Non-linear processes

In the fields of economics, ecology and social affairs, small differences in where you start can have a huge impact on where you end up. This is the path dependency that led to driving on the left hand side of the road (in the UK), or the near-universal use of the (supposedly) inefficient QWERTY keyboard. Since tiny causes can have large effects on complex systems then 'even knowing 99% of what you need to know leaves you vulnerable to large errors. And 100% knowledge is impossible.' (Source).

All this is one reason for considering Social Policy Bonds for, especially, those social and environmental goals that have many possible causes and are characterised by time lags and seeming intractability. The peaceful resolution of conflicts, for instance, or the promotion of biodiversity, or the avoidance of natural or man-made catastrophe.

As society becomes increasingly complex, you would think that policy instruments that reward positive outcomes but do not prejudge how to achieve them, such as Social Policy Bonds, might be considered more widely. I did try to interest the Santa Fe Institute in Social Policy Bonds. It conducts research into complexity. However, I didn't receive a response to my approach (made nearly two years ago).

Government by television

One of the main policy drivers, clear to all, but rarely acknowledged, is the urge not to look bad on television. Failure is acceptable, provided it doesn't take the form of tv footage.

A Social Policy Bond regime would be different. Objectives would be chosen in a calm, rational manner. Unlike under the current regime, they would be stable over time. Stable objectives would mean that rational allocation of resources would not be undermined by high-profile events. For instance, in the aftermath of a tragic rail disaster in London that resulted in the deaths of 40 people the UK Government came under considerable pressure to order the installation of an automatic braking system for trains that go through red signals. Cold calculations showed that this would cost around $21 million for each life that the system could be expected to save. This is around five times the figure that the UK Treasury used as its benchmark valuation of a human life, which means that if the government had succumbed to pressure to install the automatic braking system it would have diverted funds from more cost-effective life-saving projects, and so caused the loss of more lives than it would have saved.

A Social Policy Bond regime that had as its objective the maximising of the number of lives saved per government dollar would not waver in the face of spectacular one-off events.

How policy is made

When [Tony] Blair announced that 50 per cent of young people would be able to go to university, the first the civil servant in charge of higher education knew about it was when he heard it on the radio.... Things like that and the scheme to take drunken yobbos to cash points to pay on-the-spot fines were mainly dreamt up in the back of a car when Blair was on his way to a meeting or a TV studio. As quoted by Sue Cameron, 'Notebook', Financial Times, 1 July

What is particularly striking is how, at the highest level of national government, big decisions appear to be made on the basis of reactive, primal emotion. Rationality and the long-term interests of the people politicians are supposed to represent hardly figure at all.

…policies are often adopted on the basis of less careful analysis than their importance warrants, leaving wide room for mistakes and misperceptions. Forces of knowledge destruction are often stronger than those favoring knowledge creation. Hence states have an inherent tendency toward primitive thought, and the conduct of public affairs is often polluted by myth, misinformation, and flimsy analysis. Source (pdf)

This type of thinking is particularly dangerous when military conflict looms. An article about Henry Kissinger's role in US foreign policy quotes him saying to US President George W Bush’s speechwriter, about radical Islamic opponents: ‘We need to humiliate them’. Comments like this abound in high politics. George W Bush himself cried ‘bring ‘em on’ at an early point in the invasion of Iraq. These are not examples of high-level thinking.

One of the benefits of a Social Policy Bond regime would be the clarification of social goals, and the transparency of the process that targets them. Goals would have to be articulated before targeting. It's unlikely that random emotional outbursts would crystallise into policy in such a policymaking environment, however eminent the people who make them.

Transition to a Social Policy Bond regime

Asked about a migration path to a Social Policy Bond regime, I give the example of health. 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.

The important point is that a transition to an outcome-based, Social Policy Bond regime need not be disruptive. Nor need it necessarily mean the loss of funding to existing bodies, simply because they have been around for many years. But it would mean the beginning of the end for bodies that are inefficient and, in the eyes of bondholders, incapable of becoming efficient. The winners would be society as a whole, and taxpayers in particular.

Process and image versus outcomes

Frank Furedi writes:

This is probably the most disturbing revelation to come out of the Washington hearings: that oil companies now devote far greater time and energy to managing how they appear in the eyes of the public than they do developing an effective emergency-response plan. So we learned that ExxonMobil’s emergency-response plan has 40 pages on dealing with the media but only nine on dealing with an oil spill. The plan seems more preoccupied with the science of drafting press releases than with the science of taking practical steps in an emergency. Why BP is not very slick in an emergency, Frank Furedi, 21 June

We do need clarity about means and ends. One of the virtues of a Social Policy Bond regime is that it would inextricably bind policymakers to focus on ends rather than procedure. If the goal, for instance, is to avoid environmental catastrophe, then Social Policy Bonds can be issued that will target the sustained absence of environmental catastrophe. Investors in the bonds would have powerful incentives to ensure that resources went into avoiding catastrophe, rather than ticking boxes or shaping a company's image. Government could spend less time trying (unsuccessfully) to regulate against every conceivable adverse event, and more time focusing on the broad social and environmental outcomes that society wants to see. Incentives, in short, would be channelled into society's goal, rather than that of corporations or government agencies.

