Time to Rethink Climate Finance

In his speech to the UN General Assembly in September 2021, U.S. President Joe Biden pledged to double U.S. aid to developing nations for dealing with climate change to $11.4 billion per year by 2024. Chinese President Xi Jinping made a similar promise about green and low-carbon energy. More than a year later, however, neither leader has followed through: the U.S. Congress has yet to appropriate any additional climate-related funds for developing countries, and China has little to show for its clean energy push in poor countries. In fact, China’s oil-related financing and investments in the Belt and Road Initiative, its massive infrastructure investment scheme, more than doubled in 2021 from the previous year, while its green energy investments stayed about the same, according to analysts at Fudan University.

Around the world, governments, especially rich ones, are failing to follow through on their climate finance commitments. At the 2021 UN Climate Change Conference in Glasgow, government negotiators were forced to concede that they had failed to meet their goal of raising $100 billion in climate finance from public and private sources by 2020 and that they likely will not do so until 2023. Meanwhile, the Glasgow Financial Alliance for Net Zero, a coalition of private financial institutions that pledged to take rapid action to curb carbon emissions and move the global economy toward net zero, has begun to fall apart as members have balked at restricting financing for new fossil-fuel-based projects.

It is not just governments and private companies that are backing away from their climate commitments. At a public event in October 2022, World Bank President David Malpass refused to acknowledge that burning fossil fuels causes climate change, much less answer the question of whether addressing climate change is central to the mission of the world’s biggest development finance institution. According to the bank’s project database, it has invested $31.6 billion in renewable energy and $34.4 billion in electricity transmission and distribution since the Paris climate accord was adopted in 2015, but it has also invested $18.8 billion in oil and gas. It may be that some of these fossil fuel investments have enabled poverty reduction or enhanced energy access in developing countries, but the bank’s lack of a coherent strategy for the energy transition has sapped public trust.

Another brake on the energy transition has been rising and volatile energy prices and rapid inflation. Consumers have been hit hard not just in developing countries but in large economies such as the United States, where as many as 20 million people have fallen behind on their electricity bills. Crude oil prices started this year at $86 per barrel, shooting up to a high of $122 in June before falling back to $89 by October. More worrying as winter approaches, natural gas prices have more than doubled since the beginning of the year in Europe and the United States. In Asia, liquefied natural gas prices have also surged dramatically, calling into question the ability of countries such as Vietnam to execute planned shifts from coal to more climate-friendly gas.

Russia’s invasion of Ukraine not only accelerated these inflationary trends but has diverted the attention of world leaders (already distracted by the COVID-19 pandemic) from urgent climate mitigation and adaptation efforts. The United States has already committed $17.5 billion in military aid to Ukraine. Just two-thirds of that amount would have allowed Biden to honor his climate finance pledge to the developing world. The point is not that the United States should have left Ukraine to its own defenses, but rather that the war, along with many other factors, has caused governments, corporations, and development finance institutions to pull back from climate finance at exactly the moment when such spending is needed most.

As world leaders gather this week in the Egyptian Red Sea resort of Sharm el-Sheikh for this year’s UN Climate Change Conference, known as COP27, they confront a global effort to respond to climate change that is going off the rails. To get it back on track, they will need to do more than meet their climate finance pledges and encourage private actors to do the same. They will need to fundamentally overhaul the architecture of development finance, push all sources of capital in the developing world to embrace the goal of a low-carbon future, and realign national strategies around the need to achieve net-zero emissions and climate resilience.

HEADS IN THE SAND

Though it is not yet over, 2022 has already been a year of devastating climate crises. Pakistan continues to suffer from record flooding that covered a third of the country, affecting 33 million people and causing 1,500 premature deaths, including of 552 children. An initial estimate of the damage is at least $40 billion. In October, Nigeria also struggled to cope with massive flooding that displaced more than 1.4 million people, killed more than 600, and damaged or destroyed an estimated 440,000 hectares of farmland—which in turn will contribute to food scarcity. And China recorded its most severe heat wave and third-driest summer on record this year, both of which caused forest fires, crop losses, and hydroelectric electricity shortages.

