"Pay for success" is a hot new social impact financing tool, but does it work?

"Pay for success" is a hot new social impact financing tool, but does it work?

 The frenetic pace of social impact bond imeplementation is matched only by the Saigon rush hour <a href=http://www.flickr.com/photos/jonashansel/4548443949/">Flickr, Jonas Hansel</a>
The frenetic pace of social impact bond imeplementation is matched only by the Saigon rush hour Flickr, Jonas Hansel

Countries and investors are lining up to implement a new way to fund social services, but with few existing projects and scant evidence that it works.

The news that Goldman Sachs is investing double digit millions in a New York city jail is heating up questions about social impact bonds (SIB), a "social good" financial tool. Pay-for-success contracts, as they are sometimes known, allow governments to bid out social service projects and withhold payment until the project has been completed. Groups of investors raise capital to administer these projects and only receive payouts from the contracting agency if the project meets certain predetermined measurements of success. Obviously Goldman is expecting a serious return in dollars, and New York City is expecting a serious decrease in returning criminals.

In 2010, the first SIB was issued in Peterborough, England, for an anti-recidivism project. Since that time, the model has migrated to the U.S. (Massachussetts, Minnesota) where it will be used to address homelessness, unemployment, and juvenile involvement with the justice system. And this is only the beginning. With President Obama pushing the concept at a conference earlier this year and Goldman's flashy investment, many more local governments will be implementing projects in the near future.

Global predictions
SIBs are gaining ground in the international development community, too. Ideas abound from uses in public health, potable water, and even forest conservation. For now, one group is leading this charge. Instiglio, located at the Harvard Innovation Lab, plans to engage developing nations and advise them in developing SIB projects of their own. But don’t think the market will stay barren for long. A working group held between Social Finance Limited and the Center for Global Development in May of this year featured some of the industry’s heavy hitters (Gates Foundation, Citigroup, USAID, World Bank, DFID, OPIC, Rockefeller Foundation, among others) discussing the future of SIBs in international development. If these funders enter the marketplace, an explosion of SIB projects similar to that seen in America and Europe can be assured.

One thing seemingly missed in the rush to adopt the new model is the gaping hole where evidentiary support should be. The Peterborough project is only halfway complete, and even though preliminary results are being met with cautious optimism, going off of less than two years of data makes the international push to implementation seem a tad premature. There is a definite dearth of hard data on SIB projects, as none except Peterborough's have been in operation for more than a year. In addition, concerns exist over the influence of political pressure in determining rates for success: the temptation to cherrypick clients to achieve outcomes is worrisome, and there's a lack of comparable results to government service.

An Economist article points out that innovation itself is not a panacea and fiscal tools are are all relatively equal, one no more vile than another. Instead, human nature is to blame. “When bubbles froth, greedy folk use innovations inappropriately—to take on exposures that they should not, to manufacture risk rather than transfer it, to add complexity in order to plump up margins rather than solve problems.” If it took a decade to discover how credit swaps could be abused, what makes anyone think SIB’s might not contain similar flaws? Abuse is a serious concern when discussing commercial products that becomes frightening when considering the impacts it could have on the social service sector.

Social impact bonds certainly offer an enticing new financial tool to combat poverty, environmental issues and other social ills. But let’s not to get too carried away in the “pay for success” euphoria. If we aren’t careful, we may all end up paying the high price of failure.

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