Innovating With Development Impact Bonds
In his 2015 State of the Union address, President Obama spoke of the importance of using the lesson of Ebola to “build a more effective global effort to prevent the spread of future pandemics, invest in smart development, and eradicate extreme poverty.” What if this “investment” he mentioned wasn’t just an off-the-cuff message about the need to do more? What if it referred to the hard-core investors we normally associate with Wall Street and expensive suits? What if the large companies where we do our banking, save for our retirement, and manage our investments could help fund this global effort – say through vaccinations for millions of people in developing nations – while also generating a profit?
The concept isn’t as radical as you might think, and in fact, pilots like these are cropping up throughout the world. The model is the Development Impact Bond (DIB). In the simplest terms, DIBs are a partnership between private sector investors, donor and host governments, and a local service provider (often a non-governmental organization, or NGO) to implement an economic development program. For example, let’s say the partnership is around improving girls’ education in a given African nation. The partners will sit down together and assess the available data on girls’ education (such as the proportion of girls educated and how long they stay in school); what the limitations are to their education (e.g., is there a lack of access to schools or teachers, or are there disincentives to go to school such as laboring in a family business?); and finally, what the partners would agree is a good outcome for girls’ education. Let’s say the group agrees that, given available evidence, a 20 percent improvement in the number of girls completing school sounds ambitious, but achievable.
The need for innovation in development funding
In previous years, donor agencies and organizations like USAID likely would have either directly implemented the girls’ education program themselves, or perhaps funded a local NGO or government body to run it. However, in recent years, donor agencies have faced a number of constraints, including limitations on foreign aid budgets and the political difficulties of selling expanded aid budgets to taxpayers who may feel the impact of aid has been too limited over the years. Donor agencies (not unlike other government departments working on domestic issues) have been pretty restricted in recent years. Yet, as President Obama points out, it’s more important than ever for us to invest in economic development programs. Inequality is at an all-time high. Lack of economic opportunity and livelihoods is feeding conflicts in several nations. Over the course of last year, Ebola rapidly spread in West Africa, claiming over 8,000 lives. Sadly, the list goes on.
In other words, we face persistent needs in developing economies, but a limited ability to pay for solutions. Perhaps the silver lining to these sorts of complex situations is that if there’s one thing we know about innovation, it’s that need and demand are its life source. As a result, we’re seeing a number of innovations emerge in the development space that seek to reduce poverty through new models and innovative sources of funding. DIBs are one of these innovations. The concept of DIBs is similar to Social Impact Bonds (sometimes called Pay for Success Bonds in the US) first launched in the UK in 2010 to reduce the proportion of prisoners who re- offend after being released from prison.
How Development Impact Bonds work
DIBs provide an up-front supply of capital from private investors to implement a specific project. This is helpful because it provides desperately needed funding much sooner than government-negotiated contracts tend to be able to provide it (if they even have funding available). That capital is given to a partner service provider to implement the program, such as a girls’ education program in our example above. If the girls’ education program achieves the agreed upon metric of a 20 percent improvement rate in the number of girls completing school, then the outcome funder (e.g., a donor government) will repay the private investors, with interest. Often, achievement metrics are tiered, so if the education program hits its target of 20 percent, investors might receive an eight percent interest rate. If, however, the program sees 25 percent more girls finish school, then the investors might receive 10 percent interest. Investors are only paid by the donor government if and when the project is successful. If it doesn’t work, the investors aren’t paid back.
You can see why the model is appealing to donors. Donors avoid the large chunk of risk that goes with paying upfront for development programs that may or may not be successful. It also means that donors can increasingly focus their attention on service providers and NGOs that have a track record of generating innovative and effective solutions to development challenges. Therein lies another reason innovation is key to the DIBs.
Throughout the life of the bond, the service provider is generally given flexibility to innovate around how the outcomes are achieved. The DIB partnership determines what will be achieved (e.g., a 20 percent improvement in education), but the service provider is encouraged to innovate and develop the most effective program to achieve that goal.
For investors, DIBs provide a mechanism to generate both a financial and social return on their investments. Smart, forward-thinking investors also see these investments as an opportunity to further expand into developing and emerging markets.
Development Impact Bonds in practice
DIB pilots are now rolling out across the globe. Perhaps one of the best known is the Global Alliance for Vaccines and Immunization (GAVI). Through its partner body, the International Finance Facility for Immunization, GAVI has raised over $5 billion from private investors, including names like JP Morgan, la Caixa Foundation, and Vodafone. An alliance of several donor nations including the United States, as well as the Bill and Melinda Gates Foundation, have committed over $6.3 billion to repay these investors if programs are successfully achieved. Since GAVI was launched in 2000, half a billion children have been vaccinated and over seven million lives saved from diseases like hepatitis B, measles, pneumococcal disease, rotavirus diarrhea, and yellow fever.
DIBs won’t be a silver bullet for poverty. In many cases, no matter how valuable the program, there won’t be a financial case to make an investment possible. Data and metrics around social issues can also be difficult to acquire in developing economies. However, the possibility of deploying alternative and innovative sources of finance to improve the health, education, and livelihoods of billions of people in poor economies is surely something we must continue to explore.