Doug Smith: Social Impact Bonds – Wrong Result, Wrong Way (Part 2)

By Douglas K. Smith, Member, Board of Directors, SeaChange Capital Partners

This is the second part of a two-part post on social impact bonds. Please see Part 1 for a description of how they work as well as the benefits ascribed to them by supporters such as New York Times writer David Leonhardt and Harvard Professor Jeffrey Liebman.

Liebman, Leonhardt and others need to move beyond sloganeering to learn how to increase the odds that various market disciplines can combine with organizational, network and personal disciplines to promote effective performance instead of cancerous performance. Their all-too glossy, air brushed pin up pictures of ‘market discipline’ jeopardize instead of advance the odds of success for social impact bonds. The conventional wisdom spouted in their writings actually increase the odds of ‘wrong result/wrong way’ for social impact bonds.

For example, Liebman expresses concern that non-profits benefiting from social impact bond investment might unduly manipulate promised performance results by cleverly figuring out how to pick and choose among the people they are trying to help. Yes, it’s fair to worry about whether and how organizations might manipulate markets (again, though, let’s please note how regulatory and cognitive capture combined with ‘market discipline’ and ‘performance’ in the financial sector over the past decade. Now that’s world-class manipulation!)

But, it’s worrisome that an expert like Liebman doesn’t appear to grasp that the same ‘market discipline’ he’s praising includes the disciplines of customer and market segmentation. Private sector organizations pick and choose the customers they wish to serve versus those they won’t. Tiffany’s and Zales quite intentionally do not serve the same customers. And these choices are key to success as competitors subject to ‘market discipline’. Why, then, would we construct social impact bonds to prevent social service agencies from practicing this same market discipline of segmentation?

Liebman, though, worries about social service groups ‘creaming’ the easiest-to-serve customers. But this means his notion of ‘market discipline’ carries castor oil and spinach demands for social service groups that are not required of private sector players. Yes, if we are serious about doing our best to solve serious social problems, then we should embrace the ethical obligation to respond to the full spectrum of customers and beneficiaries. And, if there are government resources involved, then at least in the US there are (or at least used to be) legal requirements to seek ways of benefiting all and not just some. But no ‘market discipline’ of which I’m aware demands that the all competitors serve all segments all the time.

Liebman goes on to celebrate how ‘market discipline’ will permit private sector investors to choose social service agencies without any government interference. Well, not so fast. Most ‘market disciplines’ involving collaboration recognize the reality that players who collaborate inevitably have a say in choices about with whom they will collaborate. Even private equity investors in, say, car rental companies lack total control over the joint venture partners and suppliers of those companies. They might recommend to management that they collaborate with, say, some chain of body shops. But, if the body shops don’t want the business, then the investor’s choice is stymied.

Similarly, the social service agencies working to reduce recidivism in the UK prison are likely to need the active collaboration of government employees and managers of that prison. It is predictable, then, that the prison folks will get involved – whether before or after the fact – with choices about the agencies. Yes, the private investors can propose such groups to the prisons; but the prison folks will have a say. This is just common sense – and, by the way, critical to success because the real commitment of prison employees to work closely with the social service agencies is needed to meet the 10% goal. So, one would actually want them to have a say in this matter. But, it’s a sad corollary of the ‘markets good/governments bad’ ideology that this ‘say’ by the prisons is considered interference while the parallel phenomenon in the private sector is not so much meddling as yet another Panglossian paean to the best of all possible worlds of ‘market discipline’.

Liebman’s monochramtic use of ‘market discipline’ threatens the wrong result/wrong way outcome because it denies non-profit and governmental organizations the use of strategies open to private sector competitors. It’s as if Liebman wishes the non-profit and governmental groups to run the race with one arm tied behind the back.

