The challenges of measuring the economic contribution of the third sector

Introduction

Third sector organisations (TSOs) contribute significantly to our economy in most sectors of the economy, yet in Scotland and the UK we have never attempted to estimate the overall economic contribution of the third sector. What would our economy look like without third sector organisations? At the Fraser of Allander Institute (FAI) we decided it was time to find out, but it’s not an easy question to answer.

The FAI has a longstanding history of expertise in input-output modelling – an economic model based on national accounts that can be used to estimate the economic value of organisations and industries. Recent examples include: The Contribution of Robertson to Scotland’s Economy, The Economic Contribution of the Pharmaceutical Sector in Scotland, and The Economic Contribution of the Aluminium industry in the UK.

The FAI has worked on many projects over the years to estimate the impact of particular sectors, and has also estimated the impact of large public sector organisations. In addition, the impact of large educational institutions has been estimated readily in previous work. We also have partnerships with third sector organisations in Scotland and have estimated their economic contribution to the Scottish economy. A recent example (the full report for which will be published soon) was the impact of medical research spending that we produced in partnership with the British Heart Foundation.

However, we have not attempted in the past the estimate the overall economic contribution of the third sector. So, over the past year, we have been working towards this. In this project, we are trying to use the national economic accounts to quantify the sector and estimate the economic value, in terms of jobs and gross value added (GVA), that charities support.

This research requires us to estimate the amount of charitable spend that flows throughout the Scottish economy. Once we have this estimate, we can model the gap that would be left in the economy if we were to "hypothetically extract" the third sector and its activities.

The gap left in the economy gives us our estimate for the economic contribution of the third sector to the Scottish economy.

This research has been carried out by Strathclyde University’s MSc. Applied Economics students as part of the FAI work placement programme, and was a 6-week research project as part of the Economic Futures’ 2021 summer placement programme. The research has been led and overseen by senior researchers in the FAI to ensure continuity.

So how do charities appear in the national economic accounts?

The central part of the economic accounts are called the Supply and Use tables. These tables show the linkages between industrial sectors in the economy: i.e. they show how much wood and metal the construction industry buys, they show how much the financial sector spends on legal services and so on.

Input-Output (IO) tables are derived from this and are what we use to model the impact of sectors on the economy. Supply linkages between industries are used to derive economic multipliers, which are the source of all claims you see like £1 of spending in the construction sector generates £X of GVA and so many jobs in the economy.

The third sector, as you would think of it, is not specified in the national accounts. The focus in many parts of the accounts in to define what is within government control and therefore within the public sector boundary (for the purposes of defining government spending, deficit and debt).

However, in the IO tables, a portion of the sector is separately identified. There is a special sector called “Non-Profit Institutions Serving Households”, nattily shortened to NPISH. These are bodies outside of government which provide services to households free or at “economically insignificant prices”. Essentially, prices that don’t relate to the cost of provision, or are very heavily discounted.

In practice, bodies are defined as NPISH if 50% or more of income comes from donations and legacies (called the “market test”). You can see that many third sector organisations would not meet this test – many rely on trading income to support their charitable work.

In addition, the Office for National Statistics (ONS) includes a number of organisations in NPISH as a matter of course. These organisations include

• higher education institutions
• religious organisations
• trade unions; and
• political parties

So, in practice, the NPISH sector is dominated by higher education institutions. In this sector, the economic output of a body is equal to that body’s spending.

So where do charities go in the accounts if they pass the “market test”? Just like all corporations in the economy, their activity is then captured in the industrial sector that best describes the activity that they carry out – i.e. the service that they provide.

So, a housing association would appear in the sector which has all corporations that provide housing services – whether those providers are public sector, private sector, or third sector.

Many charities who have a large retail arm can actually appear as retailers in the national accounts, given this is the dominant economic activity. Given the heterogeneous nature of the third sector, you can see that there are likely third sector organisations in many of the industrial sectors of the economy.

So, our challenge was to think how we could estimate which “slice” of each sector in the economy (of which there are around 100 in the I-O tables) could reasonably be assigned to the third sector.

Our work so far

Given this challenge, our starting point was to look at the information that was available on the spending that charities perform in the economy. Therefore we turned to the information that was available in the Office of the Scottish Charity Regulator (OSCR) database.

Now, we are aware that the third sector is not just made up of charities, and that there are many other organisations, such as social enterprises, which would define themselves as such without necessarily being constituted as charities. But it is a decent place to start, and in the absence of other information, the most comprehensive coverage we have.

So far, our research has been split in to two subprojects –

• Part 1 involves assigning industry codes to Scottish charities using the OSCR database and Companies House information; and,
• Part 2 involves analysis into national accounts methodology used to determine whether charities belong in NPISH or Market (i.e. within industries).

Throughout our research we refer to the Office for National Statistics (ONS) and Scottish Government’s national accounts methodology which are used to estimate NPISH for the UK and Scotland.#

Part 1

The OSCR database was organised according to most recent year expenditure. In doing this it was possible to take the top 1,000 spenders, representative of 90% of charity spend, and assign industry codes to this group. It was then assumed that the remaining charities follow a similar trend in terms of industry share.

Many of the charitable bodies have already been assigned Standard Industrial Classification (SIC) codes which can be found on Companies House. If the charitable body has not yet been assigned a SIC code, then we referred to the ONS SIC codes, assigning charities to industries based on their main activities. For example, a charity which primarily operates under cancer research would be classified as scientific research and development, SIC72.

Part 2

Using the Scottish charity database, the aim was to identify which charities fall under NPISH – both using the market test and the organisations we know are included.

Using this approach, we were able to allocate just 55% of charity spend to NPISH or Market – with those in market allocated a SIC code and therefore an industry in which they belong.

A key challenge was missing income data, a large number of charities did not specify their donation income, meaning we were unable to apply the Market Test.

Therefore, we spoke with OSCR and they provided multiple years of income data for charities which we are using to sort more charities into NPISH or Market.

Ambitions for this research

When the database of charities is complete, we will be able to create a new sector in national accounts, which will be the third sector as defined by those who are registered as charities.  

But, tracking the economic contribution of this sector is not as simple as modelling the expenditure of Scottish charities. Each charity makes purchases from different sectors in the economy and provides goods and services to sectors too. Therefore, estimating the economic value of the third sector requires hypothetically extracting the whole sector from the economy and examining the gap left behind.

For example, if a charity was to cease operating, this will not only impact those that the charity provides goods and services too but it also will have knock on effects onto suppliers and any other organisations involved in the supply chain of that charity.

However, even when the database is complete, data and conceptual challenges remain to accurately reflect the economic contribution of the third sector.

These include:

• the challenges of applying our standard techniques to this sector. Normally when assuming both impacts on supply chains and wages in the economy, industrial sector average purchasing patterns, and employee spending patterns are used. In a sector that sources some of its supplies and income from donations, and that employs volunteers, this issue becomes more complex.
• the sector is defined using the OSCR charity definition, which is narrower than the definition that many would use to define the third sector.

We will be investigating how to deal with these issues over the next phase of the project. Although there are challenges we hope that this research will be further progressed this summer with the help of another 6-8-week summer placement as part of the Economic Futures summer programme.

By the end of the summer we hope to produce our first estimates of GVA and employment supported by the sector.

In addition, we hope to engage with the Scottish Government, to try and think through how the research could be useful for the estimation of the NPISH sector in Scottish National Accounts.

Get some hints and tips from Professor Mairi Spowage on how to measure the economic impact of your charity at a free webinar Measuring the Economic Impact of Charities on 9 March.