Could ‘Development Impact Bonds’ work?

This blog post first appeared on Views from the Center at the Center for Global Development.  Last week, CGD and Social Finance launched a new high-level Working Group to consider Development Impact Bonds, a new mechanism to enable private investment in development outcomes. Owen Barder and Rita Perakis explain.

There is nothing new about the idea that development assistance is an investment: spending money today in the hope of future benefits. Putting money into immunizing kids or giving them an education is an excellent investment in the future well-being of those people. But if there are financial returns they are often far in the future and cannot be directly linked back to the investment.  For many development investments the returns are mainly social, not financial. And the absence of financial returns on a reasonable timescale could be why there is no market for investing in development. There is a small pool of investors who are willing to be paid in good karma; but most would rather be paid in dollars, sterling or euros.

When the market cannot provide – such as where the financial returns are not in line with the social returns – we often turn to public sector solutions.  But that can bring new problems: government failures are different from market failures, but real nonetheless. Political time horizons can be short, leading to myopic decisions; budgets can be inflexible and siloed; performance management inadequate; and Treasuries and fiscal policies may constrain sensible investments.  In developing countries, government failures can be compounded by the involvement of multiple aid agencies.

One promising answer to this set of problems is Social Impact Bonds. Under this scheme, private investors put money into key services, often delivered by non-profit organisations, to produce certain kinds of social benefits. Once reliable independent evidence shows that there has been an improvement leading to a social benefit, the government uses taxpayer money to give the investors their money back with a decent (roughly commercial) return. But if there is no proven social benefit, there is no payout by government. So investors take the risk that interventions don’t work, while being paid with interest for the ones that do. (Alert readers will notice that this is not really a ‘bond’ in the conventional sense.)

This approach is now being tested in the UK, US, Australia and elsewhere. In the UK pilot developed by Social Finance, Social Impact Bonds are being used to pay for services which are intended to reduce reoffending by ex-offenders. Investors put money into a coordinating organization which funds a variety of interventions intended to reduce recidivism, such as training programmes, housing, and counseling. The investors will be paid by the Ministry of Justice (out of the savings they make lower prisoner numbers) if reoffending is shown to go down faster for this group of prisoners than with other comparable prisoners in the prison population.

When this was launched in the UK, we asked whether this model had applications in development. For example, could donors translate social impact into a financial return for investors, in the way the Ministry of Justice has turned lower reoffending into financial returns for investors in the UK?  Or are there development interventions which could yield sufficient financial returns to be attractive to investors even without donor support?  Over the past few months CGD in Europe has partnered with Social Finance to explore the idea of Development Impact Bonds – to create a new way to invest in development.

The Development Impact Bonds Working Group recently met for the first time to explore whether and how social impact bonds could work in development. I’m privileged to be co-chairing the group with Elizabeth Littlefield of OPIC and Toby Eccles of Social Finance.  It is a frighteningly smart and experienced group of people, which is a sign of the considerable interest in the idea from financial institutions, donor agencies, foundations, and others. (The full list of members of the Working Group members is here.)

Here are some problems this approach may be able to help solve:

