World Bank President Jim Yong Kim is putting policies to meet and combat climate change on top of the Bank’s agenda. That is extremely timely and has the potential to fundamentally revitalize the Bank, making it more relevant in today’s world.
Global finance for new clean energy projects is currently at $300-400 billion per year, of which the Bank funds about $10 billion. The International Energy Agency estimates that a minimum agenda, compatible with a two-degree temperature target, requires “green” energy investments of about $1 trillion per year. The Bank alone will only be able to provide a small portion of such additional finance.
A more important question is how to realize the potential for overall “green” finance from private markets. The pool from which such finance can be mobilized is huge – at least $100 trillion. The key is to engage as much as possible of this funding in “green” projects prioritized by the Bank.
The Bank can play an important role in this process. Considering this huge potential financing possibility, the Bank’s main role is arguably not in its own direct finance, but rather in facilitating the unlocking of funding from other sources. That requires two conditions, and the Bank can serve as a facilitator for both. One is that countries hosting projects must have an interest in, and put policies that support, the same agenda as the projects. These include promoting green growth, being concerned about greenhouse gas mitigation, encouraging and supporting a “clean” energy policy (such as not subsidizing fossil fuels), and promoting overall economic efficiency. Effectively, such policies and measures would push the prices of fossil energy above its production cost, making “clean” energy projects more competitive. The other condition, closely related to the first, is that countries targeted for climate finance cannot have policies that directly contradict the mission of “green” investments.
In this context, Fossil fuel subsidies are one policy that directly contradicts green investments. They represent “negative climate finance” in two ways. First, they boost the consumption of fossil fuels that mitigation or green policies seek to reduce. Second, they reduce, in a distortive way, the price ratio between fossils and other energy sources, making it far harder, and costlier, to implement renewable energy and energy efficiency projects.
To be blunt, when a country provides $10 billion in consumer subsidies to fossil fuels, and the Bank provides $1 billion to projects that aim to phase out fossil fuels, the overall “negative climate finance” balance is $9 billion. Roughly speaking, the same mitigation agenda could then have been achieved by the Bank dropping its financing, and the country reducing its fuel subsidies by $1 billion.
Regardless of climate concerns, fossil fuel subsidies serve few constructive purposes in the Bank’s client countries. Its impact (fiscally, environmentally, for economic efficiency; even for distribution) is largely harmful. These countries should, for their own sake, tax and not subsidize fossil fuels. Potential “green” investors would like to see the Bank help its clients perform a “judo trick” turnaround by reversing the fossil fuel subsidies, and instead put a positive price on carbon emissions, profoundly strengthening the profitability and market outlook for green investments.
One of the Bank’s main roles in this setting is working as a facilitator of the process to stimulate private finance to “green” projects in Bank client countries. This does not eliminate the Bank’s role as a direct provider of finance. But serving this facilitator role effectively would tremendously enhance the Bank’s overall impact on the global climate agenda.
A key question is how to actually do it. It is difficult to reform energy subsidy policies, and easy to give up. But recent developments could make the task less challenging:
- Phasing out energy subsidies has recently been widely analyzed and documented, with a sharper focus on policy impacts which are (almost) unambiguously harmful That has substantially expanded the basis for support to the phase-out of subsidies.
- The IMF is working on mapping externality costs of fossil fuels in member countries, adjusting its policy advice accordingly.
- Many governments recognize these inefficiencies, but often face resistance from interest groups. The Bank can serve as a counterweight and support good policy initiatives, sometimes through a renewed function of development policy lending -- another opportunity for Bank policy reform.
- The typical argument against energy subsidy reform is that the poor lose out when energy prices increase. The Bank needs to help clients compensate for their loss through direct cash transfers. Several countries ( a good example being Indonesia) have shown that this is possible, at the cost of only a fraction of the original energy subsidy. The Bank is already doing a great job in many countries, but this work needs to be scaled up.
Introducing a positive carbon price is even more difficult. The main driver of such a price must be to the countries’ own interest in doing so. The Bank must step up its work to categorize and measure the welfare and growth effects for its client countries, and integrate that effort with the Fund’s ongoing work. Some Bank clients, including China and South Africa, are already planning for a positive carbon price; this should be strongly supported. And many other clients should be vigorously encouraged to do the same.
The Bank must work on two related fronts. It needs to continue its traditional climate finance role, but it needs to focus more on its role as a catalyst for private finance. The key role here is as a facilitator of policy changes in client countries, necessary for major “green” private finance to materialize. Success would demonstrate the World Bank’s new role as a “solutions Bank.”