Mobilizing $100 Billion per Year for Climate Financing

Kemal Derviş and
Kemal Dervis
Kemal Derviş Vice President and Director

Katherine Sierra
Katherine Sierra Former Brookings Expert

November 5, 2010

Today, the U.N. Secretary General’s High Level Group on Climate Change Financing (AGF) reported that raising $100 billion each year by 2020 to finance climate mitigation and adaptation in developing countries is “challenging but feasible.” The group, made up of heads of state and government, as well as finance leaders from both developed and developing countries, was tasked to develop the $100 billion per year pledge of long-term financing under the Copenhagen Accord. Designed in parallel to the global climate negotiations under the UNFCCC, it aims to provide a technical assessment of financing options, filtered against criteria such as political acceptability. While the report will disappoint those who want a bold recommendation, it does move the dial by providing a menu of international and domestic financing options, some considered more promising than others.

So how is raising $100 billion per year doable? Members of the high-level group anticipate new public funds to flow in from a combination of revenues from emission allowances or direct taxes; taxes on international transportation fuels; and redeployment of fossil fuel subsidies or other carbon-based mechanisms like a small levy on electricity (wire tax) that could raise $50 billion per year. Add to this the net flows from private investment that could raise $10-20 billion per year (total private investment that could be leveraged by this would be in the order of $100-200b) and net flows from the carbon markets of $10 billion. Another $11 billion per year could be raised by providing increased resources to the Multilateral Development Banks. Taken together, these could total $80-$90 billion per year, with traditional public finance from budget appropriations covering the balance. Fast Start funding under the Copenhagen Accord of $10 billion per year shows that public finance could cover the difference at the higher end of the assumptions, but more effort would be needed at the lower end.

The report emphasizes that raising these sums has to be part of a broader package of meaningful mitigation actions along with transparency of implementation. This ties the debate back to the Copenhagen Accord and the United States’ position that the elements of the accord have to be mutually reinforcing. A key assumption is that emission reductions targets, and associated instruments, would result in a price on carbon of $20-25 per tonne of CO2 equivalent. So it is critical to take action on this in order to raise financing.

An opportunity missed. The report reaffirms the importance of strong commitments to domestic climate mitigation and introduction of carbon-based instruments, and calls for strengthening the carbon markets. But a much stronger case could have been made for taxing carbon through an outright tax or broad-based use of auctioned permits to not only provide a source of finance for developing countries, but to also help reduce deficits in advanced economies.

Some innovative public finance proposals gain momentum. While sources of public finance have continually been debated over the past several years, the AGF report signals that several previously controversial innovative sources of finance are now being considered viable, such as revenues from taxation and auctioning of emission allowances; taxation on international transport via maritime bunker and aviation fuel taxation; and redeployment of fossil fuel subsidies. Though delicately worded, the proposal to leverage IMF Special Drawing Rights seems to have been eliminated, as well an international financial transaction tax, though a nod is given to countries and regions that may want to use this as a source. And despite the dismal fiscal situation of advanced economies, use of general public revenues remains. The report acknowledges that public finances in many developed countries are under extreme pressure. Indeed, the current political environments will make this option difficult in many countries. Simultaneously, the AGF reaffirms the expectation that direct general public contributions will also play a key role in the long term.

The potential of private finance. The AGF correctly makes the case that whatever the source, private sector investment will be critical if developing countries are to successfully move to low-emission development pathways. But the diplomatic language describing differing points of views on whether and how to count total flows, and on the balance between public versus private finance in the overall package, point to continued strain between developed and developing countries. We maintain that developing countries are right to expect that only the grant equivalent of public flows should be accounted for as part of the contribution from the developed countries. This should also include the net grant element embedded in the potential increasing carbon markets as has been the case for the Clean Development Mechanism. The logic here is that these flows are going to support a global public good: mitigation. But developed countries are also correct in their position that private flows will need to cover a significant part of the costs. So having a metric that also captures the total flows will be critical to assess whether the incremental public financing is indeed crowding out the massive amounts of private funds that will be needed to finance the investments as a whole.

The loan versus grant debate. Authors of the report found consensus over a topic that has caused great consternation in the climate finance world, especially among civil society advocates: should all climate finance come in the form of grants, or can concessional loans (and guarantees) serve as the right instruments? The report supports the use of both loans and grants, but notes that grants and highly concessional loans are crucial for adaptation in the most vulnerable countries. The AGF is correct in saying that for mitigation, funds like the Clean Technology Fund prove loans and guarantees can be structured to leverage significant private and public finance. But this has to be accompanied with the caveat that, in terms of burden sharing on mitigation efforts, only the grant equivalent embedded in these loans should be counted toward the contribution from the developed countries. For adaptation initiatives, a stronger call for grants for the poorest countries would make sense politically. Otherwise, the positive results from these flows, like building trust, will be obscured by the rhetoric that highly concessional loans deepens the debt of those countries who are least responsible for climate change in the first place.

The role of the multilateral development banks. The report notes the importance of the U.N. in capacity building, and describes some proposals for direct access of funds to developing countries. But simultaneously it strongly defends the use of MDB capabilities, sending a clear signal to those who advocate against the utilization of the MDBs. The AGF focuses in particular on the multiplier role that the MDBs can play by combining support for public policies that will support low-carbon and climate-resilient futures. The MDBs have the ability to combine sources of finance to provide significant leverage. The AGF also sets the stage for considering the contribution to the climate finance equation of future capital increases and IDA-type replenishments.

While the report is not the breakthrough that many hoped for, it does make progress on tackling climate change by signaling acceptance of innovations that may now gain momentum. But designing these instruments will be challenging. The financial amounts that can be raised will depend on significant mitigation targets. And ultimately, domestic action will depend on each nation’s political acceptance. It will be an uphill battle in the United States to overcome the skepticism of the electorate and the expected opposition in the new Congress to any new taxes (even if they are immediately given back to domestic taxpayers by lowering other taxes on income or payroll) and policies that provide transfers to the developing world. Although challenging, it is these types of policies that will make climate finance, and in turn global coordination and agreement, feasible.