Social Policy Bonds: free riding and perverse incentives

The Social Policy Bond principle really needs to be tried, discussed and refined before large-scale implementation. At a recent discussion with a London think-tank, I was asked a couple of questions about free-riding and perverse incentives.

I have in fact written about the possibility of some purchasers of Social Policy Bonds wanting to free ride on the activities of those bondholders who will work to achieve a targeted goal. In chapter 4 of my book, I examine the issue and come to the conclusion that it probably wouldn't do much to undermine the bond mechanism. other purchasers. But, what about a variant in which people would buy a large proportion of the bonds very cheaply and sit on them with the intention of selling them for a higher price to people who are prepared to achieve the goal. This would be counter-productive to the extent that it would deter the would-be goal-achievers from actually working to achieve the goal. How could the issuers prevent this sort of free-riding? They could ensure that the initial price of bonds is not negligible. The choice of objective, the number of bonds issued, and their redemption value could all be chosen with a view to seeing that a bond redeemable for £100, say, could be expected to sell for anywhere between, say, £30 and £90.

• They could give the bonds an expiry date, so that if there were no significant progress toward the objective being achieved, or if the market value of the bonds showed no significant increase, the bonds would become invalid.

• The issuers could retain the power to declare a particular bond issue invalid, either at their discretion or, better, if certain objective criteria, such as each bond’s market price, were not fulfilled.
  

Another question posed was: could people buy the bonds, and do nothing to achieve the targeted goal in the expectation that the issuers are so keen to see the goal achieved that they then will issue more bonds and so boost the value of all the issued bonds, including their passive holding? The possibility of a supplementary bond issue would then have the effect of reducing the motivation of would-be target-achievers to take action. If this were thought to be a significant deterrent to achieving the targeted goal, again, the issuers could:

• Build in an expiry date to the bond issue, and issue a completely new set of bonds targeting the same goal, so that holders of the first bond issue would lose their investment.

• Retain and, if necessary, exercise the power to declare the first bond issue invalid.
  

For large-scale issues of Social Policy Bonds then, the conclusion is that issuers should retain the right to declare bond issues invalid if bondholders don't comply with the spirit, as well as the letter, of the bonds' redemption terms.

Expanding the corporatist state

From a comment (subscription, I think) to the Economist:

All right, Obama is not a socialist: he is a corporatist. Is that better? He would yoke government and big business together, pulling towards objectives defined by the great and good.

I'd disagree to the extent that I think the great and good can sensibly define objectives: it's when the ways of achieving them are centrally planned that things go awry. As the commenter recognises. He goes on:

This ignores the fact that it was this collusion that primarily got us into this mess in the first place. For example: government mandates that poorer people get houses. The mortgage industry, which is backstopped by a government controlled (and now owned) "company," tries to devise ways to do this without losing its shirt. These new techniques seem to work so well that they generate a huge bubble. The bubble bursts. And what happens then? The government intrudes even further into the home mortgage industry.

Again, the problem is government prescribing how things shall be done, rather than prescribing what shall be achieved.

"Too big to fail" is a symptom of the corporatist disease; so are "national champions," propped up by the state, to the detriment of innovation and competition. And instead of unwinding the relationship between big business and government, we're entwining them yet more. This marginalizes small businesses, which is where most of the innovation and job creation takes place. How can a small business make any plans, or hire any workers, when every day seems to bring down a new government mandate that favors large corporations? The law is ignored (as during the Chrysler bankruptcy, when bondholders were slighted in favor of unionized workers) to bring about a politically favored result. Only large companies, with corresponding muscle, can play on this politicized field.

Exactly so. Government and big business on one side, versus ordinary people and small enterprises on the other.

Communism, socialism, fascism, corporatism: all branches of the same tree, and all based on the premise that a chosen elite must guide the average person, who will otherwise screw it up. The perversion of the Enlightenment and the long march back to serfdom continues.

I don't know about serfdom, but I do foresee a crisis. Government - and big organizations generally - are, it seems, instinctively against the 'creative destruction' of capitalism, which has done so much to lift people out of poverty. The largest corporations work more by manipulating government and trying to subvert markets. Government and big business collectively have become too big. Not 'too big to fail', but too big to ensure that, when they do fail, society can recover without crises and extremely painful transitions. Corporatism has created a policy monoculture, with all the fragility and potential for disastrous consequences that that implies.

