In the past few years, and especially after the recent United Nations Climate Change Conference, or COP26, in Glasgow, private investors have seen an opportunity for the bumpy transition of developing countries to net carbon dioxide emissions. After all, if BlackRock CEO Larry Fink and climate activist Greta Thunberg can find a common cause, the tantalizing possibility posited by William Blake – “Great things are done when men and mountains meet.”
Extreme optimism is reflected in the numbers. Asset managers believe that tens of trillions of dollars, mostly in green financing, could be available for ESG lending. Mark Carney, the former Bank of England governor, claims to have mobilized $130 trillion to help fund the zero net transition. The $100 billion a year in climate finance that rich nations promised the developing world at COP15 in 2009—a pledge that was not fulfilled—is starting to look like little change by comparison.
The response of developing economies to the new push for net-zero emissions has focused on the hypocrisy of rich countries in the field of fossil fuels. As Vijaya Ramachandran of the Breakthrough Institute and Todd Moss of Energy for Growth note, advanced economies are asking developing countries to phase out coal and natural gas while continuing to rely on the latter energy source in particular. The failure of the rich world to obtain the necessary financing compounds the hypocrisy.
But the concerns of developing countries are misplaced. Perhaps they shouldn’t worry that there will be too little climate finance, but rather that there will be too much, particularly from the private sector.
The implicit bargain – financing for fossil fuel reduction – is the basis of the intellectual consensus on climate change: the rich provide the financing while the poor move to renewables. But while a decade ago the burden was on the governments of rich countries to mobilize the money, now the expectation is that the private sector will do so.
This deal is problematic for two reasons: tacit political concessions and looming economic risks.
Sublime can be summed up starkly: “We, the rich, have anarchic politics, but the poor do not.”
For example, when protesters in France rejected fuel tax increases in 2018 and 2019, the discussion focused on the difficulty of climate action and the need to accept rollbacks on those taxes as an understandable consequence of democratic politics. But this latitude ends where the Global South begins. There, financing is more or less a magic bullet that overcomes the social and political hurdles of climate action.
The Indian government’s rollback of its planned reforms of the agricultural sector, after a 15-month protest of farmers, shows how misguided this view is. One of the concessions farmers extracted from the government was to thwart any effort to reduce the large energy subsidies they received. Subsidies are devastatingly harmful in terms of CO22 Emissions, soil quality, water availability and atmospheric pollution. But reducing it will be very difficult, with or without external funding.
More important is the economic risks of the deal. Climate change offers investors an opportunity to achieve global social good without sacrificing profits. ESG-related lending, which combines conscience and equity, has become a major financial fad.
But mounting evidence indicates that this activity exposes all the diseases associated with mania and financial bubbles. It was explained by Tariq Fancy, former chief investment officer of BlackRock. The opportunities for green projects in developing countries are exaggerated. Questionable ESG standards and ratings lead to ambiguity about how to measure the impact of ESG financing, as well as doubts about the incentives of borrowers, given the light and penalized nature of non-compliance. Since the financing is fungible, some companies may obtain ESG financing only to divert other sources of financing to non-ESG activities.
If trillions of dollars of climate finance went to emerging markets, the flows could reach 5% to 10% of these economies’ GDP — similar to the financing booms that preceded the 1997 Asian financial crisis and 2013’s “gradual tantrum.” Unregulated private money of this magnitude will lead to overactivity, volatility, imprudent lending and exaggerated exchange rates. Ultimately, when mania is seen for what it is, costly consequences will follow: capital flows will be reversed, and both production and the financial sector will collapse. We’ve seen this movie before in country after country, and we know how it ends. in a bad manner.
Turkey is only the latest example of the failure of financial globalization. Long periods of private financial flows get caught up in unsustainable macroeconomic policies rather than regulation, until suddenly, as always, inflows become outflows.
Of course, if interest rates start to rise in advanced economies, capital will become more expensive for poor countries. But to the extent that there is still sufficient liquidity in the system, the risks associated with environmental, social, corporate governance and climate finance are real. There is a cynical view that private climate finance can end up hurting poorer economies and achieving few positive climate outcomes, while enabling the financial sector to smear its somewhat tarnished reputation with a shade of green.
The conventional wisdom is that the next financial meltdown will come from the collapse of the cryptocurrency bubble. But climate finance may pose more serious risks. Financial markets are naturally concerned about cryptocurrencies and the like, recognizing that they are inherently risky assets (if they can be called assets), the kind of investors they attract, and the smell of Ponzi on them. In contrast, investing in ESG appears more serious and less risky, and the aura of perceived social benefit can easily lull regulators into complacency and inattention.
As Mark Twain wisely warned: “It is not what you do not know that kills you; it is not what you know is not.” Private climate finance may be the next financial bubble – and the world needs to wake up to the danger. – © Project Syndicate
Arvind Subramanian, Senior Fellow at Brown University, Non-Resident Distinguished Fellow at the Center for Global Development