Published 28 September 2023 in Purpose • 11 min read • 
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First introduced in 2007 as a niche investment strategy for enterprising philanthropists and foundations, the field of “impact investing” has since transitioned into a much broader movement: the “impact economy”. In a world confronted with numerous and overlapping crises, the impact economy provides a holistic framework for how we create, exchange, and distribute value.Â
The impact economy envisions a future where impact investing is not just an option for niche players in the investment landscape, but a norm for the economy. In this future, investors would unleash more capital for social good, and entrepreneurs would build more innovative and scalable businesses that simultaneously match market demand and meet societal needs. Consumers would vote with their wallets for social businesses while governments and public agencies create more sustainable policies from the top down. Meanwhile, mainstream companies would look to accelerate fair, inclusive, and sustainable global value chains. Â
At its core, the impact economy aims to account for positive and negative externalities (the full costs and benefits) in all productive activities, with net positive impacts pursued in business and rewarded through trade, investment, taxation, and labor. Given estimates from the Global Footprint Network that the global economy is currently consuming resources at 1.75 times the Earth’s carrying capacity, these shifts in mindset and behavior are both pertinent and pressing. Â
To deliver on the promise of the impact economy, entrepreneurs, executives, investors, philanthropists, researchers, and other change agents are employing social innovations – in the form of new products, services, markets, models, and processes – to benefit society and address social and environmental needs more efficiently and effectively than current public policies and business activities. We will explore these themes in greater depth in the December issue of I by IMD, which will focus on the impact economy, impact investing, and social innovation.Â
Around the world, the impact economy is emerging through a dynamic and organic interchange of ideas, missions, mechanisms, strategies, and alliances. References to the Green New Deal, impact investing, social entrepreneurship, the circular economy, purpose-led business, ethical consumption, and civic wealth creation all represent approaches that feed into a broad intent to integrate economic activity with improved social and environmental outcomes.Â
This movement is emerging within a context of unprecedented and accelerating global change. Through just two data points – population growth and economic output – the scale and pace of recent human development is nothing less than an explosion by any geological or historical timescale, even calling for the introduction of a new geological epoch – the Anthropocene (i.e., the first time in history where humans have had a substantial impact on the planet).Â
While these developments have created immeasurable gains for humanity, they have also created negative spillovers, unintended consequences, and systemic risks that now undermine prospects for progress, safety, and well-being. Discourse in public media indicates growing political polarization, economic volatility, and societal unrest with the status quo. For example, the 2022 Edelman Trust Barometer revealed that 52% of people (across 27 countries) believe that capitalism, as it exists today, is doing more harm than good, and 81% stated that CEOs should be personally visible when discussing what their business has done to benefit society. Whether it is ongoing conflict in the Middle East or Russia’s invasion of Ukraine, migrant crises in Asia and Europe, climate-induced natural disasters, longstanding social ills such as poverty, water scarcity, gender inequality, and famine, or the more recent COVID-19 pandemic, grand challenges remain stubbornly persistent despite technological, economic, and social progress. Â
As a result, the prevailing paradigm of economic growth is being challenged. The interconnectedness of economic, social, and environmental systems calls for an end to the sole supremacy of economic indicators as a measure to human progress and well-being. Put simply, relying on GDP as a measure of human progress without considering a wider set of indicators is like running the world on a profit and loss statement without a balance sheet. Â
We are, therefore, at an important inflection point in the evolution of social innovation’s ability to deliver the impact economy. While the field of social innovation has shown tremendous growth over the past decade, many actors within the spectrum of capital are still sitting on the sidelines – interested in impact, but not yet allocating enough resources or investments. Â
Much of the discussion over the past decade has focused on understanding and measuring impact, and rightfully so. But a key challenge that has not received its fair due in the conversation, in our view, is how impact is managed by social innovators. Â
We believe now is the time for impact management to take center stage. Asset owners such as investors, banks, entrepreneurs, corporates, or family offices articulate and realize their impact objectives through impact management. That is, they identify what problems they want to solve, who they want to reach, where they want to invest, and what risks they want to take. Impact management requires asset owners to consider how they want to prototype, onboard, and create a pipeline of social innovation.Â
No organization can escape the need to transform to become more sustainable. The need to act is urgent. It calls for strong leadership, difficult decisions, and deep cultural change. In Issue XI, we explore how to build sustainable organizations to succeed in turbulent times.
