Rethinking climate finance for the developing world

Kenneth Rogoff June 30, 2023 08:55

Speaking to the Financial Times at the June 22-23 Summit for a New Global Financing Pact in Paris, Kenyan President William Ruto called for the establishment of a “global green bank” that would assist developing countries in mitigating the effects of climate change without further exacerbating their already-unsustainable debt levels. This thoughtful and important proposal is one that rich countries must consider if they are serious about tackling climate change, fostering peace, and promoting prosperity in Africa and the rest of the developing world.

Until recently, developing economies’ only bargaining chips were their abundant natural resources and cheap labor. But climate change has enhanced low-income countries’ bargaining power and altered the dynamics of North-South relations. Developing countries are no longer willing to be bullied into taking on massive debt to finance green development, especially when cheaper alternatives are available.

Affluent countries’ ongoing efforts to persuade low-income countries to assign a higher value to the global commons than they themselves have done are doomed to fail. Although incentives have aligned in some cases, aided by the falling costs of solar and wind energy, developing economies often find it far more cost-effective to follow in the footsteps of advanced economies and rely on fossil-fuel technologies.

The war in Ukraine has laid bare the developed world’s hypocrisy. For years, developed countries have advised developing economies against using fossil fuels, routinely denying them development loans for gas and oil projects, particularly when intended for domestic consumption. But since the Russian invasion, European leaders have been pressing African countries to ramp up gas production so that it could be converted to liquefied natural gas and shipped to Europe. Germany has even reopened its coal-fired power plants. Moreover, European households and businesses have been granted the same kind of massive energy-consumption subsidies for which African countries were lambasted in, for example, the International Energy Agency’s 2022 annual report.

While European governments view these actions as a justified response to extraordinary circumstances, developing countries where electricity rationing is the norm – even during peacetime – find this hard to swallow. The United States, for its part, is not doing much better. When gasoline prices soared following the outbreak of the Ukraine war, US President Joe Biden similarly assured American consumers that he would do everything in his power to bring prices back down. Biden even pleaded with Saudi Arabia to pump more oil, despite his administration’s previously adversarial approach toward the country and its leader, Crown Prince Mohammed bin Salman.

Besides Ruto’s proposal for a green bank, other observers have suggested alternative approaches to providing developing countries with the financing they need to complete the clean-energy transition. For example, one proposal advocated by several prominent commentators calls for reducing foreign investors’ exposure to exchange-rate risk in developing economies.

But this proposal is misguided. Given that a large part of exchange-rate risk is rooted in sovereign risk, it cannot be eliminated through financial engineering alone. The main threat to exchange rates, after all, is the strong incentive for cash-strapped governments to inflate away debt. Subsidizing a huge increase in debt in developing countries is not a solution to global warming but a recipe for another debt crisis. Climate financing for low-income countries must prioritize grants over loans.

While the Bretton Woods institutions serve an important purpose, their financial and governance structures, as well as their existing resources, are inadequate. The International Monetary Fund and the World Bank primarily provide loans, not the outright grants that developing countries need. Moreover, these institutions’ governance mechanisms are designed to favor the interests of wealthy lender countries. To persuade developing economies to join the fight against climate change, they must be given a greater role in formulating global policy. The proposed funding must also be massive.

Another solution I have advocated in recent years is the establishment of a World Carbon Bank to support technology transfers, provide unbiased country reports on issues related to global warming (for example, monitoring carbon-credit schemes), and facilitate large-scale aid financing. In a recent paper, I proposed funding this new institution through ten-year irrevocable bond donations. But aviation and transport taxes, as proposed by Ruto, are an alternative that might be explored.

To be effective, the World Carbon Bank would need to focus exclusively on the green transition. Ideally, it should be structured in a way that gives it significant independence, which is one reason why a bond endowment from rich countries represents an attractive financing option.

While agencies such as the US International Development Finance Corporation have initiated some climate projects, their scale falls short of what is needed to address global warming. In general, developed economies have not come close to meeting their existing climate-financing commitments, and they do not appear particularly enthusiastic about facilitating additional transfers. Moreover, the prospect of former US President Donald Trump – a climate-change denier – retaking the White House in 2024 raises concerns about the feasibility of any meaningful solution. (Then again, it is worth noting that prior to 1972, few would have foreseen the fervent anti-communist Richard Nixon’s visit to China.)

For far too long, rich countries have lectured developing economies about climate change while failing to heed their own advice. Hopefully, innovative proposals such as Ruto’s global green bank idea could foster a more constructive, equitable debate.

Copyright: Project Syndicate

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Kenneth Rogoff

Professor of Economics and Public Policy, Harvard University. He was formerly chief economist at the IMF.