If social impact feels hard to measure, try thinking about externalities

I recently taught a class of business school students at the ESMT business school in Berlin. Trying to explain impact and how to measure it is not an easy challenge, although this is hardly news for anyone who has tried to do so, especially in the charity or impact enterprise sector when made to do so by funders. Students find two concepts particularly challenging.

The first of these is what can be considered social or ethical. We discussed examples such as a cooperatively-owned house of prostitution in Amsterdam, or a beer company that manufactures ales made from bread that would otherwise go to waste. Whether or not you consider these to be “social” depends on your belief system. You might find any form of alcohol immoral, and you might feel similarly about prostitution. This also veers into questions about absolute or relative truth, which are well outside the scope of this piece. These are big questions, but hard to resolve.

The second relates to the question of measuring impact. Even something as seemingly straightforward as assessing carbon dioxide emissions has difficulties. It relies on self-declarations and companies might not always be 100 per cent honest about things. Nor does the story end with carbon dioxide: what about sulphur dioxide, nitrous oxide, particulates and the host of other things floating about that account for air pollution? These relate to just one or two of the 17 UN sustainable development goals. And how am I to explain to students how they can compare emission reductions on the one hand with clean drinking water, or educational attainment in poor countries, or helping someone with disabilities to achieve independence? This is hard stuff, and our impact navigator, ClearlySo Atlas, which is based on the UN SDGs, takes a shot at doing some of this, with a solution focused on the needs of venture capital and private equity firms.

Rather than take the students through the complexities of impact assessment, I spoke with them about externalities. Any student who has taken economics classes is fully aware of these. They are what are passed on to society as an unintended consequence of the main thing an organisation does, and they can be positive or negative. Firms involved in chemical manufacturing do not wish to pollute; it’s just an unfortunate by-product of the manufacturing process. Large banks did not want to threaten the world’s financial system in 2008; it is just an unfortunate and undesirable (and undesired) effect of what they try to do, which is structure deals, trade securities and pay themselves well. Whatever you think of banks, nobody employed by them actually wished to cause the world’s taxpayers’ harm by what they did. It was an externality.

Many of the businesses ClearlySo helps generate positive externalities. Some relate to their primary activity – JustGiving, for example, which facilitates charitable donations – or are secondary, as with HCT, which is a bus company that also helps disabled people learn how to travel independently with public transport. Some are even unintentional.

Society foots the bill for the negative externalities generated, as in the crash of 2008 or as a result of pollution. Governments are recognising this and working to “internalise” externalities through taxes or charges. My view is that they should also reward companies that generate positive externalities.

In any event, impact is closely related to the externalities generated by organisations. The money saved by exchequers when firms generate positive externalities – the thesis behind the innovation called the social impact bond – or the cost to society in fixing the impact of negative externalities, is one way of thinking about impact and how to measure it. At the very least, my students seemed to get it when I used this explanation.

This blog first appeared on Third Sector on 04 September 2017.