Catalysts for change: Development banks and green innovation

Les banques de développement, catalyseurs de l'innovation pour le développement durable ?
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Climate Finance flows in 2013

Development agencies and international development finance institutions have long been pioneers in endorsing sustainable economic growth on an international scale. They have shown a strong ability to innovate by responding to opportunities, adapting their work to the global agenda, helping design and implement internationally disseminated tools, and by blending grants, subsidies and market funding to engineer enhanced funding mechanisms. Environment and sustainability issues, absent from international aid plans thirty years ago, have gradually risen in prominence to become a central concern. Now traditional donors find they must again redefine their policies and operations as worldwide changes demand a rethinking of cooperation models and purposes. Aid architecture has opened to new financiers, the geographic centres of manufacturing and technological innovation have moved, and financial and economic crises have weakened several industrialized donor countries, raising new challenges for international development strategists.

In the first half of this paper, we provide a short history about the way aid agencies and development banks have integrated and acted on environmental concerns over the past thirty years. In the second half, we describe how new networks of innovative, environment-oriented funders and others pose new challenges to traditional donor funding models and relationships.

Development agencies' gradual strategic focus on the environment

Development agencies first experienced environmental issues as external, operational constraints before the environment was seized on as a topic by pragmatic donors. They harnessed concern about the environment, making it a central topic in international cooperation forums. Indeed, in the late 1980s, American nongovernmental organizations (NGOs) highlighted the ecological damage that was being caused by World Bank-funded projects. Under pressure from the NGOs and the American public, the United States Congress asked US-funded multilateral development banks, to set up suitable social and environmental risks management systems. The pressure to address environmental issues grew, bolstered by the large ecological disasters of the 1980s, even as some scientists showed evidence that the development model promoted by donors should not be pursued. Concurrently, major environmental agreements, such as the Montreal Protocol, CITES, and the Rio Convention

The Rio summit built on earlier efforts, undertaken since the late 1980s by the World Bank and the Organisation for Economic Co-operation and Development (OECD) to operationalize the notion of sustainable development.

were being negotiated. Pressure from civil society and taxpayers on the governments of other aid-funding countries further bolstered the attention that development agencies and banks paid to the environmental concerns.

For donors, the 1992 United Nations Conference on Environment and Development (UNCED)

International environmental agreements numbered 17 in the 1950s, 21 in the 1960s, 35 in the 1970s, 36 in the 1980s, and over 56 in the 1990s.

in Rio de Janeiro was a turning point in bringing environmental concerns to bear on development issues (Jacquet et al., 2009). The combining of development aid and environmental policies and projects was a cultural revolution for development agencies. This was especially true of multilateral funding bodies that had seen development and the environment as diametrically opposed forces. They had viewed environmental concerns as impeding economic growth; this perspective was amplified by the views of most Southern partners, particularly aid-recipient countries. Ultimately and despite strong internal resistance, the development banks and agencies had to bridge the gap between their internal views and those of many citizens, activists and governments.

Pragmatically, throughout the 1990s, funding agencies revised their aid programmes and policies to remain in step with their publics. Financial concerns also played part in this turnaround, as international policy and economic change raised questions about the agencies' and banks' funding model. Three changes in particular - the end of the Cold War, the global debt crisis, and especially an international financial market that invested in major growth regions (notably South Asia) beginning in the 1980s - had a negative impact on the funding agencies' and banks' intervention ability.

At the turn of the millennium, the World Bank's investments contracted dramatically; for instance, to just over $500 million in China, down from an average of over $3 billion between 1993 and 1997).

Since Bretton Woods, these multi- and bi-lateral donors had long been virtually the only bodies channelling funds from the Global North to the Global South. These traditional funders suddenly found themselves in competition with commercial and investment banks when both started providing lower-interest loans and other financial products to an increasing number of emerging countries 'environment' (Bourguignon, 2011). However, the funding agencies were able to seize an opportunity after the Rio Summit: they used concern about the environment to implement new, special funding instruments, thus increasing their presence in countries where financial markets had been advancing.. In emerging economies, the overwhelming majority of projects funded by the World Bank were stamped 'environment'.