But it doesn’t end there because Liebman goes on to define winning the race – performance itself – in ways that would astonish any private sector company in any market. He (with Leonhardt’s applause) points to studies of government programs, studies that demonstrate the failure of programs to demonstrate results according to what is called the ‘scientific gold standard of randomly assigning individuals to a program or control group’ followed by finding ‘rigorous evidence’ that the programs work. Link:

This is no longer about ‘market discipline’. It’s about a different standard of performance being demanded of non-profit and governmental organizations versus private sector companies.

Before the social scientists scream, please note: I’m neither saying that random assignments of individuals to program versus control nor social scientific evaluations grounded in correlation and causality are useless. They’re very useful. We learn from them. And the Brookings study referenced by Liebman and Leonhardt is excellent.

No, what I’m saying is that neither private sector companies nor markets impose this standard of performance – especially against market challenges involving the level of complexity related to reducing recidivism or the other sorts of challenges Liebman correctly notes could benefit from social impact bonds: kindergarten readiness, employment services for hard-to-employ groups, health and disability interventions, and college retention services.

Consider kindergarten readiness. Years of working with CAP Tulsa, one of the nation’s best non-profits at providing early childhood education to low and very low income people, have taught me just how many factors influence a child’s readiness (health of the mother, socio-economic stability of parents, characteristics of neighborhood, use or not of day care and/or early childhood setting, quality of that organization and more) – not to mention an even broader array of factors that influence what happens to a ‘ready kindergartener’ from the moment of entering school to, say, graduation (or not) from high school (readiness of public school teachers and principals to take the ‘hand off’ of the child in the best way and myriad educational, family, neighborhood, social, legal, medical, spiritual and other factors from then on.)

CAP Tulsa has thoroughly embraced a range of performance disciplines and its clear that many more children and families are better off for it. But, I seriously doubt that CAP Tulsa could fully satisfy the social scientific levels of proof suggested by Liebman and Leonhardt’s writings.

In the private sector, neither investors nor executives nor employees nor customers would hold companies to social scientifically provable linkages between their efforts and their claims. Yet, that’s what happens routinely when it comes to ‘performance’ and the social sector. People are just not appliances. And the toughest socio-economic challenges are ones where people, all the messy realities that affect people, influence the outcomes – whether performance happens at all let alone whether it is sustained over time. The UK social impact bond aimed at reducing recidivism, then, is wise to measure performance by recidivism itself over some limited time frame – not by whether the prisoners ever return to prison over the course of their whole lives – and also not by whether those who avoid returning to prison are fully, effective functioning human beings in society.

There is one last element about social impact bonds that ought to make us at least a bit nervous.

Again, I’m for trying them. Still, viewed cynically, these bonds become yet one more way for financiers to strip-mine future cash flows from government. Liebman notes that the success rate is likely to be spotty – and, consequently, quite high rates of return may be needed to attract capital, which means lots of future cash flows from governmental efforts will be used to repay financiers instead of being reinvested in more effective and efficient government. Again, fair enough if and to the extent this form of capital is well tailored to fill a need not addressable by other approaches.

But, one needs to at least wonder why governments faced with the prospect of real and attractive returns on investment through scaling up solutions that work would turn to the private financial sector for the money instead of using taxes, budgeting and other means? One answer could be: having endured more than thirty years of demonization as ‘bad’ – in part because it lacks the ‘market discipline’ that is ‘good’ – government reaches a point where political and cultural ‘norms’ deny it access to capital from any source other than the private sector. The beauty of this, of course, is that if social impact bonds work, free market fundamentalists can and will sing the song “I told you so”. But, as they sing, we’ll have forfeited yet one more way that the legitimate functions of government to privatization in ways that end up serving investors more than people. If this were to happen, then social impact bonds would be much more of a trick than a treat.

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  1. Paul Tioxon

    The reason a nation state is sovereign, in practice, not some middleclass notion from English philsophers, is based on the strength of its bureaucracy to collect taxes and reserving the power to tax. A strong nation, like the US, has an IRS with a relatively high collection rate of about eighty per cent. Its ability to tax and spend is in the nature of its form and function which allows it pay a military to defend itself, build infrastructure like postal roads and a postal system to facilitate communication and canals, railroads and airports, to tie itself together as a people, trading in commerce with one another and traveling to places of opportunity, and back.

