Harnessing private cash to finance public services via ‘Social Impact Bonds’ could be an important way to boost innovation in these services but is unlikely to appeal to mainstream investors because of the impossibly high risks they would have to shoulder, new research reveals today (Wednesday 31 July).
The Risky Business report, by think tank the Social Market Foundation, explores the scope for developing a significant market in ‘Social Impact Bonds’ – a type of payment-by-results in which investors are paid when the services they finance achieve outcomes specified by government. The research considers the economics of making Social Impact Bonds work, examining the hurdles that need to be overcome if they are to grow beyond the isolated examples that exist today to finance public services, such as the rehabilitation services at Peterborough prison.
Key findings include:
- The need for government to avoid paying for statistical flukes means that, before they will pay for observed results, commissioners demand much more substantial improvement in service outcomes than would be necessary in much larger scale projects. Setting such a high bar loads extra risk onto investors.
- A lack of information about, and control over, the different things that influence outcomes means that investors cannot be sure that the effect of their intervention is rewarded appropriately.
- Would-be pioneers of Social Impact Bonds face disproportionately high capital and transaction costs due to the small and undeveloped nature of the market.
- Few voluntary and community sector organisations have the capability to absorb and deploy large amounts of investment effectively.
The SMF concludes that, along with other interventions in the market, significant subsidy will still be needed from philanthropists or government if mainstream investors are to enter the market.
Commenting on the analysis, SMF Deputy Director Nigel Keohane said:
There is a yawning gulf between what commercial investors and public sector commissioners want to get out of Social Impact Bonds. They generally exist on a small scale but this makes it hard to isolate whether interventions have worked. Uncertainty raises the risks for government that it will pay for duff interventions; but also for investors, who fear they’ll not be paid for a job well done. Into this uncertainty one party has to be willing to take a leap of faith.
Unless the Government or philanthropists are ready to step make this leap of faith, the market is unlikely to be attractive to investors seeking market rates of return.
The SMF analysis highlights that Social Impact Bonds could nonetheless be important tools to drive innovation in public services. The research identifies the steps necessary to make Social Impact Bonds more feasible. These include: government facilitating better evaluation about what kinds of interventions work; commissioners being ready to subsidise interventions in some cases, by offering large enough rewards to attract the appropriate level of investment; and helping early adopters by standardising aspects of scheme design.
Notes to Editors
- The SMF develops innovative ideas across a broad range of economic and social policy, champions policy ideas which marry markets with social justice and takes a pro-market rather than free-market approach.
- Risky Business: Social Impact Bonds and public services was sponsored by the City Bridge Trust.
- The SMF takes complete responsibility for the views contained within the publication and these do not necessarily reflect the views of the sponsor.