In the months that followed the Rio Summit, the Global Environment Facility (GEF) was created at the United Nations, based on a French and German initiative.

The GEF's French counterpart, the Fonds Français pour l'Environnement Mondial, was created in 1994.

The GEF was a groundbreaking instrument for funding environmental global public goods, such as the climate and biodiversity, or for fighting desertification and soil degradation. Other funding mechanisms followed; these included the Clean Development Mechanism (CDM) and various funds linked to the United Nations Framework Convention on Climate Change (UNFCCC), particularly the Kyoto Protocol, which was signed in 1997 and ratified in 2005 (Colombier et al., 2006). Carbon finance, which seeks to combine economic and environmental efficiency, spawned "carbon funds" housed by the World Bank. The European carbon market was later set up to reconcile environmental and development interests. Furthermore, budget aid, the traditional tool of international development banks, can also be used for climate purposes.

While the environmental component of the Millennium Development Goals set out at the 2002 Johannesburg Summit was not very successfully implemented 'green' activities, closely associated with environmental issues, nonetheless continued to gain ground, becoming a significant part of aid agency activities. In most countries, support for the larger concept of 'green growth' and for projects related to sustainable cities, agroecology and renewables were proof positive that environmental issues were becoming part of funding agencies' strategic priorities and operations.

In budgetary terms this entailed significant efforts - over 30% of total annual contributions by major multilateral donors went to environmental and climate change issues; some bilateral donors allocated much higher percentages of their funding.

For example, in the case of AFD, the French development agency, more than 50% of its project finance must have a positive impact on climate change.

As the funding agencies invented new funding mechanisms and tools, they also invented new intellectual and social infrastructure: standards, human capital, alliances and networks. Operating procedures changed with, for instance, the assessment of a project's carbon footprint or an appraisal of its vulnerability to climate change. Funders were particularly active in developing a set of measurement and assessment tools to integrate environmental considerations into project selection criteria.

In close relationship with academia, NGOs, foundations and think tanks, development agencies have been particularly active in establishing measurement and assessment tools (PES [payments for environmental services] and green accounting initiatives such as WAVES [Wealth Accounting and the Valuation of Ecosystem Services]) to take into account the flows and stock variations in natural resources.

The growing importance of research on the environment and development reflected the aid agencies' need for innovative ways to address methodological issues and improve operational efficiency. Other concerns such as gender equality, poverty reduction and education access also benefited from these scientific efforts, but environmental issues received the lion's share of research funding and attention. The development agencies had to establish or increase their research and knowledge creation capacities to support their operational needs and increase their clout in international debates about the environment-development nexus. To achieve this, the agencies set up in-house scientific committees, as had the GEF or the French Global Environment Facility (Fonds Français pour l'Environnement Mondial - FFEM).

The 2008 economic crisis further fuelled this trend. "Green growth" projects held potential as tools for national economic recovery and expansion in Organisation for Economic Co-operation and Development (OECD) countries and in some emerging economies, particularly where the green-tech sector presented industrial opportunities. In addition, green-growth projects matched many countries' desire to diversify and deploy their energy mix differently, given uncertainties around fossil fuel supply and cost. Furthermore, civil society increased pressure on governments and donors to consider environmental issues. Consequently, China has become the world leader in solar panel production and wind power, while India and Brazil present two of the largest markets for biomass-generated electricity.. Other nations, including Morocco, South Africa and the Gulf States, are investing in far-reaching green technology projects, partly to help them access innovation networks. Development agencies played a crucial role in propelling this trend in developing countries, and especially in emerging ones, by providing financial products to support public policies that promoted new, risky concepts that commercial banks shied away from financing.

The powerful rise of green growth as a goal now has considerable impact on the strategic planning of funding agencies. In 2012, for instance, the World Bank, like many other donors, developed a new operational strategy based on the notion of green growth. Most donors are currently active in the debate about the design of the Green Climate Fund which is currently being created and should be the largest public fund - $100 billion annually - dedicated to helping less-developed countries combat climate change and adapt to its effects.

