NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, January 27, 2015

The big debate during the 20th century was about the relationship between the market and the state. Both those institutions are now tarnished. The market is prone to devastating crashes and seems to be producing widening inequality. Government is gridlocked, sclerotic or captured by special interests. Government is an ever more rigid and ineffective tool to address market failures.

So over the past generation many of the most talented people on earth have tried to transform capitalism itself, to use the market to solve social problems. These are people with opposable minds: part profit-oriented and part purpose-oriented. They’ve created organizations that look a little like a business, a little like a social-service provider, and a little like a charity — or some mixture of the three.

Hippie companies like Ben & Jerry’s ice cream led the first wave in this sector, but now you’ve got a burgeoning array of social-capitalist tools to address problems — ranging from B Corporations like Warby Parker (which gives free glasses to the poor) to social impact bonds. (For example, a private investor raises money to finance a program to reduce recidivism. If the program works and the government saves money because there are fewer prisoners to house, then the government pays back the investor, with a profit.)

Impact investing is probably the most promising of these tools. Impact investing is not socially responsible investing. Socially responsible investing means avoiding certain companies, like tobacco growers. Impact investors seek out companies that are intentionally designed both to make a profit and provide a measurable and accountable social good. Impact funds are frequently willing to accept lower financial returns for the sake of doing good — say a 7 percent annual return compared with an 11 percent return. But some impact investors are seeking to deliver market-rate returns.

Brian Trelstad of Bridges Ventures, has looked at companies in early autism intervention, paid for by Medicaid, that can improve long-term educational outcomes while reducing spending on special education; affordable after-school enrichment programs that bring extra education services to charter school students; and energy efficiency companies that serve people in public housing, which saves long term heating costs.

When impact funds came on the scene, seven or so years ago, there was the usual overhyping. A 2010 report by the Rockefeller Foundation and JPMorgan projected that impact investing could see new capital inflows of up to $1 trillion by 2020. That’s looking unlikely given that right now roughly something like only $40 billion has been invested through these funds.