FAQs - Social Policy Bonds

Does anyone actually issue Social Policy Bonds?
Not that I’m aware of yet (January 2018), despite the concept having been in the public arena since 1988. (Click here for the pdf of the original paper.) Some private bodies in the US and elsewhere are thinking about it. Governments are more wary, but there is some interest at the officials' level. See News  for ways in which people are thinking about issuing the bonds. One difficulty with the bonds is that their advantage over conventional policy instruments is most marked at a large scale, for problems that require a multiplicity of diverse potential solutions, not all of which can be known in advance. Social Policy Bonds, uniquely, would see resources shifting between these solutions, which are themselves adaptive to changing circumstances. This allows the targeting of broad, long-term goals, but it also means that the bond principle cannot be readily tested on a small scale. I go into more detail about this aspect of Social Policy Bonds here, and contrast them with Social Impact Bonds, a more recent, non-tradeable financial instrument, which are being issued in about 15 countries; I explain why I think SIBs are flawed in the next FAQ, below, and on this page.

What are Social Impact Bonds, and how do they differ from Social Policy Bonds?
Social Impact Bonds are a new financial instrument being developed in the UK by the Young Foundation and Social Finance. They adopt one of the principles of Social Policy Bonds: that of linking rewards to outcomes. It seems that Social Impact Bonds would reward pre-selected organizations, or parts of pre-selected organizations for working efficiently: they would still have incentives to achieve the specified goal. They might even contract out some of the required work. But, crucially, SIBs would not be tradable. There would be no transparent market for them. The composition and structure of the organization trying to achieve the outcome would therefore be fixed and pre-determined. Under a Social Policy Bond regime, on the other hand, the type, structure and composition of organizations working to achieve the target would be subordinate to the most efficient way of reaching it. This means, amongst other things, that broad, longer-term goals could be targeted. The identity of the organizations envisaged as benefiting from any efficiency gains under a SIB regime is another point of departure. They seem to be local authorities or other government agencies. It would appear, therefore, that gains from improved efficiency would be most likely to be remain with the agency and so, perhaps regrettably, be less motivating than direct financial incentives to employees.

Unfortunately, in my view, it appears that the recipients of such rewards are to be those agencies already working to achieve the specified outcomes. This limits not only the efficiency of the bonds but, perhaps more crucially, their range of operation. Existing bodies tend to have expertise in doing specified things in a certain way. Their vision is limited by the specificity of these things. Any stipulated goals, under a Social Impact Bond regime would, I believe, therefore be too narrowly defined to allow for broad social and environmental goals and the creative destruction of those that are unpromising. Sadly, therefore, it would seem that Social Impact Bonds are afflicted by that bane of policymaking worldwide: their effectiveness and efficiency are subordinate to current institutional  structures. To that extent then, Social Impact Bonds represent only an incremental improvement over conventional policymaking. Under a Social Impact Bond regime our social and environmental objectives, would continue to be driven not by society's wishes, but by the organisational needs and limited vision of those currently supposed to be supplying them. To me, that's a recipe for failure.

What do people think of the bond concept?
Many economists are intrigued. See News  for more.

Who would buy the bonds?
The most important buyers would be institutions, who would buy many of the bonds, and use the profits they anticipate from early redemption as collateral to finance projects that would help achieve the targeted social objective.

Wouldn't people just buy Social Policy Bonds, then do nothing?
If enough people did nothing, the value of the bonds would fall, as the targeted objective became ever more remote. At some point, the market price of the bonds would fall to such a low point, that it would pay somebody to buy the bonds, and do something to help achieve the targeted objective.

What happens if Social Policy Bonds are held by many different holders?
That would mean that bondholders might be tempted to do nothing, or that they are not rewarded in proportion to their efforts. If too many Social Policy Bonds were held by would-be free riders who had no intention of doing anything to help achieve the targeted social objective, then the value of all the bonds would fall. At that point it becomes worthwhile for active bondholders to buy those bonds that are traded, do something to achieve the goal, and see the value of their bonds rise. This would benefit any remaining free riders of course, but not as much as the new bondholders, because these new bondholders would have paid less for their bonds. Most likely, we'd see aggregation of bond holdings as it becomes worthwhile for passive bondholders to sell their holding. This would see most bonds' being held by relatively large owners. They would then have incentives to cooperate with each other. This would mean, amongst other things, that they would all benefit by agreeing on how the specified social problem could best be targeted. One element of the optimal strategy will be to decide who will be responsible for what activities, and how they shall be compensated. Major bondholders will certainly have incentives to share information with each other. Many of the bonds would be traded between bondholders.