    The nation-state should be more like a business model, attacks the very structural integrity of government. If it does not have the power to tax, especially during an emergency, has it suffered an irreversible demise as a political entity. The US and the states are devolving into the status of a joint stock corporation, that can be dissolved due to insolvency. That is not the hallmark of a political entity with absolute control over itself, but a conquered, colonized and subjugated people, with no domestic government, but administrators deciding their fate, with no say in what goes on. The “we can’t raise taxes because it is political suicide” for the republicans and “we can’t raise taxes because then we are called politicians who raise money and then spend it on the public” makes us lose as democrats, leaves us with discussions about state bankruptcy, and republicans talking about the federal government as if the economy of sitting around the kitchen table is all that American people could possibly understand.

    A nation that can not collect taxes, from the obvious sources, the untold trillions of dollars, sitting on the sidelines of corporate America, the money stashed in tax havens by tax exiles, the money stashed in various hedge funds, exported out of the country, is obviously not a nation state. The answer is simple, tax the wealth producing source, the corporations whose sole purpose is to endlessly accumulate capital. They have piled so much money up all in one nice neat place, easily distinguished by Forbes and FOrtune annual lists, that the job is not a mystery. Invest in the economy or be taxed. And tax anyway,tax some more until the economy is brought back to some measure of relief. As if Bill Gates and the Koch brothers will be diminished in their humanity if they are reduced to personal fortunes of only five hundred million a piece. At least we will still have a country.

    Lincoln had to face the same category of arguments, he addresses them in his first inaugural speech.

    “I hold that in contemplation of universal law and of the Constitution the Union of these States is perpetual. Perpetuity is implied, if not expressed, in the fundamental law of all national governments. It is safe to assert that no government proper ever had a provision in its organic law for its own termination. Continue to execute all the express provisions of our National Constitution, and the Union will endure forever, it being impossible to destroy it except by some action not provided for in the instrument itself.

    Again: If the United States be not a government proper, but an association of States in the nature of contract merely, can it, as a contract, be peaceably unmade by less than all the parties who made it? One party to a contract may violate it-break it, so to speak-but does it not require all to lawfully rescind it?

    Descending from these general principles, we find the proposition that in legal contemplation the Union is perpetual confirmed by the history of the Union itself. The Union is much older than the Constitution. It was formed, in fact, by the Articles of Association in 1774. It was matured and continued by the Declaration of Independence in 1776. It was further matured, and the faith of all the then thirteen States expressly plighted and engaged that it should be perpetual, by the Articles of Confederation in 1778. And finally, in 1787, one of the declared objects for ordaining and establishing the Constitution was “to form a more perfect Union.”

    But if destruction of the Union by one or by a part only of the States be lawfully possible, the Union is less perfect than before the Constitution, having lost the vital element of perpetuity.

    It follows from these views that no State upon its own mere motion can lawfully get out of the Union; that resolves and ordinances to that effect are legally void, and that acts of violence within any State or States against the authority of the United States are insurrectionary or revolutionary, according to circumstances.”

    An attack on taxation of the wealthy, and its absolute lack of consideration is an abdication of state power in the face of private interests, manipulation of the wealthy and their paid agents, to the point of dissolution of the our governments, national, state and local. Look at the police and teachers going on the unemployment lines, look at the attack on pensions and medical care for retirees. All, because the politicians will not use the power to tax. The government is under the grip of forces that used to be left on the other side of the Rubicon, but have crossed over here to remake America like they made so many other other nations. Through the trade craft of assassination, propaganda de-legitimization initiatives, cooption and terror, our country is a battle ground of cold war era techniques employed against ourselves by factions within. As government shrinks, private, tightly and closely held circles of power shrink as well, with cartel formation holding sway in the financial sector after years of fragmentation. It mimics the scale and power of military industrial cartels. The trip wire is Social Security, if it is brought down, then there is absolutely no will on the part of the people to defend their interests, because it is in the the cash money interest of well over half of America
    to preserve what is the only retirement money they have that will keep them from starving to death.

