Knocking Down Strawmen

Let's debate about real -- not pretend -- issues.

You can tell that Social Impact Bonds are making headway by the increasing criticisms being lobbed in their direction.  I responded to one recent salvo here, and this post offers a response to a guest blog from Jon Pratt, Executive Director, Minnesota Council of Nonprofits, entitled “Flaws in the Social Impact Bond Craze.”

My reason for writing is to try to shift the debate from knocking down arguments that no one is making – strawmen – to legitimate issues about which reasonable and well-informed people can disagree, of which there are many.  I don’t know Mr. Pratt, but I have had some exposure to the Minnesota nonprofit sector, and I’ve long considered it to be more robust and effective than most.  (Here's an example.)  If Minnesotans decide not to pursue SIBs and other kinds of impact investments, that’s certainly their prerogative.  I would just invite them to consider the matter on real rather than imaginary grounds.

Mr. Pratt implies that the reason for the supposed “craze” is that “an extraordinary amount of enthusiasm is building among consultants, foundations and financial services firms.”  He calls this “the foundation/consultant enthusiasm stage of SIBs.”  He warns that, “[h]owever fast growing the Social Impact Bond promotion” may be, everyone should keep an eye on the “big money and very well-known supporters” behind the curtain.

Before we dismiss SIBs as “admirable but dreamy” and “almost too good to be true!”, as Mr. Pratt would have us do, let’s be honest and clear about the real reason for SIBs.  As one of the founding fathers of social investing, Sir Ronald Cohen, has put it, “Government is out of money and out of breath.”  We are enmeshed in a long-term fiscal and economic crisis that will increase the need, but decrease the funding, for effective social services long after unemployment returns to normal levels.  This is a “new normal” of government retrenchment, rising inequality and decreasing social mobility to which we have not yet adjusted.  The safety net ain’t what it used to be, plus we can’t afford it.

While there are many encouraging trends in social sector innovation, as well as room for improvement, beleaguered nonprofits are in no position to take up the slack left by an eroding public sector.  They don’t just, as Mr. Pratt puts it, “frequently feel under-compensated, need more resources, and blame their limited success on lack of funding,” they are under-compensated, in need of more resources and held back by a chronic and worsening lack of funding.  Nonprofits are fighting a holding action that they can’t win over the long term.  They, too, haven’t figured out how to cope with the new normal.

Mr. Pratt dismisses the notion that SIBs will attract “more resources” by setting up and then knocking down another strawman.  SIBs, he says, are “based on the idea that legislative bodies will appropriate additional funds based on a projection of future savings.”  But, apparently, this is just a sleight of hand:

“If your organization’s services reduce repeat trips to prison, saving government money, your organization (and its financiers) deserve to be rewarded with extra payments — made possible by the reduced expenditures required of government in housing these prisoners. 
The argument is a good one, certainly, which is why it is used constantly in every legislative and appropriation process — that this particular expenditure for (early childhood education/crime prevention/sanitary sewers/vaccinations, etc.) is better spent to prevent a problem than to try to remediate it later.  Legislative bodies understand this, and often agree — and these intended savings across all of these areas are already taken into account in the overall appropriation process.

You can certainly make the case that your particular service is special and new, and has a superior claim to savings, but your ability to get legislative approval is almost certainly a displacement from other funding — not an actual specific addition to total expenditures.”

SIBs are most definitely not “based on the idea that legislative bodies will appropriate additional funds based on a projection of future savings.”  It’s precisely the opposite:  we don’t ask legislatures to appropriate additional spending, we ask them to agree now to share savings that SIBs produce in the future, but only if those savings actually materialize and only if they’re sufficient to pay investors back. 

Even if SIBs succeed, we’re not proposing that nonprofits “be rewarded with extra payments.”  The financial benefits of SIBs for nonprofits is that they’ll know in advance that they’ll receive reliable and adequate funding over the entire five-year or longer duration of the SIB project, something that is rarely the case with grants or government contracts. 

As every nonprofit can attest, it’s not just the amount of money that holds them back, it’s also the unpredictability and tenuousness of the funding.  When a social enterprise has a one-year grant or contract, it can’t make long-term plans and can’t attract and train the talent it needs to accomplish big things.  Five grants or contracts of, say, $50,000 each, that have to be applied for and won each year, can’t accomplish as much as one $250,000 SIB for the same period of time.  This is especially true when the nonprofit is empowered to decide how to spend the $250,000 because the SIB investors know that’s the best chance they have of achieving the social outcomes upon which their financial returns depend under the outcomes-based contract with the state. 

