To create lasting change, we must shift our economies to create positive outcomes. Our current economic system is self-defeating. Left unregulated, modern capitalism creates substantial social and environmental problems. Governments try to fix these problems by taxing everyone, while investors and companies focus only on making more money.
This has not served us well so far, but impact changes everything. It transforms the private sector from a polluter and a driver of inequality into a powerful force for good. By optimizing risk-return–impact, entrepreneurs and companies create new products and services that improve lives and our planet. And given the scale of the social and environmental challenges facing us today, governments need businesses to play a central role in developing new solutions. It is the way we will transition to impact economies, where decisions regarding consumption and investment are based on risk-return–impact.
Transitioning to an actual impact economy will represent a fundamental change in how our economies work—a shift from seeing business and investment as purely about profit to understanding that they are necessary to bring about the solutions we need. The private sector must do its part by creating innovative new solutions, and governments need to embrace new ways of tackling big problems.
How Impact Investment Can Help
Governments have the responsibility and the power to initiate real change. They realize that economic growth has not provided the solutions we hoped for—that our communities need more than just an increase in the average standard of living. Those who have been left behind by growing prosperity are most often unable to escape their difficult circumstances, which they sometimes find themselves in from birth. If you are born into a family with unemployed parents who have a drug habit, there is a high chance that you will end up trapped in the same cycle.
Poverty, under-education, unemployment, an aging population, and environmental destruction are just some of the big challenges we face. Despite their efforts, governments have failed to find the necessary solutions, mainly because risky investment, innovation, and even the occasional failure are not in their nature. This is why it is now crucial to drive impact investment forward.
In recent weeks, everything we have discussed has shown that impact positively disrupts the prevailing models of entrepreneurship, investment, big business, and philanthropy. It also brings several transformational forces to help governments solve bigger problems faster:
1.) It brings the measurement of social outcomes achieved by government spending, making government more transparent, accountable and effective.
2.) It harnesses private capital and entrepreneurship in much the same way as the Tech Revolution did to stimulate innovation in tackling social and environmental issues. In so doing, it unites investors, charitable organizations, businesses, philanthropists and governments in the drive to solve big problems.
3.) It introduces pay-for-outcomes approaches to public service procurement and attracts philanthropists to contribute through Outcome Funds and private investors to provide the upfront money needed through SIB and DIB funds. This ensures that government money is spent effectively because government only pays for outcomes that have been achieved.
4.) It can access money that is public money but not tax money, such as unclaimed assets in banks, insurance companies and investment funds. This money can be used to develop a strong sector of impact investment managers who provide start-up and growth capital to charitable organizations and purpose-driven businesses.
Shifting the mindset of government procurement from prescribing services in detail to paying for outcomes achieved through SIBs will drive the use of pay-for-outcomes approaches and create a thriving outcomes market for the first time. Our best chance of finding urgent solutions is for governments to encourage the development of impact investment in all its forms, pay-for-outcomes models and impact measurement by companies and investors.
In this way, governments can accelerate the transition to risk-return–impact economies. They are best positioned to catalyze rapid growth in impact investment, just as they did for venture capital in the late 1970s. In 1979, the US made an amendment to the Employee Retirement Income Security Act (ERISA), which resulted in a dramatic increase in the supply of available capital that company pension funds could invest in venture funds.
Before this, they had been severely limited in how much they could allocate to high-risk assets, including venture capital. After 1979, pension fund commitments to venture capital rose dramatically, from $100–200 million a year during the 1970s to more than $4 billion each year by the end of the 1980s. This critical change in regulation combined with the reduction of capital gains tax to 28 percent in 1978 and 20 percent in 1981 boosted venture capital, which has since grown to become about a trillion-dollar global pool.
The role of government in creating systemic change is crucial. Governments have actively shaped and developed markets, and they can stimulate their growth in clear ways. Join me next time as we begin to explore nine key actions governments need to take to embrace the impact market today. Until then, read more about how we can transform capitalism in my book, IMPACT: Reshaping Capitalism to Drive Real Change.