Pay on Performance Bonds incentivize private-sector creativity in the performance of public goals. One of the first Pop bonds (also called social improvement or social impact bonds, SIBs) was pioneered by the British government and the UK group Social Finance. The UK Pop bond is designed to reduce prisoner re-conviction rates. Social Finance raised about $8 million from investors to fund a variety of programs for released prisoners, helping them to find work, stay off alcohol and drugs, reintegrate with society and so forth. The programs are managed by a group of non-profits. The UK government has agreed to pay the investors a return but only if reconviction rates are 7.5% less than those of a control group. If reconviction rates fall below the target level, the investors will earn a good rate of return, 7.5-13%, depending on how far rates fall below the control, but they could also lose everything if rates do not fall. The Pop bond issued in 2010 and appears to be going well although no (potential) bond payments are scheduled until 2014.
A Pop bond puts little risk on governments, who pay nothing if the program does not work but who save money if the program does work. With less at risk government should be willing to experiment more and try new approaches to problems. By contracting out, the government also eliminates a public bureaucracy resistant to change. Most importantly, a Pop bond encourages creativity and innovation in social programs. Investors in a Pop bond have an incentive to monitor the groups implementing the programs and to ensure that they choose the very best, most cost-effective programs. The better the program works, the more the investors earn. If Pop bonds expand it may even pay investors to undertake their own experiments to see how best to maximize their returns.
For Pop bonds to work it is critical that outcomes be measured and marked to an appropriate, randomized, control group. If not carefully monitored, the private sector will also excel at innovative and creative gaming at the public expense (see the comments for some suggestions).
More Pop bonds are being planned in the UK and the idea is also catching on in the United States. The Department of Justice and the Department of Labor both have pilot programs in the works and Massachusetts has issued a request for proposals. By the way, Pop bonds are said to be a new idea but the U.S. bounty hunter and bail bond system which works very well is a clear precursor as is the system of privateering.
Pop bonds have the potential to produce public goods with private innovation; they are an idea worth watching.