle or by some other mechanism that doesn’t allow for charitable exemption.]

5. The real target. Perhaps the most important and relevant reason that the theory of displacement doesn’t fly is that the target pool of financing is not charitable donation dollars.  We are targeting a much different and much larger pool of money.  So it’s not really a choice at all.

Certainly, charitable donations represent a very large and important source of funds.  In 2008, according to Statistics Canada, 5.8 million Canadians donated $8.2 billion to over 80,000 charities in the country.  In 2007, the average donation contribution made by individual donors was $437.

The real target is a tiny fraction of total financial assets in Canada and around the world.  Total managed assets in Canada equalled approximately $3 trillion in 2008.  This is part of a much larger (and almost unfathomable) pool of capital that makes up world financial assets.  In 2007, “…the total value of global financial assets reached a peak of $194 trillion, equal to 343 percent of GDP.”

Herein lies the power and potential for impact investing.  Over the past generation, we have witnessed a fundamental shift in the potential and size of financial assets.  Although there has been some slight reversal, world financial assets have quadrupled in size relative to GDP since 1980.

And if we require capital (ie. money) to grow, sustain, or improve our response to social and environmental problems, then we should pursue the largest and most readily available source of that capital. Fortunately, there are many enterprises and individual actors that do (or could) meet the pre-conditions for obtaining that capital: some form of or potential for financial return (even moderate), and a demonstrable ability to achieve certain social and environmental outcomes.  [Following a trajectory in line with the increasing interest of citizens that funds be directed to places that better align with their values.]

So, if even one per cent of Canadian assets were channelled in this direction, this would be equivalent to four times ($30 billion) the amount of money donated to charities in the same year.  This shift would not be unprecedented, as core SRI assets in Canada already totalled $54.2 billion in 2008, according to the Canadian Socially Responsible Investment Review 2008.  All screened SRI investments represent almost 20 per cent of the total managed assets.  The number of investors in this space continues to grow.  Between 2006 and 2008, the total value of assets invested according to SRI guidelines increased by 21 per cent.  Impact investing would be expected to follow this trajectory as a subset of the broader SRI space.

Arguably, this is part necessity and part opportunity.

Government revenues will be increasingly constrained over the foreseeable future as modest economic growth drives modest government revenues, and fiscal pressures from rising health costs, economic security programs, and public pension programs stretch the public purse.  The ability to invest in important programs such as the construction of affordable housing will become even more limited.

And the necessity, or need for capital to provide resources to address increasingly complex and monumental social and environmental problems grows.  A similar thesis was featured in Ralph Nader’s most recent book, Only the Super Rich Can Save Us!  Although a fictional account, it recognizes that we need significant amounts of capital to catalyze the necessary change we require for both survival and success.

There is a significant opportunity to grow the number of individuals who are engaged directly and indirectly in solving social and environmental problems with their available financial resources.  At present, a declining number of Canadians report financial donations to the federal government.  Only 24.1 per cent of all tax filers made donations to charity in 2008, representing a slight decline from 1999, when 25.5 per cent of all tax filers made charitable financial donations.

As we know, these individuals are only donating, on average, slightly over $400 per year.  We need to work to increase the percentage of Canadians who give, as well as the amount of their donations.  The charitable sector requires additional grant and donation dollars to build and sustain operations.  But we must also think of the potential of the savings and investments of current donors.  And imagine the even greater potential of the investments of individuals (retail investors) as well as corporations (and other institutional investors) who do not currently contribute to charity.

The potential is tremendous.  But it will take a lot of work to realize that potential.  Think of what you can do to help move this forward.

This blog post was cross-posted from the Social Ventyre Exchange (SVX) website.

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