Society needs more creative destruction

'Creative destruction' is the term coined by Joseph Schumpeter to denote a "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one." 

Creative destruction in the private sector essentially means that failing companies go out of business and successful ones survive and prosper. One of the reasons that social problems persist is that creative destruction rarely determines which policies shall be aimed at solving them. Largely for historic reasons, the solution of national and global social problems, including crime, pollution, terrorism and war, has been left to the public sector. That is, to bodies that face no competition and are seldom rewarded in ways that correlate with their success. Indeed, many failing institutions supposedly devoted to solving social problems are likely be penalised for success, by seeing their budgets cut or even their very survival threatened. At some level, for some employees, this perverse incentive is bound to operate, to the detriment of the people they are supposed to serve but to the continued survival of the inefficient institution.

Social Policy Bonds are intended to re-jig these incentives by injecting market incentives into the solution of social problems. A bond regime would direct funding to those approaches that bring about the most benefit, defined in terms of beneficial social impact per taxpayer dollar. Note the word 'approaches': it's the best policy initiatives that are rewarded, not the body that introduces them, which otherwise might well become more interested in self-perpetuation than in achieving targeted social goals.

The unfortunate trend is that, rather than social problems becoming more subject to creative destruction, the private sector is becoming less and less subject to it. The current Economist focuses on the US manifestation of this:

The excess cash generated domestically by American firms beyond their investment budgets is running at $800 billion a year, or 4% of GDP. The tax system encourages them to park foreign profits abroad. Abnormally high profits can worsen inequality if they are the result of persistently high prices or depressed wages. ... If steep earnings are not luring in new entrants, that may mean that firms are abusing monopoly positions, or using lobbying to stifle competition. The game may indeed be rigged. The problem with profits, 'the Economist, dated 26 March

Exactly, and it's not only the biggest firms that can abuse government for their own purposes. Farmers do it too, and have been for decades, though it is likely that most benefits that are in the public mind accrue to farmers do in fact go to the biggest landowners and agribusiness corporates.

I believe this trend is unsustainable. The capture of government by big business and its lobbyists, which has led so much inequality, is already provoking a reaction. Let's hope that this leads to a policy environment that will allow creative destruction to play a bigger role in both the public and private sectors. I write about the need for a new protean type of organization, whose composition and activities will be exclusively focused on achieving social goals, here. New technology, including the blockchain, might help bring these organizations into being.

Bypassing democracy

Jeff Madrick, reviews a book by Lee Drutman about lobbying in the US. Drutman  finds that business spends $34 on lobbying for every dollar spent by likely opponents such as labour unions and other interest groups. Drutman also briefly cites academic research showing that:

• The stocks of the firms that spent the most on lobbying as a percentage of their assets beat market averages substantially.
• The more firms lobby, the lower their tax rates. 
• Lobbying has a positive effect on a firm’s return on equity compared to the market as a whole. 
• Companies that lobby intensively are less likely to be detected for fraud than other companies. 
• Companies with politically connected board members have higher stock market returns than others. How the lobbyists win in Washington, Jeff Madrick, 'New York Review of Books', dated 7 April

Big business is the major beneficiary then, of a system that rewards lobbying. On one side we have corporations and their friends in government; on the other, small businesses and ordinary citizens. When policymaking is overly influenced by lobbyists, government is failing in its duty to articulate the wishes of society as a whole. Democracy is undermined and the response from ordinary people, who aren't consulted about issues that drastically affect their lives, could be dangerous indeed. We see portents of such danger in the western world today.

Social Policy Bonds could do much to close the ever-widening gap between lobbyist-influenced government and ordinary citizens. Under the current system policymakers can get away with favouring their lobbyist-paymasters because making policy has become an arcane, legalistic, protracted process to which ordinary people have no access. Discussion is centred around points of law, detailed regulation, and the structures and funding of various bodies. Only people paid to follow the process have the resources to do so. This means lobbyists. A Social Policy Bond regime, however, would focus on outcomes: policy would be expressed in terms that ordinary people can understand. Broad social and environmental goals would be targeted, and the people who help achieve these goals will be rewarded.

