Why bother to buy Social Policy Bonds?

I am often asked why corporations or other agencies would bother to buy Social Policy Bonds. Those that are already trying to achieve social or environmental goals probably won't have much cash to spend on bonds and, unless they bought a great many, would hardly gain much by seeing the market value of their bonds rise.

I have two answers: first is that existing bodies could benefit substantially from holding Social Policy Bonds that target a remote objective (where the initial market price of the bonds would be very low). They could see the value of any bonds they buy multiply many times. But my main answer, which applies especially to larger projects, is that in the long run Social Policy Bonds would bring about new sorts of organisation: those dedicated financing the most efficient solutions to social and environmental problems. These organisations would, I think, end up owning large proportions of the bonds in circulation. They could subsidise the most cost-effective existing projects that are aimed at solving social problems; they could bribe socially destructive operations to reduce their activities; or they could help maximise returns from law enforcement. They could also finance research into the most promising new ways of achieving our social goals.

The profits of these bondholding organisations would be highly correlated with their success in solving social problems. Their profit-seeking would fit in exactly with the goals of wider society. Many bondholders, whether individuals or corporations, would be rich and, if their bonds were redeemed early, they would become richer. But this would be a socially beneficial way of acquiring wealth. What would be the implications of this? Two long-run possibilities:

It would enlarge the pool of talented people working to achieve social and environmental goals; and

As a way of accumulating wealth that is strictly correlated with wider public benefit, it could allow other, less socially beneficial ways, to be taxed more heavily.

Emissions are not climate change

From the Economist:

Emissions trading is also taking off. America led the way with its sulphur-dioxide trading scheme, and today the EU is pioneering carbon-dioxide trading with the (albeit still controversial) goal of slowing down climate change. ... Here, politics merely sets the goal. How that goal is achieved is up to the traders.

Not quite. The goal is to mitigate climate change, not cut back on anthropogenic carbon dioxide emissions.

For sulphur dioxide, there is probably a strong correlation between amounts emitted by those (relatively few) polluters whose emissions can be accurately monitored and its adverse effects on social welfare. But this is not the case with carbon dioxide. What will emissions trading in CO2 achieve? It might put a cap on anthropogenic emissions of carbon dioxide - those at least that can be reliably monitored. It may or may not bring about a significant reduction in total anthropogenic greenhouse gas emissions. It might even limit total greenhouse gas emissions. But it does not target beneficial changes in the composition of the atmosphere. And it does nothing to encouarge those who find ways of mitigating climate change other than reduce CO2 emissions.

It is in short an indirect and tenuous way of cutting back one possible driver of climate change. If imposed in a way that will have any effect on emissions at all, it will be expensive, divisive and almost certainly ineffectual if its real goal is actually to mitigate climate change.

Here's another idea: instead of targeting anthropogenic CO2 emissions, reward people who mitigate climate change however they do so. Better still, offer market incentives, so that people not only to do the right thing, but do it efficiently. In other words: issue Climate Stability Bonds.

Another day, another set of Mickey Mouse targets

More Mickey Mouse targets, this time from a typical day in the UK election campaign. The Tories are saying they want to open more children's hospitals, Labour promises shorter waiting lists for women seeing breast cancer specialists, and the Liberal Democrats say they'll spend more on police and community support officers.

This is more run-of-the-mill policymaking as if outcomes don't matter. The parties' Public Relations consultants identify an 'issue' of the day and the politicians think of some policy response. What is missing is the link between the policies they come up with and achievement of a meaningful outcome. What do political parties know about improving children's health outcomes, women's health outcomes, or reducing crime rates? Not much, but our policymakers are not known for their humility. Rather than relinquish their role in dictating how social goals shall be achieved, our politicos impose their own Mickey Mouse targets for peripheral pseudo-goals that may or may not be tenuously linked with what society actually wants to achieve.

But the world is too complex and fast-changing for that. We cannot assume that any single group of people knows the answers. Under a Social Policy Bond regime, the achievement of broad social and environmental goals would be contracted out to the most efficient operators. Bondholders would have powerful incentives to be efficient themselves, or to sell their bonds to more efficient investors. So if, for instance, a government were serious about reducing crime it wouldn't assume that more police or community support officers are the best solution. It would hand over responsibility to bondholders, who might decide that more could be achieved by subsidising employment in some areas, or installing effective alarms and cameras in others, or building youth clubs in still others. We need diverse, responsive, solutions run by people with incentives to perform. We do not need politicians' micro-management, Mickey Mouse pseudo-targets, chosen because of their high profile, or because they can staffed by government agencies, or subject to central control.

Ideology = Intellectual Bankruptcy

The New Zealand opposition National Party decries the increasing size of the state sector, saying it would conduct a thorough review of all state spending and "identify waste" if it returned to power. Fine, and it is true that after five years of Labour (to September 2004) total state sector staff numbers had grown by 33 630 to 278 831. In core government departments, staffing has risen from 30 702 to 38 270.