  2. Eleanor

    Here in Minnesota, many, many social services are already provided by nonprofits, which contract with the government and rely on foundations and donors for additional funds.

    I can’t see the point of new “market discipline” for these organizations. Nonprofits have to compete for funding now. Grant applications set goals, and grant reports have to explain how these goals were met. Both applications and reports contain budgets. Funders always want to know how the money will be/was spent.

    If the funders — government, private foundations, donors — don’t like the way their money has been used, the funding ends. Competition for grant money is often brutal, and nonprofits go out of existance if they are not able to compete successfully.

    Are there problems with this system? Yes. But it works pretty well, all in all; and it is goal and money oriented and highly competitive. What else do the market lovers want?

    1. Birch

      I think the market lovers are looking for more ways to speculate and skim money off the top – to get a cut for doing nothing. Any money that goes to them is quite simply money that won’t go to the cause it’s intended for. They always look for anywhere they could slip in another middle man.

      Tons of people invest in non-profit organizations, that’s what keeps them going. They get tax receipts as an incentive, their dividend is the resulting improvement in their community. If they want more than that, they should buy derivatives or go to the horse races.

  3. Joe Rebholz

    These social development bonds are an unnecessarily convoluted mess. Here is a simpler direct free market solution. Pay ex prisoners to behave. Pay them to work at some job. Pay them to educate themselves. Pay the parants of chilkdren to send them to school. Pay them acording to the grades the children get. As the children get older pay them an increasing proportion. Etc. Let governmenbts pay individuals to behave in ways that are beneficial to the individuals and society. Society gets paid back through income taxes and all the beneficial behavior by the paid individuals. Very simple. No copnvoluted financing needed.

  4. Jerry

    I live in Wisconsin where the costs of our prison system is outrageous. My solution for all those inmates that have life sentences without a chance of release….lets contract with Mexico for their care…If corporations can use low labor rates from other countries, why can’t our states….we may need to provide transport for family visits 1-2 times per month, but that would be far more managable.
    Second, when are blogs going to start addressing the cost of health care…i.e. I just picked up some ear drops (1/2 oz) cost $199.00….something is wrong here….my son has a problem with his ears, one pressure wash by Nurse’s aid which took 5 minutes cost $180.000 something is wrong here!!

  5. Ray L Phenicie

    I would again present the idea of a rule of law and how that is central to this discussion as the comments @ Paul Tioxon show; in addition from part I of this post:

    —– Liebman notes that too many government programs have disciplines that focus more on defining activities than results. But it does not follow logically or empirically that ‘market discipline’ is the only cure when such an activity-focus has ill effects. (I say “when” because, while there are ill effects to address, Liebman’s ‘either/or-ism’ ignores the good effects of an activity-focus in governmental contexts; namely, the means and ends demanded by notions of fairness and due process inherent in some versions of the rule of law.) Most private sector organizations, by the way, also have various forms of activity-driven disciplines that arise from the operations of their hierarchies, management processes and shared values – patterns that emerge notwithstanding the effects of the disciplines imposed by the markets in which they compete. Consider only the long, sad history of American automakers over much of the last three to four decades. For them, activity-driven organizational disciplines trumped ‘market discipline’.——-

