The climate change finance problem

There are some dangerous misconceptions associated with climate change finance. This post is a continuation of earlier posts here, here, here, and here. 

One, there are very few trade-offs involved in the pursuit of development and climate change adaptation and mitigation. Two, reducing the flow of carbon emissions is more important than lowering the stock of accumulated carbon emissions. Three, there is sufficient financing available to meet the ambitious and expedited agenda on climate adaptation and mitigation. Four, there are trillions of dollars of private capital that are waiting to finance climate change interventions. Five, the few hundreds of billions of public finance is sufficient to de-risk and leverage the trillions of private capital required. Six, the private sector can play the lead role in climate adaptation and mitigation projects, and governments should merely derrick projects for the private sector. 

I have a co-authored paper coming out on this soon where these misconceptions are discussed in detail. In the meantime, in a recent issue The Economist discussed the challenges associated with climate change finance policies. The Economist captures the challenge succinctly

From the panels of Davos to the pages of newspapers, it is increasingly argued that no trade-off exists between the economic development of low- and middle-income countries and reducing their greenhouse-gas emissions. This is partly because much of the rich world has successfully made some cuts in emissions while continuing to grow, and its leaders want more of the same. But more crucially, it is because governments and development banks with limited budgets struggle to admit that not all their goals can be reconciled, and that they must therefore choose between them.

Yet choose they must, because the trade-off is in plain sight. Growth is the best way to lift people out of poverty and improve average living standards. But in the developing world, more growth still leads to more emissions. Researchers at the IMF have found that in 72 developing countries since 1990, a 1% rise in annual GDP was on average associated with a 0.7% rise in emissions. By 2030, fast-growing India and Indonesia alone will have increased their annual emissions by the equivalent of over 800m tonnes of carbon dioxide—an extra Germany’s-worth of greenhouse-gas belching. In other big emerging markets such as Brazil, Egypt and the Philippines, emissions are rising, too...

The need to spend money decarbonising big developing economies that already offer citizens reasonable services threatens aid budgets which help pay for things like vaccines and schooling in the poorest parts of Africa. Unlike Brazil or India, say, such nations are unlikely ever to contribute significantly to global emissions. They lose out, however, when foreign aid and loans come with green strings attached. As well as facing stingier health-care and education budgets, they might find scant funding for expanding a gas-powered electricity grid, even though nobody stands ready to pay for the far greater costs of converting it to a green one. African governments rightly resent being told to cut emissions rather than help people in desperate need—especially given that Westerners continue to belch carbon.

Another article puts the trade-off in very stark terms

Suppose, for a minute, that you are a finance minister in the developing world. At the end of a year in which your tax take has disappointed, you are just about out of money. You could plough what little remains into your health-care system: dollars spent by clinics help control infectious diseases, and there is not much that development experts believe to be a better use of cash. But you could also spend the money constructing an electrical grid that is able to handle a switch to clean energy. In the long run this will mean less pollution, more productive farmland and fewer floods. Which is a wiser use of the marginal dollar: alleviating acute poverty straight away or doing your country’s bit to stop baking the planet?

... “How do I justify to voters taking away subsidies, school funding and health care to build a waste-processing plant or a big sea wall?” asks a finance minister. “In 20 years of course it will be useful, but it is the cost now that is concerning.” He reckons that the cost of building a school in his capital city has doubled in the past decade, because of the need to make facilities green and resilient. “What about when we have to choose between hospitals treating lung disease and swapping to electric buses?”

The financing gap is massive

The Grantham Institute, a think-tank at the London School of Economics, estimates that at this point poor countries will need to spend $2.8trn a year in order to reduce emissions and protect their economies against climate change. The institute thinks these countries will also need to spend $3trn a year on sectors like health care and education to keep tackling poverty. This figure could rise... In 2019, the latest year for which reliable data are available, just $2.4trn went on climate and development combined. According to the Grantham Institute, rich countries and development banks will have to stump up at least $1trn of the annual shortfall (the rest should come directly from the private sector, and from developing countries themselves). In 2009 rich countries agreed to provide $100bn a year in fresh finance by 2020. They have missed the target every year since, reaching just $83bn in 2020—with much of the money coming from development banks. Excluding climate finance and spending on internal refugees, aid from OECD countries has been flat over the past decade... Across the board, damage from climate change makes development more expensive—and halting climate change makes it more affordable.

To reach net-zero emissions by 2050, the International Energy Agency, an official forecaster, reckons developing countries would have to spend at least $300bn on renewable grids until 2030, five times their current outgoings.

This sorely inadequate finance is itself very skewed in its allocation.

 

According to researchers at the IMF, some $357bn will need to flow to three big middle-income countries (India, Indonesia and South Africa) each year until 2030 in order to phase out their coal-power plants by 2050... In 2021 less than a quarter of grants and cheap loans from development outfits went to the poorest countries, down from almost a third a decade earlier. Eighty poor countries, including Nigeria and Pakistan, together received just $22bn in mitigation and adaptation aid in 2021. Last year bilateral aid to sub-Saharan Africa fell by 8%.

For low income countries, the priority should be poverty alleviation and subsistence, and as the graphic below shows, their contribution to climate change is tiny (a US refrigerator alone consumes multiples of energy more than the average Kenyan human).  

Clearly Africa needs several times more energy. And the kind of energy its economies can sustain is on the non-renewable traditional thermal and natural gas kinds. 

International Energy Agency (IEA) pointed out that if Africa is to provide universal electricity access by 2030 it would have to almost double its total generation capacity from 260 GW (currently 3% of the global total) to 510 GW. Renewables could provide 80% of the increase, it reckons. Achieving that would be a mammoth task... The IEA thinks that total capital spending on energy between 2026 and 2030 in Africa would have to be nearly twice what it was between 2016 and 2020. Investment in clean energy would need to rise six-fold... African public finances are in a woeful state. Twenty-two countries are in debt distress or at high risk of it, according to the IMF. Those considering turning to international capital markets are facing eye-watering borrowing costs... the cost of capital... can be up to seven times higher in Africa than in America and Europe... pension assets in the ten most developed African countries (a bit more than $300bn) are only slightly greater than those of the California state teachers’ pension fund... investors complain of a shortage of bankable African projects. Coal or gas plants are relatively cheap to build, as most of their lifetime costs come from buying fuel. Solar- or wind-power projects, by contrast, are cheap to run but expensive to build. 

But it's difficult to attract private investors into the electricity sector without addressing deep-rooted political economy and governance problems. 

More than half of power utilities in sub-Saharan Africa cannot cover their operating costs—let alone fund investments... Many do not maintain equipment, stop illegal connections or bill properly... Most African utilities do not charge tariffs that reflect costs. At root this is a political problem... it has been “politically expedient” for regulators to keep prices low... Other governments directly subsidise electricity tariffs. Removing subsidies entirely is not easy.

It's important to bear in mind that the developed countries are the most important contributors to climate change both in terms of their stock of carbon emissions and also in terms of their flow contribution.

Global temperatures depend on the stock of carbon in the atmosphere, not the current flow of emissions. On a per-person basis, the rich world has been disproportionately responsible for rising global temperatures and has more capacity to respond to them. Poor countries lack the resources to invest to cut emissions or adapt to climate change themselves. Yet relative to the size of their economies, they face the biggest costs.