Nothing could be further from the truth that “these intended savings across all of these areas are already taken into account in the overall appropriation process.”  Again, the reality is precisely the opposite:  government is forced to cut spending on prevention programs because they don’t even have enough money for emergency services.  We’re exploring SIBs because we find ourselves stuck in a downward spiral where funding for more expensive and less effective programs crowds out taxpayer funding for early intervention programs that have been shown to prevent people from becoming homeless or going back to prison, which then requires us to build more emergency shelters and prison capacity that takes more money from prevention, and on and on.

You don’t have to take my word for it.  A 2010 study funded by The Boston Foundation on “Adopting Effective Probation Practice” confirms our collective dilemma:

“The budget crisis has come at a time when the DOC, Parole and many sheriffs have begun to make progress in re-shaping agencies and focusing their resources on efforts that enhance public safety.  Some of these agencies have made significant strides in implementing evidence-based practices, those proven to reduce recidivism, and have begun to show lower recidivism rates.  Leaders of these agencies have focused on changing offender behavior in order to reduce the risk of re-offense rather than simply warehousing offenders and releasing them after the sentence is served.  Because of the massive fixed costs in the corrections system, corrections officials have few budget reduction options other than eliminating the critical programs and services that change offender behavior and, in turn, improve public safety.”

Here's a February 8th story from the Londonist about a local government council spending more than £2m to house homeless families in hotels "because housing benefit cuts and a shortage of suitable properties have left them with nowhere else to go." 

“Westminster isn’t the only council placing families in B&B accommodation. In December we saw that several boroughs were breaking the law that’s supposed to limit these temporary placements to six weeks – but what else are they supposed to do? Councils have a statutory duty to house anyone who turns up and is homeless; benefit cuts have led to more people becoming homeless and councils are struggling to find anywhere else families can afford. And that’s leading to councils spending more on hotels than they were on housing benefit. This may be the very definition of a false economy.”

Massachusetts faces the identical problem.

SIBs don’t displace government funding or foundation grants.  They raise new money from new sources – private investors – who will only invest if they believe that prevention programs the government can’t afford will work, and produce the savings from which government can pay them back without additional appropriations.

It certainly remains to be seen whether social investing can be part of a more effective response to the new reality.  Mr. Pratt is correct when he says we have no results yet from any SIB project.  But, to be fair, the reasons we don’t are, first, they’re just getting underway, and, second, SIBs aren’t quick fixes for little problems.  Rather, they’re designed to scale what works over a long period of time. 

Which brings me to my second quarrel with Mr. Pratt’s imagined SIB “craze.”  He says that “the biggest SIB innovation is the transaction itself, and accompanying financial instruments and intermediaries, not the service method.”  In other words, there’s no there there:

“There are no proposed special service innovations for the work supported by the SIBs (they are understood to apply effective methods considered best practice in their field), but will get improved results through enhanced discipline by virtue of their participation in the SIB process and its restriction to only pay for results.  This high stakes carrot and stick approach is not unlike the expectations of results in the “No Child Left Behind” legislation, which had its own unintended consequences (including cheating scandals by pressured school administrators).”

Again, it’s perfectly fair to be skeptical about whether SIBs will produce better outcomes, but it's not fair to dismiss them by mischaracterizing how they work.  SIBs don’t just include “a dose of business incentive” that gullible funders who “view business managers as inherently more effective than nonprofit managers” accept as an article of faith.  I can assure Mr. Pratt that no one working to develop the new and still untested field of impact investing thinks, “after all – how hard can it be to run a nonprofit?” 

To the contrary, risk-averse investors are very conscious of the difficulty in running a social enterprise dependent on funding sources that Lucy Bernholz has described as “episodic, donor directed, temporal, fragmented, decentralized and disaggregated.”  Before social investors will buy SIBs, they want to know if, unlike philanthropy, their money is invested in a way that is steady, controlled by nonprofits, reliable, integrated, consolidated, and aggregated, will it enhance what nonprofits accomplish?  And the obvious answer to that question is:  not necessarily.  If we just add money without materially changing “the service method,” as Mr. Pratt claims, we’re unlikely to see better results.

