Social impact bonds – could they work in development?

The British Government is testing the idea of Social Impact Bonds.  Social Finance, the organisation which developed the idea, describes them like this:

A Social Impact Bond is a contract with the public sector in which it commits to pay for improved social outcomes. On the back of this contract, investment is raised from socially-motivated investors. This investment is used to pay for a range of interventions to improve the social outcomes. The financial returns investors receive are dependent on the degree to which outcomes improve.

This idea is being tested to pay for a project which aims to cut re-offending by prisoners in Peterborough. Here it is described in the Financial Times:

The £5m bond is being used to fund the St Giles Trust, a third-sector organisation with a record of reducing reoffending by up to 40 per cent. It engages with offenders in jail and then supports them once out – something the probation service does for those on longer sentences but not for short-term prisoners.

If St Giles fails to cut reoffending at Peterborough, investors will get nothing back. If the reoffending rate reduces by 7.5 per cent they start to get a return. As it rises, the justice ministry will pay more, up to a maximum 13.5 per cent a year.

…  The justice secretary was careful yesterday not to paint the social impact bond – “a small scheme, although I would hope to have it on a much bigger scale across the country if we can make it work” – as the big answer to that. But payment only for results would be a key part of his green paper on reducing reoffending, he said.

Kenneth Clarke talks to inmates at Peterborough prison

The logic of these bonds is that the private sector invests in schemes if they are convinced it will deliver certain kinds of results.  But because the results are social benefits, they don’t generate cash which can be used to provide a return to investors.  So the government steps in to translate the social impact into a financial return for the investor.  It is this government promise to turn social impact into financial returns which unlocks the possible engagement of a much wider range of organisations in finance and delivery of social outcomes.

The concept is explained at more length in a publication by Social Finance, Towards a New Social Economy.   Social Finance’s role has been to get the contract put in place, and then attract capital into the fund. They are not themselves an investor in social impact bonds: their goal is to develop ways to enable finance to work better in social areas, both to raise more money and to allow it to be more effective. According to the FT:

If this is a revolution in social financing, it will not happen overnight. It will take three to four years for absolute proof the Peterborough project works, “but we believe there is the potential for hundreds of millions of pounds, even billions, of investment for social change through these sorts of structures,” Mr Eccles says.

Could something like this work in development?

One way this could work in development is as follows.

"I have a cunning plan"

A group of donors could make a binding commitment to pay a certain amount for particular outcomes, such as the number of  kids who complete school, or every household to get access to clean drinking water. (This is the kernel of the Cash on Delivery idea proposed by my colleagues at the Center for Global Development.)   Suppose you are a Minister in a developing country with a great plan for getting kids into school.  If the donors have promised to turn social results into financial returns, could you then persuade private investors – perhaps social investors or development finance institutions  – to front up the money to enable you to implement your plan?  (If not, might it be that you need a better plan?)

If your education scheme works, and the outcomes are achieved, donors hand over the money and investors get a financial return.  If your scheme doesn’t work, donors don’t hand over the aid, and your investors don’t get their money back.  Donor aid budgets are spent elsewhere.  You might have a little less luck raising money next time you have a cunning plan.

In general, a promise by donors to turn social returns (such as more kids vaccinated, reduced maternal mortality, more access to clean water) into a financial return might unlock a bigger range of sources of short-term financing for development. Possible financiers might include private sector institutional investors in search of commercial returns, social investors, high net worth individuals, foundations, development finance institutions (such as the World Bank and African Development Bank), or perhaps socially conscious individuals who want to put in a small amount of cash through an online service, with the expectation of just getting their money back, and nothing more, if the development results are achieved.   As well as (perhaps because of) the greater diversity of sources of finance, this might unlock more innovation and diversity in how those results can be achieved.

This could lead to a big change in the aid relationship and the role of aid agencies.  At the moment donors bundle together two potentially separate roles:

• providing finance for development;
• selecting among approaches for meeting development goals and supporting and monitoring their delivery.

The social impact bond approach would enable those two potentially distinct roles to be unbundled.  Donors could concentrate on identifying results for which they are willing to pay, putting a suitable price-tag on them, and ensuring that measurement of results is fair and accurate.

Once donors have made a commitment to turn social results into financial returns, developing countries could turn to a much wider range of organisations to help them design and deliver services, and a much bigger range of sources of short-term finance.  It would be up to the countries themselves to decide which social objectives to target, and how they wanted to go about doing it, subject to the discipline of being able to convince an investor (but not necessarily donors) that their plan makes sense. This approach would respect country ownership and prioritisation, and yet ensure that aid money was used only where it was really delivering results.

No substantial consideration has yet been given to whether and how social impact bonds might be used in the context of international development.    The closest analogy so far has been the International Finance Facility for Immunisation, but in that case there is no link between performance and the payout to investors.  In domestic policy, the Peterborough project to reduce re-offending is the only example so far of social impact bonds, though others are planned.

Those of us who are interested in international development should track the progress of these experiments and, if they are a success, think about how we might adapt the idea of social impact bonds to attract more diverse finance into development, as a way to improve the effectiveness with which aid money is used to reduce poverty.