Insights from the Department for Digital, Culture, Media & Sport - Pauli Platek, Senior Policy Advisor, Social Impact Investing
There are a few different reasons why policy makers use subsidies. It could be when markets aren’t operating well, or well enough, by themselves (market failure). Or, it could be to support a government objective (levelling up), or during times of crisis (Covid-19). In the context of social impact investment, they are generally used for one of two reasons. The first is to make the financial equation stack up for investments which have very high risk and/or low returns, but a high social benefit. The second is to stimulate the growth of a market which aligns with government objectives and creates social, economic, or environmental value.
A recently published report, commissioned by the Department for Digital, Culture, Media & Sport (DCMS) and delivered by the Impact Investing Institute and Big Society Capital, entitled ‘Bridging Capital into Communities’ takes a closer look at the effectiveness of different types of subsidies in achieving these goals. These subsidies would all fall under Big Society Capital’s definition of ‘blended finance’.
…and why subsidy for social impact investment?
The case for supporting the social impact investment sector has always been clear to the UK Government. This type of investment supports the growth, resilience and sustainability of civil society organisations, spurs social innovation, delivers a huge amount of social impact (particularly in disadvantaged areas) and encourages finite grant making to go to where it’s needed most.
Since the early beginnings in the 2000s, the UK Government has used pretty much every tool in the policy maker’s toolbox to catalyse this sector. Starting with capitalising big investment funds (Bridges Ventures Social Entrepreneurs’ Fund) and granting investment capital (Futurebuilders England), moving on to setting up new means of sustainable funding for the sector’s development (Dormant Assets) and creating new tax reliefs (Community Investment Tax Relief and Social Investment Tax Relief). More recently the UK Government has provided or unlocked grant for blended finance and technical assistance (Access Foundation), as well as making guarantee schemes more accessible to impactful businesses (Recovery Loan Scheme).
Not all subsidies were created equal
The length of this list highlights that there are many ways to stimulate a market, and experience tells us they don’t all work equally well. Impact measurement and evaluation is crucial to drawing out lessons, but it hasn’t been easy to compare the effectiveness of certain policy levers against others, partly due to their sheer versatility. Each programme or scheme was implemented at a different time, with different aims, on a different scale, using a range of different support systems, partners, durations and tools.
The Bridging Capital into Communities report is the first attempt at a comparative study on this. It describes and evaluates the three most common types of subsidy - grants (for use in blended finance), guarantees and tax reliefs - in achieving a series of policy objectives.
Importantly, the objectives don’t stop at leveraging private capital. This is a crucial part of the puzzle, but just as vital is the fit of that capital for organisations receiving it, as well as issues around accessibility, reach, equity, sustainability and investor participation. The report considers the use of each subsidy type against all of these factors.
Different subsidy serves different priorities
The overarching conclusion of the report is that different subsidy types work best for different priorities - as is often the case, there is no one-size-fits-all approach. The effectiveness of each is also largely determined by design choices, with a lot of variation within each subsidy type. The tools were found to complement one another, multiplying their benefits where they can be layered together to create more accessible, targeted, and effective products.
Grants used for blended finance were found to excel at leveraging capital, with a strong track record for providing tailored investment for small and early-stage businesses, which would otherwise not be available. In addition, unlocking additional investment capital particularly from mission-driven investors. Grants are the subsidy type which are the most versatile in itself, but also creates the most flexible and tailored products for the enterprises. Over time this type of subsidy has been shown to reduce grant dependency, as well as having strong potential to reach marginalised communities. The main downside is that they are wholly dependent on sustained injections of grant funding which, right now, doesn't have a long-term source.
Guarantees were found to be the most efficient at de-risking investments and mobilising private capital at scale towards charities, social enterprises, and impactful SMEs. They work especially well in counteracting economic volatility, as was seen throughout the Covid-19 pandemic. During this time, guarantee schemes became more accessible to social investors than ever before, e.g. through the Resilience and Recovery Loan Fund. Guarantees don’t have as strong an evidence base for reaching underserved people and communities, serving marginalised groups, although some examples of innovative good practice are emerging.
Tax Reliefs are perhaps the subsidy type which is the most dependent on the design, purpose, and execution of individual schemes. It is also the subsidy type which has the most obvious opportunity to engage with the individual investor as a source of capital. While the potential is there for tax reliefs to support this sector, past track record has been varied, with Community Investment Tax Relief seeing this potential realised but Social Investment Tax Relief lagging behind.