Do Social Impact Bonds Work?


Ounce of Prevention, Pound of Cure

Governments spend a great deal of money and effort fixing things. They try to fix homelessness, fix poverty, fix crime. As any good mechanic will tell you, fixing things is expensive, and, as any good dentist will tell you, it is often cheaper to prevent problems than to try to fix them afterward.

Governments are not always good at implementing preventative measures. They are probably more risk averse than the private sector, and more likely to simply keep doing what they have done in the past. Preventative projects can be difficult and risky, and It may be more difficult to secure funding for these unproven projects.

This reticence is a bummer, because if these are genuinely good projects, they could both improve outcomes and reduce government costs. It is entirely possible that the cost savings would more than pay for the project.

If only someone else was willing to pay to try new programs.

How Do Social Impact Bonds Work?

A Social Impact Bond is an arrangement where investors fund programs designed to improve a societal outcome and save the government money. If this occurs, the government will reimburse the investors (often plus a bit) using a portion of the money it would have otherwise spent. Social Impact Bonds are linked with pay for success policies, but the two are not synonymous.

While there is no exact standard or formats for Social Impact Bonds, they typically have the following structure:

Investors who believe in a certain program provide money to fund it.

Program Operators take their money and use it run the program.

An Evaluator measures the outcomes of the program with respect to certain targets.

After the program The Government pays back the investors depending on how successful the program was at meeting pre-determined targets.  A more detailed illustration can be found here.


This is a picture of smiling children. It has nothing at all to do with Social Impact Bonds. When writing about anything having to do with social responsibility, pictures of smiling children, attractive landscapes, and water, are very important.


The British county of Essex has an issue with young people ending up in state care. This can get expensive, with costs running between £20,000 to £180,000 per person per year. In an attempt to reduce the number of young people entering state care to begin with, the county used a Social Impact Bond to fund a program that provides therapy for 380 individuals and their families. This therapy will help families better deal with some of the issues that lead children to end up in state care in the first place. The £3.1 million upfront cost of the program is being largely funded by social impact investors Bridges Ventures and Big Society Capital[1]. This money goes to[2] a group called Action for Children, which provides the actual therapy.

To determine what payments the investors receive, a comparison is made between those who have received treatment and a predetermined historical control group. For two and a half years after their referral into the program, each participant is tracked on a quarterly basis. The difference in observed days spent in care between the participants and the control group determines how much the government of Essex will pay to the Investors. As of fall 2016  82% of the 208 adolescents[3] who have received treatment remain with their families.[4]

Kent England Sky United Kingdom Landscape Scenic

This has nothing at all to do with Social Impact Bonds. But it is lovely.

Do Social Impact Bonds work?

Social Impact Bonds are new enough that this is a mostly unanswerable question.  Based on this report from SocialFinance, there are few Social Impact bonds that have been around long enough for payments to begin. Of the 22 early projects that SocialFinance reports on, 12 have made payments and 4 have fully repaid investor capital. This is a higher percentage than it might seem, as many of the projects are too new to be able to report results. Only one project, a project to reduce recidivism at Rikers island[5], has demonstrably failed to return value to its investors.

This appears to be a positive outcome. If very few social impact bonds pay out, then both the specific programs and Social Impact Bonds in general would fail. For Social Impact Bonds to work, there needs to be sufficient motivation for investors (even the socially minded ones who currently make up most of the Social Impact Bond investors) to invest. If Social Impact Bonds aren’t paying out, this source of funding will vanish. If social impact bonds are paying out, it means that they are achieving the measurable outcomes that they are designed to. If these outcomes are being achieved, the desired positive social change and associated cost savings, should be achieved as well.

Low Hanging Fruit

It may be that Social impact bonds are a deeply clever idea and there are lots of projects that provide opportunities for them to be used effectively. This would require many issues where early interventions can return cost savings down the road, and lots of places for social impact bonds to come in and make these interventions happen.

This might be true, especially in the early stages of Social Impact bonds. Many of the social impact bonds deal with similar issues such as homelessness or recidivism. If this is the case, Social Impact Bonds should be less successful as time goes on, as the easy improvements are all exhausted.

Not Enough Failure?

One of the motivations for social impact bonds is that they allow riskier, more unusual or innovative projects to be implemented. It seems only reasonable that many of these unproven projects should fail.