The green innovation ecosystem challenges development agencies

Paradoxically, the global rise in concern and funding for green and sustainable projects is currently challenging the development banks and aid agencies. In effect, a phenomenal interest in climate-related financing is happening today: an entire ecosystem of new environmental financiers has grown up around the traditional donors, who now find themselves to be one source of funds and solutions among many. According to estimates from studies conducted over the past several years by the Climate Policy Initiative, the global financial ecosystem currently allocates $359 billion per year to combat climate change. Today hundreds of global financial players - development banks, public and private funders such as philanthropists, institutional investors, commercial banks, and others - increasingly include environmental issues in their strategic planning and operations, albeit to varying degrees (Figure 1). New actors, notably regional and national development banks in the developing world have strengthened their role in the architecture of international sustainable-development funding. Consequently, traditional aid agencies and donors confront the need to redefine their position within a complex and diverse architecture ruled by commercial and investment banks and private-sector companies

Development agencies must change how they operate within the global financial architecture. At the recent Rio+20 United Nations Conference on Sustainable Development (UNCSD), a group was created to develop a strategy for sustainable development financing by 2015. Any such strategy will probably call for multiple funding sources and instruments that enable synergies and in-depth partnerships between funders, to give aid agencies an additional competitive advantage. Relying only on grant-based solutions is unreasonable, just as it is unrealistic to assume that a single institution should bear the investment risk of, for instance, a renewable energy project alone. The GEF discussed earlier and the Green Climate Fund demonstrates the trend toward even further blending different types of funding with other tools.

Meanwhile, development banks are stepping up and beginning to coordinate their own efforts, for example by setting up donor clubs such as the International Development Finance Club (IDFC). It brings together experts and twenty major national, sub-regional and bilateral development banks from developed and developing countries. The founding rational for the IDFC proves interesting. The organization helps overcome the traditional north-south divide on numerous issues, including the evolution of traditional sustainable-development funding (Bonnel, 2014). In addition, the creation of such a club testifies to the development banks' willingness to maximize leverage on other funding. Doing so will allow them to have greater effectiveness and impact in a financial environment where they have otherwise lost considerable influence to other sources of financing, particularly private ones. IDFC members never fail to point out that their cumulative funding activity outranks that of the multilateral banks. The IDFC actively uses its influence in discussions about the modalities of the Green Climate Fund; the latter holds the key to the future of IDFC member institutions, particularly those associated with official development assistance (ODA). It appears that the role of aid agencies and the value added by multi- or bilateral donors of public funds must be further clarified and examined. Public funds, from the North and from the South, need to serve as catalysts to private actors and orient them towards the production of (global) public goods.

A nother challenge facing traditional aid agencies revolves around their positioning within the global industrial ecosystem. Emerging economies have largely taken on 'climate' funding facilities, such as the Clean Development Mechanism (CDM). This has certainly contributed to gains in emerging countries' energy efficiency and industrial performance. The strengthening of these rising industrial powers compared to the weakening of the economies of traditional donor countries looms as a growing concern. Indeed, the international community once thought - or perhaps hoped - that investments in renewables through aid channels would benefit green industries in developed countries. However, since the geography of manufacturing and innovation has profoundly changed, moving from West to East, some emerging countries have become global leaders in green technology, such as China for solar panels.

Donors of ODA did not foresee these changes in worldwide manufacturing leadership, but the diplomatic and commercial tensions such an evolution engenders (see Chapter 15 of this volume) have repercussions on aid providers. Taxpayers in traditional donor countries find it increasingly hard to support the work of development agencies when this work builds the industrial and technological capacity of competitors. Questions now arise about donors' especially position in the worldwide industrial ecosystem, particularly for "green tech" and for bilateral donors: such questions merit clear answers.

The World Bank made an effort to clarify the situation in a 2012 report: "Green Growth, Technology and Innvoation." (Dutz et al. 2012).

Indeed, late 2013 saw increased collaboration between bilateral funding agencies and their own country's trade and export organizations. This movement, which some find in contradiction with the principle of untied aid, found purchase in countries as varied as Australia, Canada, France and the Netherlands.

