Catalyzing the
growth of the impact economy
PART II
Asset
allocators, such as foundations and pension
funds, would gradually progress from screening companies or sectors out of
their portfolios depending on whether they fail to meet specific thresholds for
social or environmental performance (a “no negatives” requirement) and toward
actively targeting companies that intend to help solve social and environmental
challenges (a “positive” or “positive offset” requirement).
Fund managers, responding to the needs and expectations of asset
allocators, would devote less time and effort to seeding and nurturing
early-stage impact models and more time to financing the expansion of
organizations with large-scale impact potential. Some fund managers would also
consider financing carve-outs and major transformations of organizations that
can have a disproportionate impact on social or environmental opportunities.
For fund managers, the ability to help impact enterprises scale up their activities
to a significant degree would become an enduring source of what might be called
“impact alpha”—social and environmental performance that consistently exceeds
industry benchmarks.
Social
entrepreneurs would undergo a radical change in
composition: away from the private-sector stars whom many investors and fund
managers now hope to attract into executive roles, and toward proven
“public-sector champions.” These are seasoned government officials and civil
servants who have firsthand experience dealing with environmental and social
problems that are rooted in market failures and therefore resistant to
market-based solutions. As executives and managers at social enterprises, these
public-sector champions not only commit to developing their own skills as leaders,
they also assemble capable teams to pursue major opportunities for both revenue
and impact, tapping into an expanding pool of millennials who are interested in
impact-economy careers.
Governments would make a significant change to their operating
model that sees them partner actively with private-sector organizations to
deliver social outcomes. Amid rising costs (government spending is more than
one-third of global GDP) and strained budgets (the global public-sector deficit
is nearly $4 trillion a year), governments’ longstanding approach to financing
and implementing public services appears increasingly unsustainable. In a
mature impact economy, governments would work with other stakeholders to
produce social outcomes that governments lack the capacity to deliver and to
boost the productivity of public spending on core services. This approach would
require policy makers and civil servants to first adopt the mind-set that
private-sector collaboration offers a means of increasing governments’
effectiveness. Governments will also need the ingenuity to finance the delivery
of social outcomes in a way that aligns the interests of private investors and
enterprises with the interests of citizens. That will mean reassigning their
most talented and creative people to engineer governments’ collaborations with
the private sector.
Just as
importantly, governments would enact public policies that favor the continued
development of the impact economy by providing incentives and reducing
uncertainty for investors, entrepreneurs, and other stakeholders about the
viability of the social sector. For example, the National Institution for
Transforming India (also known as NITI Aayog), a think-tank-style branch of
India’s government, has mapped the activities of various government ministries
against the SDGs and tracks the social outcomes they produce.
Social-sector
organizations would pursue fewer innovations in
cost containment and excellence in donor management, and more innovations in
scaling and excellence in outcomes. This would represent a significant shift
away from the risk-averse mode in which many social-sector organizations now
operate, by which they adhere to such practices as keeping employees’ salaries
low to avoid criticism for excessive spending on administrative activities.
Instead, social-sector organizations in an impact economy would increase their
spending in research and development or use part of their long-term endowment
to make impact investments. These approaches would embolden impact investors
and social entrepreneurs to invest more in their own institutional capabilities
and people.
Intermediaries would move beyond merely explaining how to use
various impact measures and instead compile and publish impact ratings in a new
role as independent rating agencies. This activity would create greater
transparency across the impact economy and reinforce demand for consistent,
reliable ratings among asset allocators, investors, impact organizations, and
policy makers. Highly rated agencies would be rewarded for their work and
interventions, such that they would receive more or lower-cost funds. Taking
this activity further, intermediaries might develop and administer
professional-certification programs for fund managers and other impact-economy
participants, thereby acting as gatekeepers for the impact economy.
Consumers would shift out of their relatively passive roles,
in which they have weak affiliations with organizations that support progress
toward positive environmental and social outcomes, and adopt patterns of
actively consuming goods and services from social enterprises and sustainable
brands. This shift would represent the closure of the so-called
attitude-behavior gap that separates consumers’ stated preferences from their
spending habits. Consumers would also help drive the development of an impact
economy by engaging in local communities and political systems and expressing
their views directly to institutions through traditional media, social media,
and other channels.
Media
organizations and analysts would
take a more sophisticated approach to appraising and documenting the impact
economy and its stakeholders. As the impact economy matures, media
organizations would have less need to publish stories about the market
distortions caused by traditional capitalism and could offer more stories about
the positive outcomes produced by social enterprises and sustainability-focused
enterprises. Top-tier media outlets would offer serious and high-profile
coverage of the impact economy, as they do for the rest of the business
world—think of an “Impact 500” business ranking that commands as much attention
as annual rankings of the largest companies, wealthiest individuals, and
fastest-growing businesses. Similarly, analysts in the financial and other
sectors would reexamine their assumptions and make a renewed effort to evaluate
impact-economy organizations on their merits and make their findings
understandable to mainstream audiences. For their part, impact-economy
stakeholders have an essential part to play in setting acceptable cultural and
behavioral norms, demystifying concepts such as impact investment, and
challenging the myths that surround these norms and concepts.