If they don’t fail, this is concerning. Some possible reasons for a lack of failure might be:

  • The riskiness of these projects has been vastly overestimated. This brings into doubt how the government and other institutions decide on what projects to undertake and the measures they use to evaluate risk.
  • Social Impact bonds are not driving risky innovative projects, but instead are only providing an alternative method to undertake relatively safe projects. This might mean that the projects are successful, but it seems like a key promise of Social Impact Bonds would be missing.
  • The measures of success of social impact bond funded projects are being artificially inflated. Even with third party evaluators and pre-determined metrics of success, most indicators can be manipulated. If money and success is on the line, the temptation to do what it takes to achieve this outcome will increase.


So far, It is not obvious what the failure rate should be, what is an appropriate rate of return for a social impact bond is, what sort of projects are best suited for them, and who are the appropriate partners, and how the answers to all these questions might vary across projects and issues.


Some water. This has nothing to do with Social Impact Bonds.

What Gets Funded?

Not every project is well suited to Social Impact Bond Funding. A necessary attribute for is to have a clearly measurable outcome.  There are many important issues for which this is not the case. Any program tackling a problem that cannot be easily quantified will not work for a Social Impact Bond.  If Social Impact Bonds work, they will funnel resources toward things that are measurable, and not necessarily the most important. Social Impact bonds will also lead to the funneling of resources toward the sort of projects that investors want to fund. This might channel resources toward projects that tackle very visible problems such as homelessness.

A Cautious Optimism

When I first heard about them (while researching this post) I thought they were super clever. I like the ‘you get what you pay for’ concept- if you pay someone to run a program that reduces recidivism, you’ll get a program. If you pay someone to reduce recidivism, you’ll get reduced recidivism. I also think the programs undertaken should be more innovative than traditional programs and possibly more effective for it.

As with nearly anything, there are issues and potential issues. Social Impact bonds only work in certain situations, but when used properly, they appear to be beneficial. One of the nice things about them, as an outsider, is that most of the risk is borne by the original investors.  I wish these investors the very best of luck in their investments. Maybe the rest of us will get something out of it as well.


Related Posts from PARTYSHEEPHATS

How should companies that operate private prisons get paid?

Sources, References, and Further Reading


Other Reading


[1] Due to a mostly fortuitous set of circumstances, there was a period of my life where I spent a great deal of time looking at Corporate Social Responsibility reports. These inevitably consisted largely of images of smiling children and attractive landscapes- all completely insufferable. The people who designed those reports appear to be well employed designing the websites for Social Impact investment firms.

[2] Via a SPV called Children’s Support Services Ltd

[3] I have No idea if that is a good number or not.

[4] For other examples of social impact bonds see Social Finance’s database of social impact bonds.

[5] Maybe a social impact bond to improve the Yelp rating would have been more successful.

How should companies that operate private prisons be paid?

Private Prisons

I am not a proponent of privatizing prisons. Since I am not yet in charge, there are private prisons in the United States. In 2010 there were just under 100,000 people incarcerated in private prisons in the US. (Although no longer for federal prisoners). There are also private prisons in other countries, both the UK and Australia have a higher percentage of their prisoners in private prisons than the US does.

Payment per Inmate

Private prison operators get paid by the government. This takes several forms, but is typically based on the number of prisoners that are incarcerated[1]. For a profit-minded business, the incentives are clear: maximize the number of people incarcerated while keeping costs as low as possible. These motivations can reduce overall costs of prisons[2]-which is why privatized prisons can be attractive to governments.

This often doesn’t work out too well for inmates, private prisons tend to have more issues with violence, overcrowding, and general unpleasantness. A 2016 DOJ report found that privately run federal prisons were 9 times more likely to place prisoners in solitary confinement, and had higher levels of prisoner complaints on issues like food and treatment by prison staff.

Paying per inmate creates three different perverse incentives for the prison management company. First, unlike most of us, the company would prefer a world which has as many people incarcerated as possible. Second, they are encouraged to keep costs as low as they can get away with. This isn’t necessarily bad, a true efficiency gain is a genuine improvement, but excessive cost cutting can contribute to the problems cited above. Lastly, private prisons have no incentive to keep prisoners from reoffending, and may even have an incentive for them to come back to the prison after they have been released.

Melaleuca, Peterbourough, and Doncaster

In a women’s prison in Australia called Melaleuca, the last point is being addressed. For each prisoner that doesn’t return within two years Sodexo (the company that runs the prison) will get AUS $ 15,000. This is supposed to get the company to provide programs and services to reduce recidivism.