Under a bond regime, government would do what it is good at - indeed what only government can do: articulating society's goals and raising the revenue for their achievement. It would have more time and energy for these activities because, by contracting out the achievement of these goals to the private sector, it would spend less time trying to achieve them itself or working out ways to word legislation in ways that favour lobbyists and the corporates that employ them. Big business might lose out. But ordinary citizens would gain. So too would democracy.

Money isn't everything

In chats with friends about deploying Social Policy Bonds to counter religious or ideological extremism, I'm often told that the fanatics just won't respond to financial incentives so, the reasoning goes, a bond issue aimed at reducing conflict would be unlikely to succeed. I think the premise is correct: fanatics are motivated entirely by their beliefs. Money doesn't come into it. But I think the conclusion is false: financial incentives can work to eliminate conflict; fanatics are found in any bar, campus or on any street corner. Without backing, either direct or indirect, from others, they do not ascend into positions of influnce. The further one goes from the fanatical centre, the more one will find supporters of the extremists who are amenable to financial incentives. Social Policy Bonds can motivate these people to withdraw their support from the fanatics and, possibly, to channel their support into goals that are more congruent with those of society. A bond regime wouldn't change the beliefs of the extremists, but it would decouple them from positions of influnence. At its most simple level, a bond regime could act as a counterbalance to all the financial incentives that exist to create and continue conflict: those that motivate, at some level, arms manufacturers and brokers, and the interests of those who think they will gain if the conflict resolves in their favour. Money isn't everything, but Social Policy Bonds targeting conflict for reduction could channel the urge to acquire it into socially beneficial activities.

Blockchains and Social Policy Bonds

I've started learning about blockchains, a fairly new technology, and specifically the possibility that they can function as a platform for markets for Social Policy Bonds. This suggestion has been made by two of my correspondents in the past few days; it's a new idea, and my first thought is that it's an exciting one. The blockchain principle allows us to bypass government (or whoever issues the bonds) when it comes to monitoring progress toward goal achievement. It facilitates payments made to those who help achieve the objective; a role that I have thought might have to be played by a coalition of holders of large numbers of the bonds making decisions as to which projects are likely to be most efficient. This link is to a short article showing how the blockchain principle is being applied to searching for a cure for HIV. Though it talks about a Social Impact Bond, if I surmise correctly the tradeability of the bonds means that they are in fact Social Policy Bonds - perhaps the first ever to be issued.

Update 12 March: there is a discussion about implementing Social Policy Bonds in Ethereum here.

Economic growth and inequality

One of the less obvious advantages of a Social Policy Bond regime is that it insists on defining our goals; transparently and explicitly. And perhaps the least laudable feature of the current regime is that there are few explicit goals, and those that are stated have little to do with society's well-being. The goal that is usually invoked to justify some policy or other is economic growth, expressed most often as Gross Domestic Product per person. I've blogged about the flaws in the targeting of GDP before (here and here, for instance). It needs restating, though, that economic growth, however measured, does not inevitably benefit everybody. Most people in the US, for instance, feel this, but work by Professor John Komlos tries to quantify it. His main conclusion?

The major consistent findings are what in the colloquial is referred to as the “hollowing out” of the middle class as well as the tremendous increase in the income of the top 1%. The income of the latter relative to the 1st [poorest] quintile increased from a factor of 21 in 1979 to 51 in 2011. Growth of income and welfare in the U.S, (pdf) 1979-2011, John Komlos, Professor Emeritus, University of Munich

In a column, Professor Komlos shows that US census data shows that:

[T]he bottom 20 percent of U.S. households is underwater with an average net worth of -$32,000, that is, the debts of about 60 million people are greater than all their assets combined. If you combine the first and second quintiles of the wealth distribution, it’s apparent that 120 million people’s average net wealth is still below zero at minus $11,000. These facts about inequality can’t be whitewashed, 21 December 2015

The essential lesson from all this is one that bears repetition: economic growth is not an end in itself. In our increasingly complex world we cannot rely on trickle-down economics to achieve our social goals. More explicit targeting of broad social and environmental outcomes is necessary. Social Policy Bonds are one way of setting such targets and ensuring that they are achieved efficiently.