Redefining the impact
economy’s potential
Among
the impact-economy stakeholders we have interviewed or spoken with, there seems
to be general agreement on what a mature impact economy will look like. There
is also a broad consensus on this point: the impact economy will not reach
maturity until it develops policies, practices, and standards to govern the
social dimension of impact-related economic activities.
Such
norms are readily observed in mature sectors of the service economy such as
accounting and finance. For example, when mainstream investors estimate their
returns on potential deals and managers make choices for their businesses, they
can compare the financial aspects of their options according to common
accounting principles—norms that have taken the better part of a century to
develop. But when investors and managers come to evaluating the impact-related
aspects of their options, no such norms exist. And while impact investors are
supposed to maintain professional certifications and abide by regulations in
their roles as managers of other people’s money, no such norms pertain to
managing the social impact of their clients’ investment holdings.
Certain
other conditions, such as a limited flow of funding, also limit the growth of
the impact economy, although targeted government interventions could correct
these with relative ease. (For example, the UK government used funding from
dormant bank accounts and four large UK banks to provide seed capital to new
impact-investment managers.4 ) The lack of
norms governing the social dimension of impact investing, then, arguably stands
out as the most powerful constraint. As such norms are established, we
anticipate that the transition to an impact economy will accelerate and flows
of capital, talent, and knowledge will increase. Three activities can help
establish the norms that stakeholders say they need to devote more of their
time and resources to the impact economy.
Instituting
public policies that provide incentives and disincentives and create certainty
for stakeholders.
Governments
can consider instituting policies that would encourage impact investments and
the expansion of social enterprises. One such policy is incentives—for example,
tax deductions for social investments that are similar to tax deductions for
charitable donations. The United Kingdom has had this kind of tax-relief scheme
in place since 2014 and expanded it in 2017. Incentives would also help attract
wider interest in impact investments and stimulate the emergence of investment
products for retail investors.
Other
policy options include those that level the playing field for social
enterprises, such as regulations that permit nonprofit organizations to earn
revenues from the provision of services. Policy makers can also consider
additional ways of creating demand for enterprise-created social impact. New
approaches to contracting for public services could let government entities act
as “purchasers” of social outcomes that could be funded with social-impact
bonds or other impact investments.
Achieving
a broad commitment to mutually reinforcing operational, measurement, and reporting
norms for fund managers, social entrepreneurs, and impact-economy
intermediaries.
As in
other fields, professional requirements and standards for conduct would help
increase the quality and consistency of services provided by fund managers,
social entrepreneurs, and other impact-economy stakeholders, just as they do in
other fields. Industry associations could help by defining the competencies
that these professionals must possess and developing programs to test and
accredit those who wish to do business in the field.
Widely
accepted standards and norms are especially needed for measuring and reporting
impact. It is not uncommon for impact-fund managers to track social impact with
metrics taken from numerous sets of standards. In a survey of fund managers,
only 24 percent of respondents said they use a set of standard metrics across
all the investments in their portfolios.5 The
overwhelming majority select particular sets of metrics for each investment,
sector, impact, or customer-specific objective. Social enterprises, too, have
multiple sets of impact indicators to choose from. These disparate approaches
to measurement impose administrative burdens: asset owners must figure out how
to compare the effectiveness of fund managers that report impact in different
ways, and fund managers and social entrepreneurs must spend time studying
different sets of indicators and deciding how to apply them. A single set of
indicators, covering the many sectors, themes, and contexts in which impact can
be tracked, would alleviate this burden and help promote accountability and
transparency. One recent idea of this kind, proposed by the Global Steering
Group for Impact Investment, is that of “impact-weighted financial accounts,”
which use multipliers to estimate a company’s social impact based on ordinary
financial measures.
Creating
an industry body that promotes policies and standards of excellence and moves
all participants to adopt them.
Some
impact-economy constituents, particularly among asset managers and entrepreneurs,
are relatively new to the tasks of financing and creating social impact. It is
also apparent that these relative newcomers spend a lot of time developing the
systems and processes to operate impact-economy organizations. (Investors have
picked up on this; some have shared concerns that fund managers lack the skills
required to deliver social returns on investment.) Foundations and investors
have done a great deal to assist fund managers and entrepreneurs by setting up
organizations where they can exchange knowledge and ideas. A well-organized
industry body could now streamline the adoption of policies and standards by
acting as a clearinghouse for this kind of knowledge.
Given
the extent of the world’s social and environmental challenges, a major increase
in the scale and reach of the impact economy is urgently needed—and will be
hard to achieve. Investors, entrepreneurs, governments, and other stakeholders
will need to overcome their own practical constraints and prepare themselves to
assume new roles. These individual efforts will be complicated by the dynamics
of convincing multiple stakeholders to agree on the shifts that have to take
place and compelling them to work together rather than pursue individual
agendas. An essential first step will be to agree on a shared vision for the
impact economy, along the general lines proposed in this paper. With such a
vision in mind, impact-economy stakeholders can together start to carry out the
three main tasks described above and register initial successes that will
provide motivation for a continued, sustained effort. None of this will be
easy, but as the impact economy matures, it will bring new rewards to
stakeholders while enhancing the welfare of people worldwide.
By David Fine, Hugo Hickson, Vivek Pandit, and Philip Tuinenburg
https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/catalyzing-the-growth-of-the-impact-economy
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