Global financial leaders are convening for the World Bank’s spring meetings this week. Amid much talk of reform, our focus must be on the most vulnerable when aligning development and climate action. The food, fuel, finance and fever (pandemic) crises all impact the poor disproportionately. A just green transition must rest on four pillars of finance, technology, people, and partnerships, which are embedded in several G20 working groups and the agenda items put forward by India’s presidency. For sustainable development, however, we must solve three market failures and three political failures.
The biggest market failure is the lack of insurance cover against non-linear climate risks. Insurance works on averages and probabilities, with risks spread across different entities and geographies. The climate crisis is different. What is a tail risk today (a super cyclone that occurs, say, only once in 30 years) becomes normal 10 years from now (with more frequent and intense cyclones). It is this nonlinearity that makes it difficult to insure against climate shocks.
Countries don’t just need disaster relief but also a mechanism to increase resilience and allow economies to bounce back after shocks above a threshold. A Global Resilience Reserve Fund (GRRF) could be a multilateral mechanism for countries with varying levels of vulnerability to pool their risks to climate shocks to lower the peaks of risk curves. After assuming an initial loss, GRRF would transfer the bulk of the subscribed risk to existing market insurance mechanisms.
The second market failure is the gap between perceived and real risks in investing in sustainable infrastructure in developing economies. There is no doubt that there is some risk involved in investing in poorer countries but it is also true that the risks perceived by institutional investors are higher than what is often observed.
The real challenge is associated with non-project risks, particularly currency risks as well as off-taker risks, or policy uncertainty. The latter two could be mitigated by standardised contracting and first-loss guarantees. But currency risk continues to plague developing countries. When interest rates rise in developed countries in response to domestic inflation, project developers in developing economies suffer. A Global Clean Investment Risk Mitigation Mechanism (GCI-RMM) could offer de-risking solutions at scale. Risks could be pooled across projects and across countries. The double pooling would spread the risks and lower the cost of hedging currency (and other non-project) risks.
The third market failure relates to unpriced or under-priced externalities, not just carbon but also land, water, air, and biodiversity. Not accounting for the real value of ecosystem services deprives many countries in the Global South of access to financial resources for preserving natural resources that contribute to the global commons. In order to mobilise capital for developing countries, we could tap the proceeds of carbon markets (voluntary and international compliance markets). For instance, the rules for international carbon markets under the Paris Agreement’s Article 6.4 mechanism provide for a 5% share of proceeds at issuance to be transferred to the Adaptation Fund.
Compounding the market failures are at least three political failures. The first is technology mercantilism that could result in a widening clean tech divide. Trade in renewable energy products has become increasingly concentrated. Four countries dominate more than 70% of solar photovoltaic cells and lithium-ion batteries exports and more than 80% of wind gensets exports. Only 15 countries produce 70-95% of critical minerals for low-carbon technologies. Import concentration levels — and thereby vulnerability — are particularly high for middle-income countries.
The response must be to increase the capacity of developing countries to participate in clean tech manufacturing and have a stake in more diversified and resilient supply chains. Sectoral cooperation is one way. Technology co-development is another, by pooling financial, technical and human resources, co-owning intellectual property, and coordinating green procurement policies at scale.
A related political failure is that we do not have an energy security architecture for the fuels of the future. Whether it is solar modules, wind turbines, green hydrogen electrolysers or critical minerals embedded in these products, the lack of common standards and definitions makes it harder to develop energy-secure supply chains where standards are interoperable. We need an architecture of rules that responds to the needs of emerging energy demanders, reduces non-tariff trade barriers, and increases the security of supply of emerging energy fuels.
The third failure is that we have yet to find a politically viable approach to an orderly transition away from fossil fuels. This matters not just for stranded physical or financial assets, but also for communities that are dependent on fossil fuel mining, extraction, processing and use. As much as large-scale renewable energy deployment could generate net additional jobs, they might be in places far away from the concentrated sources of fossil fuels.
One response should be to bring the energy transition closer to people and communities. Distributed renewable energy could power livelihoods at scale (a market opportunity worth at least $11 billion in Sub-Saharan Africa or over $50 billion in India). When livelihoods are created and entrepreneurs and micro-entrepreneurs supported, communities become empowered as subjects of the energy transition, rather than objects of our top-down largesse.
The finance policymakers meeting in Washington DC must realise that the greatest political failure is a lack of accountability and trust that promises made will be delivered. Reforms of multilateral development banks must deliver outcomes that are substantial in scale and credible in delivery.
Arunabha Ghosh is CEO, Council on Energy, Environment and Water The views expressed are personal