Such catastrophes have become terrifyingly common, prompting developing countries to demand compensation for “loss and damage” from climate change that has overwhelmingly been caused by developed countries. A group of the most vulnerable countries, known as the V-20, is expected to launch a new insurance mechanism with G-7 countries at COP27 called the Global Shield Against Climate Risks. It establishes prearranged funds and subsidies for insurance to help at-risk societies cope with climate disasters. Such initiatives are laudable, but they will not be sufficient for all countries, some of which face the real possibility of being completely submerged by rising sea levels.

Rich countries are not immune to the effects of climate change, either. Hurricane Ian is just the latest extreme weather event in the United States, and it may turn out to be Florida’s costliest storm ever, with initial insured losses estimated at $47 billion. According to the National Oceanic and Atmospheric Administration, since 1980 the United States has experienced 338 weather and climate disasters that caused damages in excess of $1 billion (adjusted for inflation) for a total cost of more than $2.295 trillion. So far in 2022, the United States has experienced 15 climate disasters that exceed $1 billion in damages, including droughts, floods, severe storms, tropical cyclones, and wildfires that together killed 342 Americans.

The global effort to respond to climate change is going off the rails.

Despite these ever more costly manmade catastrophes, global emissions of greenhouse gases continue to rise. After a brief slump during the start of the pandemic, total fossil-fuel-based greenhouse gas emissions rose 5.3 percent in 2021, driven in part by increased coal capacity in China, India, Indonesia, and Japan. Fossil-fuel-based emissions increased in every major emitting country last year, with the largest growth coming from Brazil (11.0 percent) and India (10.5 percent), followed by France, Italy, Russia, and Turkey (all roughly 8 percent). In the United States and the European Union, emissions rose 6.5 percent. This pronounced rebound has demonstrated that the drastic global emissions reductions recorded in the early months of the pandemic were a short-term phenomenon.

And it is not just carbon emissions that have risen. Poverty rates have, too, especially in the developing world, making the challenge of shifting to clean energy even more daunting. According to the United Nations, COVID-19 has erased four years of progress in fighting poverty, and inflation is causing even more hardship. As many as 95 million people are projected to fall into extreme poverty (defined as living on less than $1.90 per day) in 2022. Nearly 90 million people in developing countries who had gained access to electricity can no longer afford to pay for their energy needs. In many countries, provision of basic services, such as heat and refrigeration, will inevitably take precedence over reducing carbon emissions.

NO JOKE

To jump-start the clean energy transition and avoid a tsunami of emissions from developing countries that are understandably more concerned about preventing their populations from sliding back into poverty than addressing climate change, the world leaders gathered at COP27 will need to do more than tinker around the edges of the problem. The previous goal of $100 billion in climate finance is almost laughable in the face of everyday climate disasters that routinely cause billions of dollars in damage. According to the International Monetary Fund (IMF), the true scale of the funding need for climate mitigation and adaptation is in the trillions, not the billions.

Climate negotiators at COP27 should adopt a “nationally determined” approach to climate finance: each country should consider the scale of the funding for climate mitigation and adaptation it can mobilize, for both domestic and international purposes. Some developing countries may be able to gather sufficient financing only for domestic needs. Others, such as China, that have previously made pledges to increase support for clean energy abroad may be able to do much more to support poorer countries. Such south-south cooperation could be transformative. And of course, industrialized countries must move beyond the unfulfilled $100 billion pledge made at the last summit and commit to new policies such as climate disclosure requirements for public companies that can mobilize much greater volumes of funding.

