Discussion of capitalism often focuses on contributions to economic growth or productivity, but this emphasis places an artificial limit on the potential benefits of free markets. In a new article in the Journal of Economic Perspectives, Professor Canice Prendergast of the Booth School of Business analyses how a nonprofit food bank has harnessed the power of markets to help reduce costs.

Even in areas removed from revenue or profit considerations, free markets can provide value. Other nonprofits and components of civil society could potentially make similar progress.

The Choice System

Feeding America could only offer donations to one food bank at a time.

Feeding America is a nonprofit that receives food donations from manufacturers and distributors around the country. Its mission is to distribute food to a network of 210 food banks throughout the country. Until 2005, the organization allocated food in the same way as many nonprofits, through a “wait your turn” system, in which food was assigned based on a food bank’s position in the queue.

A food bank high in the queue would receive a notification from Feeding America that it had been assigned food, and if it accepted the offer it would be responsible for collecting the food from the donor. The system did not distinguish between different types of food, which contributed to one of the major problems of the centralized system.

Food banks receive donations from manufacturers, grocery stores, and individuals. Feeding America accounts for about a quarter of donations received at those regional food banks, and the system had no way of incorporating information about donations from other sources into its allocation. Sometimes a donation would be allocated to one food bank when another would have valued it more. For example, the Idaho Food Bank might already have had an adequate supply of potatoes and would have valued additional donations of potatoes less than other locations.

Feeding America was also severely constrained in how quickly it could allocate food. It could only offer donations to one food bank at a time. The logistical limitations contributed to delays and situations where food spoiled in donor warehouses.

The previous system was unable to distinguish between different donation types, leading to large losses in efficiency.

Hoping for a more efficient way to allocate donations, Feeding America instituted a new method called the Choice System in 2005. In the Choice System, food banks were given a form of specialized currency by Feeding America based on their calculation of need. Food banks could then use these shares to bid on truckloads of food in auctions, while also gaining the ability to borrow and save, or put their own stores up for auction. The system incorporated negative pricing, so the food bank received additional shares for accepting undesirable foods. Previously, food banks were penalized for refusing food they could not use.

The Choice System improved the allocation of food donations by allowing food banks to reveal their valuations of different types of donations. Produce, which introduces concerns about spoiling, “sold” for less than 8 percent of the price of the average good. At the other end of the spectrum, more durable staples such as cereal and pasta went for 3 times the price of the average good (but still below supermarket prices). The previous system was unable to distinguish between different donation types, leading to large losses in efficiency.

Efficient Resource Allocation

Now food banks with less access to donors and manufacturers are able to increase the amount of total food they acquire by focusing their acquisition on lower-price staples for which other food banks might already have an excess of supply.

The food supply increased by more than 50 million pounds in the first year of the Choice System.

Allowing food banks to offer their own food stores for auction increased the supply of food in the network by about 12 million pounds annually, with food banks using the shares they received for this supply to acquire other products their beneficiaries valued more. In total, the supply of food available increased by more than 50 million pounds in the first year of the Choice System.

The same problems with centralized planning that afflict efforts in the public policy sphere can arise in other areas as well, as was the case with Feeding America when it tried to allocate limited resources. Nonprofit organizations should consider the potential benefits of utilizing the information transmitted by markets and prices as they work towards their varied objectives. On Giving Tuesday, we should be thankful that these mechanisms can allow nonprofits and other organizations in civil society to help people more effectively.

Reprinted from Economics21.