Photo: mars_discovery_district/Flickr

Interest in Canadian “social impact bonds” has spiked following Human Resources and Skills Development Minster Diane Finley’s announcement that the federal government is investigating them for use in Canada. I’ve already commented on the story in the Toronto Star and on The Current (min 16) but I wanted to write my thoughts up in a fuller blog post for readers.

So what is a “social impact bond”? Well the idea is that a banker or foundation decides to fund a particular service. When (you’ll see why not “if” below) the program hits its goals, then the government pays the funder back all they invested and includes a profit margin of somewhere in the neighbourhood of 7-15 per cent on top.

For example, in New York City there is a youth recidivism program. In NYC half of all youth released from prison will re-offend within a year. This is obviously bad for society and the kids, but it’s also expensive for the government who has to pay for these kids to be in prison. So a social service agency and the government convinced Goldman Sachs to spend $5 million on a youth recidivism program. The program will take in a portion of the kids released and give them an intensive program.  If the program manages to reduce the re-offence rate by 10 per cent compared to the average, then the government pays Goldman back their original $5 million and an additional 13 per cent profit or $650,000, in total paying them $5,650,000.

This stands in stark contrast to actual philanthropy of say a company donating $20,000 to the local food bank at Christmas. They get a tax break for the donation to be sure, but they don’t expect to get their $20,000 back from the government with interest after homeless folks get their Christmas meal. However, that is what happens with social impact bonds; they get the entire donation/investment back with interest once the program is delivered. If anything, social impact bonds are anti-philanthropy.

It’s no surprise why some social service agencies are open to social impact bonds. The backdrop, in Canada and elsewhere, has been a decade of tax cuts and reduced expenditures on social services. So the poor social service agencies are stuck between a rock and a hard place. On the one hand, they see a growing need for their services and on the other, governments are cutting back resources to deal with the need. If the government wants them to get in bed with bankers to raise new money for social services, well, it’s pretty hard to look a gift horse in the mouth.

But this new way of funding social services is a significant departure to how Canadian government have done it in the past. Ten years ago, if a social service agency had a good idea that had been tested elsewhere or tested on a small scale and worked, they’d pitch it to a government granting committee and get it funded. Governments used to just fund new ideas: social service agencies could help kids who’d run afoul with the law, governments would save on prison expenditures and importantly, no one would make a profit.

Social impact bonds are a very different approach as they insert a middleman into social service delivery, someone like Goldman Sachs. The bankers are there because they smell an opportunity to make large, government-guaranteed profits. We have to remember that the same industry that took down the world economy not four years ago is the one interested in becoming social services middlemen. Whenever there is a middleman, there is always a middleman mark-up.

Often times, these social impact bonds are pitched as if they transfer risk to the private sector.  That is, if the project doesn’t hit its 10 per cent reduction in recidivism for example, then the government pays them nothing. In the real world, it is quite a different story.

First of all, the projects that would make it to the funding stage are not experimental. They need to have been proven on a smaller scale and in other places. There is no way that Goldman and others are going to put up $5 million with a 50/50 chance of losing it all. Instead, they are much more likely to back projects that have a proven track record. Experimentation is almost always going to be on a smaller scale and funded by government money because of the high risk of failure.

But if by some fluke, the project still doesn’t work as expected, say they only get an 8 per cent instead of a 10 per cent reduction in recidivism, it’s highly unlikely that the government will burn Goldman Sachs for $5 million. If you force Goldman Sachs to take a $5-million bath, they aren’t coming back next year and neither are any of the other bankers and foundations. The investor demands to be paid… with interest. If the government allows project backers to lose their investment, the money to back these projects is going to dry up very quickly.

In either the traditional model or the social impact bond model, it is always the government that pays. However, for social impact bond, the government now has to pay a middleman mark-up.  Not only that, but they also have to make sure that Goldman Sachs’ shareholders are happy. If the shareholders aren’t happy with their returns, they aren’t going to pony up the cash next time around.

It is this change of who government serves that really concerns me. People pay their taxes (and expect corporations to as well) in part because they want the government to deliver good services to the people that need them. However, social impact bonds direct tax dollars to bank profits instead of to a homeless fellow trying to get off the street. This dramatically changes who is being served by the government: from those who need a helping hand to the shareholders of a bank.

There is an alternative. Since the government is going to pay either way, let’s say “thanks but no thanks” to a middleman mark-up. The government could create its own fund to push forward ideas that have been proven elsewhere. Again since the government is going to pay either way, why not borrow at historically low rates of 1 per cent instead the of 7 per cent-15 per cent offered by a middleman. When these projects succeed, we can provide them to more people instead of lining the pockets of a bank.

Photo: mars_discovery_district/Flickr