How Can We Untie the Climate-Development Gordian Knot?

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The participation of developing countries is essential for effective climate policy. But this participation is hampered by the fact that many developing countries perceive environmental policies as a new form of Malthusianism. And unfortunately, despite repeated references to sustainable development in the climate negotiations, the debates about climate and development policies continue to occur in separate spheres. A new Gordian knot has been tied through a succession of misunderstandings.

Economists may have caused some of these misunderstandings by laying out simple principles that are useful as a introduction to the underlying economic parameters of climate policies: first, a unique carbon price (through carbon taxes or a cap & trade system) to foster carbon saving behaviours without distorting international competition; second, compensatory transfers to offset the adverse impact of higher energy prices for the most affected countries. But this has resulted in climate policies being considered a cost-minimization exercise conducted regardless of the nature of development issues.

In developing economies, the efficacy of carbon prices will be undermined by incomplete markets, and noises from many other signals (including the political markets). Their adverse effects—on   the real income of households and the production costs of the energy-intensive industry necessary for an industrial take-off—will be greater than in the OECD. A 50$/tCO2 would double the price of cement in India, thus making decent housing less accessible for low and middle-income families. It is unlikely that OECD countries will consent to compensation for such large impacts during a financial crisis and a major rebalancing of the world economic power. The order of magnitude at stake is obviously far higher than the $15 billion a year over ten years proposed by the European Commission. This represents 0.08% of the European GDP and would result into a 31G$ transfer if retained by the EU Member States and all OECD countries.

But time is short. Emerging countries will build the bulk of their infrastructure in a few decades. There is, then, a narrow window of opportunity to help them to shift towards alternative paths by mobilizing upfront investments in alternative infrastructure, fostering the penetration of efficient end-use equipment, reforming their pricing systems (energy, transports, real estates, land) and setting up climate-friendly fiscal systems to respond to increasing demands for some form of social security. A failure to mobilize the needed financing will mean that developing countries will proceed much further along largely irreversible carbon-intensive development paths.

Adopting a low carbon development path is the right way forward – but it does entail surmounting daunting political and financial obstacles. Yet nothing concrete has been tabled yet in the ongoing discussion on climate architecture that could help developing countries to remove these obstacles.  Consensual rules to allocate emissions quotas will not emerge for a while.  And carbon prices are unlikely to be enough to motivate the upfront financing for carbon saving infrastructure. 

The World Development Report 2010 estimates that $265 – $565 billion a year has to be invested by 2030 to allow developing countries to shift towards low carbon development paths. This is the financing need, not the net cost, since some of these investments will, at least in part, “pay for themselves”.  Bridging the gap between this range and the $31 billion I mentioned earlier implies that a leveraging effect is a financing architecture challenge, but it is manageable.

 The financing challenge is one of  direction of savings, including private and local public finance, in a context where emerging countries are capital exporters and some rich countries capital importers. Let us be clear: we are not faced with a problem of global capital shortage.  Thus it is both possible and necessary to have a global financial architecture that includes risk-management and risk-sharing mechanisms to reorient capital flows at a scale unprecedented for any environmental policy. The time has come to move from a climate-centric view in these matters, and to link the reform of the financial system to the decarbonisation imperative.  That is the only way to propose a palatable (and real) deal to developing countries.

Currently, OECD governments socialize “bad debts” to secure interbank loans. What, you may ask do we get in exchange? The modern financial system relies on the commerce of promises¹. In this system, speculative bubbles have some virtue for the real economy as long as they do not burst before a new bubble takes over. The challenge is to back the system against something more solid. The best experts in finance and money should think about how a social value of carbon could help reconcile the need for long-term funding on low-carbon infrastructure projects with the usual fears and requirements of lenders.

This social value of carbon could serve as a reference price to lower the risk premium in concessionary loans, in risk coverage mechanisms, and in an international re-insurance fund. It could also create attractive assets to collect household savings in bonds or liquid deposit accounts dedicated to carbon saving investments, such as assets that assemble large pools of projects and are backed on the social value of carbon. Ultimately, this social value could be utilized by Central Banks of the OECD countries, maybe with New Special Drawing Rights at a reformed IMF, to interest banks in granting more credits to the carbon savings projects and policies. The finance sleight-of-hand that created today’s woes could then paradoxically be of help for shaping financial architectures grounded on this value, which are much needed to untie the Gordian knot that binds climate and development.  

A proposal in this direction by OECD countries could dispel the existing feeling of distrust surrounding climate negotiations, accelerate the willingness of developing countries to take serious commitments, lower investment risks, and, by the same token, shorten the duration of what Paul Krugman calls depression economics.

 

 

^[1] I borrow this expression from the title of a book published by Pierre-Nôel Giraud on the past transformation of the world economy: “le Commerce des Promesses” (P.N. Giraud, Le Seuil, 2001)