One of the most interesting aspects of social innovation is the range of investment options available to actors throughout the impact economy. Innovative financial tools are emerging across the entire capital spectrum. As our illustration shows, between traditional investing and traditional philanthropy lie a myriad of alternative options to mobilize private capital for impact – from the reinvention of public contracting arrangements to increased efficiency and crowd-in private investors to the creation of financial products available to retail banking customers.  Â
Social innovators are creating entirely new markets that can attract private capital at scale. Many philanthropists have moved beyond providing one-off grants to non-profit organizations and begun to focus on identifying and funding nascent social innovators. The socially beneficial goods and services created through social innovation – be they improved value chains, solar panels, seeds, or medicines – are, after all, the “purpose” of businesses. Philanthropic impact investors also understand that profit is a condition – and result – of achieving purpose. Â
Understanding this is critical to the ability of impact investors to leverage their scarce capital with that of traditional market-rate investors. Philanthropic impact investing fills an important role in the lifecycle of social enterprises (organizations that pursue a social mission through commercial activities) by helping them overcome the pioneer gap and navigate the “death valley curve” – the perilous phase in enterprise development when negative cash flows from operations need to be funded. Â
Although philanthropic impact investing operates through an impact-first mentality, the creation of new markets also leads to attractive investment opportunities for investors with a finance-first mentality as they mature and scale. Â
At the other end of the spectrum, financial products that bring environmental, social, and governance (ESG) considerations into investment decisions are also being created. Three popular strategies include:Â
Negative screening (exclusionary and norms-based screening): exclude companies or sectors from the investment universe based on ESG concerns.Â
Positive screening (sustainability-themed, best-in-class, ESG integration): integrate the financial implications of ESG factors into research and analysis – weight fund toward holdings with higher ESG quality.Â
Active ownership (engagement and proxy voting): identify ESG as a lever for value creation. Pursue improvements in a company’s ESG performance by engaging with the board or management.Â
Relying on GDP as a measure of human progress without considering a wider set of indicators is like running the world on a profit and loss statement without a balance sheet.
Alongside investor demands, we believe societal demands will continue to put pressure on firms to develop sustainability strategies and, accordingly, encourage a process of business model transformation that can satisfy both owners and other stakeholders. This might be met in part through the scaling and mainstreaming of social enterprises. However, we also believe that corporate transformation will be a key piece of the puzzle. Firms that are able to successfully place purpose at the center of their strategy, along with committed leadership and the dedication of resources, have a leg up on the competition. Â
Despite the potential gains of corporate transformation, many firms have been sinking money into ineffective sustainability solutions for the better part of two decades. Solutions based on mobilizing public relations and recognition awards appear unlikely to move the needle if they are not backed by fundamental changes within the business model. In our view, recent social innovations like blended finance – the strategic use of development finance and philanthropic funds to mobilize private capital flows to emerging and frontier markets transactions – can speed up and de-risk this process and mobilize private capital at scale. Â
Blended finance creates positive, win-win ecosystems among private firms, civil society actors, and government institutions, as the total costs and risks of investments are syndicated across different institutions. They play to the strengths of each type of actor: private companies realize entrepreneurial opportunities for impact value creation, civil society organizations monitor the social/environmental impact, while public actors step in to offer financial guarantees. Such ecosystems can lead to effective impact creation while enjoying high levels of trust by societies. Â
Blended finance is still in the initial stages of experimentation, and it remains to be seen whether it can truly scale investments that will transform business models. However, the early signs are promising, particularly where organizations can identify and measure the externalities created in their value chains.Â
The world is rapidly becoming more complex and connected. How we think about the economy – productivity, value, markets, growth, and capital – requires an equally radical shift in mindset. Â
It’s up to us to determine the future that we want. To this end, we believe the impact economy helps to frame much of the progressive developments already underway and identify the issues that can be addressed by change agents across the spectrum of capital.Â
To see how private investors can help improve development outcomes, consider the world’s first “Humanitarian Impact Bond” (HIB). This innovative finance pilot was an experiment by the International Committee of Red Cross (ICRC) to engage the private sector differently and diversify funding – critical given the widening humanitarian aid gap. It was a massive undertaking.
Created by the ICRC in 2017, the HIB raised CHF26m ($29m) from private funders (New Re, Lombard Odier, and others) to build and run three new physical rehabilitation centers in conflict-affected parts of Africa (Nigeria, Mali, and Democratic Republic of Congo) over a five-year period, providing services for thousands of people injured by violent conflict, disease, or accident.
The HIB is based on the social impact bond model, which brings together outcome funders (donors such as governments, foundations, and corporations), service providers (NGOs, social enterprises, etc.), and social investors to pay for the delivery of social outcomes through “results-based financing” agreements.
At the end of the fifth year, outcome funders like the governments of Belgium, Switzerland, Italy, the UK, and the “la Caixa” Foundation paid the ICRC according to the results achieved. The results-based financing model (alternatively referred to as “pay-for-success”) only repays the outcome funders in full if the project meets pre-defined social objectives.
To this end, independent auditors verified the ICRC’s reported efficiency in the three new centers. The efficiency – the ratio of how many people receive mobility devices per physical rehabilitation professional – is compared to existing centers. If above the benchmark, ICRC pays back the private investors their initial investment plus an annual return (up to 7%). If the performance of the new centers is, however, below the benchmark, then the private investors will lose a certain amount of their initial investment (up to 40%).
Despite the challenges of COVID-19, military coups and ongoing violence, the ICRC centers were evaluated to be 9% more efficient than the benchmark center in terms of time management, staff members skills, management of stock and resources. The successful results of the project demonstrate the power of innovative financing schemes, like blended finance, to diversify and attract more stable year-on-year funding.
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