December 30th, 2012

Impact Investing: Who has the Last Word?

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December 30th, 2012

Impact investing transfers risk from the government to the investor. With this shift, is the decision-making from the public being handed over to the wealthy few?

Impact investing (through social impact bonds) has an amazing potential for tackling social issues. Essentially how it works is a private investor provides money to fund a social intervention, which is then implemented by a non-profit organization. If and when that intervention produces previously established outcomes, the government then reimburses the private investor with a return on the original investment (at competitive rates). However, if the intervention does not produce the intended outcomes, the government will not provide any funds and the private investor is left to absorb the costs.

This form of transaction transfers risk from the government onto the private investor, where the investor has the potential of gaining a financial return and the government of obtaining their desired social and/or environmental outcomes. In theory, it should be more cost-effective and increase the likelihood that public dollars will not be wasted on programs that do not work.

Impact investing is increasingly being looked at as a viable option for addressing major societal issues such as poverty reduction and foreign aid, and is already being used to address recidivism rates among offenders. However, too often, impact investing is considered to be a replacement for the funding of social programs, as opposed to being complimentary to them. Impact investing is not a panacea for social services; it may be an instrument to address certain issues, but other issues will continue to rely on traditional funding. For example, Dreams Come True is a nonprofit in Jacksonville, Florida dedicated to fulfilling the dreams of local terminally ill children. Dreams Come True will never reap economic benefits, nor will any impact measurements be able to justify any expenditure, because everything will be a sunk cost. Yet not a single person would say granting a child’s dying wish is a waste of money, or at least I would hope not.

Moreover, impact investing poses serious questions about our democratic structures. We elect our governments; each person, irrespective of their personal wealth, is worth one vote. We pay taxes throughout the year of which our elected government then, among other tasks, redistributes to maintain the “welfare state.” Impact investing introduces another voice into the democratic process. Instead of our elected government deciding where to redistribute our tax dollars, it hands the responsibility of the decision over to a private investor. Essentially, democratically unaccountable individuals will be making the decision of whether a social program is worth implementing, instead of policy analysts or experts in the field.

As there are no metrics in place (nor can there be in an absolute sense) as to what constitutes worth, it is fair to conclude profit will be at the forefront of worth by default, not necessarily impact. Instead of the government doing the due diligence on the effectiveness of a social program, with impact investing, it simply relies on wealthy persons to make that final decision now. There is also something fundamentally questionable about wealthy individuals being paid out with tax dollars, which ideally should be redistributed to those who need them most, and not those who can afford to buy risk from the government.

Thus, with the rising interest in, and potential reliance on, impact investing and the use of social impact bonds, it is imperative that we remind ourselves and our governments that there are reasons in place why we use tax dollars, and not the free market to finance certain programs. As we develop financial instruments to better utilize tax dollars, we must ensure we do not diminish our democratic rights or Canadian values in the process.

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