Wednesday, 31 July 2013

What is ‘inclusive green growth’, and how should it be financed in low income countries?

By Stephen Spratt

Last year, colleagues from the Initiative for Policy Dialogue (IPD) at Columbia University and I were asked to assess what institutional investors (pensions funds and the like) could do to boost ‘inclusive green growth’ in low-income countries (LICs). We were also asked to consider what donors could do to support this. Our answers to these questions have now been published.

To get a handle on this, we had first to unpack the phrase, ‘inclusive green growth’. First up, we have two dimensions – ‘inclusive’ and ‘green’ – both of which mean different things to different people. ‘Inclusive’ can mean that the poor benefit to some extent from the process of growth – this is its ‘weak’ form. It can also mean that the poor benefit more than other groups, so that inequalities decline – this is ‘strong inclusivity’. A similar approach can be applied to ‘green’: proponents of ‘weak green’ growth, for example, would assume that many forms of ‘natural capital’ can be replaced, while supporters of ‘strong green’ growth would be less sanguine, and more likely to apply the precautionary principle to the exploitation of environmental resources. Already we can see that ‘inclusive green growth’ in its ‘weak’ or ‘strong’ form would imply very different things.

The next step was to consider what impact institutional investors could have on these versions of inclusive green growth. We identified investment in the energy sector as crucial, particularly how private investment might be used to increase the supply of renewable energy, to increase energy efficiency (green), and to expand affordable access and eliminate energy poverty (inclusive).

The purpose of these institutions is not to mitigate climate change, however, but rather to build and manage a portfolio of investments that produce the best risk-adjusted returns for their members. The question, therefore, is how compatible this goal is with investing in energy efficiency or renewable energy generation in LICs, and doing so in such a way that energy poverty is reduced?

On this question, the first point to make is that renewable energy remains more expensive than fossil-fuel generation in most instances. Potential returns are thus lower than comparable, alternative investments. Given this, most countries have used a variety of subsidies (feed-in tariffs, for example) to boost returns and attract private investors. While LICs are no different, the question of who should pick up this bill is different? Our conclusion was that donors should make a major contribution.

LICs bear no responsibility for climate change, and it is therefore unfair for them to be penalised for implementing measures needed to address it. As well as this ethical point, there is also a pragmatic argument: the credibility of financial support for renewables is key to attracting private investors; our interviews in the City of London made it clear that donor involvement could be essential in boosting this credibility. By providing financial support for mechanisms like feed-in-tariffs, therefore, donors would be both boosting returns and reducing risks: a double benefit.

The second point relates to inclusivity. Generally, the ‘stronger’ the level of inclusivity that is desired the lower the potential profitability of the project. This does not always hold, but doing things like ensuring access to remote rural areas, and making tariffs affordable for the poor, are unlikely to boost the returns available for investors. This is why definitions matter: the ‘stronger’ we want inclusive green growth to be, the more financial support is likely to be needed to make these investments attractive to private investors. A key finding is that this issue needs to be recognised and explicitly addressed if inclusiveness is to be realised, particularly in its strong form.

Not everything comes with a price tag though. We also found that donors can do much to mitigate the different forms of risk that act as obstacles to institutional investors.
  • Reduce early stage project risk: many developing countries have real advantages with respect to renewable energy resources. Institutional investors, however, are not going to invest in projects until they are fully ‘investment ready’. Sourcing and developing projects so that they reach this stage is a precondition for investment, and an important role for donors.
  • Reduce regulatory risk: renewable energy projects in particular are heavily dependent on the maintenance of a supportive policy framework. Donors can do a number of things in this regard. First, they can boost the credibility of policy instruments by directly contributing as described above. Second, by co-investing they may provide some ‘insurance’ for private investors, who believe that policy is less likely to be changed in these circumstances. As well as partnering on individual deals, there is potential value in donors establishing – and investing in – dedicated investment vehicles that focus on low-income countries.
  • Reduce information asymmetries and logistical barriers: for energy efficiency, interventions are needed less to improve project economics, than to overcome informational and structural barriers. Projects tend to be small in scale but large in number, raising transaction costs. There are also costs to identifying viable projects, and structures need to allow diversified access to the sector. Here donors have an important role to play in helping develop these structures. They may also play a role as co-investors and guarantors.
As described in the report, there are many examples of best practice that can be drawn upon. While it is possible to imagine how most of the key obstacles to institutional investment could be addressed, we also identified a major underlying issue. Achieving a shift to a trajectory of inclusive green growth in LICs requires very large investments. The assumption has been that only institutional investors can provide resources at the scale required. As well as the level of finance, the attraction of institutional investors is that they may also provide long-term finance with reasonable return expectations. An important finding is that some investors have excessive expectations in developing countries, which do not seem to have been adjusted downwards in the light of the global financial crisis and the low yields available in developed countries.

