Financing the ecological transition
This blog follows up on the event ‘Financing the Ecological Transition’, a panel from the IIPP Forum 2024. You can watch the recording of the event above.
While the transition to a green economy has become a central policy objective for many governments, the chosen policy instruments — such as subsidies and carbon taxation — are based on a consensus that the state’s role is to enable the private sector to lead this transition.
The panel “Financing the Ecological Transition” at the IIPP Forum 2024 critically challenged this assumption and identified some of the necessary changes in the financial sector to move towards a sustainable economy.
Understanding the risks
The panel agreed on one premise: if we want to really commit to the energy transition, some things need to change in the financial sector. The market is driving climate transition too slowly and with very minimum policy scaffolding.
But what are the risks if we don’t accelerate our efforts? The speakers highlighted several dangers of maintaining the status quo.
The most significant risk is failing to transition altogether. “Global flows in climate finance currently amount to around 1.3 trillion dollars annually. To meet our commitments, we need almost seven times that investment — 8.6 trillion USD,” noted Josh Ryan-Collins, Associate Professor in Economics and Finance at IIPP. To put this in perspective, we spend 7 trillion USD annually on fossil fuel subsidies, and the global fiscal response to COVID-19 reached 11.7 trillion USD.
A second risk in the absence of a stronger policy framework, introduced by Sarah Bloom Raskin, former deputy secretary at the U.S. Department of the Treasury, is a disordered and costly transition. The lack of a clear direction increases uncertainty, which in turn diminishes business investment. Funding a solar plant, for example, is expensive and long-term, and you can’t plan multimillion-dollar investments if there’s no sense of where the transition is going.
Thirdly, without a robust policy framework, the transition is unlikely to be inclusive. It is also encouraging unproductive lobbying, as companies and interest groups vie for short-term advantages rather than long-term sustainability.
“There’s no one-size-fits-all model that every jurisdiction in the world has to have. But societies need some scaffolding that’s going to move this decarbonization transition in a way that’s inclusive, just and efficient”, Sarah said.
Changing mental models
Steffen Murau, Principal Investigator at Global Climate Forum, emphasized the need to rethink our understanding of the financial system. To do things differently, we first need to be able to think differently.
For Steffen, financial systems have been studied for too long as ahistorical and detached from their specific contexts. Instead, he proposes examining each financing system within its unique historical and institutional framework, particularly focusing on how institutions shape and enable specific financial behaviours. “What we do is we look at historical case studies like war finance and reconstruction finance, trying to see these structures, how that has happened in the past, and then try to get learnings out of it for the green transition,” he explained.
Recognizing the dynamic nature of financial systems and their capacity to adapt and evolve, Murau urged the audience to look beyond the central bank and treasury as the sole entities responsible for providing financing. Historically, specialized public-private institutions have emerged to tackle grand challenges, such as post-war rebuilding. Financing large-scale transformations like the ecological transition requires innovative and flexible institutional arrangements.
Who absorbs the risks?
“Seventy-five per cent of our energy is still fossil fuel-based. Essentially, we’re still almost in a business-as-usual environment,” observed Vera Songwe, Senior Fellow in the Africa Growth Initiative at The Brookings Institution.
To understand how to change these dynamics, Vera studies how this transition looks from the financial systems point of view. Her findings point towards two main buckets of risk: financial and fiscal risks.
Financial risks are particularly pronounced in the developing world. Transitioning to a new energy matrix could disrupt the financing system. For example, what would happen if oil-related activities in a country shut down and an entire industry couldn’t repay its loans?
Vera emphasized the importance of policy instruments that align all players in the green finance ecosystem, facilitating funding innovation without creating new risks to the financial system. “We need to help transition countries -Indonesia, Vietnam, or South Africa- that are all coal-producing economies that are trying to grow, and so they have choices and decisions they have to make”, she said.
On the fiscal side, Vera warned of the significant capital flight from developing to developed countries, driven by fears of climate change and disasters. “There’s about $8 billion in net capital exits from the developing world,” she noted. Songwe argued for new institutional arrangements to protect threatened developing economies, ensuring they don’t have to choose between safeguarding their populations after a climate disaster and repaying their debts.
Conclusion
The panel agreed that a combination of policy scaffolding, innovative financial instruments, and historical lessons can guide finance toward a sustainable future. But, above everything, it will demand a lot of conviction, stakeholder mobilisation and a mission-oriented approach. As Josh Ryan-Collins put it: “It is possible to meet these challenges if we have the ambition and political will to act decisively.”
