Welfare Expansion through Social Impact Bonds Kim, Kab Lae* In the social impact bond (SIB) mechanism, cost savings result when an early intervention program successfully eliminates a problem, and then the savings are reinvested in the program. This virtuous cycle can be useful tool for expanding welfare without tax hikes, and it has profound implications for Korean society. Korea now suffers from high social costs from economic polarization, and public inefficiency in solving the problem is high. Against the backdrop, SIBs are likely to be applied in Korea. Introduction Social demand for increased welfare is growing as part of attempts to reduce economic polarization and income disparity. Welfare expansion is becoming a hot potato issue with the presidential election only two months away. Enhancing social welfare and building social safety nets are necessary for Korea to become a more advanced nation. However, it s impossible to respond to all social demands at the same time because welfare expenditure imposes burdens on taxpayers. Nobel laureate Christopher Antoniou Pissarides, commenting on Korea s welfare policy, said that higher welfare without tax hikes, as suggested by politicians, is unsustainable. 1) This indicates how difficult it is for the public sector to implement welfare policies without increasing taxes. Just as one needs a cool drink to swallow a hot potato, Korean policy makers need innovative ideas to deal with social welfare. One idea, that received global recognition as an innovative solution for public welfare, is the Open Government Initiative (OGI) led by the US and UK. Social impact bonds (SIBs) realize the core principles of the OGI. Hereupon, I first look into the broad concept of the Open Government All opinions expressed in this paper represent the author s personal views and thus should not be interpreted as Korea Capital Market Institute s official position. SJD, Research Fellow, Capital Markets Department, Tel: 82-2-3771-0656, E-mail: c0mrade@kcmi.re.kr 1) Sang-hoon Lee, Pissarides says that higher welfare without tax hikes is unsustainable, Dong-A Ilbo, February 24, 2012. 1
Initiative, which emphasizes public transparency, private participation, and cooperation. Then, I explain the SIBs as a tool for implementing the ideas, as well as the mechanism that enables higher welfare without tax increases. Last, I discuss the implications of the SIBs. Open Government and SIBs Expanding welfare may be fundamentally necessary to address Korea s inequality and polarization and achieve social integration and sustainable economic growth. But public welfare policies have so far only had limited results because of budget shortages, inefficiency, and the lack of outcome measurement and accountability. These problems are found not only in Korea, but also in other nations around the world. Particularly in the midst of the US financial crisis and Europe s fiscal crisis, most countries were pressured for social welfare budgets. In response to the pressure, many nations adopted the Open Government Partnership (OGP), which is a global initiative that includes about 50 countries. Its principles are based on government transparency, accountability, private participation, and technological innovation. 2) OGP is a politically and ideologically neutral policy framework embraced by both the Obama administration (Democratic Party) in the US, and the Cameron Ministry (Conservative Party) in the UK. Improving government transparency and encouraging private participation and cooperation are highlights of OGP. More specifically, OGP is about clearly monitoring how taxpayers money is spent, the increase of efficiency and innovation in social programs through private participation, and the enhancement of accountability through strict performance assessments. 3) As part of these efforts, the White House Social Innovation and Civic Participation Office announced in September that it would consider a bottom-up innovation approach from the private sector, e.g., pay-for-success bonds and admit the limits of the existing top-down, government-led approach. 4) This statement is a reference to SIB s characteristics - private sector efficiency, stronger accountability based on outcome, and early intervention - which are consistent with OGP principles. 2) For details, refer to http://www.opengovpartnership.org, the official OGP website. 3) Refer to the White House official website, http://www.whitehouse.gov/open. 4) Refer to Marks, J., Bringing the private sector into federal innovation, Nextgov, 2012 (Sep. 6) (http://www.nextgov.com/ciobriefing/2012/09/bringing-private-sector-federal-innovation/57918). Please note that the term Pay-for-Success Bond is more commonly used in the US than SIB. 2
