February 2017: the paper below was written about 20 years ago. I am currently working on updating it.
Despite decades of economic growth and efforts to make their public sectors more efficient, most western countries are plagued by seemingly intractable social problems. Deregulation and the freer operation of self-
I think this is because too often, instead of rewarding meaningful outcomes, we reward organizations, activities, inputs or outputs, in ways that do not encourage effectiveness or efficiency in achieving our social goals. I propose that a new financial instrument, Social Policy Bonds, be issued as a means of injecting market incentives into the achievement of our social and environmental outcomes, to the benefit of all. Importantly, these bonds need not be issued by government: they can be issued by anybody -
Social Policy Bonds
My proposal is to issue non interest-
Assume now that the bonds targeting unemployment have been issued and sold. The opening value of the bonds might have been, say, £2.50. People, or institutions, now hold bonds that can quadruple in value once unemployment is down to three per cent. The bond issuers have nothing more to do: the holders of the bonds now have a strong interest in seeing the value of their bonds increase as quickly as possible. If other people's interest is stronger they will bid more for the bonds than they are worth in the hands of current holders. So Social Policy Bonds will be owned by those with the strongest interest in seeing the objective attained. These owners will form a new type of organization: one whose structure, composition and activities are entirely subordinate to the targeted outcome.
Who would buy the bonds?
Passive investors hoping to make a capital gain
casual purchasers, who might buy bonds in the same way as they would a raffle ticket;
speculators, who believe that the likelihood of the targeted objective being achieved is greater than the rest of the market thinks it is; and
hedgers, who stand to lose if the particular objective is actually achieved. They might buy bonds as a form of insurance policy against this possibility.
All these passive investors would want to become 'free-
organisations trying to achieve a targeted goal, whose bond-
investors or brokers who would use their own capital, or borrow on the strength of the redemption value of the bonds, in order to support projects aimed at helping achieve targeted objectives.
Active holders, in the unemployment example, could be expected to increase employment by using part of the present value of their expected above-
Prospective holders of the bonds have an incentive -
Many of the initiatives that would be stimulated by the unemployment-
Current efforts by government generally focus on the most obvious symptom of a social problem -
Note that agencies that are currently fully funded by government could also benefit from holding the bonds. In the transition to a bond regime, their funding from tax revenues would fall but, if they were efficient, the value of their bonds would rise -
Key criteria for policy areas within which Social Policy Bonds would show the most marked improvement over current programmes are:
existing policies have objectives that are unstated, uncosted, obscure or conflicting;
financial rewards to those involved in achieving objectives are uncorrelated to their effectiveness in doing so;
a wide array of diverse, adaptive approaches may be necessary;
our knowledge of the problems, their causes and solutions, is improving all the time.
Many national and global social and environmental problems satisfy these criteria, especially those that are currently the responsibility of governments or are not targeted at all. So, for instance, health care or crime prevention are largely dependent on government-
Social Policy Bonds and social goals
Currently touted methods of combating crime are longer sentences for convicted criminals, and more money for the police force. Social Policy Bonds targeting crime would home in directly on what society actually wants to achieve: they would become redeemable only when crime and the fear of crime had fallen to low levels.
Social Policy Bonds targeting unemployment could replace a wide range of measures including protectionist barriers to imports of labour-
Priorities for health services are strongly influenced by groups of medical specialists with little incentive or capacity to see improvements in the general health of the nation as an objective. So funding of medical specialities depends on the strength of their lobby groups. And what is arguably the most efficient way of spending the taxpayer's health dollar -
Targeting general indicators of well-
Bonds could target results achieved in basic literacy and numeracy tests taken by schoolchildren.
Bonds could target nationally averaged levels of water or air pollution, or the effects of such pollution on human, animal and plant life.
In all these examples there would be difficulties in the specification of the objective to be attained. 'Approved housing units' for instance, or 'reported crimes' could be subject to varying interpretation, or to deliberate attempts to falsify the information required to monitor achievement of the objective in question. But these difficulties are not insuperable, so long as the following three processes are soundly carried out:
The objective must be capable of being quantified, or there must be a strongly correlated proxy for the objective, whose targeting would inevitably result in the objective being achieved.
Careful thought will have to be given to the definition of each objective targeted by the bonds. Consider the unemployment example. It would be unsatisfactory to redeem the bonds when unemployment was down to a certain level for a short time only. The objective is a sustained level of low unemployment, and this is how it would have to be defined when the bond is issued. The Social Policy Bond principle is versatile in that it can target combinations of targets, all of which shall have to be reached and sustained before the bonds are redeemed.
All bond issues will require reliable and accurate monitoring of the targeted problem so that progress toward its solution can be reliably and unambiguously assessed. This surveillance must also be seen to be independent of the government or interest groups, both of which could benefit unfairly from dubious data collection. The nature of the monitoring -
The market for Social Policy Bonds
For the bond mechanism to work it is essential that active investors purchase the bonds and help to solve social problems. But there is no need artificially to boost investor interest in the bonds: the anticipated supernormal profit arising from early redemption of the bonds generates the required self-
But there is another important reason for requiring the bonds to be tradeable: active investors may be able to speed up only one, or a few, of the processes necessary for the targeted objective to be achieved. Once these investors have done their bit, and seen the capital value of their bonds in line with the increased probability of the bonds' early redemption, they may have no wish to speculate on the speed at which the remaining processes will be carried out. Other groups of active investors, who will have greater expertise in performing these later processes, must be given an incentive to use their expertise to accelerate attainment of the targeted objective. The possible capital appreciation of bonds bought from previous owners and sold at a still higher price [or redeemed] provides this incentive. The new owners will, if they are successful in these later stages, realise this capital appreciation.
