Thinking about the long term

A draft piece on why Social Policy Bonds could address long-term problems 

Because our governments and their paymasters in big business have no sense of a long-term future, catastrophes such as environmental collapse or nuclear conflict are going to become more likely unless we find ways of:

• Giving people a chance to decide on our long-term goals because, I suspect, most us have a longer-term outlook than government, 
• Targeting those goals, and
• Rewarding the people who achieve these goals most efficiently, whoever they are and however they do so.

Efficiency is important. In economic theory, and on all the evidence, markets are the best way of allocating society’s scarce resources to achieve targeted goals. Ideally, we’d inject market incentives into the achievement of our goals. That’s difficult to imagine in today’s policymaking environment, dominated by lawyers, big business, lobbyists and others with their own interests to pursue – including resistance to any change. So it’s important not to take today’s institutional structures, including that of government, as a given. Our goals should shape our institutions; not the reverse.

One possibility would be to contract out the achievement of our goals to a corporation. It would be paid only when our goal had been achieved. This could work for narrow, short-term goals, where the costs of achieving the goal can be estimated. But our most important goals are long term, and for these goals, a single body would, at best, require a huge premium over its expected cost of achieving the goal. More likely, since we are talking about goals that could take decades to achieve, any single entity would not take on such a huge commitment.

(It’s a fact that people working for charitable organisations do work to achieve these long-term goals. But such efforts, though admirable, are small in scale and, because there are few financial incentives, they are likely to remain so.)

If we are going to reward outcomes then, we need:

•         to reward people along the path to goal achievement, so that they can exit, with profits, before that point; and
•         to find ways of sharing the risks inherent in long-term commitments between different operators.

A single company?

One option would be to set up a company solely to achieve this outcome and to sell shares in it. The motivation would be provided by a large sum, kept in escrow, that would be paid out to the company once the goal has been achieved. The shares would rise and fall with progress toward or away from the targeted goal. A disadvantage of this is that there would be no link between those who would profit from progress toward goal achievement and those working towards goal achievement. Shareholders would be passive investors, and all decisions as to how to allocate funds for goal achievement would be made by the directors of the single company. Directors would be promised a share of the payout or would own shares. The problem is that the directors would be making all the decisions as to where to allocate funding for the various projects. With such a huge overall goal, they would not have sufficient oversight to keep up with progress on all those projects; nor to determine which are the most promising, and which it would be more efficient to terminate. Again, because of the necessarily large size of the company, it is unlikely that it would be subject to the market discipline through the possibility of takeover. On the plus side, the market prices of the shares, on flotation and beyond, would supply useful information as to how much progress is being made.

We need to motivate all who are working to achieve the goal all the time. One big company can't do this; so we need a way that doesn't require a large, overseeing organisation.

Social Policy Bonds

The problem remains: how to inject market incentives into the achievement of society’s long-term goals. I propose that we begin, again, with a large sum in escrow that would be paid out when the goal has been achieved. I propose that, shares in a company being sold, bonds be issued on the open market. Each bond would entitle the holder to a share of the payout once the goal has been achieved. The bonds would be tradeable at any time until redemption. Bondholders would benefit either by being passive investors, hoping for progress toward achievement of the goal, or they would be motivated to become, or to sell their bonds to, active investors, who would work to increase the probability of early achievement of the goal, and so benefit from a rise in the value of their bonds. Some sort of tacit or explicit co-ordination between bondholders and, possibly, aggregation of the bonds into a few hands, would lead to the creation of a new sort of organisation; one of protean structure with the sole aim of achieving the targeted goal quickly. Anybody or any entity, public- or private-sector could hold the bonds.

One potential disadvantage of the bonds is that there will be no necessary or direct link between the progress that each operator (body working to achieve the goal) makes toward goal achievement and the consequent rise in the value of its bonds. Indeed, it’s possible that despite the efforts of an operator, there may be movement away from achievement of the goal, so that the operator’s bonds fall in value. From the operator’s view, that would be unfortunate, but from society’s view it’s positive, in that the bigger the gap between the bond’s price and its redemption value, the greater the incentive for other investors to buy the bonds and work toward achieving the goal. It’s possible that at the lower levels of the subcontracting pyramid, operators would be paid for their time, rather than their performance. The risk of underperformance would be borne by those higher up the pyramid, who stand to gain most when the goal is achieved.

But what if nothing works, and the bonds stay at a low level despite the best efforts of investors? That could happen if events outside any bondholder’s control occur: a plausible scenario, if we target such goals as reducing the impact of natural disasters. The goal would remain unachieved; the funds would remain in escrow. Backers of the bonds could increase the motivation to achieve the goal either: by boosting the funds in the escrow account and increasing the redemption value of each bond in circulation correspondingly; or by boosting the funds in the escrow account but issuing more bonds with redemption terms identical to those currently in circulation.

Either would work, but the second option is better: if bondholders anticipated that there might be a swelling of the redemption funds, they might refrain from actively trying to achieve the goal, waiting instead for the larger payout.

It’s likely that operators with a good idea will be able to maximise their gains not only by buying bonds, but by buying futures or call options in the bonds; or by borrowing from bondholders to implement, or speed up the implementation, of their promising goal-achieving activities.  

Big bondholders would probably subcontract at least some of the work required to achieve the goal. They could do this in collusion (tacit or formal) with other large bondholders. Smaller operators could approach big bondholders with requests for funding; their rewards might be fully or partially conditional on a rising bond price. At all times, the market price of the bonds and movements in that price would provide information of great value to investors, would-be investors and policymakers.

Financial incentives aren’t everything. And people working to achieve goals might not be motivated by thoughts of personal gain, but many already working for charities or NGOs and who are already working hard to achieve social and environmental goals would be grateful for funds received from bondholders that they could use for other purposes than their own financial renumeration. A Social Policy Bond regime should boost the funding the most efficient of these organisations, which they could use to expand the scope of their activities by employing more people, for example, or expanding their scope.

There would be many benefits from such an approach. Apart from the efficiency gains that would result from allowing non-public-sector bodies to compete for the work, there'd be:

•   a long-term approach to policymaking, with much greater stability of policy goals,
•  more transparency about these goals,
•  more buy-in from ordinary citizens, and
• more widespread appreciation of the notion of trade-offs inherent in policymaking.

While government would relinquish some of its powers, especially over the funding of public-sector bodies, it would still have the responsibility of articulating society's wishes coherently, and in raising the revenue for their fulfilment. These are functions that our democratic governments can do well; they are not so good at efficient achievement of long-term societal outcomes. Under a bond regime, that would be done by market forces: in economic theory - and on all the evidence - the most efficient means of deploying society's scarce resources. Social Policy Bonds would represent a radical transformation from current policymaking systems; but it's one that is now practical, has huge advantages, and would close the gap between government and the people.