Projects that can attract long-term financing at 5-8% in Europe or the US, might need to yield 25-30% in low-income countries to attract the same private investors. This could only be achieved by charging very high tariff rates, or by increasing public subsidies to high levels. Neither is particularly attractive in a low-income country setting.

Achieving growth that is both green and inclusive is inherently difficult. Doing so using private investment which requires very high returns may be impossible. Unless investors can be persuaded to adopt more reasonable expectations, alternative sources of finance may be needed if the goal of generating genuinely inclusive green growth in low-income countries is to be achieved.

Stephen Spratt is a Fellow in the IDS Globalisation Team working on development finance, financial sector reform and regulation, socially responsible investment, the emerging climate change financing architecture and the intersection between these issues.
Previous Globalisation and Development blog posts on investment, energy and the green transformation:

Wednesday, 17 July 2013

Business Leaders From The South: Addressing Inequality to Increase Business Sustainability

By Akansha Yadav

Many have observed that economically and culturally diverse countries such as Indonesia, Singapore, Malaysia, Colombia, Turkey and the Gulf Cooperation Council (GCC) countries are latching on to the global dynamics created by China, India and Brazil in business and trade. At the same time, the fact that business ventures in the South can no longer focus on profits alone while leaving the provision of public goods and development of local capacity to national governments has finally been acknowledged. If this is not addressed, it could threaten business sustainability.

This was the focus of the Growth Net, an international business conference held early this year in New Delhi. I attended the conference while working on the ‘Business From the Rising Powers in Africa’ strand of the Rising Powers in International Development programme led by Lizbeth Navas-Alem├ín.  The conference, which centred on the new and emerging players of the global economy, brought together business leaders from emerging economies to discuss common aspirations, business opportunities and challenges.

Despite a clear diversity in trade practices, discussions were grounded in the reality of the participants’ countries, with perspectives that have evolved from common experiences rather than being borrowed from industrialised countries. A number of challenges were highlighted as some of the constant risks to investors in these countries, including:
  • diversifying markets
  • optimum use of available funds and resources
  • corruption
  • lack of hard infrastructure
  • Government accountability.

A Southern way of doing business

While the BRICS (Brazil, Russia, India, China and South Africa) were not the sole focus of the conference, the need for a new development bank was acknowledged by industry representatives who expressed general dissatisfaction with institutions such as the IMF and the World Bank.

Conference participants called for various South-South Cooperation (SSC) initiatives aimed at increasing regional trade agreements, keeping emerging markets open for more investments, enhancing domestic market capacity and addressing supply-side constraints. Many wished to establish their own network, recognising the challenge this implies for the established order of current global governance. A core component of these discussions was the stress on equitable patterns of growth in the host countries from the South, where business leaders are making informed decisions on new ventures, embracing all their societal and market complexities.

This interest in social equity from business leaders reflects the growing belief that there is a need to create a strong middle class on which a robust domestic market can depend. It is also linked to the growth of Multi-National Corporations (MNCs) and Small and Medium Enterprises (SMEs) in the emerging economies, which aspire to venture beyond the traditional domestic market. Understandably, they are now pushing for market access in countries which have been traditionally dominated by companies based in rich countries.

In this context, it makes sense for these business leaders to come together and press for better policies in general (whether in terms of trade, infrastructure or social protection) and to work towards bridging the social class gap in particular. The key to this lies in addressing and facilitating both the supply- and demand-side issues of access to basic services and commodities in the emerging economies. Similar ambitions have also led these industry representatives to agree on the need to take on more responsibility in public-private collaboration.

