Financing for development under a changing climate

18 September 2015

Development finance has significant implications for climate action. Where have these linkages been recognised by the international community and what more work is needed?

Towards the end of July in Addis Ababa, Ethiopia, UN members clinched an agreement updating the rules on development finance, aligning these flows with broader economic, social, and environmental priorities. The meeting covered development funding issues related to macroeconomic, financial, trade, investment tax, and monetary policies. The conference coincided with the recent creation of two large development banks including the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank; a global economy still recovering from financial crisis; and the finalisation of a set of new Sustainable Development Goals (SDGs) in separate talks at UN headquarters in New York.

The Addis gathering – dubbed the Third International Conference on Financing for Development (FfD3) – kicked off a series of important UN summits, including the adoption of the post-2015 development agenda later this month, as well as the pivotal UN Framework Convention on Climate Change (UNFCCC) negotiations due to be held in December. Moreover, while countries aim to achieve many of the SDGs by 2030, progress against these goals also has repercussions well beyond that timescale. The preamble of the Addis outcome document recognises the need to preserve the planet “for our children and future generations.”

However, while it is difficult to prioritise among such a comprehensive list of urgent global challenges, arguably none of the individual SDGs has such far-reaching implications as the goal on climate change. Climate change not only threatens to impede further development, it could also reverse decades of development progress. In the face of climate change, countries’ economies, living conditions, ecosystems, and basic functioning will be at stake. Does the Addis outcome fully take into account the urgency of climate action? Does it support the necessary scale up of climate finance critical to future sustainable development? 

Addis appraisal

Perhaps unsurprisingly the Addis outcome document has been viewed differently by various stakeholders within the international development community. It’s fairly easy to dismiss parts of the so-called “Addis Ababa Action Agenda” (AAAA) for its uninspiring language. It makes the usual acknowledgements, reaffirmations, and recognitions on important issues such as gender empowerment and poverty, which have been stated in past UN financing for development conferences, as well as other international processes.  Many developed countries have, for example, so far failed to meet a long-standing commitment of distributing 0.7 percent of gross national income as aid. A simple reaffirmation may do little to ensure that countries meet this pledge. The Addis outcome also contains few details regarding timetables.

The AAAA, however, should also be seen as a document that takes stock of the current state of development cooperation.  Importantly, it brings together in one place many essential and interconnected issues implying these are now being seen more holistically, rather than focusing on the narrow and unsustainable agenda of transferring resources from developed to developing countries.  Challenges that frustrate many low income countries’ attempts to move forward – such as illicit financial flows, raising taxes, and mobilising private investment – are rightfully acknowledged.  The role of non-traditional financing intermediaries and instruments are also highlighted. The outcome identifies a clear narrative for investing in development for the poorest that is resilient to climate change. It provides a robust roadmap for development efforts while also helping to maintain political momentum around addressing key global challenges ahead of the important post-2015 and climate conferences later this year. In order to further the Addis development effort, however, these subsequent meetings must now obtain effective and measureable commitments, timetables, and means of implementation. 

Tussle over tax policy

Heavily negotiated language around tax featured in the Addis outcome, with a commitment to progressive tax systems, improved tax policy, and reduction of tax evasion, corruption, and avoidance. This includes ensuring multinational corporations pay taxes in countries where economic activity occurs.  A reporting proposal was rejected, however, that would have made clearer how much corporations pay in taxes and where profits were generated.  Also rejected was a proposal by developing countries to establish an intergovernmental UN tax body, which almost caused the collapse of negotiations, until the G77 group of developing countries climbed down on demands. Perhaps most surprising is the absence of an explicit mention of carbon taxes in connection with development finance, although the outcome does refer to carbon pricing as an innovative mechanism to combine public and private resources. The International Institute for Environment and Development (IIED)’s director Andrew Norton suggests that the former was blocked by certain countries, despite arguments that “taxing carbon is the most compelling win-win that could have been put on the table,” with benefits for emissions reduction and a source of funds for public investment in development and climate action.