Bonds therefore would, as from would-
Anther source of efficiency is that the market for Social Policy Bonds will generate extremely valuable information for policymakers. They will do so even as the bonds are issued: the price they fetch will be an important indicator of how remote the market believes is the targeted objective. Thereafter bond prices, and the way in which they change, will supply continuously updated information on which policy programmes and events are, in the market's view, likely to be most effective at achieving the targeted goal.
Government, while it may profit from appreciation of the bonds it purchases, will also be interested in the cost of its social policies. The Social Policy Bond principle is superior to existing budgetary mechanisms in that the cost of each scheme is not only inexorably linked to attainment of its objective, but its maximum cost can be decided in advance. The number of bonds is limited, and the most the scheme could cost the government would be the cost of redeeming the bonds very soon after they are issued (assuming a negligible issue price] plus all the administrative costs. Even then, though, the objective will have been achieved before any cost is incurred.
The efficiency of the bonds could be tested by allocating the same sums of money as are currently allocated for a particular social objective to the redemption of bonds targeting the same objective. The maximum cost to the government of the issue could then be set so as not to exceed the expenditure that would anyway have been incurred in pursuit of the same objective.
We should note too that Social Policy Bonds allow for the complexity of social problems. No single approach will solve them, so a wide variety of approaches to their solution is essential. Social Policy Bonds will encourage and reward the most efficient of these approaches. This occurs because of the nature of the bond mechanism, and requires no selection or supervision by government [or government agency] of the most efficient policy. Only the objective, not the policy, is dictated by government. This feature tends to stabilise the political environment. Obviously the objectives will have to be carefully defined, but there is near-
The main advantage of Social Policy Bonds is that they make the achievement of social objectives more efficient by injecting self-
The bonds guarantee stability of policy objectives. Policy instability is an important reason why people do not undertake projects or activities that could benefit society. Objectives with a necessarily long lead time -
The bonds make policy objectives more transparent. Apologists for current policies often point to benefits that can result only haphazardly -
A less obvious distributional benefit would arise from the existence of a means of acquiring wealth with which private gain is strongly correlated with public benefit. Many bondholders would be rich and, if their bonds were redeemed early, they would become richer. But this would be a socially acceptable way of acquiring wealth. And the existence of such a way of accumulating wealth would allow other, less socially beneficial ways to be taxed more heavily.
The biggest potential problem of Social Policy Bonds is probably the incentive they will give bondholders to achieve specified objectives at the expense of other societal goals. For instance, assume that the concentration of atmospheric lead is targeted in a bond issue. It might be that targeting lead in this way would cause people to increase their use of substitutes -
Another safeguard against legal, but negative activities undertaken in pursuit of a targeted objective, could be provisos on the bonds specifying indicators of social welfare which, while not explicitly targeted by the bond issue, must be satisfied for the bonds to be redeemed. Thus Social Policy Bonds targeting unemployment could embody provisos to the effect that the bonds would not be redeemed if the inflation rate exceeded a certain limit.
Illegal activities could, of course, be dealt with by existing laws, possibly backed by a system of bondholder registration, which would identify those with the biggest incentive to commit them.
The question of how well Social Policy Bonds would achieve societal goals needs to be considered alongside current policymaking methods. In today's environment policymakers can escape or deflect censure because the adverse results of their policies are difficult to relate to their cause. If the bonds were to lead to negative-
Of course, a Social Policy Bond regime would need some getting used to. There would need to be a transition period during which existing bodies, whose funding is largely unrelated to their effectiveness, would see a fall in their resources, matched by the possibility of increased funding from bondholders dependent on how effective and efficient they are.
Resources are always going to be limited and Social Policy Bonds will not change that. Priorities and choices will always have to be made: under a bond regime the choice of problems to be targeted, and the funds allocated to their solution, will all be limited. The difference is that the bonds would allow and encourage public participation in the forming of policy goals and their relative priority.
A Social Policy Bond regime would see government, in effect, contracting out the achievement of social goals to the private sector, though importantly government would still be articulating our social goals and could play an essential role in raising the revenue for their achievement. Even so, the surrendering of responsibilities to the private sector could be politically difficult, and must be a gradual process. But the potential benefits should not be ignored. Western governments' spending on education, health, the justice system, the environment and other items continues to grow, despite all efforts to restrain it. Even relatively small gains in efficiency in this spending could greatly benefit those who are most in need.
In economic theory, and on all the evidence, markets are the best way of allocating scarce resources to achieve prescribed ends. Social Policy Bonds allow governments, individually or collectively, to do what they are best at -
For more about the operational aspects of Social Policy Bonds, click on The book. For examples of how the Social Policy Bond concept can address health, education, environnmental and other concerns, click on Applications.