Social investors know this and they don’t engage in wishful thinking that SIBs will magically work “through enhanced discipline by virtue of their participation in the SIB process and its restriction to only pay for results.”  The “market discipline” that we hope will come from private investment isn’t based on an ideological belief in the natural superiority of business.  Instead, the service innovations that we hope SIBs will engender (whose existence Mr. Pratt denies) is a direct result of the financial innovation that SIBs enable.  Why do I say that?

The business case for SIBs is that investors can accomplish their twin objectives of increasing the benefits of social programs and earning a modest financial return if and only if they apply the same due diligence to their social investments that they apply to their financial investments.  SIB investors won’t give us their money unless we convince them, using credible data, that the prevention programs work and can save government enough money to pay them back.  If not, the experiment ends.

Mr. Pratt makes the mistake of assuming that, because SIBs look for "evidence-based" programs delivered by nonprofits with track records of effective service delivery, they don't need any operational improvements.  As decades of research shows, programs that work well in some places at certain levels of operations often don't work nearly as well when they're transported to new places or expanded to reach more people.  When SIBs try to "scale what works," that's a very tall order requiring more than just adding money.

So, even if we can persuade  investors to buy SIBs, they will watch how we use it very carefully, just as they do with their long-term financial investments.  Interim performance metrics, such as enrollment rates, compliance with eligibility criteria and fidelity to the critical success factors of the intervention model, will be reported on a regular basis.  If the numbers don’t look right, the SIB intermediaries have time to make course corrections, and investors will expect them to do so.  All stakeholders, including the service providers, the intermediaries, the government agencies, and the measurement experts, will meet regularly to analyze progress and, through a collaborative governing process established in advance, decide how to get back on track. 

This is not the way most social services are delivered today.  Diligent selection of effective interventions and growth-ready providers, investing in managerial and organizational capacity, careful articulation of measurable outcomes, long-term planning, robust data collection with quality control, ongoing performance reviews, collaborative oversight, and independent verification of results might not be glamorous, but they are indeed “special service innovations for the work supported by the SIBs.”  

These kinds of best practices, some of which many nonprofits follow today as best they can with limited and unreliable funding, are indispensable with SIBs.  Without them, investors won't invest and the projects won't succeed.  There's a cause-and-effect relationship between the kind of money SIBs are designed to attract and the kinds of operational improvements needed under results-based contracts.

Mr. Pratt cites Donald T. Campbell for the “law” that “[t]he more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor.”  Campbell’s Law is certainly sound and counsels caution and humility in performance-based contracting. 

But Professor Campbell was not saying, as Mr. Pratt seems to argue, that performance measurement is a fool’s errand.  The professor wrote a paper in 1976 called, “Assessing the Impact of Planned Social Change,” which offered an observation to which all of us trying to advance social change can relate:  “It is a special characteristic of all modern societies that we consciously decide on and plan projects designed to improve our social systems.  It is our universal predicament that our projects do not always have their intended effects.  Very probably we all share in the experience that often we cannot tell whether the project had any impact at all, so complex is the flux of historical changes that would have been going anyway, and so many are the other projects that might be expected to modify the same indicators.”

In other words, impact assessment is absolutely essential but diabolically difficult.  It is neither a waste of time nor a sham designed to enrich investors.

Those of us working on social investment don’t think we’re smarter than those who aren’t, but we’re not selling snake oil, either.  We are well aware that impact investment would not be possible without the decades of social innovation that was nourished by philanthropy and sustained by taxpayers.  It is no criticism of either to acknowledge that we now face systemic challenges that traditional approaches haven't been able to overcome.  We have no intention of abandoning the vital work of the organizations that brought us this far, but we are exploring new approaches that might be able to pick up where they left off.  We don’t know if they’ll work yet, but we do know they'll fail without the help of organizations like Mr. Pratt's.  We understand there are risks inherent in bringing private capital into the mix, and we’re thinking hard about ways to manage those risks.  We expect to be judged by our performance.

SIBs are neither a quick fix nor a panacea.  There's nothing magical about them.  These are ideas worth considering and developing further, and healthy skepticism will force us to wrestle honestly with difficult questions.  Mr. Pratt says we should “closely examine and question the claims made for SIBs.”  Let’s do that.