Social Impact Bonds, Youth Employment, and Pensions

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People are talking about a relatively new financial instrument — called social impact bonds (SIBs) — that can help governments implement social programs without using taxpayers' monies, that is, unless the programs work. In fact, the Economist magazine recently had an article about SIBs. These bonds were introduced by the British in 2010 to fund a prisoner-rehabilitation program in Peterborough. Last year, New York City launched a SIB, working with Goldman Sachs, to tackle recidivism among inmates at Rikers Island prison. The White House is exploring how to use SIBs for financing some of the programs managed by the Department of Labor on workforce readiness. And emerging markets, with the help of international development agencies, are also showing an interest. 

Waiting for salvation — a homeless man in London, 02-22-11 @ Chris Schmidt


A snapshot of SIBs 

So how do SIBs work? Well, the bonds are not really bonds, in the sense that investors who buy them don't receive a fixed payment or return. They are more like equity investments, where the investor takes the risk that the business will succeed or fail. Basically, an organization aiming to implement a given program would issue "bonds" that are purchased by private investors and that promise to pay a certain return if — and this is a key feature — certain measurable outcomes are achieved (such as an increase in school enrollment rates). The revenues from the sales of these bonds then become working capital for implementing the program, and the government assumes the contingent liabilities related to the value of the bonds. Then, if and when the desired impact occurs, the government pays the investors. (For more details, see a good technical description by the U.K.-based Social Finance, along with a recent assessment by the Center for American Progress.) 

This financial innovation is important for two key reasons: 

  • It links taxpayers' monies to results. The government will invest only in programs that have measurable impacts and that either create savings or improve social welfare.
  • It creates incentives for service providers — including public providers — to improve their performance. Indeed, just to mobilize the funds, they need to show what the program will achieve, how they will evaluate the impacts (such as through randomized control trials), and how they intend to successfully design and implement the program. Private investors are unlikely to buy bonds issued by a provider that lacks the institutional capacity and governance arrangements to be effective.


Using SIBs for youth employment 

It seems to me that an obvious application would be for financing some of the active labor market programs that governments implement to connect people to jobs — such as youth employment programs — which was a prime topic at the 4th South-South Learning Forum in Hyderabad last November. 

Tunisia, for example, is now implementing a new set of programs that include counseling, training, job-search assistance, and wage subsidies to help first-time job seekers get work experience and ultimately find stable jobs. The programs will be financed by an Employment Fund set up by the government (using taxpayers' monies). Some colleagues and I are working with them to pilot and evaluate the programs, and hopefully they will work. But if they don't, the monies are gone. And frankly, even if the evaluation doesn't generate the expected results, it would be difficult to stop the programs. Things could have been different. Instead of setting up the Employment Fund, the government could have facilitated the issuance of SIBs — transferring the risk to private investors and creating incentives for providers to design and implement programs that are likely to work. For now it's too late in Tunisia, but other countries could try to follow this alternative approach.


Linking SIBs with pensions

In a recent blog, I wrote about how to set up sustainable "pay-as-you-go" systems. Often, part of the liabilities in these programs are backed by financial assets. In fact, "young" systems, where there are still many workers per retiree, can accumulate substantial reserves (the Jordanian pension fund, for instance, has assets worth one-quarter of GDP). There is always the question of what to do with the money and there is always the temptation to use it to finance development projects, unfortunately without the right governance and accountability. For that reason, we typically advise policymakers to give the reserves to private asset managers — rather than using them to finance government expenditures "under the table" or invest in the government's pet projects. 

The SIBs, however, could be a mechanism to mobilize pension funds toward social programs, such as youth employment programs under transparent rules. Because the bonds are traded in the market, their "price" (and therefore the yield demanded by investors) would reflect expectations about the risk of the programs not achieving their targets. Pension funds would then invest in projects that match their risk tolerance. One can even imagine that, to protect workers savings, the government could guarantee part of the principal. 

But for this to happen, in many countries, pension funds need to be reformed and the provision of active labor market programs needs to change. Let's hope that these new bonds become an incentive to get these reforms done sooner rather than later.

This post was first published on the Jobs Knowledge Platform.