SIB structure and characteristics An SIB refers to an investment contract where a social impact bond-issuing organization (SIBIO) sells private investors bonds whose principal and return are linked to the social program outcome. The government guarantees repayment if the social program achieves preset performance targets. The government contracts with the SIBIO for a social service, and then the SIBIO issues bonds and sells them to private investors in order to obtain working capital for the social service. If the service meets predetermined social performance targets, then the government pays the SIBIO based on cost savings achieved by the service. The payments are repaid by the SIBIO to bond holders. The SIB follows four steps: capital raising, management, assessment, and distribution. First, during the capital raising process, a SIBIO issues SIBs and sells them to private investors based on the government guarantee for repayment. In exchange, private investors provide capital to operate a social program linked to the SIB. Second, the fund is managed as the SIBIO provides capital to social service providers who work to meet the social performance targets. Third, performance is assessed by an independent assessor. If the targets are met, the government pays the principal and performance-based returns to the SIBIO. Otherwise, the government does not pay. Fourth, the principal and return are repaid to investors at expiration, or the bond expires without payments. The SIB is characterized by early intervention to social problems, improved service efficiency through the private-public partnership, and outcome-based accountability. By transferring the risk of social program failure to private investors, the SIB reduces taxpayers burden, and thus enhances efficiency of public expenditure. Moreover, this scheme helps create a virtuous cycle in social innovation in the sense that it channels more investments to successful social programs based on market principles. SIB mechanisms for higher welfare without tax hikes SIBs are performance-based, preventive social programs that tap into capital markets. This expands welfare, without raising taxes, through three mechanisms. First, SIBs bring about cost savings because competitive private social service providers enhance social service efficiency. Second, SIBs use early intervention to prevent social problems from deteriorating, and thus deliver cost savings. Third, SIBs help put larger investments into effective social service programs 3
with proven success. Let s take an example of an SIB that provides English education programs for the socially disadvantaged class. The current social polarization is believed to come from income disparity, and the income gap leads to education gap that directly affects employment and future income levels. This passes on today s income disparity to the next generation. Therefore, if a program teaches kids from the socially disadvantaged class English, which accounts for a large part of the education gap in Korea, then this will help alleviate social costs such as a low birth rate, social disintegration, and costs to help the vulnerable. The problem is that Korea s English education programs led by the public sector are inefficient, not cost-effective, and not feasible. 5) An SIB program that runs English lessons for kids from low-income families in local areas will effectively reduce inefficiency, enhance accountability, and improve cost-effectiveness. First, when devising an SIB program, service providers assess the cause of social problems and then select the area where early intervention can have preventive effects. This is to prevent unnecessary spending and maximize cost saving effects. If early intervention, for example an English education program for teenagers from low-income families in rural areas, is judged to be preventive, then performance measures and metrics are designed to enhance accountability of the program. If the program is inefficient and has unclear performance measures, then next funding will falter because of private investors concerns about losing their investment principal. If a program is successful, the SIB linked to the program will attract more investors. Moreover, the SIBIO has incentives of reputation and business sustainability to select the most competitive service provider. This will enhance program performance. A program that meets performance targets will receive more government funding (the funding sources come from cost savings), and attract more investors, eventually expanding the program. Simply put, if an SIB English lesson program in a local area meets performance targets, it can expand to other areas. This results in social welfare expansion without tax increases to finance the program. Social implications of the SIB In the SIB mechanism, cost savings result when a social program successfully eliminates a problem, and then the savings are reinvested in the program. This virtuous cycle can be useful tool for expanding welfare without tax hikes, and it has profound implications for Korean society. 5) Young-sik Woo, What happened to the English Village boom?, Yonhap News, September 6, 2012. 4
Korea now suffers from high social costs from economic polarization, and public inefficiency in solving the problem is high. Against the backdrop, SIBs are likely to be applied in Korea. But a new system is not always successful. Success will require sophisticated efforts to minimize operation risk, assessment risk, and failure risk involved in the SIB. The global community is acting to implement the vision of the Open Government, such as enhancing government transparency and accountability, encouraging private participation, and facilitating social innovation through technological development. There are major implications from all this. Currently, politicians in Korea are giving various ideas to address social polarization and expand welfare. But very few of those ideas sound innovative enough to give the public hope. A thorough review of those ideas is necessary, especially regarding whether they could be sufficiently financed, whether they could operate efficiently, and whether their performance can be properly measured. It would not be wise to seek a solution only inside the public arena. Instead, market-based, private-public partnerships can result in innovative welfare expansion. 5