Social Policy Bonds

Does anyone actually issue Social Policy Bonds?
Not that I’m aware of, yet (September 2012), despite having been in the public arena since 1988 (long pdf). Some private bodies in the US and Australia are thinking about it. Governments are more wary, but there is some interest at the officials' level. See Social Policy Bonds on other websites for the ways in which people are thinking about issuing the bonds.

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. Compared with Social Policy Bonds, though, SIBs would be less 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.

Nevertheless, I have emailed both the Young Foundation and Social Finance (as well as the Economist, which publicised Social Impact Bonds) and invited them to make use of my work on Social Policy Bonds if they wish.

What do people think of the bond concept?
Many economists are intrigued. In early 1997 I received this letter from Professor Robert Shiller, Professor of Economics at Yale University, about the Social Policy Bond concept. He mentions Social Policy Bonds in his books Finance and the Good Society, and The New Financial Order. More recently, Robert Hahn and Paul Tetlock mention Social Policy Bonds in their paper Using information markets to improve public decision making. I have spoken about Social Policy Bonds in numerous fora, including the Universities of Cambridge and St Andrews, think tanks in the UK, Australia and New Zealand, and I have given a presentation on their application to environmental problems at the OECD in Paris.

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. This would lead to aggregation of bond holdings, so that most bonds would be 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.

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.