Smoking and health

Anna Gilmore of the University of Bath and her colleagues looked at how many people were admitted to hospital with a heart attack in England between 2002 and 2008. About 110,000 people are struck down each year.... Ms Gilmore and her team found that, in the 12 months after the smoking ban came into force, some 1,200 fewer people were admitted to hospital with heart attacks than even the prevailing downward trend had suggested was likely. That drop of 2.4% saved £8.4m in emergency hospital care. Breathe Easy, 'The Economist' (subscription), 10 June

There are several problems with drawing any policy conclusions from this. The most important is: what happened to physical well-being as a whole? Heart attacks might have fallen (though not by very much), but did other forms of morbidity rise? For instance (as pointed out by one of the commenters):

The prevalence of allergic asthma and allergic rhino-conjunctivitis decreased, in a dose-response manner (P = 0.03 and P = 0.004, respectively), with increasing exposure to tobacco smoke in the adult study population. ... This study demonstrates an association between current exposure to tobacco smoke and a low risk for atopic disorders in smokers themselves and a similar tendency in their children. Does tobacco smoke prevent atopic disorders? A study of two generations of Swedish residents. Hjern A, Hedberg A, Haglund B, Rosén M., 'Clinical and experimental allergy: journal of the British Society for Allergy and Clinical Immunology', June 2001

The other important qualification is that the reduction in heart attacks might have causes completely unrelated to bans on smoking: one correspondent suggests the withdrawal of hydrogenated fats from supermarket shelves.

More generally, results like this point to the need for broad indicators, not only of health, but of education, poverty, and well-being generally, including environmental well-being. Unfortunately, we are not geared up to using broad indicators for policy purposes. Or the broad indicators that do have de facto status as targets, such as Gross Domestic Product (or GDP per capita), are seriously flawed in that they bear no necessary relationship to well-being. Other indicators tend to be dictated by governmental structures, rather than the other round: policy is subordinated to the perceived need to keep public sector agencies happy, rather than to the well-being of ordinary people. (If this sounds far fetched, take a look at my piece on the New Zealand public sector reforms of the 1980s in my book.)

Social Policy Bonds would allow and encourage governments - and others - to target broad indicators of well-being; including those with a very long lead time. A new type of organization would result: one whose existence, structure and activities are totally subordinated to societal goals, rather than to current vested interests. If it comes to a choice between (say) a small number of heart attacks versus a higher incidence of asthma, then such choices, under a bond regime, would be made transparently and according to transparent criteria.

Externalities

Externalities are impacts from economic activity that don't enter the market. They can be negative or positive. The negatives attract a lot of attention, especially if they are visible. George Monbiot writes eloquently of the environmental costs of the oil pollution in the Gulf of Mexico. Less obvious are the social impacts, positive and negative, of business. The Gulf of Mexico pollution is truly appalling. But not all its non-market costs result in additional profits to BP. Some of it takes the form of lower oil costs. Through those, most of us benefit and so are complicit. Ideally, externalities would be internalised: costs of products would embody the social and environmental impacts of their production; and not just the visible impacts. But that's just too complex an exercise.

Social Policy Bonds might help in dealing with the most catastrophic of the negative externalities arising from our way of life. They could target the largest, most obvious potential disasters, and reward people for making sure such disasters do not occur. Because they do not prejudge how a negative externality shall be eliminated, they would reward the most efficient ways of avoiding disaster. And only the desired outcome, rather than the exact nature of the disaster, need be specified. The health of plants, animals and humans could all be targeted: investors in the bonds would have incentives to mitigate any sort of threat. Click on the link to read more about Disaster Prevention Bonds.

Preventing disasters

The vast majority of spending on social and environmental programmes is carried out by bodies whose success is barely linked to the welfare of those who are their intended beneficiaries. These bodies, for the most part, are government agencies, or non-governmental organizations. The motivations of individual employees can scarcely be questioned. My own experience of working in the public sector tells me that they are usually well intentioned and hard working. But they work for an institution within which the over-arching goal is self-perpetuation, and that goal often conflcits with the ostensible aim of the organization. The bigger the organization, the more remote it is from both the people it employs and the people it is supposed to serve. About half of the funds allocated to humanitarian relief and development aid organizations stays with these bodies. Corporations are little different from government. Big private sector companies spend much of the time and energy trying to manipulate government and stifle competition. Unfortunately, the trend is toward more bigness.

Social Policy Bonds could be one way of realigning the goals of organizations with those of ordinary people. Under a bond regime, it would be unimportant whether problem-solving organizations were public or private sector. The structure and activities of the organization would be entirely subordinated to the goals targeted by Social Policy Bonds. The organization's funding - its very existence - would be dictated by the well-being of society, as expressed in the social and environmental outcomes targeted by the bonds. New types of organization could come into being, motivated by the cascading incentives that the bonds would generate.

All this would be a radical change from the current system. But a gradual transition is possible: one that would reward and encouarge those who, even under the current system, are efficient in converting taxpayer dollars into meaningful outcomes. I go into some detail as to how a transition to a Social Policy Bond regime can occur in my book, which can now be downloaded freely - see here.