Private money, public good

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  • It's time to experiment with a new way of leveraging private capital to finance #highered—the social-impact bond.

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  • It's no secret that states / the federal government have found themselves in a financial pinch when it comes to #highered.

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  • How can social-impact bonds help #highered?

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It's no secret that states and the federal government have found themselves in a financial pinch when it comes to higher education. After years of recession and sluggish recovery, states have slashed per-pupil public spending on higher education by 14.6 percent since 2008. At the federal level, though money for Pell Grants has more than doubled since 2008, the program faces a shortfall of about $6-billion for 2014.

Meanwhile, projections from Georgetown University's Center on Education and the Workforce suggest that 63 percent of jobs will require postsecondary training (not just bachelor's degrees) in the coming decade. We will fall short of filling those positions by 300,000 people a year if current trends persist. Nearly half of U.S. businesses already complain that they can't fill job openings right now. We face the specter of an intractable "skills gap" that we don't have the public money to solve.

It's time to experiment with a new way of leveraging private capital to finance postsecondary education and training—the social-impact bond.

Private businesses now spend untold billions of dollars on what qualifies as postsecondary education, investing in tuition-reimbursement programs, on-the-job training, and professional-development programs at community colleges. But that spending, and the role of the private sector in education more generally, has been ad hoc and uncoordinated.

In its simplest form, a social-impact bond has three players: the government, private investors, and providers of a social program. Under a bond agreement issued by the government, private investors front the money to providers, who offer services designed to reduce the likelihood that those in the program will need additional government services in the future.

But unlike traditional state or municipal bond programs, the government repays investors only if the social program meets agreed-upon performance targets. If the program fails, the government pays nothing. And if it exceeds expectations, resulting in public savings, investors reap a return on their investment.

Social-impact bonds got their start in Peterborough prison in Cambridgeshire, England, in 2010. Peterborough suffered from a recidivism problem, with 60 percent of short-sentence inmates winding up back in prison after their release. The Ministry of Justice formed partnerships with 17 "social investors," who put up £5-million to finance a program aimed at easing the prisoners' re-entry to society. If the program decreases recidivism by 7.5 percent compared with similar prisons around Britain, the investors will receive their investment back plus a share of the savings that result from lower incarceration rates.

These bonds are now popping up around the United States, including a partnership between Goldman Sachs and New York City to decrease recidivism of young offenders in Riker's Island jail and new programs in Massachusetts to reduce homelessness and juvenile recidivism. President Obama has announced pilot "pay-for-success projects" at the Departments of Labor and Justice to achieve specific social-service outcomes.

What do such programs have to do with solving the skills gap?

It's time to experiment with a new way of leveraging private capital to finance higher education.

Local employers who need more skilled workers face a dilemma when it comes to investing in training employees. Directly subsidizing tuition for employees can help retain workers temporarily, but better-educated employees may also be more likely to defect and join competitors. Meanwhile, binding them to the company in return for postsecondary training raises legitimate concerns about "indentured servitude." Business-sponsored scholarship programs for prospective students present a similar problem: Competitors can get a "free ride" on those investments.

The social-impact bond mitigates those problems. It also provides local businesses with an additional avenue to shape postsecondary offerings to reflect labor-force needs.

Take work-force development programs as an example. The federal Workforce Investment Act finances job-training programs for unemployed and underemployed adults, dislocated workers, and at-risk youth. Federal funds flow to local work-force-investment boards appointed by local officials, and those boards dole the dollars out to select training programs. Because one of WIA's goals was to promote private-sector involvement in worker training, 50 percent of the appointed positions on the boards must come from the business community, with the rest drawn from labor unions, community organizations, and community colleges.

But this broad coalition comes at a price: A U.S. Department of Education report last year found that work-force investment boards are "frequently ineffective." The boards also provide individual businesses with little direct incentive to ensure that public money is well spent.

The logic of social-impact bonds lends itself to work-force training: Programs that successfully remove people from the unemployment rolls (or keep them off in the first place) save public money. Under such a model, local employers (or consortia of employers) could act as investors who form a direct partnership with a job-training provider and enter into a performance contract with the work-force investment board. The employer or employers would pay for the training program upfront and be reimbursed by the government (in the case of the Workforce Investment Act, by the board) if the program met certain performance targets, namely the sustained employment of trained workers. To the extent it surpassed expectations, the investors would earn a share of the money that was saved.

The Labor Department has announced a $20-million "pay for success" pilot project for 2013. But policy makers could go further, building flexibility into the Workforce Investment Act by allowing local investment boards to create social-impact bonds.

Let's go another step further. The logic of prevention could also apply to remediation. States and the federal government spend significant amounts of money on remedial courses for underprepared college students. These courses are not for credit, and a large percentage of remedial students fail to progress to credit-bearing coursework. A social-impact bond could open up space for partnerships between private-sector investors and education providers—public, nonprofit, or for-profit—to develop "preventive" programs that provide students the focused instruction they need to avoid remediation, preferably before they enter college.

States like California and Kentucky are already using early assessments to identify high-school students who are underprepared for college work and guide them toward pre-college help. Creating preventive programs financed with social-impact bonds could save public money by reducing the amount states spend on traditional, semester-long remedial courses. Under a bond agreement, investors would be reimbursed based on the number of students that successfully progressed to credit-bearing coursework after enrolling in a preventive program.

Thinking even more broadly, social-impact bonds could also finance early interventions that encourage disadvantaged students to raise their aspirations and get academically prepared for college. As the educational researchers Robert Kelchen and Sara Goldrick-Rab recently argued, financial-literacy instruction in middle school and high school, college savings accounts, and "promise programs" that provide early commitments of financial aid could help place students on the path to college. The costs here are upfront and the benefits long term, which makes such programs less attractive to shortsighted, budget-conscious policy makers. But investors with a longer horizon could reap a portion of the increased tax revenue that results from additional students benefiting from the wage premium that comes with a college education.

There are many other possible incarnations of social-impact bonds for higher education. In an era of declining public revenues and increasing expectations, harnessing new sources of private capital to programs with clear performance measures, like completion rates in credit-bearing courses or job-placement rates, may be one key to the continued economic success of the nation.

Andrew P. Kelly and Michael Q. McShane are research fellows in education-policy studies at the American Enterprise Institute.

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