October 24, 2014
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How 'social impact' bonds could transform government programs
William L. Swann

It was announced last month that Goldman Sachs would invest nearly $10 million in a new four-year program aimed at reducing recidivism – the tendency for released offenders to reoffend – at Rikers Island in New York City, with the promise that Goldman would profit if the program reduces recidivism rates by at least 10 percent.

So how, one might ask, did a financial services firm ever become involved in prisoner programs?

What Goldman was awarded is known as a “pay for success” contract, or a “social impact” bond (SIB). Although new in the United States, these funding mechanisms have been used in Britain in an attempt to save government money in financing social programs targeted toward prisoners, the homeless, substance abusers, vulnerable children and preventive health patients, by shifting upfront costs and thus the financial risk to private investors.

Here’s how the basic SIB model works: A bond issuer raises capital from private investors and then distributes the funds to service providers – mostly non-profits – who coordinate and deliver programs. If a program meets predetermined performance targets, then the government reimburses the issuer with the principal, plus a return on the investment. If, however, the program fails to meet such targets, investors stand to lose their money. Essentially, the government pays only for successful outcomes.

According to the New York Times, Massachusetts, Connecticut, New York and the federal government are all at various stages of planning for the implementation of SIB-like mechanisms. So far, there isn’t enough evidence to suggest that they are any more effective than the traditional approaches, but this lack of empiricism hasn’t quelled the excitement surrounding what has been hailed as a promising tool to save taxpayer dollars while potentially ameliorating some of society’s thorniest problems.

SIBs offer several major advantages for cash-strapped governments. First, they allow government to pay only for programs deemed effective. Gone would be the days when government blindly funds social endeavors with little assurance that it’s getting its money’s worth.

Second, with this structure, service providers could, to some extent, distance themselves from government’s ever-tightening budgetary constraints, potentially having greater access to capital sufficient to achieve their goals. In other words, no longer would providers be tasked with making miracles with too few resources.

Third, with external organizations funding programs directly, government escapes the pressure associated with picking between the good and the bad but politically connected service providers. As the Center for American Progress (CAP) puts it, government is effectively “depoliticized” from the situation.

Most important, SIBs would bring market-like competitiveness to social programs. Such infusion of capitalism might better distinguish effective programs from the ineffective and, like a traditional market, foster an environment of innovation, allowing for the best ideas to grow and be rewarded.

Still, some critical challenges remain ahead. For starters, evaluations must be transparent and objective if programs are to be accountable to taxpayers. Indeed, some worry that the incentive for profit could distort the integrity of programs and outcomes. This is why evaluations must be conducted independently and perhaps paid for equally by involved parties to avoid a conflict of interest.

Another challenge will be defining measurable outcomes. Oftentimes outcomes in the public sector aren’t conducive to clear-cut metrics and take years, if not decades, to achieve. CAP recommends using SIBs when it’s possible to measure outcomes in an objective manner, within a timeframe of three to eight years. In any event, outcomes must be defined, measurable and meaningful to government if SIBs are to achieve their mission.

Additionally, government must determine the price it’s willing to pay for achieving these outcomes. In so doing, government must conduct rigorous cost-benefit analyses to see whether it’s cost-effective to reward investors for goals it could otherwise achieve for less on its own. CAP suggests that outcomes should also be paid for by a combination of agencies, since the benefits will likely accrue across departments.

Furthermore, CAP recommends incorporating into contracts clear exit strategies so that external organizations have the option of leaving if indicators show little chance of achieving outcomes. Prolonging ineffective programs throughout the life of a contract serves no purpose.

Lastly and perhaps most difficult, government must relinquish control. To maximize the potential of SIBs, government should rest the full responsibility of achieving meaningful outcomes with external organizations. Once contractual terms are set, these organizations should have complete authority over a program’s destiny and must live with the results. Indeed, to do otherwise defeats the very intent of SIBs in the first place.

If implemented properly, SIBs potentially offer significant cost savings and benefits to society. What’s most exciting about this model, however, is that it’s a rare attempt to experiment in areas that have been historically controlled by government. To solve some of the country’s most pressing problems, government must step out of its comfort zone, empower social entrepreneurs and give new ideas the freedom to flourish but, more importantly, the freedom to fail.

SIBs are no panacea, nor are they appropriate in many instances, but they’re precisely the experimentation government needs.

William L. Swann, an occasional contributor, is a Rhode Island native and a Ph.D. student at the Askew School of Public Administration and Policy at Florida State University.


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