Financing What Works: Social Impact Bonds Hold Promise

Is it possible to reduce crime and save taxpayers money at the same time? That’s exactly the question an experiment in the English town of Peterborough set out to answer—with implications far beyond its city limits.

Peterborough is a town with 170,000 people about 80 miles north of London. Its prison houses up to 1,000 offenders who are largely serving short sentences. In most ways, they are an unremarkable group of prisoners. But they are also subjects of a groundbreaking experiment in public policy, which if successful could not only bring down crime but also save taxpayers’ money. The key to the experiment: Social Impact Bonds.

Social Impact Bondshow do they work?

The first set of Social Impact Bonds is being issued by the British Ministry of Justice. The bonds promise to pay a nonprofit organization called Social Finance up to $13 million over eight years if the nonprofit can work with the prisoners (both while they are inmates and after their release) to reduce reoffending. To receive the full payment, the nonprofit has to reduce recidivism by at least 10 percent more than other prisons with similar populations (a nationwide control group). If the reoffending rates do not come down more in Peterborough than other similar prisons, the government pays nothing.

Social Finance does not itself work with ex-offenders. Instead, it finds charities that are likely to be successful at reducing recidivism, and it gives them money to fund their work. In deciding which charities to back, it makes judgments about what approaches are most likely to work. And because it is heavily incentivized to reduce reoffending, it is likely to constantly look at which approaches are working. Those that are would get more money, and those that aren’t might need to be rethought.

Investors in Social Impact Bonds are mostly socially aware institutions who want a return on their capital but also want to do good. One investor is the Rockefeller Foundation, the only American foundation to be involved so far. If Social Finance is able to choose approaches that are effective, they cash in their “Social Impact Bond” and get the promised funds from government to distribute to their investors. If the nonprofit cannot accomplish major reductions in reoffending, then the investors lose their money and the taxpayer is no worse off.

Advantages for government

There are two major advantages for government. First, it does not need to decide which approaches to back. Instead, it decides only what outcome to target. It is for Social Finance to work out the most effective approach to reduce reoffending. Social Finance and investors in the bonds bear essentially all of the risk.

Normally, government allocates funds to program activities rather than outcomes. So, for example, there might be funding for a program that aims to cut reoffending through drug rehabilitation, and distinct funding for another that works to help offenders get back to work. But if the job training program gets ten times more money than the drug rehab program, is that because government thinks it is ten times more effective? No. Normally it is just a reflection of how much money was available when it was set up.

What if the job-training program proves to be less effective than drug rehab? Does that mean money can be easily reallocated? No again. The program allocation is likely to be set in stone at the Ministry of Justice and changing the allocation would likely take some considerable time.

Indeed, in the United States, the detail might be set out in the congressional appropriations process, which makes reallocation even more cumbersome. By issuing Social Impact Bonds, the money should transfer from approaches that are less effective to those that are more effective.

A second advantage is that the approach could save government money. Jonathan Slater, director general for transforming justice at the British Ministry of Justice, oversees the Peterborough pilot. He says that:

“Reducing reoffending has the potential to save government money through lower police, court, and prison costs. And reduced crime is something that communities all want. Through Social Impact Bonds we have promised to share our savings with Social Finance—money they can pass back to their investors. But if they do not succeed, our funding commitment is nil.”

The bottom line: Social Finance either manages to reduce reoffending, which saves the government money (and has social benefits too), or doesn’t, in which case government’s outlay is nil.

But will it work?

Could the experiment in Peterborough revolutionize the way government funds are allocated? Could government only release money when approaches have been shown to work, and rely on funding from others to fund the experimentation stage? The Peterborough experiment is the first in the world to pioneer this approach, and is in very early days. The program began in August.

But if it could work, then the potential is enormous. Speaking at an event at the Center for American Progress in July, Judith Rodin, the president of the Rockefeller Foundation, said that it is essential for the public, private, and nonprofit sectors to work together and find new financing vehicles to address the problems of the future. On Social Impact Bonds, she says they “unlock new flows of capital and have the potential to revolutionize the manner in which a variety of persistent social problems are funded and addressed. Because today’s challenges are vast, complicated, and interdependent, they require new financing vehicles that go beyond what government and philanthropy currently have to offer.”

Many are watching the Peterborough experiment with interest. They are right to do so, but other pilots need to emerge too. They need to cover a wider range of policy areas and different budgeting systems. Perhaps socially aware investors could be drawn to fund, say, different approaches to reducing truancy or helping the long-term jobless back into work.

Indeed, there needs to be more thinking about when Social Impact Bonds are most likely to work, and what pitfalls need to be avoided. And if this new financing model were to be tried in the United States, there needs to be work to win support for the concept in Congress, which is accustomed to funding narrowly defined programs setting out what government will do, not what it will achieve.

Despite these cautionary words, there is the real possibility that the prisoners of Peterborough will be pioneers—if their recidivism rate comes down sharply. Not only will their neighbors feel safer, but the taxpayers of England will be better off and a new form of government financing will have emerged.

Jitinder Kohli is a Senior Fellow with the Doing What Works project at the Center for American Progress. Prior to joining the Center, he worked in the British Government. The Center recently published two reports on public sector innovation: “Capital Ideas” is a practical guide for public sector organizations on how to generate a flow of ideas, and “Scaling New Heights” looks at the scaling process for successful innovations. Social Impact Bonds are featured in that report.