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Financial Markets · Lecture 22 of 23 · 1:12:33

Lecture 22: Public and Non-Profit Finance

22. Public and Non-Profit Finance on YouTube

Study guide

What this lecture covers

This lecture asks how finance serves purposes beyond private profit: how nonprofits get funded and run, how governments end up co-owning or controlling supposedly private companies, and how state and local governments and social insurance systems manage risk for the public. It builds on the course's recurring theme that finance is a tool for incentivizing teamwork and managing risk, applied here to organizations that are not driven purely by ownership and profit.

The lecture sits second-to-last in the course, functioning as a broadening of scope after many sessions on private markets and institutions. After watching, you can describe why some ventures are structured as nonprofits, explain the difference between an operating budget and a capital budget in municipal finance, and outline how government social insurance programs like Social Security developed.

Key ideas

  • Nonprofit organization: a corporation with a charitable or social purpose, no shareholders, and profits retained for its mission rather than distributed.
  • Social entrepreneurship: founding an organization around a mission-driven idea, illustrated through examples like Teach for America, Innovations for Poverty Action, and the Ashoka Foundation.
  • Corporate profits tax as partial nationalization: because governments tax a large share of corporate profits worldwide, private companies are never fully separate from government interests.
  • Chapter 7 vs. Chapter 11 bankruptcy: Chapter 7 liquidates a company; Chapter 11 restructures it so the business can continue operating, as happened with General Motors.
  • Operating budget vs. capital budget: state and local governments must balance their operating budgets by law but can borrow for capital projects like schools and sewage systems.
  • Municipal bonds: debt issued by local governments (and some universities) that is exempt from federal income tax, giving it a lower yield and particular appeal to higher-income investors.
  • Social insurance: government-provided protection against income shocks, including progressive taxation, public education, and Old Age, Survivors, and Disability Insurance (OASDI).
  • Information technology and bureaucracy: Shiller argues that innovations like cheap paper, carbon paper, typewriters, and postal services enabled Germany to launch the first national social insurance system in the 1880s.

Walkthrough

Why organized causes need financing (0:00)

Shiller opens by arguing that even seemingly individual achievements, such as Einstein's physics or Darwin's voyage on the Beagle, depended on institutional support: universities, journals, and patrons. This sets up the lecture's broader claim that good work is almost always a team effort that needs financing, whether through for-profit, nonprofit, or government channels.

Nonprofits and their founders (6:45)

The lecture defines nonprofits as organizations with a charitable purpose and no shareholders, noting that the U.S. had about 1.6 million of them in 2010, accounting for roughly 4% of GDP. Shiller walks through examples of people who built nonprofits around a specific idea: Peter Tufano's Doorways to Dreams, Dean Karlan's Innovations for Poverty Action, Bill Drayton's Ashoka Foundation, and Wendy Kopp's Teach for America, which she founded from a Princeton senior thesis. He also traces the nonprofit origins of two New Haven hospitals, Yale New Haven and St. Raphael's, to argue that framing a venture as nonprofit can unlock funding and trust that a for-profit structure would not.

Government involvement in for-profit companies (18:55)

Shiller argues that corporate profits taxes, which run as high as roughly 47% combined in the U.S. and are common worldwide, effectively make governments partial owners of private companies. He illustrates this with two case studies: TEPCO, whose share price collapsed after the Fukushima disaster and which faced massive liability claims, and General Motors, which filed for Chapter 11 bankruptcy during the financial crisis and emerged partly owned by the U.S. and Canadian governments and the United Auto Workers union. He contrasts Chapter 7 liquidation with Chapter 11 reorganization and notes that nonprofits also resemble for-profits in practice, citing a statistic that 42% of nonprofits pay executive bonuses.

Municipal and state finance (36:43)

State and local governments in the U.S. spend roughly twice as much as the federal government and typically operate under balanced-budget rules for their operating budgets, while financing infrastructure like schools and sewage systems through a separate capital budget funded by borrowing. Shiller explains why a small town might borrow heavily to build infrastructure sized for future growth, and the resulting bankruptcy risk if growth does not materialize, referencing Chapter 9 of the bankruptcy code and New York City's near-bankruptcy in the 1970s.

