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a blog from young economists at Nova SBE

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Yielding social profit

When we think of financial innovation we do not automatically associate it with humanitarianism. However a financial product has been designed to make that connection.

The aim of this post is to present Social Bonds. I will explain what these bonds are and how they work, showing some real cases. In addition to that I will demonstrate how, in my opinion, they can be used to fight several social problems, including poverty.

A social bond represents a loan between an investor who buys the bond (the lender) and usually the state who sells the bond (the borrower). What distinguishes this bond from conventional government bonds is that the lent capital shall be used to finance a specific activity with positive social impact and the payback (of the initial amount and interest) will depend on the success of this activity. What’s more, the main difference between these bonds and most funding for social projects is that while the latter’s funding tend to pay for inputs, the former’s rely on results. 

This instrument has a huge potential, since it is broadly known that governments could save much money if they invest in prevention rather than just financing correction. Two main examples of this may be the prevention of diseases by stimulating health instead of spending huge amounts on healing, or preventing what causes people to become criminals instead of paying their caging. It is much preferable to prevent the continuous rollercoaster trail of prisons, courts, homeless shelters and hospital emergency rooms. Besides it is known that there are interventions that are proven to help and to save money, thus unburdening the taxpayer.

Despite the potential savings, cash-strapped public authorities cannot just relocate its expenses from correction to prevention activities. This would mean cancelling health treatments or freeing criminals… Social Bonds may help to solve this situation by financing the prevention which will increase public savings. These savings will then be used to repay the initial investment and interest. Therefore, the Social Bond’s buyer will face the following risk: if the prevention activity is successful, which means that public savings will rise, he will win; if the activity fails, this investor will lose money (which mean that it is not technically a bond).

This instrument was first proposed by the economist Ronnie Horesh in the year of 2000 and its first implementation was made in 2010 in Peterborough, a town in Britain. The city issued bonds raising £5 million to finance a project that aimed at preventing recidivism, managed by the group Social Finance. Over 6 years recidivism rate will be compared between Peterborough and other similar towns. If, in 2016, its rate is 7.5% lower than the control group, the British government will repay the bond holders with interest. If that threshold is not met, investors will lose their money. The main outcomes will just be published in 2014. However Tina Rosenberg at the New York Times argues that according to local police the program looks like being paying off through a decrease in crimes.

In the US a similar project is being developed, but instead of being financed by philanthropic organizations, it is being financed with $9.6 million by the bank Goldman Sachs, a Wall Street institution. Alicia Glen, head of Goldman’s Urban Investment Group, said to The Economist that it is a real loan. Furthermore, she stated to the Financial Times that this bank would get involved in more transactions of this type in 2013.

If this proves to work there is a huge market to be explored. For instance Jannet Currie from UCLA shows that early childhood education programs to disadvantaged children may increase future earnings, reducing welfare dependence and crime. This would then be a good candidate to be financed by Social Bonds.

Improving poor neighbourhood’s environment, encouraging civic participation and promoting social activities, could be a next stage aspirant. The only need is for independent monitoring and consulting organizations that are capable of estimating social as well as financial returns.

In conclusion, Social Bonds are a veil of promoting social value in a sustainable and profiting way. This, besides leading to a better society, helps governments to be more efficient, sharing its extra savings with the lenders of these investments, which leads to the right incentives. These projects are just being launched, though we may be starting to watch a new form of social oriented financial innovation that may radically change the way we face social problems.


Diogo Silva Pereira Teles Machado, nº546