The UK has piloted similar programs at two privately run prisons for about half a decade now. At one prison, Peterbourough, the project is conducted through a Social Impact Bond.[3] At another prison, HMP Doncaster, Prison management company Serco’s payments are partially dependent upon the reconviction rate of released prisoners. If the rate does not fall from 58% to 53% the government will get 10% of the value of the contract back, if it falls below 52% Serco will be entitled to additional payments.

One motivation behind these sorts of programs is that the government only needs to pay for programs that are successful in meeting a certain target. Programs that do not meet their goals do not cost the government anything. This should allow for attempting a greater variety of programs and policies. 

Did it work?

Despite somewhat positive early results, the most recent results out of the prisons were mixed. At Doncaster, the most recent cohort of released prisoners had a proven reoffending rate of 54.6% as this is greater than the 53% target, Serco must pay back part of the contract. At Peterborough, larger scale policy changes meant that the social impact bond could not be properly evaluated.

The success of the individual programs and policies used to reduce recidivism need to be evaluated separately from the general payment policies. Just because recidivism was not reduced does not mean that the pay for success program failed. It just means that the programs used to reduce recidivism were not as successful as hoped. Maintaining these sorts of payment schemes should encourage companies to experiment with different policies and ideas.


Careful What You Pay For

Having some payment based on reoffending is almost certainly an improvement over simply paying on a per prisoner basis, but it is not without risks. The advantage of any sort of metric based rewards system is that it encourages performance on a certain specific metric. The problem with these systems is that they encourage performance on a certain specific metric. Funders will get exactly what they pay for and very little else.

There are myriad examples of this happening: Food corporation Green Giant had a problem, customers kept finding bits of insects in their bags of frozen peas.  Presuming their customers were not fans of entomophagy, Green Giant management decided to institute a rewards system for workers who found insect parts. The employees started finding many insect parts, because they were bringing insects from home, just to ‘find’ them and claim the reward[4].

How to reduce reoffending (without doing any work)

Even without outright fraud, there are lots of ways for a company to meet a target without actually making improvements. Imagine a prison which exclusively makes money from rehabilitating prisoners. Pretend the prison management company gets paid $10,000 for every year a released prisoner goes without committing a crime, and that this is its only source of funding. The prison management company likely would do some of the following[5]:

  • Try to house inmates who are unlikely to commit crimes after their release. The most valuable inmates are the ones who are least likely to commit crimes in the future. Additionally, the prison will try to avoid those people who it deems more likely to commit crimes in the future.
  • Release a lot of prisoners. A prisoner in prison has no chance of making the prison any money, whatever the prison can do to get people out so they can not commit crimes, it will do.
  • Take In a lot of prisoners. To release as many as possible, the prison management company will need to get as many people into the prison as possible.
  • Provide services for those that can be cheaply helped. It might benefit the prison’s bottom line to fund programs that increase the likelihood of someone not reoffending in the future. They will not offer these programs for everyone, but just for the prisoners who they believe are worth the cost.
  • Release young prisoners. If a prisoner is released at 25 and lives a crime free life until they are 80, the company will get $550,000. A prisoner who is released at 60 and lives a crime free life until 80 is only worth $200,000 to the company. This means that younger prisoners are more likely to get whatever services the company can offer, and older prisoners are likely to be ignored.
  • Keep costs as low as possible. Presumably the prison would still need to house prisoners for the duration of their sentences. It would have no incentive to fund improvements, unless it thought these improvements would help recidivism.


Most of these depend on the particulars of the exact payment metric. A payment metric that paid out based on the percentage of released prisoners who reoffended, would not encourage prisons to take in and release as many prisoners as possible.

A single clear metric is very easy to manipulate. It is likely better to use a lot of metrics. Prison management companies could be paid based on how many prisoners they housed, how many went on to commit crimes, the number of violent incidents, the type of prisoners, and possibly dozens of other metrics. While this might be harder to manipulate, it is also harder to keep track of, and may be difficult to find the right balance of metrics and payments.

All payments are based on some sort of metric. Currently that metric is the number of prisoners incarcerated. In select prisons, such as Melaleuca, another metric involving recidivism has been added. While finding the perfect mix of metrics is somewhere between difficult and impossible, improving on the current system seems manageable. Certainly, it is worth trying.







References, Sources, and Further Reading





[1] In addition, many contracts provide a guaranteed income for the prison company regardless of how many prisoners they actually house.