1. Could Development Impact Bonds be a way to engage the private sector to help improve the management of public services?
   Governments in both developed and developing countries find it difficult to manage service delivery contracts successfully. The private sector can be more effective at testing different approaches, monitoring performance, scaling up success and exiting from failure, creating incentives to do better, and is less susceptible to political pressures to misallocate resources.  Purely private sector solutions can suffer from problems of access and equity, but can Development Impact Bonds harness the strengths of private sector management while using government money to ensure that services are accessible to the poorest?
2. Can Development Impact Bonds provide flexible money to support outcomes instead of targeting money inflexibly on particular services?
   Governments organize budgets around particular services, and find it difficult to create flexibility to pool the money so that it can be used efficiently to solve particular problems.  This is especially true if the spending has been programmed by aid donors, which usually leaves very little discretion for governments to move the money to where it will be used to greatest effect. But if payments are linked to outcomes, could there be more flexibility to spend the money in the most effective ways?
3. Can Development Impact Bonds enable innovation to find answers for the ‘last mile’?
   It is a consistent challenge in development to provide equitable access to important goods (bednets, drugs, fertilizer) and services (clinics, schools, maintenance of water pumps). Getting these products to the poorest people often requires solutions tailored to local circumstances, and the ability to identify and overcome specific obstacles.  Centralised development strategies supported by donors have often failed because it has been difficult to provide funding and support institutions with sufficient flexibility to innovate, test ideas, react to local conditions, and enable locally successful solutions to emerge for these ‘last mile’ problems.
4. Could Development Impact Bonds improve the management of aid-financed services?
   For a variety of reasons, service delivery financed by aid can be very inefficient. Much of the money can end up in the overhead costs of organisations that pass the money along very long supply chains, or end up paying for the bureaucracy of planning, monitoring and reporting how the money was used. The intended beneficiaries of aid have no way to identify failure or reward success, and no voice or representation, so there is no bottom up pressure to improve. Many of these problems are an unintended consequence of donors having to mitigate the risks inherent in providing money in advance of outcomes being achieved.
5. Could Development Impact Bonds enable governments and donors to invest more in prevention, to avoid bigger problems later?
   Underinvestment in prevention is a problem for many governments: for example, if we provide too little preventative health care, we end up having to pay for operations and medicines (as well as creating misery from poor health). It would be cheaper to prevent malaria from taking hold again in Zanzibar, than to have to pay later to bring it down again.
6. Can Development Impact Bonds enable donors to focus on paying for what they get, instead of focusing on getting what they paid for?
   Results based aid and results based finance (there is a technical distinction between these terms) are based on the idea that payments are made when services are delivered. But in very poor countries, it is difficult to expect governments to provide services unless someone is willing to put in the money up front.  When donors do this, they are drawn into micromanaging how ‘their money’ is used, leading to huge costs of administration and coordination, and undermining country ownership and the use of country systems.
7. Could Development Impact Bonds enable small scale investing and giving?
   Could schemes be designed – perhaps building on the example of Kiva – in which a large number of small, individual investors put money into development opportunities in the expectation of both a financial and a social return?  Alternatively or additionally, might individuals and companies be more willing to make donations for development – perhaps building on GlobalGiving – if they know they will only be asked to pay for an outcome when it has been proven to have been achieved, rather than, as now, on the promise that the money will be well used?

There is a strong parallel between Development Impact Bonds and the case made by our colleagues at CGD for Cash on Delivery Aid. In both cases, the focus is on paying for outcomes, leaving discretion for developing countries, including their private sector and NGOs, to find ways to deliver the services.  Development Impact Bonds could solve one of the potential conundrums of results-based aid: who is going finance the service in the first place if the donors won’t pay up until the outcome has been achieved?

The Working Group has a lot of questions to address in the coming months. It will need to consider how Development Impact Bonds can work with the grain of country ownership and strengthening of country systems. Will investors, however socially-responsible, invest in something as risky as development?  Does the involvement of private investors add sufficient value to justify the risk premium they will need to be paid?  (If not, this is just an expensive way for donors to borrow.) Are there examples of Development Impact Bonds which can be self-financing for developing countries, or do they all require donors to be involved to pay back the investors? Will it be possible to measure these outcomes in developing countries, and can changes be attributed to investments with sufficient certainty? If we can answer these questions, and solve some thorny design issues, then Development Impact Bonds could offer a new vehicle for private and public investors, small scale and large scale, who want to invest in development.  We are confident that if anyone can find good answers to these questions, it will be this group of people.

For more information, you may be interested in this briefing note by CGD and Social Finance. We would welcome any ideas and analysis which might contribute to the Working Group’s thinking, and we will provide regular updates as the work progresses.