But the selection of 'cutting back the state sector' as a policy goal is, I believe, a symptom of intellectual bankruptcy. In this respect the New Zealand National Party is no worse than the New Zealand Labour Party or virtually any other political party in the world. Driven by ideology, they fail to target outcomes that are meaningful to the people they want to represent.

Cutting back on the numbers employed by the state is not valid as an end in itself. It might be a means to certain ends, but these ends should be explicit and transparent, and people should be given a chance to vote on them. The size of the state sector should be a result of decisions made about what social and environmental outcomes people want, not a matter of blind ideology. If political parties treated the electorate as adults, and gave us choices about meaningful outcomes, we might take politics more seriously and even participate in it. Perhaps that’s what they’re afraid of.

What happens when government tries to help

"Ask yourself," wrote John Fund of the Wall Street Journal a decade ago, "If you had a financial windfall and wanted to help the poor, would you even think about giving time or a check to the government?" My explanation for why the answer should be a resounding, unanimous "no" is that government is inefficient in helping the poor, even if that is its actual goal. And it is inefficient because it has no incentives to be efficient. Charities are far more efficient, but have to run on a shoestring because most of what we would spend on the poor is compulsorily taken away from us to be spent by government.

Government, by default is now taking charge of our physical environment. Given the mess it's made of our social environment, we know what to expect: good intentions, massive funding of government agencies, supplanting of environmental goals by insitutional goals, some corruption, more waste, and the crowding out of our own intrinsic motivation to do the right thing. If only government would issue Social Policy Bonds. Then it would concentrate on articulating society's wishes and raising the funds necessary to achieve them - things it does quite well. It would leave to markets the actual allocation of resources to achieve our goals - which government does very badly indeed.

Numbers and happiness

One of the points Richard Layard makes in his new book on happiness is that beyond certain levels of income and wealth, more money does not make us much happier. There are very significant policy implications. One is that most governments' de facto goal, faster economic growth as (badly) measured by GDP per capita, is even less useful than you might think. (For work on alternatives see, for instance, Redefining Progress.)

A Social Policy Bond regime would target explicit, quantifiable goals. Already this would improve on the current system, where goals are often unstated or sufficiently vague so that governments cannot be held accountable when they fail to achieve them. But Social Policy Bonds would target outcomes, and whoever issues them could make sure that their targets would be inextricably linked to increased social welfare. As Layard points out, at low levels of income and wealth, gains do translate into increased welfare, and it would therefore be worthwhile for governments (or other bodies) to target such gains. Far better to do that, than to target obsessively GDP per capita.

The problems with targeting economic growth to the exclusion of most other goals are becoming ever more obvious: a deteriorating environment; a fraying social fabric; the entrenchment of poverty; and health and education systems that seem perpetually to be in crisis. There is also the frightening prospect of violent political conflict; another area where significant financial incentives (to arms merchants and others) are available only to the creators of social problems, not to the would-be solvers.

Corporate goals and perverse subsidies

The corporate sector has very clear objectives, comprising mainly sales, profits, market share and growth. In achieving its objectives the corporate sector generates positive and negative externalities. If corporations were human beings, informal pressures would probably ensure that the positives outweighed the negatives, or at least we could appeal to their humanity when the negatives become outrageous. They aren't, so we try formal regulation instead. But what happens when the regulators - governments - don't have equally clear objectives?

One answer is that they can be easily corrupted by the corporations. So we get perverse subsidies, such as those to the energy or agriculture sectors, that are financially and environmentally disastrous, and subsidise the rich at the expense of the poor.

Perverse subsidies are essentially expensive ways of protecting sectoral investments and employment. They constitute sufficient evidence that governments mis-allocate significant resources. But they are only the most spectacular wastes of government funds, representing entire policies almost all of whose effects on society and the environment are negative. Other government failings are not always so obvious or quantifiable. Sometimes only certain elements of a programme are questionable, or only fractions of public funds may be misdirected or abused. Or government may be carrying out worthwhile activities inefficiently, so that their costs to the taxpayer are higher than necessary.

The result is that in many of the wealthiest societies that have ever existed in human history, there are significant pockets of deprivation, crime rates are high and rising, health services are plagued by too much demand and occasional scares, and public education seems always to be in crisis. Environmental problems are a growing cause for concern at all levels: local, national and global. Indeed the entire human population is now threatened by global environmental catastrophe and by the proliferation of weapons of mass destruction. These problems persist despite high levels of government spending and the less well-funded but laudable efforts of many non-governmental organisations.

Under a Social Policy Bond regime, governments would target social and environmental outcomes as single-mindedly as corporations target their own objectives. A Social Policy Bond regime would combine explicit, meaningful goals with the other essential element that defines corporations: financial incentives. Click here to go to the Social Policy Bonds website and find out more about how the bonds would work.