Previous rounds of climate negotiations have led to the establishment of climate finance funds with the mission of facilitating adaptation and mitigation. But all these funds are relatively small. The Green Climate Fund, for instance, has an initial capitalization of $10.3 billion in pledges, and the Adaptation Fund has current commitments of just over $1 billion. Both funds were established by governments party to the UN Framework Convention on Climate Change. These funds also take a painfully slow project-by-project approach, requiring burdensome application and approval processes (although the Adaptation Fund pioneered a more streamlined direct-access procedure). A better approach would be for development banks and agencies to proactively invest in projects in developing countries, thereby reducing the risk for commercial banks from which they could solicit cofinancing.

Negotiations at the G-7 and G-20 groupings have been no more successful at mobilizing climate finance, even though finance ministers participate in these negotiations (and not in climate negotiations such as COP27). To date, the G-7 and G-20 have been better at stopping the bad than at mobilizing the good. They have, for example, agreed to stop financing coal and to phase out subsidies for fossil fuels—although many nations have since gone back on these pledges in the wake of Russia’s invasion of Ukraine. The G-20 has been paralyzed by the war in Ukraine—both Russia and China are G-20 members—but it remains a potentially crucial negotiating forum for addressing climate finance needs.

RIPE FOR REFORM

A new agenda for climate finance should begin with reform of the major development finance institutions, including the World Bank and the IMF. Currently, these institutions are simply not putting sufficient funding into clean energy and climate change mitigation. They need to mobilize additional “green” capital for climate-related lending, and then they need to use it. (Even now, these institutions have the ability to lend much more than they do.) Doing so would help create a pipeline of climate-related projects that would appear less risky for bilateral finance organizations and the private sector.

The World Bank in particular must be overhauled. After Malpass’s ill-considered remarks, many shareholders—including the largest one, the United States—have called for far-reaching reform. In remarks to the IMF’s International Monetary and Financial Committee in October, U.S. Treasury Secretary Janet Yellen called on the World Bank to “explore areas of reform to its vision, incentives, operational approach, and financial model to better respond to global challenges” such as climate change. She requested that the bank’s management deliver a road map for reform for its executive board to consider by the end of 2022.

Developing countries are also calling for international finance institutions to be reformed to incorporate the promotion of global public good into their missions. The Bridgetown Agenda, led by Barbados Prime Minister Mia Mottley, for instance, calls for a new global mechanism for disbursing reconstruction grants to countries imperiled by a climate disaster and for the IMF to issue $500 billion in special drawing rights or other low-interest, long-term financial instruments to accelerate private investment in clean energy or climate-resilience measures. Such broad-based demands may offer a once-in-a-generation opportunity to modernize development finance institutions, a process that should be done in close consultation with the developing countries that will bear the brunt of global challenges such as climate change.

But more than reform of international finance institutions is needed. All sources of finance for developing countries—from private lenders to bilateral development agencies—must align their strategies around the goal of low-carbon growth. And then they must convert their strategies into action, balancing climate concerns against their existing mandates, whether those are to maximize returns or facilitate development. All investments must be consistent with a low-carbon, climate-resilient future. Such “climate proofing” of the finance industry has yet to take place, despite many ambitious promises and widespread understanding that all types of finance need to take into account climate risks and opportunities. As climate damages pile up, it is increasingly obvious that such measures make good economic sense as well. And, as China has already proved, clean energy industries can create jobs and spur economic activity.

Finally, developing countries must get their policy frameworks right. They need to develop, implement, and enforce climate policies that effectively channel domestic and international finance, public and private, toward solutions to their problems. In this endeavor, they will need support from developed countries, especially on best practices and customization of policies to suit local circumstances. The world’s advanced economies also need to improve their policies for steering public and private finance in a climate-friendly direction, whether through policies that create new markets or regulatory policies such as climate disclosure requirements that clarify the rules of the road. Half measures of the kind that previous climate summits have produced will not cut it. Only far-reaching reforms that unite national governments, private companies, and development finance corporations around the goals of broad-based economic development, net-zero emissions, and climate resilience can stave off catastrophe.