Tax-exempt municipal debt (46:06)

The lecture explains that municipal bonds, and similarly Yale University's own bonds, are exempt from federal income tax, which lowers their yield but makes them attractive to higher-income investors. Shiller notes that Yale carries billions in debt despite a large endowment partly because tax-subsidized borrowing is advantageous when used for appropriate purposes, and observes that the federal government, unlike states, has no capital budget.

Government social insurance (51:24)

Shiller defines social insurance as protection against income shocks not typically offered by private insurers, including progressive taxes with an earned income tax credit, free public education, and OASDI (old age, survivors, and disability insurance). He explains why private markets struggle to offer some of these products, such as disability insurance, due to selection bias.

The German origins of social insurance (1:00:10)

Germany under Otto von Bismarck launched the first national social insurance programs in the 1880s, which contemporaries doubted could be administered reliably. Shiller argues this was made possible by information technology advances, including cheap machine-made paper, carbon paper, typewriters, standardized forms, and a national postal service used to collect contributions and pay benefits, contrasting Germany's success with the earlier failed Speenhamland experiment in England.

Before you watch

  • Earlier lectures on corporate finance and bankruptcy provide useful background for the General Motors and Chapter 7/Chapter 11 discussion.
  • Basic familiarity with how income taxes and bonds work will help with the sections on municipal finance and tax-exempt debt.

Check your understanding

  1. Why might founders choose to structure a venture as a nonprofit rather than a for-profit company?
  2. In what sense does a corporate profits tax make a government a partial owner of private companies?
  3. What is the difference between an operating budget and a capital budget for a city government, and why does the distinction matter for municipal bankruptcy risk?
  4. What information technologies does Shiller credit for making Germany's 1880s social insurance system feasible?

Vocabulary

nonprofit organization (noun)
A company with a charitable or social purpose that has no owners and keeps its profits for its mission.
A nonprofit organization does not pay its earnings to shareholders.
for-profit (adjective)
Describes a company set up to earn money for its owners.
The hospital started as a nonprofit but now behaves like a for-profit business.
shareholder (noun)
A person or group that owns part of a company.
Nonprofits have no shareholders to receive their profits.
social entrepreneurship (noun)
The act of starting an organization to solve a social problem, not just to make money.
Wendy Kopp's Teach for America is an example of social entrepreneurship.
charitable (adjective)
Intended to help people or good causes rather than to earn profit.
The organization has a charitable purpose and depends on donations.
philanthropy (noun)
The act of giving money or help to good causes.
Many nonprofits rely on philanthropy from wealthy donors.
endowment (noun)
A large fund of money that an institution keeps and invests to earn income over time.
Yale has a large endowment but still borrows money.
nationalization (noun)
The process of a government taking ownership or control of a company.
Shiller compares corporate taxation to a partial nationalization of companies.
corporate profits tax (noun)
A tax that a government charges on a company's earnings.
The corporate profits tax can take close to half of a firm's profits.
liability (noun)
A legal responsibility to pay for damage or loss.
TEPCO faced huge liability claims after the Fukushima disaster.
bankruptcy (noun)
A legal process for a person or company that cannot pay its debts.
General Motors went through bankruptcy during the financial crisis.
liquidate (verb)
To close a company and sell all its assets to pay debts.
Chapter 7 bankruptcy is used to liquidate a company.
restructure (verb)
To reorganize a company's debts or operations so it can keep running.
Chapter 11 lets a company restructure instead of shutting down.
reorganization (noun)
A change in how a company is structured or financed, often to survive a crisis.
GM's reorganization left the government holding shares in the company.
municipal finance (noun)
The management of money and debt by city and local governments.
The lecture turns to municipal finance after discussing bankruptcy.
operating budget (noun)
The plan for a government's regular yearly spending, which must usually be balanced by law.
Cities cannot borrow to cover their operating budget.
capital budget (noun)
A separate government spending plan for long-term projects like roads or schools, often paid for with borrowed money.
The new sewage system was paid for through the capital budget.
infrastructure (noun)
Large public systems like roads, schools, and water pipes that a community needs.
The town borrowed money to build infrastructure for future growth.
municipal bond (noun)
A debt security issued by a local government to raise money, often free from federal income tax.
A municipal bond pays a lower interest rate because of its tax exemption.
tax-exempt (adjective)
Not required to be taxed by the government.
Interest from tax-exempt municipal bonds is not taxed federally.
yield (noun)
The income an investor earns from a bond, shown as a percentage of its price.
The tax exemption lets municipal bonds offer a lower yield.
social insurance (noun)
Government programs that protect people from a sudden loss of income.
Social Security is a major form of social insurance in the U.S.
progressive taxation (noun)
A tax system where people with higher incomes pay a higher tax rate.
Progressive taxation is one part of the government's social insurance system.
earned income tax credit (noun)
A government payment that increases the income of low-paid workers through the tax system.
The earned income tax credit helps working families with low pay.
OASDI (Old Age, Survivors, and Disability Insurance) (noun)
The official U.S. government program that pays benefits for retirement, death of a family earner, and disability.
OASDI is the formal name for the Social Security program.
disability insurance (noun)
Insurance that pays income to someone who cannot work because of illness or injury.
Private companies struggle to sell disability insurance profitably.
selection bias (noun)
A distortion that happens when the people who buy insurance are more likely to need it than average.
Selection bias makes disability insurance hard for private firms to price.
bureaucracy (noun)
The system of officials and offices that runs a large organization or government program.
Running a national pension needs a large bureaucracy to track records.
carbon paper (noun)
A thin sheet once used to make copies of handwritten or typed documents.
Cheap carbon paper helped Germany manage its new social insurance records.
administer (verb)
To manage or run a program or system.
Contemporaries doubted Germany could administer a national pension system.
co-own (verb)
To share ownership of something with another party.
Governments sometimes co-own companies they help rescue from bankruptcy.
incentivize (verb)
To give someone a reason or reward to do something.
Finance is used to incentivize teamwork toward a shared goal.
budget deficit (noun)
The amount by which spending is greater than income in a set period.
State laws usually forbid a budget deficit in the operating budget.
collateral (noun)
An asset promised to a lender that can be taken if a debt is not repaid.
Some municipal borrowing is backed by future tax revenue as collateral.
solvent (adjective)
Able to pay all debts that are owed.
A city must stay solvent to avoid a bankruptcy filing.
welfare state (noun)
A system in which the government provides broad social and economic protection to its citizens.
Germany's programs in the 1880s were an early form of a welfare state.
franchise (business) (noun)
A special right or license granted by a government to run a certain business or service.
The lecture briefly touches on government franchises in earlier public utility discussions.