[2] Although it is not clear if they actually do

[3] A social impact bond allows private parties to pay the upfront costs of a program, and the government only pays the investors if certain targets are met. Private parties buy into the social impact bond, the money from which is used to provide programs (mostly mentorship) to help short term prisoners not reoffend. If the reoffending rate does not drop by 7.5% The investors don’t get any money.


[5] Admittedly, I do not know what sort of control prison management companies have on decisions of release and who enters the prison. I would guess their roles in these things are largely indirect.


What is the Economy?


If you ever watch, read, or listen to something called “the news” you will likely hear people talking about “the economy.” People on the news might say that the economy is getting bigger or smaller, weaker or stronger. They might compare one economy to another, in rather the same way they compare the polling results of presidential candidates. Listening to all of this, one begins to see the economy as an almost living thing. Nor is it a particularly sensible one. It has spells where it gets all sluggish and depressed or irrationally exuberant. The whole thing can seem both random and distant, and you reasonably might wonder if you should care.


Usually when people talk about the economy they do so in terms of one of a few numbers. The most common one is Gross Domestic Product (GDP). GDP measures all of value of the final output produced in a place in a period of time.  If you add up all the goods and services produced in the United States and subtract the goods and services spent in their production, you get a number, in 2015 this number was just shy of 18 trillion dollars.

Fortunately, this is not a post about the GDP, so we don’t need to worry about how exactly this number is calculated, or how it could be calculated better, or what other numbers one might use instead. The important thing is what is attempting to be measured-the value of everything produced in a country. If you read most definitions of “economy” you will usually read something like this. The economy is the value of everything produced in a society, or the ability of a society to produce valuable things, or something like that.

While GDP and the economy are often talked about as being synonymous the GDP is only one measure of the economy.  A change in the methodology of calculating the GDP will change the GDP numbers, but does not change the real situation. Hopefully any methodological changes to GDP would bring it more in line with the real thing it is trying to measure.



We tend to talk about the economy as a singular thing. It isn’t.  It is better thought of as a summation and aggregation of many things. When you hear “the economy grew by .4% in the fourth quarter” you should not think about one vague thing changing, but many concrete things changing. There might have been more cars produced, less tax accounting done, and about the same amount of pies and cookies baked.  Since we can measure each of these things in terms of their dollar value, we can add them all up and come up with a sort of aggregate that we call ‘the economy’.


The Economy


No one, with the possible exception of some economists, should care about the economy in and of itself. That said, the economy does have an influence over things that most people do care about. The first is the wealth and livelihood of yourself and your friends and family. For this, nationally reported measures such as GDP growth or unemployment rates are likely to be mediocre indicators.  You should probably pay them some mind, but in the context of your own situation.  You likely already know what your own economy looks like. You know if it looks weak or strong, if your wealth is likely to increase or decrease. Depending on who you are, your own economy might follow the larger economy closely or not at all.

This is fine as far as you are concerned, but what about everybody else. What if you care about how everyone else in your society is doing?

If you care about the well-being of your fellow members of society, you will likely want to pay at least some attention to their economic and financial situations.  The aggregate of everyone’s individual economic situations is not vaguely correlated to the economy, it is the economy.

A desire to see how everyone is doing is why we started measuring the economy in the first place.  During The Great Depression, there was a sense that things weren’t working very well, but there was no way to really capture the whole of what was going on, to see if things were getting better or worse. In response to this the government started measuring National Income, which would later be replaced by Gross Domestic Product.

At a fundamental level, economic well-being tends to gives people choices, and a lack of wealth takes away choices. You should care about how the economy is doing, not because we like bigger numbers on our GDPs, but because we like more people to have more and better choices about how they live their lives.






In the future we likely going to need more things than we do today. There will be more of us, and we are going to be richer and consume more than our predecessors. It seems only reasonable that increased future demand should drive up commodity prices.

The earth is a finite system and contains finite resources. As time goes on, we extract the easiest and cheapest resources first leaving only the more difficult and expensive sources. Combining this with increased resource consumption and an increasing population and the argument for long run increases in prices becomes clear.

To aid in empiric ease and exactness I’ll look at copper and aluminum. These metals (especially copper) are sort of a barometer of global economic conditions and correlate strongly with economic growth. This makes them a good tool to examine the relationship between economic growth, resource demand, and commodity prices.

Copper Consumption

I did a Google Image Search for the term “Copper Consumption” this chart was the first result.


This is from the website of Canadian copper company AQM Copper[1]. The image shows the amount of copper demanded by the world between 1900 and 2007 as 608 Million tonnes. It estimates that over the next twenty-five years the world will use more copper than it has in the previous one-hundred and seven. AQM says that the surging demand is largely due to increases in urbanization and consumption in China.  Similar growth can be seen in Aluminum[2].

