The government as venture capitalist

The American public's attitude toward government, especially toward the federal government, recalls a classic scene in Monty Python's "Life of Brian."

"What have they ever given us in return?" fulminates John Cleese, playing a Judean revolutionary. "The aqueduct," concedes a sheepish co-conspirator. "And sanitation," says a second, as others pipe up with more examples.

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"All right," Cleese erupts in exasperation. "But apart from the sanitation, the medicine, education, wine, public order, irrigation, roads, the fresh-water system, and public health, what have the Romans ever done for us?"

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The scene brilliantly captures America's cantankerous and contradictory zeitgeist. On one hand, public trust in government is at an all-time low. On the other hand, Americans are deeply frustrated with gaping holes in health care, education, equality of opportunity, infrastructure, and environmental protection – goods and services traditionally provided by government.

A reflection of this contradictory mindset is a surge in private activity to address social problems. These include billion-dollar efforts by non-profits like the Bill & Melinda Gates Foundation and Bloomberg Philanthropies to spur innovative solutions in education, public health, and poverty reduction. It is also reflected in social-enterprise start-ups designed to achieve both social and financial returns, as well as in new impact-investing platforms aimed at the growing number of investors who are also seeking both types of returns.

All of this is good news. The government's capacity to invest is under severe pressure. And, though many government programs deliver good value for money – Medicare is a good example – far too many do not.

Peter Schuck's new book Why Government Fails So Often provides a thoughtful if pessimistic analysis. Government agencies are always at risk of putting money into what Schuck calls "bad bets" and "bad apples." They are also inherently rigid, risk-averse, and reluctant to innovate, because they know that if they deviate from the letter of the law, or if an innovation goes awry, they will be chastised politically. And costly, ineffective programs are notorious for surviving indefinitely because they develop powerful defenders.

But blanket distrust in government, framed by glaring examples of boondoggles and fueled by ideology, too often focuses on the wrong question: How big should government be? The right question is how to develop innovative and efficient government programs to provide public goods and services that neither the marketplace nor the nonprofit sector can deliver on its own.

One approach is to put government in the role of venture capitalist. Its task would be less to design and implement top-down solutions than to solicit, support, evaluate, and scale up innovative strategies by tapping into ideas developed by state and local governments, businesses, and non-profit institutions. This can happen – indeed, in the US under President Barack Obama's leadership it is already happening – in many different ways.

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For example, the US Department of Education's Race to the Top Fund, which offered $4 billion in grants to states that developed successful educational reforms, spurred innovations that hold promise for school systems across the country. More broadly, prize competitions to reward targeted innovation and crowd-source new ideas offer a highly cost-effective opportunity for government to leverage its scarce resources for important public goals. The federal government now operates, an Internet platform to facilitate new competitions. Some 50 public agencies have sponsored more than 260 challenges since 2011.

After the 2010 Deepwater Horizon oil spill in the Gulf of Mexico, the Obama administration teamed up with the X-Prize Foundation to offer a $1.4 million prize to the group that produced the most efficient oil-recovery solution. The winning approach, from Elastec American Marine, was three times as efficient as the industry's previous best rate.

The United States' Affordable Care Act, which entered into force this year, contains further variants on the idea of government as a catalyst, including incentives to reward health-care systems that improve outcomes and reduce costs. The incentives have spurred a number of state-level experiments in Medicaid (America's health-insurance program for the poor) through waivers of the standard rules.

Likewise, the new federal Social Innovation Fund provides grants to social-sector intermediaries – foundations, non-profits, and social enterprises – that develop new programs to tackle problems like unequal educational opportunity. These grants are awarded on a competitive basis, and funding is contingent on achieving measurable outcomes.

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Some state and local governments are experimenting with new "pay-for-performance" contracts – sometimes called social impact bonds (SIBs) – to promote social innovation. In a SIB, the government contracts with an outside provider to achieve a measurable social goal (like reducing recidivism among juvenile offenders), private impact investors finance the program's upfront costs, and the government promises a return to them if the program's targets are achieved.

Recently, the Obama administration proposed a $300 million fund to catalyze federal pay-for-performance contracts. Several existing federal programs like the Community Reinvestment Act and the Small Business Investment Companies program are supporting the growth of impact investing funds. According to a recent study, impact investing in the US would not exist without the support of and partnership with the federal government through grants, loans, and guarantees.

Metrics are an essential feature of pay-for-performance contracts, and must be an essential feature of all government programs. This is mostly not the case today, but the situation is improving as the Obama administration links more of its spending to evidence of success, and as non-profit groups, like America Achieves, develop sophisticated new techniques to evaluate government programs.

With the government acting as a venture capitalist, the private sector can create effective new programs to address social problems. But scaling up these programs will require government resources. The Gates Foundation may devise breakthrough innovations for public schools; but, even with its billions of dollars, it lacks the resources to revitalize education at the national or even the state level. As former New York City Mayor Michael Bloomberg recently observed, philanthropists should test innovative policy ideas and then rely on government money to implement them widely.

Only governments can provide public goods and address social challenges on a national scale. But there are numerous ways in which governments can work with non-profits, investors, businesses, and citizens to find the best ways to achieve these goals – and thus restore public trust in government itself.

Commentary by Laura Tyson, a former chair of the US President's Council of Economic Advisers. She is also a professor at the Haas School of Business at the University of California, Berkeley, and a senior adviser at The Rock Creek Group. Follow her on Twitter @LauraDTyson.

Copyright: Project Syndicate, 2014.