If the proportion of bonds held by free riders is small, then their passivity would have little effect on the market value of the bonds, and they might benefit by hanging on to their holdings if active bondholders are successful in their efforts to move towards the goal’s achievement. Such behaviour would, to a limited degree, undermine the Social Policy Bond concept, but keep in mind that:

• The true standard of comparison is not perfection: just something significantly better than any alternative.
  

• The goal is to achieve social goals as efficiently and quickly as possible; not to ensure that everyone is rewarded strictly in accordance with their efforts.
  

But what about those with smaller holdings?
Some might think that holders of bonds representing, say, 5 per cent of all the bonds issued would be deterred from taking actions to help achieve the targeted objective because they will not be the sole beneficiaries of appreciation in the value of the bonds. First, typically people do take actions that will enrich others as well as themselves. Minority shareholders and company managers, for instance, frequently initiate actions that will see major shareholders benefit far more than themselves. They might try to accumulate more shares in anticipation of their own activities, but this activity certainly does not inhibit initiatives aimed at increasing share prices. Second, the important criterion for bondholders is whether their investment in objective-achieving activities will generate a sufficient return to themselves. They will not be deterred if their activities also benefit others. Of course, if their activities are successful in achieving a specified objective, then other bondholders may replicate them, so raising the price of the bonds significantly. Third, minority bondholders could use futures or options markets, so that they would enjoy a leveraged return if their activities are successful in raising the bond price.

What happens when a targeted objective has actually been achieved? Wouldn't more bonds have to be issued to maintain the status quo?
For the bonds to be redeemed, the achievement would have to be sustained for a specified period. After that period, it is likely that the most successful and efficient systems developed to solve the social problem the first time will allow government to allocate less funding for maintaining or improving the new status quo. The bonds encourage diverse and efficient solutions to social problems.

Could the bonds really solve such global problems as war, famine, disease and environmental disaster?
Once the bonds have been successfully used at the national level, there would be every reason to apply the principle to global problems. The thrust of the concept is to give people incentives to solve targeted problems. Too many global resources are wasted on corrupt or inefficient governments who have no real incentive to help solve global problems. Social Policy Bonds can undermine, co-opt, or distract those who are opposed to social goals.

What about short selling: couldn't people sell Social Policy Bonds short and then work to profit from movements away from targeted goals?

(1) The short seller doesn't own the bonds, but has to borrow the bonds from the broker or dealer when placing the sell order. The seller is then obliged to buy back the bonds at some point in the future. Just as the seller will want to see the value of the bonds fall, so the broker or dealer will want to see their value rise. So any additional incentive to move away from a targeted goal on the part of the seller would be balanced by an incentive on the part of the broker to reduce conflict.

(2) The weight of money - that is, the funds for the bonds' redemption - will be in favour of progress toward the goal; just as in the share market, the short selling of a company's shares doesn't change the incentives for the company itself to succeed. It's likely that any profits from short selling will be short term in nature; the long arc of the market for the bonds will bend in favour of achieving the goal.

(3) Public opprobrium. While people or corporations do profit from the failure to achieve social goals, they do so in ways that are indirect. If short sellers were to work to make social goals less achievable, the source of their activity and the reasons for it would be direct and identifiable. Take, for example, Conflict Reduction Bonds. Weapons manufacturers and military contractors already profit from their activities. They could be already deliberately fomenting conflict with the aim of boosting their revenue. Short selling would be only one more way of profiting from war, but it is one that is both more readily identifiable and likely to attract more public opprobrium than any other so, even if a corporation were that way inclined, it would be unlikely to follow through.

Why .com?
Social Policy Bonds are not a profit-making venture. I chose the .com suffix in the early days of the world-wide web when that appeared, to non-experts, to be the default name for all non-governmental, non-academic websites.

Why Social Policy Bonds?
For my original presentation (pdf; for context see here), back in 1988, at the Australian Agricultural Economics Society meeting in Blenheim, New Zealand, I had decided to call them 'Social Objective Bonds'. But a day or two before the conference, one of my more worldly colleagues, on reading my draft paper, told me exactly what the acronym meant and how widespread it was. I hurriedly changed the name to Social Policy Bonds. Again, that early, perhaps sub-optimal, choice decided the matter.