In addition, the environment and development mandate of traditional donors is coming under strong pressure, as it can be noticed with the efforts to combat climate change, the environmental issue that development agencies have invested the most. On one hand, climate-related financing facilities have done little for the poorest countries, especially in sub-Saharan Africa (Colombier et al., 2006). Nor have they contributed much to financing climate-change adaptation, the poor sister to climate finance. On the other hand, anticipating synergy between financial profitability and environmental efficiency, funding bodies have primarily structured environment-development integration around the following syllogism: climate = mitigation = renewable energy. Donors have focused their efforts on disseminating green, alternative-energy production technologies (Dechezleprêtre et al., 2008) and have spent little effort on energy demand management or efficiency. Together, the latter generate the highest social and environmental impacts; however, their implementation costs are also higher.

India's experience is a good example. From the end of 80's, the Indian government plans an ambitious capacity development programme for renewable energy,

The National Climate Plan forecasts a 5% increase in renewable electricity production, up to 15% by 2020, and a 25% reduction in the country's energy intensity, also by 2020.

targeting 90 GW by 2032

Understanding Energy Challenges in India - Policies, Players and Issues - International Energy Agency - 2012

(the equivalent of Italy's installed capacity). However, based on current trends, India's reliance on coal will continue to increase, from 52% of its energy needs in 2008 to 57% in 2013, reaching 67% in 2017-2018, before it begins to drop to 59% in 2031-2032. Between 2008 and 2032, the installed capacity is projected to grown by a factor of four, from 141 to 609 GW. The Indian government has clearly maintained development as a priority over the environment. Institutions and programmes dedicate large resources to developing alternative energies, but this effort is above all aimed at diversifying India's energy mix and improving access for its citizens. More than 20 years after the creation of Indian Renewable Development (IREDA), India's position on renewables certainly needs to be updated, because the costly tools implemented so far, funded by public and private resources, are not finding sufficient support to be translated in consolidated robust industrial sectors. The institutional architecture is complex, creates uncertainty and complicates efforts to align actors and interests.

See e.g. the work of Zérah and Kohler (2013).

For development agencies, the picking of low-hanging fruit is justified by the very nature of greenhouse gas emissions; they are global externalities - where ever they are reduced, the cheapest and most effective way to do so must be selected. Nevertheless, one can question the relevance of development agencies funding a few megawatts of renewable energy while gigawatts of conventional power are funded. Especially since the financing of the more expensive renewables. Especially since the financing of the more expensive renewables directly affects household budgets; citizens must shoulder the higher cost of alternatives. The tension surrounding aid agencies' and especially development banks' 'environment-and-development' mandate is very strong. Their emerging-country financing activities are now an integral part of their business model, contributing to their financial stability.

Beyond matters of the international framework and of financial coordination, there are also questions about the methods and roles of various stakeholders. Here again, agencies must innovate, focusing on the development of hybrid and collaborative models.

See Under the radar 9 in this volume, in the field of biodiversity funding.

The post-2015 agenda will certainly accelerate the formation of new coalitions and partnerships that will be implementation-oriented and very focused on specific targets (e.g., the Sustainable Development Goals). These alliances will try to align the interests of various actors in governments, civil society and the private sector in quite innovative models and initiatives. Indeed, the big push will be to see more private sector involvement as the universal sustainable development agenda raises expectations and thus global public and private commitments and efforts. Organizing collaboration between heterogeneous actors is a key issue to incite, nurture and scale-up innovation.

These innovative ideas will be present in the environmental sector, taking advantage of the numerous positive outcomes that were tested in the fields of biodiversity or climate change. They will also inform social justice and poverty eradication efforts. We should recall that many innovative financing means and public-private partnerships were first invented in the healthcare sector. Most agencies and development finance institutions are now becoming involved with these new, pragmatic solutions, pursuing an impact-oriented agenda where innovation in finance, processes, technology and partnerships that combine know-how with funding will dominate.

Climate Finance flows in 2013

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