    One can imagine a market place, literally, the awnings, the carts, the produce, the crates, the straw packing, the colonnades, in short the Greek Agora. Imagine that gathering place to be so separate from the legal reach of the government or the law that thieves or scammers or frauds could not be apprehended. Vendors would not want to sell if they thought that the only way to obstruct dishonest dealings was to rely on vendors gathering together to show enforcement of any rules by moral persuasion, discussion, more deal making and counterdeals. It would begin to take on the atmosphere of a gangland. And yet somehow, we are being led to believe by wanna be libertarian armchair philosophers that the vendors of various services, traditionally rendered by government agencies(police agencies, prisons, fire departments, fact a great many ‘public service agencies’) can safely conduct their business and keep it free of corruption by mere acts involved in the moral persuasion of all of the participants. No need to get all technical about a messy concept of what legal enforcement should really mean and the necessary social environment that we would have to construct to have such a rare day as the setting needed to make a country run by rule of law.

    This country is in dire need of a serious discussion to gain an understanding of some real basic stuff about the political setting needed to have a well ordered society and to define these important concepts:
    Free Markets
    Rule of Law
    Equal protection before the law
    Constitutional representative form of government.

    When honest discussions can take place around these subjects, when these topics and others closely related to them can be discussed with sincerity and clarity, when we can build a body of overlapping consensus about what capitalism is and its relation to democracy, when all of this begins to take place, then schemers like the Center for American Progress will looking for other jobs.

  6. William

    @Paul Tioxon says:
    February 15, 2011 at 6:58 am
    “The reason a nation state is sovereign, in practice, not some middleclass notion from English philsophers, is based on the strength of its bureaucracy to collect taxes and reserving the power to tax.”

    I agree with what you say, but I would suggest that there is missing side to this argument. Reserving the right to tax, implies the reserving the right to use force. Ultimately a state must be able to force tax evaders to ‘cough up’.

    Which connects your point to that of Ray when he says

    @Ray L Phenicie says:
    February 15, 2011 at 8:29 pm
    “Imagine that gathering place to be so separate from the legal reach of the government or the law that thieves or scammers or frauds could not be apprehended… It would begin to take on the atmosphere of a gangland.”

    Indeed the right to use force should be reserved to one consistent, impartial, and credible body: The law.

    If there are multiple points of force, then there are multiple justices, then it follows that justice will not be final as rival ‘justices’ have no president over one another. As both sides will appeal to the ‘justice’ that suits them no decision can be impartial, and so the only resolution is ultimately violence.

    Sovereignty is the one decisive, restrained and acceptable use of force that prevents the blur of multiple, uncontrolled uses of force – a gangland.

    Of course for people to buy into it, to accept this use of force and to avoid looking for external options (gangs, seditionists, foreign interventions, etc) sovereignty must convince people of its restraint and acceptability. It must have consent.

    I agree with you that the US is becoming like a joint stock company. Because their has been a wave of media propaganda to to replace consent by choice. (Just as citizens where replaced by consumers) But consent, is NOT choice, and NOT the mumbo jumbo of the spineless political lickspittles to the marketeers. Choice belongs to the market, consent belongs to governments and they cannot ever mix, because consent is general and choice is particular.

    Now we know that any petty thief – or tax evader will attempt to deny the legitimacy of the sovereign body in their particular case and when it is to their advantage, this is not important. The sovereign only needs the broad consent of society in the abstract general case, so that it can enforce an individual’s compliance in that particular case.

    If that weren’t true there would be no possibility of a legal system at all, as everyone would try and revoke consent when consenting was no longer to their personal advantage. But we know that a market place cannot operate if individuals cannot exercise choice to maximise their personal advantage. So the very foundation of a nation is the idea that the body of the nation can impose justice on the individual. And it follows that justice is antithetical to the market, and that ‘government by market’ is in fact naked thuggery.

    Now here I must speak up for the notions of English philosophers because it was Thomas Hobbes who laid this all out in his book Leviathan.

    And so eventually we end up with a Democracy, and the method of voting; In which personal wants are averaged over by the vote to create an abstract median centre potion that has general consent without actually being an particular view.

    Anyway thank you Paul and Ray, we wandered off the topic of the article a bit but I think we’ve thrashed out some very useful points across these comments.

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