This has been the story with copper (along with other commodities). Those in the business of producing copper have been quick to cite growing demand from an increasingly wealthy Chinese population, with additional boosts from other emerging markets, as a driver of increased commodity demand. So far, the story has been true. This is a microcosm of the question asked at the top of this post. Increases in the standard of living are indeed driving increased demand.

Cyclical Price Changes

The fact that the world is likely to need more metals in the future is hardly a secret. This is exactly what commodity traders and producers are looking at when they are trying to figure out the future price of metals.  The people who are buying and selling metals are doing it with the full knowledge that consumption is increasing. They sell it at prices that they believe to be worthwhile after considering this information.

Despite increased demand, both aluminum and copper are worth about half of what they were five years ago. That’s a serious drop.  aluminum is about 40 percent cheaper than it was ten years ago, which is also a significant drop.

After the financial crisis, many investors rushed into various commodities. Driven partially by the idea of surging demand from emerging markets, and partially by the fact that every other investment class seemed really scary at the time. They sort of overdid it, and there was a surge in copper, gold, and other commodities. Prices collapsed, bringing us to the current situation. We are currently on the downward side of a commodities cycle. Copper and aluminum had their recent peak about five years ago, and have been dropping ever since[3].




Price increases will inspire increased production, substituting, and recycling. At higher prices projects that were not viable at lower prices become worthwhile.  For metals, this means mining more difficult to reach ore, as well as increased recycling and other methods of salvage.  All of these factors help to counter the very price increases that spawned them. Both copper and aluminum production has increased over recent years.


This is the economist’s basic response to this question. As something get more expensive, people have greater reason to find more of it, find alternatives, and conserve what that they already have.

If rising prices increase production, falling prices should reduce it. This is true, but there are costs to starting and stopping operations. Mines are very expensive. A large proportion of their costs are the upfront costs of construction, surveying, satisfying regulatory agencies, and all the other costs of building a mine. Once a project has begun operations, it is likely to keep producing even if the price drops significantly. Therefore, while high prices might be enough to inspire increased production, low prices may not be able to stifle It in the short term.  For the individual producer, the most profitable course of action during low prices might be to recoup as much of their investment as they can by producing as much as they can. These asymmetries help to create the pronounced cycles commonly seen in commodity prices.

Long Run Price Trends

Perhaps more importantly for the answer of this question is the long term trend of metal prices. Aluminum used to very expensive. It was considered a semiprecious metal in the late 1800s[4].


Both copper and aluminum prices fell during the first half of the 20th century. Since about 1950, the trend for Aluminum is down, and the trend for copper is mixed[5]CU LONG RUN




Several factors counter the long run rise of resource demand. Technological change, along with improvements in mining, leads to cheaper extraction of greater quantities. Metals, unlike other commodities such as corn or oil, stick around after being extracted. This allows for recycling, “urban mining” and selling scrap. The relationship between these forces and demand should determine long run price trends.

Just because the world will need more commodities in the future does not mean that those commodities will be more expensive now. Prices are determined by the intersection of supply and demand. Going forward, Technological improvement will make some commodities easier to produce, it will make others more important, and it may make others unnecessary. So far production has been able to keep up with demand, and current prices indicate that this trend is not expected to change in the near future.










[2] See the first chart in this article.

[3] Price charts from Obviously.


[5] The data for these four charts comes from the USGS  This data only goes through 2013, both AL and CU prices have fallen since then.

Who are the Self-Employed?

Who are the self-employed?

I thought this would be a pretty straightforward empirical question. It seems like the sort of question that has an actual answer. There are people who are self-employed, and those people have characteristics, and they are the sort of characteristics that researches would be interested in and would document. This is sort of true, but the answers are not as clear as I was hoping they would be. For one thing the material presented here is somewhat dated. I am pulling numbers from reports from 2010, and 2006. In any case, this should be a good starting point for some basic demographics regarding the self-employed.

Data and Definitions

Much of the data comes from this report which is a 2010 report using data from 2009. The report on duration of employment is older, published in 2006, uses National Longitudinal Survey of Youth (NLSY1979) Data using data that runs through 2002. With the rise of the “gig-economy” and the proliferation of startups, current trends in self-employment may be different than the data presented here.
People counted as self-employed are those who answered “self-employed” to the following question from the Current Population Survey .
“Last week, were you employed by government, by a private company, a nonprofit organization, or were you self-employed? ”
If they answer “government”, “private company”, nonprofit organization” they are counted as wage and salary workers.
The CPS goes on to ask “if this business in incorporated” if they answer yes, they get classified as incorporated self-employed, if no, they get classified as unincorporated self-employed. These two classifications have different demographics, and are probably best treated separately.

