Social Impact Bonds

Following up on my earlier post on Impact Investing, I was following some threads on impact measurement when I came across a New York Times article about Social Impact Bonds.  This led to the website for The Young Foundation in the UK, which has been developing the concept.

What is clear is that these are not bonds that we would recognize.  Instead, it is a a funding mechanism that links the capital markets (which provide the funding for social programs) with the government appropriation that is conditioned on outcomes.  According to the Young Foundation, this structure addresses some of the problems created by misaligned incentives in social policy.

The problem is that the "bonds" just replace one amorphous source of funding with another.  The only consequence to the service agency is that it does not raise the next round of funding.  In reality, one could expect to see gaming of the outcome requirements to assure success and continued funding, just as we have now.

What would really align incentives is for the agency to get paid a part of the value created by the services provided.  For instance, an agency contracted to provide job training could be paid out of the first year wages earned by its students.  Let's say a training program can train 60 workers a month, and 75% of them get jobs that pay $15,000 per year on average.  If the agency were to charge the employer 5% of wages paid, the agency would receive $33,750 for each monthly class.  The value created is more than just the wages being earned by the students.  It includes a thriving business community that is employing the students, renting local real estate, and paying business and payroll taxes.  It includes allowing the human capital of a community to become productive.  And it reduces the demand for services from the governmental entities, from subsidized housing to law enforcement.

Of course, if the above scenario were possible, there would be no need for specialized funding vehicles like Social Impact Bonds.  The trick is to find a way to fund operations that create societal value which is not easily monetized.  And the hardest part of that is measurement.  Shifting the risk to the capital markets is not the answer.