For example, it is vital for agribusiness to consider the issue of food security and for the pharmaceutical industry to address the issue of Intellectual Property Rights and patent issues. This is because the majority of the population in emerging economies is not otherwise able to afford access to medication (and often food) without heavy government subsidies, which in turn leads to fiscal deficit and impacts macro-economic stability.

Resource diplomacy

Claude Smadja, formerly of the World Economic Forum, acknowledged the structural problem of money and power going hand in hand in the current global governance system. It is true that the era of focusing only on growth figures appears to be giving way to an increased focus on the quality of growth – addressing the issue of inclusivity, reducing the digital divide, developing a skilled workforce, and managing wealth to reduce inequality.

But it is also apparent that there is little love lost between India and China, the two largest BRICS economies, whose trade potential is still affected by strained diplomatic ties. The elephant in the room surely is the increased competition between them for markets in the African continent. The resulting resource diplomacy in Africa, which has been hotly debated by observers and scholars, certainly has the potential of reproducing the current dominant trade structure. Whether talk of social equity within the opportunity of increased trade within BRICS and emerging economies addresses this and creates a collaborative framework remains to be seen.

Akansha Yadav worked as a Research Assistant on the Rising Powers in International Development programme at the Institute of Development Studies. You can follow Rising Powers on Twitter @IDSRisingPowers

Wednesday, 10 July 2013

China and Brazil: a new phase in the ‘global currency war’?

By Musab Younis

According to a number of press sources, Brazilian President Dilma Rousseff and Chinese President Xi Jinping spoke on the phone towards the end  of June about “ways to strengthen policy coordination” in the context of recent US dollar appreciation. The exact details are likely to be worked out this month, when the BRICS finance ministers and central bank presidents meet in Russia.

This phone call is bigger news than it might initially seem. To understand why, some background may be instructive. As we know, in response to the financial crisis the US Federal Reserve (Fed) began a series of rounds of quantitative easing (QE) which have since retrospectively been compartmentalised into three rounds. The most recent, QE3, was nicknamed ‘infinity’ for what had seemed like its capacious open-endedness.

Emerging markets hit hardest by US Quantitative Easing 

Quantitative easing (QE), which increases the monetary base – that is, the sum of currency in circulation – has been one of the key responses to managing the effects of the crisis. But its application is controversial, especially amongst emerging powers, due to its deleterious side-effects. Most obviously, an increase in supply of something is commensurate with a reduction in its value. Countries like China, with large reserves held in US dollars, have expressed concern at the potential reduction in value of these holdings.

There are other concerns. In a world where many countries have financial and currency markets open to the vicissitudes of global capital, flooding the system with more of a particular currency – especially if that currency happens to function as the global reserve – causes serious problems. At the height of QE, with the US dollar losing value, one clear effect was a rapid and corresponding appreciation in value of many currencies (Colombia, Mexico, Brazil), striking a sharp blow at the export-focused industries of these countries.

A key tenet of neoliberal doctrine has been the liberalisation of capital controls. Ironic, then, that those ‘emerging market’ countries which had most enthusiastically liberalised were often those hardest hit by QE.

Monetary policy in the North denounced as openly protectionist

Little surprise, perhaps, that when the first QE round began in September 2010, Brazil's outspoken finance minister, Guido Mantega, warned of an "international currency war." Some observers have been more specific, discussing this in terms of a war between rising and established powers that mirrors a wider North/South divide.

Mantega did not stand alone. In February this year, Chile’s finance minster called QE a “globally counterproductive policy”, adding: “One thing is unmistakably clear: the greatest share of the exchange rate adjustment costs resulting from quantitative easing is absorbed by a small group of developing and open economies, particularly in Latin America.”

A number of countries – including Brazil, China, Indonesia and India – attempted to take independent measures to combat the damaging effects of this currency appreciation. But they faced criticism (especially China) for this action from the US and its allies. Such measures were also uncoordinated, raising the prospect of damaging internecine struggles between the rising powers to control currencies.
Dilma Rousseff’s visit to Washington, DC in 2012 was dominated by this issue. Sitting next to Obama in the Oval Office, she told the press: “We expressed Brazil’s concern with the expansionary monetary policies in rich countries … which is leading to the depreciation of developed country currencies and compromising growth among emerging economies”. Earlier, she had denounced the monetary policy of the North as “openly protectionist” and promised “institutional measures to ensure that our internal market is not cannibalised”.