Demographics of the Self-Employed

In 2009 there were 15.3 million self-employed people in the United States, 9.8 million were unincorporated and 5.5 million were incorporated. A large clump of the self-employed in America are farmers, although the percentage has been declining, in 2009 just under 40% of the unincorporated self-employed worked in Agriculture.
In general, the self-employed are older, more likely to be white, more likely to be male, and better educated than the general workforce.


Both the Incorporated and Unincorporated self-employed are more heavily male, than the general workforce. This is especially true for the Incorporated self-employed.

The Self-employed are generally older than Wage and Salary workers. This is probably because it takes time and experience to acquire the resources and skills to go into business for yourself. In general, the Incorporated self-employed are older than the unincorporated, but there are relatively more unincorporated self-employed in the greater than 65 age group. The percentages displayed here are the percentages within the employment category, so the 10% for Wage and Salary workers at 20-24 years, means that 10% of the Wage and Salary workers are between 20-24 years .


The report[1] I am using about the duration of the self-employed uses NLSY data to give the following information regarding duration of self-employment.

In general spills of self-employment are short, with many people leaving self-employment after just one year. People who have been self-employed for a while are less likely to leave self-employed for Wage or Salary work. Economic conditions seem to influence self-employment, with more people leaving self-employment when economic conditions are better. This indicates that many people are self-employed because they can’t find satisfactory work in the general labor market.


The above graph is an estimation of the duration of the first self-employment spell for males over 21.  Due to censoring issues with longitudinal surveys like the NLSY It is a better estimate than the basic survey numbers. This should be interpreted as the odds that someone who has been self-employed for the duration on the x-axis rejoins the Wage and Salary labor force. So about 15% of people who have been self-employed for three years, cease being self-employed at that time.





[1] The Self Employment duration of young men over the business cycle, Ellen R. Rissman.


Regarding the fed’s recent decision to raise interest rates:


  • Why now and not before?
  • Is it enough to make a difference?
  • If it is, what difference, inside and outside US?


Before getting to the questions let’s take a look at the purpose and goal of the fed so we can look at some of the trade-offs they are dealing with. The fed has pretty much three goals:

“The Congress established the statutory objectives for monetary policy–maximum employment, stable prices, and moderate long-term interest rates–in the Federal Reserve Act.” 

The balancing act that the fed aims to achieve is to provide enough money to keep unemployment low, without creating too much inflation and losing control of prices. The fed does provide some guidance on what it considers to be appropriate levels of these indicators. For inflation the current target is 2%. Or in fed-speak:

“The FOMC noted in its statement that the Committee judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve’s statutory mandate.”

There is no exact target for unemployment. Estimates of the long run normal rate of unemployment among members of the FOMC range between 4.7 to 5.8 percent, however these estimates are clustered at the lower end of the range,  with the median value at 4.9. Ultimately, the Fed is looking for inflation to be around 2% and unemployment to be about 5%.  It is important to keep in mind that the fed looks to as long term goals. So just because the inflation rate is below 2% at the moment does not necessarily mean that the fed will not raise interest rates, if it predicts an increase in the inflation rate in the future.

 Why now and not before? 

For all of the quantitative tools and extensive analysis at their disposal, monetary policy remains an art not a science. The FOMC[1] meets eight times a year to decide if they want to change interests rates. Each time they meet they publish a brief press release regarding their decision. Comparing the two most recent statements will help give a sense of what changed.  Here is the one from the second most recent meeting in October of 2015.

It begins with an overall description of the current economic situation. 

“Information received since the Federal Open Market Committee met in September suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft.”

Then it starts talking about unemployment.

“The pace of job gains slowed and the unemployment rate held steady. Nonetheless, labor market indicators, on balance, show that underutilization of labor resources has diminished since early this year.”

Job growth slowed since their last meeting, and the unemployment rate did not change. However, things are better than they were at the beginning of the year. Since the unemployment rate did not decline, the fed sees evidence that they should carry on with their current policy.

“Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation moved slightly lower; survey-based measures of longer-term inflation expectations have remained stable.”

