Opportunity for All and Social Innovation: Obama’s Policy Agenda

Laura D’Andrea Tyson is a professor at the Haas School of Business at the University of California, Berkeley, and headed the Council of Economic Advisers and the National Economic Council under President Bill Clinton. Jonathan Greenblatt is a special assistant to President Obama and director of the Office of Social Innovation and Civic Participation at the White House.

Updated, 3:07 p.m. | As Thomas Piketty reminds us in his new book, “Capital in the 21st Century,” we are living in an era of rising inequality of income and wealth and of eroding equality of opportunity. In the United States, income and wealth inequality have reached levels not seen since the 1920s. And both demographic trends and job-displacing technological change are aggravating the social and economic maladies rooted in widening inequality.

President Obama has set forth an ambitious agenda to expand opportunity for all Americans, including health care reform, investment in education, an expansion of the earned-income tax credit and an increase in the minimum wage. However, as a result of budgetary constraints, federal  government financing for nonmilitary discretionary programs — a category that includes most federal support for kindergarten through 12th grade and early childhood education, workforce development and training, and programs that benefit low-income, vulnerable populations — is on course to be lower in real terms than before the Great Recession and fall to a historic low as a share of gross domestic product.

As the government seeks to manage these severe fiscal pressures, improving the cost-effectiveness of government programs is also essential. That requires more evidence-based research on program performance and the reallocation of funds from less-effective programs to more effective ones. The Obama administration is doing both. At the same time, it is also using the leverage of federal government resources to strengthen incentives for the private sector to develop and expand new programs. And it is developing ways to support the nonprofits that increasingly are asked to deliver essential human services even as their resources fail to keep pace with growing demand.

In response to these challenges, President Obama created the White House Office of Social Innovation and Civic Participation in early 2009.  He recognized that to deliver on the promise of opportunity for all Americans, the government must identify and invest in innovative solutions to social challenges and work with the private sector — nonprofits, the business community and investors seeking both social and financial goals — to develop and finance these solutions. The office set out to bring different groups into the policy making process to determine which programs get the best bang for taxpayers’ bucks, to tap new resources and expand what works and to develop market-based models to sustain successful programs.

Among its first efforts to invest in what works, the office established the Social Innovation Fund. The fund embodies the administration’s approach to addressing escalating social challenges at a time of inadequate federal financing. It operates much like a fund of funds by working through intermediaries and as a partner to the private sector to amplify the impact of federal resources. The fund makes grants to social sector intermediaries like foundations, nonprofits and social enterprises on a competitive basis. It requires up to a three-to-one match of private money with government dollars.

The intermediaries in turn are responsible for investing in high-impact nonprofits that try to create and expand effective programs. Funding over the life of a grant in large part depends on the ability of the intermediary to expand, evaluate and improve these programs. This conditional approach is similar to that used by venture capitalists who invest in early rounds of a start-up, maintaining funding in further rounds only if the start-up grows and demonstrates success. To date, the fund has awarded over $175 million in grants, catalyzing more than $420 million in additional private philanthropic capital. More than 200 organizations have received money. The fund and its innovative financing model enjoy bipartisan support in the Senate, reflected in the fact that the 2014 omnibus budget increased resources for the fund to $70 million, the highest level in its five-year history, from $47 million.

While the fund focuses on building capacity and financing nonprofit interventions, the $1 billion Small Business Investment Company Impact Fund, created by the Small Business Administration in 2010, focuses on fostering new “impact investing” venture funds whose investors seek both financial and social returns. The Small Business Administration provides up to a two-to-one match to private capital raised by these funds to invest in new businesses in underserved communities and in priority areas like education and clean energy. So far, the small business fund has activated $176 million in investment toward a dozen companies in California and Michigan. Applications for new investment money are pending as private sector interest in this kind of investing is gaining momentum.

Consistent with the goal of investing in what works, the administration has also pioneered Pay for Success financing to promote and expand social innovation. In a Pay for Success contract, sometimes called a social impact bond, the government sets a specific measurable target for a program to address a particular social goal — for example, reducing recidivism among juvenile offenders or providing early childhood education for vulnerable populations — and attracts an investor to pay for the program. The investor does so, attracted by the promise of repayment of principal if the program meets the target and a higher return if the program exceeds the target. The investor gets no payback if the program fails to deliver results.

These contracts offer a win-win approach to their participants:  The nonprofit secures a new source of money for a program to address a social challenge; the investor can earn a return but bears the risk; and the government pays only for success. Moreover, payment by the government is intended to come from the savings generated by the program’s success.

In fall 2011, President Obama gathered state and city officials to brainstorm about the most promising applications of the pay for success model in the United States. Since then, nearly $50 million has been invested in these kinds of  transactions in Massachusetts, New York and Utah, and there is rising bipartisan interest in this model at all levels of government across the country.

At the federal level, the Obama administration proposed more than $80 million in its fiscal 2015 federal budget for these kinds of pilot programs in several federal agencies to encourage policy innovations in areas like juvenile justice, work force development and educational achievement.

More significantly, the administration has proposed a $300 million Pay for Success Incentive Fund to be housed in the Treasury Department. This fund is intended to catalyze initiatives by state and local governments with federal matching money for programs that improve outcomes for individuals and communities and also produce federal budget savings. This fund would also offer a credit-enhancement mechanism to reduce the risk of these transactions to state and local governments, nonprofits and investors. This is intended to encourage them to experiment with this approach and attract private capital for the upfront financing for such contracts.

The hope is that this fund could do for “outcome financing” what the Community Development Financial Institutions Fund did for community finance 20 years ago. At that time, poor communities lacked access to private capital from both nonprofit institutions and banks. Yet, by 2013, the C.D.F.I. Fund supported more than 800 such certified financial institutions that made over 24,000 loans and investments, totaling almost $2 billion. In aggregate, these institutions manage more than $50 billion in assets and provide loans to nonprofits and small businesses that serve low-income populations and communities. If the Pay for Success Incentive Fund had a similar impact, it would mobilize private capital to finance and expand effective social programs, with significant benefits for vulnerable populations, risk-taking investors and the general public.

The United States is not alone in seeking ways to use scarce public resources to join with the private sector to create and finance innovative programs to address social challenges. For example, Britain established a global Task Force on Social Impact Investing before the 2013 meeting of the Group of 8 industrialized countries in London. The United States is a member of the task force, which is expected to make recommendations this fall to advance impact investing. Such initiatives offer considerable promise at a time of constrained government budgets and rising inequality.