Risk of a balance-of-payments crisis

But while the implementation of QE has been problematic for rising powers, its slowing down could have even worse effects. Recent announcements by  the Fed chairman, Ben Bernanke, that the massive US bond-buying programme could soon be contracted, have caused havoc: ‘nowhere as loudly as in emerging economies’, reports the FT.

One effect has been a serious sell-off in equities, bonds and commodities, especially harming the ‘rising power’ countries. Another effect has been the rapid depreciation of a number of currencies, including those of Russia, Brazil and India. This might seem to be a positive sign for these countries’ exports. But high levels of volatility make forward planning difficult and can, in the worst-case scenario, leave a national treasury with a disastrous balance-of-payments crisis.

The risk of a balance-of-payments crisis is higher in the context of current account deficits. A virtual checklist of ‘rising power’ countries are suffering from such deficits, including India, Turkey, South Africa, Brazil and Indonesia. India’s current account deficit has reached a record 6.7 percent, marking it as an especially vulnerable BRICS economy.

The Brazilian Finance Ministry’s reaction to this last month was to cancel the IOF tax on financial investment, which had been a response to the original quantitative easing; this has thus far had only limited impact. Last week, Finance Minister Guido Mantega pointed out that Brazil is restricted to having to wait for the US dollar to re-establish itself at a new exchange rate. It remains true that Brazil’s currency, “like all its peers, is basically up against the Fed’s might”, as Reuters reported last month.

Finance ministers in the South are unlikely to find much solace in suggestions that QE3 withdrawal could hit Europe hard too. And though it is true that, as Jim O’Neill has argued, the long-term economic outlook of the BRICS depends on factors broader than Fed policy, it remains the case that external shocks can have deep, lasting and unequal effects.

An emerging coordinated response amongst the BRICS?

Late last month, the World Bank President Jim Yong Kim discussed how the BRICS would suffer from QE rollback. Pointing out that the countries require an estimated $4.5trn for infrastructure development over the next five years, he added: “As quantitative easing slows down, the developing countries are really worried about access to capital.”

This is accurate, but only part of the picture. It is within the vital context of serious concern with the management of the global economy, and in particular with coordinated expansionary monetary policy in the North, that the BRICS have agreed to set up their own development bank and the Contingency Reserve Arrangement (CRA).

The CRA is a coordinated central bank fund which is set up to provide mutual liquidity in the event of a crisis – probably without the involvement of the IMF. Significantly, reports of last week’s phone conversation included mention of a discussion on speeding up the creation of the CRA.

The crisis recently engendered by the Fed’s announcement is already having a significant impact. Will an attempt by the BRICS to coordinate a response (pdf) to monetary policies in advanced industrial countries work? Given the sudden onset of the latest crisis phase, we may discover the answer to this question sooner than we had expected.

Musab Younis is a Research Officer on the Rising Powers in International Development programme at the Institute of Development Studies. You can follow Rising Powers on Twitter @IDSRisingPowers 

Friday, 5 July 2013

How can the green transformation work? It's about more than recycling and renewable energy

By Tomoko Kunimitsu

Whether we live in a developed country or a developing country, we all live on the same planet. The increasing realisation that the global economic system is out of balance with the earth’s carrying capacity calls for a transformation to maintain the planet in a more sustainable way. As members of ‘the Spaceship Earth’, the green transformation is a matter for everyone in this generation regardless of our positionality.

MA Globalisation and Development students at the Institute of Development Studies (IDS) recently held two discussions on the green transformation with Hubert Schmitz, an IDS Research Fellow who is working on this topic. This is a brief summary of those discussions which tried to make some ideas and issues around the green transformation clearer to us.