Again, no major changes. Inflation is below where the Fed would like it to be, so as far as the current situation is concerned there isn’t a huge need to change monetary policy to reduce inflation.

Then the fed talks about its expectations for the future. This is important. Monetary policy is not an instant tool, so the fed really needs to base its decisions on what it thinks inflation and unemployment are going to be down the road.

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring global economic and financial developments. Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.”


Even though currently unemployment is above the target and inflation is below, the Fed predicts that the labor market will gradually improve and that inflation will gradually rise.

Then the Fed goes on to make the call about not to change the federal funds rate.

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.”

 Contrasting this with the latest press release where they explain their decision to raise interest rates and what changed.

“Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.”

This is a stronger characterization of the economy than the previous month’s report, especially regarding changes in the labor market. Which, due to their mandate, is one of the things the Fed is most concerned with.

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent.”

This is where the FOMC makes the call to raise interest rates. They have been waiting for labor market conditions to improve to the point where they can raise interest rates without too much risk to the labor market. They believe that the labor market is now at that level.

“The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.”

Even though they did raise interest rates for the first time since 2006, they didn’t raise them very much and they remain very low by historical levels. Although there have been near-zero interest rates for several years now it is important to keep in mind that they are historically abnormal. Some people have characterized this decision as lifting up on the gas pedal a little bit instead of keeping it hard pressed to the floor.[2] This is probably not a bad way to think about the change the FOMC has made.

Because of the way these decisions are made, the impact of interests rates, the huge variety of indicators that need to be taken into account, as well as different political viewpoints, there will always be people who believe that the fed should have waited, or should have raised interest rates earlier. The timing of the federal reserve’s move is not something I have an opinion on.

  • Is it enough to make a difference?
  • If it is, what difference, inside and outside US?


A difference in what? Interest rates have an incredibly broad impact on the economy. I assure you that there will be something that is affected by this change. In the most basic terms, an increase in interest rates raises the costs of borrowing money, this should reduce economic growth, job growth, and most asset prices, along with a myriad of other impacts.

As far as international impacts go, US government debt serves as a reference point for the global economy, so fed interest rate decisions do have global impacts. One impact is a likely appreciate of the US dollar, which has its own global feedback effects.

That said, the changes from this particular raise are likely to be fairly minimal. This was a small change, and one that was expected by financial markets. Expectations matter when it comes to interest rate changes, and this change was already pretty much priced into financial markets.  It is important to remember that the fed will likely continue to increase rates going forward. This isn’t the end of anything, it’s a process that will continue. Most forecasts have interest rates rising to something like 1-2 percent in the next couple of years.  Predicting the global economy is a tricky thing to do, so I’m going to refrain from guessing at specific impacts of future rate increases.





[1] Federal Open Markets Committee. Bit of the Federal reserve that actually gets together to decide what interest rates should be.

[2] In general, I don’t like analogies that equate the economy to anything like an airplane or a car. The economy is not a thing, and is much more complicated and unpredictable than any airplane.


Does Big Pharma make unusually high profits from their high prices for patented drugs? If so, why hasn’t competition whittled them down?


Does Big Pharma make unusually high profits…


According to this article from Forbes. The U.S. industry with the highest profit margins is “Health Technology” with a projected average profit margin of 21%.  I’m not sure exactly which companies are included in “Health Technology” but it certainly includes Pfizer, Merck, and Johnson and Johnson.


Does Big Pharma make unusually high profits from their high prices for patented drugs?

They certainly make up a big chunk of revenue. In 2014 the Global Innovating Pharmaceutical Operating Segment, the bit of Pfizer that contains new and innovative drugs, make around $14B in revenue, or about 30% of Pfizer’s total revenue from Biopharmaceuticals, which make up the vast majority of the company’s revenue.

Revenue is not profit, but seeing how fervently Pharmaceutical companies protect their patents and look for ways to extend them, it is pretty obvious that they are an important part of their profits. For example, when Pfizer lost the patent to Lipitor in 2011, their total profit dropped by 19%.


If so, why hasn’t competition whittled them down?

The whole point of patents is to give companies a monopoly on certain products as an incentive to invent more of these products. So there is no direct competition on patented drugs. Once patents expire, the introduction of generics can cause massive price drops.

The other way for competition to eat away at profits, would be if market forces drove large drug companies to spend most of their income on investment, as opposed to taking profits.  I am not familiar with what drives these decisions: It could be that executives are looking to maximize short term share price via profits. It could be that there are diminishing marginal returns to investments in new drugs. Just because a drug company has a bunch of money to spend on developing new drugs, doesn’t mean that there are a bunch of profitable new drugs to develop. This might be especially true given how long it takes to develop a new drug.