Chapters

From the YouTube description

Financial Markets (2011) (ECON 252)

As an introduction to public and nonprofit finance, Professor Shiller reflects on the remarkable financial structures that we have in support of public causes, making possible the achievement of higher goals that transcend individual satisfaction of needs. He gives examples of nonprofits, illustrating how that financial form can support a moral mission and social purpose. There is however sometimes a fine line between for-profit and public enterprises, because similar companies can be either for-profit or non-profit and because governments regulate and collect corporate profits taxes on for profit-organizations, implicitly creating a public purpose for them. Subsequently, he covers state and local finance, outlining the difference between operating budgets and capital budgets as well as the tax-exemption of municipal bonds. During the last part of the lecture, he provides an overview of historic improvement in governmental social insurance that ranges from progressive taxes to public services and to old age, survivors, and disability insurance. All of these advances in public and nonprofit finance have taken place in step with other advances in human society, notably advances in information technology.

00:00 - Chapter 1. Organizations Supporting Individual Causes
06:45 - Chapter 2. Nonprofits: Pursuing Common Interests
18:55 - Chapter 3. Government Involvement in For-Profits
32:26 - Chapter 4. Social Entrepreneurship and Distinguishing between Nonprofits and For-Profits
36:43 - Chapter 5. Municipal, State and Local Finance
46:06 - Chapter 6. Tax-Exemption of Municipal Bonds
51:24 - Chapter 7. Government Social Insurance -- From Progressive Taxes to Old Age, Survivors, and Disability Insurance (OASDI)
01:00:10 - Chapter 8. The Invention of Social Insurance in Germany
01:10:20 - Chapter 9. Review of the Social Purpose of Finance and of Behavioral Finance

This course was recorded in Spring 2011.

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