Addressing climate change

Climate change is explicitly referred to in the Addis outcome. This is important because our ability to tackle climate change will largely be determined by development pathways, rather than decisions taken at UN climate summits, although these are linked. The need to increase investments in low-carbon and climate resilient development was recognised, as was the need for inclusive and sustainable industrial development that addresses energy efficiency and pollution. The Addis outcome also “acknowledges” the UNFCCC as the primary intergovernmental forum for negotiating the global response to climate change; “reaffirms” the importance of fulfilling existing commitments; and “recognises” developed countries pledge to jointly mobilising US$100 billion a year by 2020 to address the needs of developing countries.  

Guidance and means to achieve these aims are now needed. An explicit commitment will eventually also be required to align the aims of bilateral and multilateral development finance with climate finance. Development actors dominate the climate finance space. Looking forward, it is clear development finance will continue to dwarf climate finance, especially now that the BRICS – comprising Brazil, Russia, India, China, and South Africa – and AIIB have entered the ring.  Ensuring appropriate safeguards for the sustainability of development projects will be paramount. Moreover, while the establishment and maintenance of social and environmental safeguards are mentioned in the Addis outcome, a commitment to upgrade these to explicitly incorporate climate change concerns would be important.  In addition, the words “fossil,” “carbon,” and “renewable” barely feature in the outcome document and although a renewal of the commitment to “rationalise inefficient fossil fuel subsidies” was made, the word “reduce” was not used.  Globally, subsidies for fossil fuel consumption amounted to an estimated US$548 billion in 2013, vastly exceeding current climate finance levels.  

The state of climate finance

Climate finance broadly refers to finance committed through the UN to help developing countries reduce emissions and adapt to climate change. A precise and universally accepted definition has, however, never existed. While most climate finance has been channelled bilaterally, some significant amounts have been delivered through designated bodies, including the Kyoto Protocol’s Adaptation Fund and the UNFCCC’s Least Developed Countries Fund.  In addition, contributions have been provided to the Global Environment Facility (GEF) and other multilateral institutions, such as the World Bank’s Climate Investment Funds (CIFs). The newest addition is the long awaited Green Climate Fund (GCF) specifically designed to tackle climate change. In 2009 developed countries committed to mobilising US$30 billion for “new and additional” climate finance over the period 2010-2012 – known as fast-start finance – to be scaled up to an annual goal of US$100 billion by the end of the decade. The newly created GCF will help to manage some of these flows.

Climate finance is, however, currently quite fragmented and faces issues of coordination.  With the emergence of the GCF, for example, questions are being asked regarding the future of other existing funds. There have been calls for the GCF to operationalise some activities through other funds to take advantage of their experience and avoid losing lessons learned. Questions are also being raised around the World Bank’s Climate Investment Funds.  When these were created, a “sunset” clause was inserted into the governance framework that could result in its operations being folded into the Green Climate Fund once it becomes effective, but it is not yet clear exactly when this would occur. 

Emerging challenges for climate finance and development

Development finance has major implications for climate change and climate finance. In 2013, for instance, more than 17 percent of the bilateral aid from OECD countries went to economic infrastructure including energy and transport. Finance for energy infrastructure, however, has sometimes included building coal plants in developing countries. Such funding has the potential to push the world across dangerous planetary warming thresholds and into uncharted territory involving extreme climate impacts.  Research by the London School of Economics (LSE) suggests that over 80 percent of current coal reserves will need to be kept in the ground in order to keep planetary warming below the internationally agreed level of a two degrees Celsius rise above pre-industrial levels. At the same time, development finance for SDG 7 on energy access will be critical, since around 1.2 billion people still have no access to electricity. 

The Addis process, with its linkages to discussion on finance for the post-2015 development agenda, would have been an excellent forum to discuss phasing out high carbon investments alongside boosting low carbon pathways.  While taking up the mantle on the latter the conference did not fulfil its potential on the former.  In fact, the Addis outcome document points to the need to encourage “investment in value addition and processing of natural resources.”  This could conflict directly with combatting climate change if natural resources are interpreted to include fossil resources.

Some stakeholders have raised concerns that developed countries are re-branding development finance as climate finance and the Addis outcome made no reference to the complex issue of climate finance being “additional” to development finance. It could be argued, however, that it was wise to leave this hotly contested issue out of the mix in order not to prompt gridlock in the negotiations.