Another possible hypothesis is that there isn’t that much competition among the major drug companies. In 2008 15 companies made about half the total global revenue for the industry[1]. Combine that with drug monopolies and high barriers to entry and you end up with something that is far from a situation of perfect competition.

In the long run, in a competitive industry profits should fall. The fact that they haven’t for the pharmaceutical industry is evidence that the competitive forces are not powerful enough.



What is a B corporation and what problem does it solve?

 In the simplest of terms, B Corporation is a corporation that has been given the ‘B Corporation’ certification by the B-Lab nonprofit organization.

What problem does it solve?

 Most corporations have a very simple goal: maximize shareholder value by maximizing profits. Indeed, under US corporate law, companies can be sued if they deviate from this goal. Due to the important role that business play in society, many people would like them to look at other things besides. This can take the form of ‘Corporate Social Responsibility’ or ‘triple bottom line’ type thinking. These approaches usually take the form of companies acting in a socially and environmentally responsible way, the triple bottom line is “social, environmental, and financial.”

Companies, realizing that consumers value purchasing responsible products have responded by marketing themselves as “Green” and “Socially Responsible.” The issue with this is when everyone is saying how responsible they are it is hard to tell who is being honest and who is just green washing.

The solution to is to provide some sort of certification process to verify which companies are actually acting in a responsible manner. There are already a number of certifications such as LEED Certified buildings, or fair trade certified coffee. However, these tend to be focused on a single issue. B-Lab tries to develop a broader certification that covers all aspects of responsible business.

In order to become a certified B-Corporation a company needs to do three things.

  • Change their company governing documents to include statements showing commitment to consider stakeholders[1] when making business decisions.
  • Have an Assessment done by B-Lab, to score the company. A company needs a score of 80 or greater to qualify to be a B-Corp.
  • Pay an annual fee ($500-$50,000+) depending on the size of the company.

The meat of this is the assessment. If the assessment gives a proper score that accurately reflects the true impact of the company then this could be a valuable tool, if it does not, it is no better than so much green packaging.

Not all companies are given the same assessment, instead assessments are varied depending on the type of industry, size of company, location of company and other factors.

I went ahead and filled out the basic survey for a company that I made up. Colorado based ABCcorp, which is in the hospitality business.  (I pretty much filled in the bubbles at random.) They asked questions about labor (how much people are paid, what benefits, how much more is the highest paid person paid, compared to the lowest. Community(questions about who the company works with, amount given to charity etc. Environmental( Questions about Recycling, Energy Use Emissions, Etc.)

At the end of this survey ABCcorp was given a score (it did above average on 12 things and below average on 26 things.)[2] If I wanted to actually get my company certified, I would have to engage in a longer assessment in which I would have to document everything I just said about ABCcorp. Presumably, the fact that my company does not exist would disqualify it. To complete the process, companies have to send documents to B-Lab and have to undergo a more detailed analysis. After they go through this process they are scored from 0-200, with a score of 80 being the minimum needed to obtain a certification as a B-Corp.


What does being a B-Certified company actually tell you about a company?

One thing it absolutely tells you is that this company wants to be a B-certified company. This means that they have an interest in being a socially and environmentally responsible company, or at least in looking like one, and they feel that it is worth putting some time and effort to do so. It also tells you that on a number of indicators related to various aspects of responsibility they perform well. For (some?) B-certified companies you can find reports that give more details on their scores. For Patagonia we see that they perform better than the Median company assessed by B-Lab on nearly every category.  Which is nice, but I couldn’t tell you exactly what that means.

Scoring companies on their social and environmental responsibility is always going to be really hard. All companies are different and have different strengths and weaknesses, different areas where they are impactful, and different problems. Any scoring system is a judgment call on how to value these things and will always be imperfect.

Ultimately, I think there is probably some value to something like B-Corps. If only that it tells consumers that these companies find it important to consider all stakeholders when making their decisions, and that another group of people seem to think that they are doing okay at actually carrying this out. I won’t be changing my shopping to purchase more B-company products, though. If you like the B-Corp produced flour you buy, I’d probably keep buying it.



[1] Stakeholders are all those involved in a business. It includes Customers, Workers, Owners, Suppliers, any anyone in the outside community that might be affected by the companies’ actions. Ex: people in the community who have to live with effects of pollution.

[2] Here at ABCcorp we are never average!