Policymakers in developed countries are increasingly looking to leverage private sector funds to finance climate action in developing nations, filling the gap left by tight government budgets and a lack of political focus on climate change in the United States and other major emitting countries.
The numbers are striking. In the analysis we conducted with the World Resources Institute (WRI) and the Overseas Development Institute, we found that the United States’ climate finance is increasingly coming from America’s two business-oriented foreign investment agencies: the Overseas Private Investment Corporation (OPIC) and the Export-Import Bank of the United States (Ex-Im). In 2010, only 20% of U.S. climate finance came from these agencies (which don’t rely on taxpayer dollars), but by 2012 they were spending almost half. Almost all the loans, loan guarantees, and insurance policies issued by OPIC and Ex-Im fund clean energy projects in developing countries.
Globally, the picture is similar. In 2011, companies based in developed countries spent close to $13 billion in support of climate projects in developing nations, surpassing climate-related official development assistance by about half a billion dollars. And there is no doubt that private capital will figure heavily in the coming years as developed countries scramble to demonstrate that they have met their pledge to provide $100 billion in financial assistance to developing nations to address climate change.
Given the current budgetary issues and a lack of focus on climate change in many developed country governments, it’s going to be challenging to get to the $100 billion with or without private sector finance. But what’s even more daunting is that $100 billion is nowhere near the size needed to meet the challenge. Experts estimate that truly comprehensive action on climate will require $700 billion per year of additional climate-related investment in developing countries, and greening another $5 trillion of infrastructure investment per year to 2020. Even if we maintain the current 50-50 split of public-private investment as we reach $100 billion in 2020, and even if every dime of $50 billion in public money leveraged private sector investment (unlikely), a 14:1 leverage ratio would be needed to meet the challenge — substantially higher than the possibly inflated ratios typical of development finance instruments.
So how can the world meet this urgent financing challenge when huge investments are needed and governments can’t come close either through public investment or by leveraging private sector investment through typical development finance? What will generate sufficient private sector investment?
Government policy that steers climate-smart investments without additional taxpayer outlays is the only possible answer. Below, we sketch out scenarios in the clean energy, forest, and agriculture sectors for getting to the $700 billion annually the world needs.
- Clean Energy: Private finance is likely to gravitate to profit-making opportunities in the clean energy sector. Particularly with the right policies in place, it is easy to imagine unlocking the estimated $7 trillion, or 11% of global GDP, spent annually worldwide on infrastructure investment toward clean alternatives. Channeling these existing expenditures through smart policies — including economic signals (e.g. putting a price on carbon), performance standards (e.g. Energy Star, renewable energy standards) and research and development — will help the world achieve more than 80% of the needed greenhouse gas mitigation by 2030 to keep the planet on a 450 ppm trajectory. Bottom line, policy signals will be key to ensuring that private flows bring clean energy to bear in the market.
- Adaptation: Companies’ daily business operations and bottom lines are likely to be affected by the impacts of climate change, so rationally one would expect the private sector to invest in adaptive actions. Yet uncertainty about climate impacts, short time horizons, and the public goods nature of some of these investments, may mean that companies underinvest relative to the social optimum. Governments can use policy levers to encourage greater levels of private sector financed adaptation in the developing world than companies otherwise would using a range of policies. These include regulations requiring adaptation, public-private partnerships that mitigate near-term investment risks, and seed funding for research and development climate infrastructure.
- Deforestation: The majority of deforestation is caused by private sector investment already — primarily through expansion of commercial scale agriculture for just a few key commodities. Government policies can help flip these investments from causing to preventing deforestation. For example, governments should do their part to help create demand for deforestation free commodities through policies such as procurement standards, forest-friendly trade agreements, and banning the importation of commodities grown on illegally cleared lands. Governments can also help the private sector create deforestation-free commodity supplies by reforming land-use policies and reducing the hurdles to expanding agriculture production onto severely degraded lands rather than forests. And finally, governments can establish policies that create transparency in commodity trading markets, so that companies and consumers alike can easily tell whether the products they buy were produced without deforestation.
Admittedly, it is not terribly insightful to recognize that meeting climate mitigation and adaptation goals will require new policies. But lately, it seems the climate finance discussion has been too divorced from the climate policy discussion. Ultimately, climate finance will only materialize at scale when climate policies do.
Note: A version of this article appeared on Climate Progress.
The U.S. Contribution to Fast-Start Finance: FY12 UPDATE
In a new fact sheet with World Resources Institute and the Overseas Development Institute, Climate Advisers’ managing directors Abigail Jones and Michael Wolosin breakdown U.S. climate finance numbers over the Fast Start Finance period.