1. The green transformation in a capitalist world

In promoting so-called green industry, such as renewable energy, the win-win relation between environmental sustainability and economic profit tends to be stressed. However, this win-win relation is only possible as long as green industry remains more profitable than non-green industries, given capitalism’s emphasis on maximizing profits.

So far it is still a relatively new industry with a lot of potential for business opportunities. But what happens if society exploits these opportunities and the profitability of green industry decreases? In other words, to what extent is the green transformation in a capitalist world truly green? The quality of the greenness should always be checked in the process of the transformation, it's not just about scale.

Two key concepts for living within our planetary boundaries

In order to think about quality, the starting point could be “what does the green transformation mean exactly?”

Two ideas are important to make the world work within its planetary boundaries
  • changing our lifestyle (specifically around consumption) 
  • circulating economy
Firstly, we need to change our lifestyle by consuming more environmentally-friendly and sustainable products. The green industry has a role to play in this. For example, renewable energy provides an alternative form of energy consumption. This could be a first step in the transformation though we also may also need to consume less in a long run.

Secondly, the circulation of production, consumption and recycling may require a new system of maintaining an economy by rethinking the connection between producers and consumers. In fact, we can learn from the informal economy in developing communities which often has an effective circulation system such as collecting and recycling trash. Formalised economies tend to lose such a voluntary system and compensate by regulations and public services, but these can be ineffective and often experience failures.

However, these ideas are not being implemented at scale, or they are misused or misinterpreted.

Challenges facing different approaches to green transformation

“Recycling” by importing old fridges and air conditioners containing chlorofluorocarbons - chemicals which damage the ozone layer - into Africa contradicts the primary objective around regulating these products (i.e. that these goods are deemed to be pollutants negates the benefit of them being recycled). In another example, solar panels, while providing renewable energy, can also be a new source for chemical pollution as they contain several environmentally toxic materials.

Additionally, it will be harder for some resource-rich developing countries to achieve the transformation since their economies are hugely dependant on the non-green resource sector. For example, in Angola, the oil sector accounts for nearly 80% of government revenue, 90% of exports and 47% of GDP.

In a capitalist world, the green transformation links to incentives for actors in the market – industries, government and consumers. It also has a risk of over-reliance on the market system where the need for environmental sustainability is just one of many factors that influence market decisions. It seems to be an issue of balance between what they do (performance) and why they do it (motivation).

2. Small scale and big scale expansion in the renewable energy industry

Approaches for the green transformation in the form of generating and consuming renewable energy have been taking place on various scales, from community-based projects to transnational ones.

Small-scale attempts have generally focused on providing access to electricity in remote areas in developing countries. According to the Alliances for Rural Electrification, small and medium wind turbines (SMWT) offer facilities that are relatively easy to maintain; are highly adaptable with other existing energy sources (e.g. diesel); and provide an opportunity for technology transfer and improving energy sustainability. Although still faced with financing and quality standards problems, SMWT have been introduced in many places including China, Indonesia, Madagascar and Namibia to provide energy within the community.

On the other hand, big-scale projects tend to separate energy production from consumption. The Desertec project – a project generating energy in North Africa for potential consumption in Europe – is an example of this. While the project would generate additional income by selling energy to Europe, energy production for consumption beyond the immediate locality could raise a new challenge for democracy and social justice in the region, with an issue of ownership of energy.

Does the expansion of a renewable energy sector contribute to the green transformation?

These different scales for expanding the renewable energy sector provide some opportunities for exploring key questions:
  • What is the relation between scale economies and efficiency in renewable energy? 
  • Does the expanding renewable energy sector really mean a “shift” to the green energy? Or is it just complementary to the existing non-green energy?
Different actors will have different priorities – job creation, access to electricity, reducing carbon emissions, etc. It is the politics of their interests that influence the direction and scales of renewable energy industry.

After these discussions, our questions for the green transformation are about its effectiveness – how it can work in relation to the conventional way of sustaining economy, with its aim of bringing a transition in our lifestyle? The green transformation may not always be based on the win-win relationship, but a more interactive process between market, governments, companies and individuals will be critical for the true transformation.

Tomoko Kunimitsu is undertaking an MA in Globalisation and Development at the Institute of Development Studies.  

Previous Globalisation and Development blog posts on the green transformation: