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Endowments.

A lot of smart people got upset that John Paulson, the guy who made a fortune betting against subprime mortgages and probably lost it all on gold, gave $400 million for Harvard to start an engineering school. The arguments were standard – Harvard is an obscenely wealthy school that by and large caters to kids from obscenely privileged backgrounds. Surely the marginal value of $400 million dollars – indeed, $400 million dollars that’s not evening being spent – would be much higher in the hands of African children.

Except that’s exactly why it’s one of the best gifts to society. The many defenses (and there were many) that focused on research and technology investment miss the point. They’re correct, but that’s not where the money is (so to speak). Let’s talk about why we respect investors like Warren Buffet. Buffet puts in a lot of capital to identify companies that are undervalued and need money, provides operational support to bring them to their potential, and makes a profit. In the process, of course, society as a whole is ever so slightly better off, with that capital producing superior societal returns than the next best opportunity (the opportunity cost, or discount rate).

This doesn’t always happen. Investors are wrong. But for the good ones this is how it basically works. But imagine if Buffet reinvested the returns, and promised to keep reinvesting them forever.

That’s basically what the Harvard Company is. Sure there’s a payout, on the order of 5%, to bankroll the universities operations, but it’s principal (and returns beyond the necessary payout) are permanent.

Go back to what investment is. Before money. When A does work for B, in return he gets some claim on B’s future work. Now since C owes B some work, B asks C to settle his debt with A who, instead, redirects C to D since D needs help building something better. Now A isn’t altruistic. Eventually he’ll reap the rewards of his patience. But imagine he never did that.

Of course, this line of reasoning isn’t anything new for economists. It’s why they advocate (at times with dubious reasoning) preferential taxation on capital gains.

But the argument here is so much more compelling. Ultimately, I’m going to spend my capital gains (economists just want to reward me for being patient). Even if I redeem it in 10,000 years, it doesn’t change the calculus (I’d just redeem a lot of capital). But on an infinite timeline – which is what Harvard’s endowment is – not only is Paulson’s gift financing Harvard’s operations (which do include research), he’s permanently financing millions of business activities around the country which have all been better than the alternative – the endowment beats the S&P500 on an annualized basis by about 3%.

None of this is to say giving to Harvard is superior philanthropy than buying bed nets for African children. But for one, it actually scales (an organization with an operating budget of $3 million isn’t exactly going to be able to absorb a $400 million gift). It doesn’t really meet the “most need” criteria, but the broad social good brought by financing superior businesses and ideas is intangibly valuable as well.

There are a lot of problems with the way university finances work. For one, the land they’re sitting on and the payout from the endowment they consume shouldn’t be tax free, for the reasons many critics cite. Education is a social good, but (for understandable reasons) Harvard’s enrollment is far outweighed by the capacity of Harvard’s enrollment (which the the value of the institution and hence its tax shield). Instead, Harvard should be required to pay taxes on the land it sits on, as well as the portion of the endowment it commits to its operating budget, with a deduction for every student it enrolls.

This isn’t ending the debate. But if we want to engage in the conversation of telling other people what to do with their money (and hey, it’s fun) let’s at least do it intelligently. I’d love to see the pros and cons of the value added to society from a permanent investment in its potential ideas compared to, say, furnishing Givewell ideas (taking into account scale, liquidity, general welfare, and distributive welfare). Let’s not make it about privileged Harvard kids and poor African babies.

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3 comments
  1. I’ve always wondered why we don’t treat government spending with the same outrage or scrutiny. Wouldnt the investment multiplier of this man’s endowment be much larger in present value terms than the same amount of money just given out for people to save or consume(rhetorical)? Why dont we seperate gov expenditures into capex and charity. Then we can at least understand the purpose of one over the other. There is a big difference in government or an individual spending X to produce a return on existing assets of X+dX, or them transferring purchasing power to other people. One is a question of asset utilization (something the gov should be very concerned with if they own ~40% of all assets) and one is a question of distribution. You can milk a cow, but its very hard to make it meow. I think if the american people saw the choice of spending a dollar to produce 3, or spending a dollar and actually losing on net in terms of productivity they would be more able to affect the priorities of politicians. The vast majority of spending increases in the last 30 years have been on charity/redistribution, and thanks to some “creative” accounting in social security, has americans convinced such spending is an “investment”. Throwing more dollars at less productivity is a recipe for…where we are today.

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