Minnesota may soon join Utah in using “social bonds” to fund early childhood education. Such bonds use money raised in private capital markets, as with building a new power plant or high school, to fund education or social programs.
The funders have a say in designing the program in question and the return on the bonds depends on measurable objectives being met. As with other state and local bonds, repayment of principal and additional variable performance rewards would have to come from tax revenues. The new initiative, the implementation of which is funded by a federal Department of Education grant, is an interesting test. But don’t get all excited about this being some sort of panacea that will solve all societal ills.
The difficult key economic issue here is that there are huge “information problems” in quantitatively measuring outcomes of educational or social service programs. Determination of causation in situations involving myriad variables is extremely difficult. So while there may be advantages to the approach, there are inherent drawbacks too.
Consider the positives first: “Social bonds” generically are promoted by those wary of large government and who are convinced that government entities inherently are less efficient in using resources to achieve ends than are private-sector organizations. This is a question of how incentives for efficiency are created in the absence of a profit motive.
To the extent that the private-sector issuers of a social bond can design and administer the program to solve a specific problem, the prospect of getting a higher reward if performance is good can motivate both innovative initial design and careful day-to-day management of the program. Society can really get greater results relative to resources expended.
However, for skeptics of government efficiency, the extent that design of the program is constrained by tight restrictions and to which implementation is performed by existing government personnel and offices, erodes incentives for innovation and good management.
The other often-identified advantage of social bonds is that they are a new source of funding for public programs that do not require, at least initially, higher taxes. Society can get the benefits of some program — such as better learning by children over many years because they had an effective pre-school program. But taxes don’t have to be raised to pay for the program’s operation. That money comes from the buyers of the bonds in private capital markets.
The bond principal has to be paid eventually, however, and the bond buyers must also get the performance-based compensation specified in the original agreement. This will depend on what levels are achieved relative to agreed-on measurement criteria.
So money from taxpayers is needed eventually. And, just as a state has to rebuild a certain number of road bridges every year, so will there be the need to fund such educational programs every year. Over the longer run, resorting to bond funding can smooth out year-to-year fluctuations, but does not reduce total tax collections needed.
Some advocates argue the using the bonds at first will motivate innovation, and any particularly effective new models developed could simply be adopted for longer term use by the existing bureaucracy. There won’t be any patenting of methods, but to the extent that is true, the smaller the incentive to attract private capital. If new innovations quickly become a free good, creating new methods is less motivated.
Advocates note that improved educational attainment resulting from the program will have concrete economic benefits in increased labor productivity. Greater output from a better-educated work force will mean that resources will be available to pay off bonds.
This is true, but if the same increase in educational attainment came from conventional early childhood programs funded through regular school budgets, there similarly would be greater economic output and hence income to pay taxes.
So the crucial question is whether such external funding through privately placed bonds will motivate design of more effective programs, to be administered more efficiently, resulting in more productive taxpayers in society than would come out of a purely taxpayer-funded government-run public education system. If this does not occur, over the long term, the exercise is largely a fiscal shell game that may become a negative-sum game for the public if the bondholders get profits to compensate for the use of their money and the risk incurred.
So that leads directly the negatives: Deciding on exact performance criteria on which payments will be made to the bondholders above and beyond return of their principal. It is harder to determine if and why students are performing better in subsequent years than to determine why a certain fraction of metal stampings or circuit boards fail quality control tests. If you are going to reward good performance then you need to be able to measure performance in light of many mitigating factors. That is not easy.
Measuring performance of students from similar programs that have been designed and administered by traditional government agencies is no easier. Over decades we have spent hundreds of billions of dollars on educational and social programs, the effects of which could not be measured well if we even tried. And the income of the few public employees who design and run traditional programs depend little on how effective their work was.
All this means that the bond-funded early education program already implemented in Salt Lake City and the one will be tried here may be promising experiments, but don’t expect a panacea. And extending the performance-based bond model to other social programs won’t be easy. It is much easier to establish and measure the results of pre-school education than of some program to reduce teen pregnancy, for example.
There is wariness on both sides. Goldman Sachs is putting up some of the money for the initial bonds. Mere mention of their name makes some on the left see a nefarious mechanism to wrest exorbitant profits from the plight of disadvantaged children. This is paranoia. At this point it is much more likely to represent a do-gooding corporate social responsibility effort than the opening of a lucrative new market. The fact that philanthropic entities like the Pritzger Family Foundation are needed at this point indicates that Wall Street does not yet view such bonds as a profit opportunity.
Minnesotans should welcome the new initiative with open minds. It is an opportunity to try out something that may be very valuable. But don’t expect economic miracles.