Not so outlandish

I'm aware that Social Policy Bonds can seem outlandish - at least at first reading. They imply the outsourcing of the achievement of our social goals to anybody, public- or private-sector, with no directive as to how they shall achieve our goals, except that they comply with legislation. That said, many social and environmental problems have resisted all attempts at solution. You are immediately dismissed as an idealist for suggesting, for instance, that war can be abolished, or that poverty or crime can be drastically reduced. In response, I might say Could a Social Policy Bond regime do worse than our current efforts? It's true that a bond regime could be completely ineffectual: people could simply refuse to buy the bonds on flotation, or they could buy them, then do nothing to help solve the targeted problem. If nobody buys the bonds, then that tells the issuers that they have allocated insufficient funds for redemption. If bondholders do nothing, then the value of their bonds would fall until either they have a powerful incentive to do something, or to sell their bonds to people who would do something. In all such cases, however, there would be no cost to taxpayers, even if the bonds had been issued by government, unless the targeted social problem is solved.

As important is that Social Policy Bonds can be issued in parallel with existing efforts to solve social problems. Bondholders could undertake their own initiatives, but would also have incentives to look at current approaches and boost the finances of the more promising ones.

Below is an excerpt from my book showing how this transition could work when addressing UK health problems. The excerpt is from Chapter 4. That chapter, and the complete book can be downloaded free of charge from here. Simpler, shorter explanations of the Social Policy Bond concept can be found via my homepage.

"Take health, for example. In the UK, central government provides funding for regional health authorities (for spending on doctors, hospitals and prescriptions) according mainly to population level, age and need. Government also supplies funds directly to medical research organizations and academic institutions. A transition to a Social Policy Bond-based, rather than institution- or activity- based, funding programme would see the direct funding government gradually decline, while expenditure allocated by bondholders to the outcomes that all these institutions are collectively trying to achieve — longer life spans and a better quality of life, say — would gradually rise.
On introducing such a bond regime a government could decide to reduce its funding of health authorities and research institutes by 1 percent a year, in real terms. (The government could allocate the saved funding to the future redemption of the health bonds it has issued.) So after five years, each health authority would be receiving directly from central government only 95 percent of the funding that it formerly received. But bondholders could choose to supplement the income of some of these health bodies. They may judge a particular group of health authorities to be especially effective at converting the funds they receive into measurable health benefits, as defined by their bonds’ redemption terms. Particularly effective health authorities might be working in deprived areas, where small outlays typically bring about larger improvements in health. Or bondholders might judge a particular research body to be
worthy of additional funding, because it was conducting excellent research into a condition that would be likely to respond especially effectively, in terms of health outcomes, to additional expenditure. In such cases, bondholders would supplement their selected health authorities’ or research institutes’ funding. It may well be that these favoured bodies end up receiving a large boost in income throughout the lifetime of a bond regime.

It could also happen that investors in bonds targeting health look at completely new ways of achieving health objectives; ways that currently receive no, or very little, funding. To give a plausible example, they may be convinced that one of the best ways of achieving society’s longevity objectives is to deter teenage drinkers from driving. Following this logic, they may find that one of the most efficient ways of doing so would be to lay on subsidised taxis for teenagers attending parties on Friday and Saturday nights – but only in certain parts of the country. It is difficult to imagine how our current centralised government fund allocation mechanisms could go about implementing such a programme. A Social Policy Bond regime would quickly eliminate some of the less rational distortions in other health care matters, amongst them the British National Health Service’s terminal-care budget, 95 percent of which was allocated to the 25 percent of the UK’s population who die from cancer, and just 5
percent to the 75 percent who die from all other causes. 

It is also likely that holders of bonds targeting health outcomes would greatly expand funding in areas such as health education or preventive medicine that rely on expertise outside those bodies traditionally devoted to health care. 

Could bonds targeting remote objectives, such as a large rise in longevity, or a halving of the crime rate, be compatible with a gradual transition of the type described above, where funding to existing health institutions reduces by 1 percent annually? At first sight there would seem to be an apparent mismatch between such incremental reductions in government spending and the time scale needed to reach long-range objectives. The critical point here is that bondholders would be investing not on the basis of the annual reductions in government expenditure on existing health institutions, but on the basis of the redemption value of all the bonds issued. To be more precise, it would be this total redemption value, minus the bonds’ existing market value, that would inform bondholders’ investment decisions. This sum could be many times each year’s incremental reduction in government’s institution-based spending. One of the virtues of a Social Policy Bond regime is that bondholders could expect capital gains in the short run from investments that will begin to impact on the targeted goal only in the long run. By doing the initial groundwork efficiently and speedily – not usually a very lucrative proposition in the current regime – they could see short term rises in the bond price
and early capital appreciation. The accumulated reductions in spending to existing institutions would be one, but not the only, factor influencing how much government decides to spend on achieving a specified social goal. Also important would be the financial savings (if any) that achieving the objective would bring about, and the value society would place on any nonfinancial benefits. Similarly gradual transitions would be warranted in other areas, such as education and crime, where schools and police forces, some of which are bound to be much more effective than others, are well entrenched. These institutions would receive slowly diminishing absolute levels of funding directly from government, while bondholders would again focus their spending on especially rewarding, in terms of specified education and crime outcomes, projects and institutions. As with health, it is likely that those areas that are initially most disadvantaged would again provide bondholders with the greatest return per unit outlay. In newer policy areas, particularly the environment, it may be possible to expand spending allocated via the bonds at a faster rate: expertise in the environment is still relatively mobile, and it would be easier to quickly establish new outcome-based institutions or to reorientate existing ones."