In an era of austerity when fiscal constraints are affecting almost every corner of society, ideological opposition to financial innovation in the social sector is seeping away. CEO of ClearlySo Rodney Schwartz unleashes a thought experiment to challenge how we think about conflicts around the world.
At ClearlySo we believe that the main difference between impact investing and the old way of thinking is that the old financial world existed in two dimensions (financial return and risk), whereas the new world exists in three. Impact, measured from a social, ethical or environmental perspective is a third, often intentional, dimension to the prior two-dimensional world.
Frequently we consider the enterprises into which impact investment is being made and observe with utter amazement how the entrepreneurs blend conventional enterprise models with beneficial societal outcomes. We are especially proud of organisations likeThird Space Learning, which reduces the cost of maths tutoring while simultaneously helping educators in India receive decent wages, or Weedingtech, which sells a non-insecticide based device for weed control.
Business model innovation has also been a feature. Consider the London Early Years Foundation, which runs high-quality nurseries where wealthier parents cross-subsidise those who are less wealthy. Another illustration is the Ethical Property Company (EPC), which buys and lets commercial property to social change tenants, who receive far better terms than they would in more conventional premises. EPC’s better terms means that void levels in its premises are substantially lower than in conventional office estates.
Impact-oriented finance has also seen innovation. Consider the quasi-equity (QE) instrument we assisted HCT Group in raising in 2010. As a charity, HCT could not offer shares, but required long term risk-oriented capital to finance growth. Impact investors took both conventional bonds and a QE instrument in a £4.2m fundraising. Those taking the more risky QE instrument received returns that grew with the growth in HCT’s turnover (above a benchmark) – and generated 10+% returns. Of course, it could have gone the other way and investors (including Bridges Ventures, Big Issue Invest, Social Investment Business and Rathbone Greenbank) might have received no interest, or even lost capital.
Of course the best known and most celebrated financial innovation concerns the much discussed Social Impact Bond (SIB). SIBs link payments received by investors to the social outcomes made possible by the underlying investments. They have initially received substantial subsidies to gain traction but are now taking off globally. Their genius is not in the structures, which are costly, but in the notion that government should pay for cost-savings which stem from social innovation. Payment-by-results contracts will certainly become a mainstay of government commissioning.
It is these types of innovation that must now come to the fore. In such fiscally constrained times, the rule of “what works?” must predominate. Ideological opposition is melting away and there should be no limit to what is now possible; blue sky thinking is essential. It can involve enterprises, business models, financial instruments and even the very way we think about societal problems.
Consider one such thought experiment...
What if we had bribed Iraqi citizens or its leaders to depose Saddam Hussein instead of using weaponry to defeat him? The estimated official cost to the US of the war is around $815bn (subsequent estimates by the Congressional Budget Office and the Nobel Laureate Joseph Stiglitz suggest the full impact was between $2-3tn). This amounts to $24,000 for every single Iraqi (or $120,000 at $3tn!), in comparison with GDP per person of $6,863 per annum. This excludes the military cost to other nations and does not consider the extraordinary damage and suffering of the Iraqi people.
One might argue that the cost of war is never known until after the fact, which is true; however, on 16 March 2003 Dick Cheney was asked on national television about the approaching war and he estimated that it would cost $100bn. Just this was equivalent to $3,852 per person at the time when GDP per person was $1,373 in Iraq. By using that money to persuade Iraqis, war could have been averted and costs in a purely economic sense (not even taking into account the damage, destruction and death caused) would have been sharply reduced.
The UK was only one of the countries involved in the Afghan War. But if we had used the £37bn it cost us to bribe Afghanis, or even their leaders, to do the things we wanted, this would have amounted to £1,600 per person, well above the current level of GDP per person of £436. Again, this does not take into account the military costs to other combatants, including the USA ($686bn), or the devastation of Afghanistan. When the figures are so compelling there must be a strong moral argument to consider such an innovation even if one might be a bit queasy about some of the underlying issues and despite the obvious technical and tactical issues involved.
The above is not to argue for Western imperialism or our right to impose “our” geopolitical preferences on others. But from our own (selfish) perspective, we might have: a) had a better chance of achieving our goals, and b) saved a fortune, using this approach. Furthermore, not to have gone to war would have avoided unspeakable suffering on the part of Iraqis and saved thousands of lives.
There are precedents for bringing behavioural persuasion into the public realm. The “nudge” unit, established by the coalition government, did precisely this. Here too, there was concern about the “nanny state”, but again in these times it is unwise to disregard any aspect of innovation.
We see cases of “bribes” being used to achieve social outcomes every day. On 8 June 2015 the Independent reported on the Peacemaker Fellowship, which could also be described as targeted bribes to those most likely to commit offences not to shoot people. This programme, operating in Richmond, California, follows on from similar programmes in Boston and Chicago.
I accept that there have to be limits and important moral issues need addressing, but these are incredibly challenging times, and our failure to face up to these questions involves an active moral choice as well, even if we pretend to ignore it. Opting to go to war because one finds bribery morally dubious is a very tricky argument to make.
We are just at the beginning of what we can do when we use financial innovation for positive outcomes. I intend only to challenge a few shibboleths and get some creative juices flowing – as always, I look forward to further discussions.