A key challenge ahead will be reaching developed countries’ US$100 billion target for climate finance. The composition of this annual target is yet to be articulated, in other words, whether it will be made available as grants or loans, or provided through a mixture of public and private sources. Moreover, with the overall Addis outcome placing an emphasis on private flows of finance, regulation and incentives will be needed to ensure these are in line with a low carbon future.

Trade and climate opportunities

Trade and investment will be crucial for sustainable development in the post-2015 era. For example, SDG target 17.11 aims to “increase significantly the exports of developing countries, in particular with a view to doubling the LDC share of global exports by 2020.” Climate change poses a particular threat to the development of least developed countries (LDCs) and small island states. These countries are recognised as particularly vulnerable to the impacts of climate change, including extreme weather events, rising temperatures, and sea level rise.  The post-2015 development agenda may therefore be impossible to achieve in these nations unless climate change is properly addressed. Specifically, given that climate change threatens exports in many LDCs including around agriculture, it is difficult to see how the trade target could be achieved without climate action.

On the flip side responding to climate change could help to achieve multiple aims across the SDG framework. Renewable energy and energy efficiency can contribute to economic growth and jobs in developing countries. A more sustainable global trading system would see environmental goods and services eligible for lower tariffs to promote their export and trade with higher tariffs on polluting goods and services. Under the WTO’s Doha Round negotiations countries sought to reduce or eliminate tariff and non-tariff barriers to environmental goods and services. While little progress has been made in the Doha Round of talks, a group of 17 WTO members are aiming to slash tariffs on a list of environmental goods, and extend these benefits to the full membership under the most favoured nation (MFN) principle.

Some experts argue that not all products should be treated equally in the international trading system. For instance, if the principle of free trade is used to facilitate trade in fossil fuels, this can result in higher global emissions. Some members of civil society have expressed concerns that the Transatlantic Trade and Investment Partnership (TTIP), a planned bilateral agreement between the EU and US, may facilitate trade in tar sand oils, which would conflict with the global goal of reducing emissions. Placing higher tariffs on imports of fossil fuels in line with their costs, including the health impacts of air pollution, would be one way for countries to counter climate change. 

Trade flows also affect emissions reporting. Research by University of Leeds demonstrates that if emissions were calculated on a consumption basis taking into account traded goods the UK’s carbon footprint would be higher than currently estimated. By importing high carbon products, the UK has outsourced emissions, suggesting a need for action on more effective emissions monitoring at the global level. Some countries’ export credits also continue to be used to fund fossil fuels. Rich nations provided around five times as much in export subsidies for fossil-fuel technology as for renewable energy over the last decade.

Ending coal-driven development

Emissions growth between 2000-2010 was larger than in the previous three decades largely fuelled by a renaissance in artificially cheap coal. Professor Edenhofer, a co-chair of the Intergovernmental Panel on Climate Change (IPCC)’s latest report, suggested in July that the renaissance of coal is due to growing use in developing countries. The global coal market is a nexus point for development, climate change, trade, and economic policy. Global coal demand continues to grow and it is imperative that this growth is reversed if both climate and development goals are to be met. Coal is artificially cheap because market prices do not take into account environmental and health side effects. While the current cost is about US$50 a tonne, its true cost is probably nearer to US$200 a tonne.  Coal is also usually the lowest and least frequently taxed fuel and subject to very limited or no import tariffs.  Conversely some renewables, for example, wind powered generating sets are subject to high import tariffs. Realigning import tariffs with climate aims could be an effective way to enable the spread of sustainable technologies around the world and discourage polluting technology.

The climate change challenge is a development problem and both areas must be tackled simultaneously. The cost of not addressing climate change risks not only development progress but also potentially the future habitability of parts of the world. These linkages should be underscored in the upcoming post-2015 development agenda and UN climate summits. Moreover, safeguards and the right policies are urgently needed to ensure flows of finance and trade do not exacerbate the climate crisis, but instead help put the world on a safe low carbon trajectory.

The views expressed in this article are those of the authors and do not necessarily reflect those of the institutions to which they are affiliated.

Adrian Fenton, PhD Researcher, University of Leeds and Visiting Researcher, International Centre for Climate Change and Development.

Helena Wright, Postgraduate Researcher, Imperial College London.

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