Private climate finance is the next financial bubble

In recent years, and particularly after the recent United Nations Climate Change Conference, or COP26, in Glasgow, private investors have seen a midwifery opportunity in developing countries’ bumpy transition to net emissions. of carbon dioxide. After all, if BlackRock CEO Larry Fink and climate activist Greta Thunberg can find common cause, then the enticing prospect tenuous by William Blake – “Great things are done when men and mountains meet” – appears in view.

The exhilarating optimism is reflected in the numbers. Asset managers believe that tens of billions of dollars, mainly in the form of green finance, could be available for environmental, social and governance (ESG) loans. Mark Carney, the former Governor of the Bank of England, claims to have 130 trillion dollars mobilized to help fund the net zero transition. The $ 100 billion a year in climate finance that rich countries pledged to provide to the developing world at COP15 in 2009 – a pledge that has yet to be fulfilled – is starting to look like a stupid change in comparison.

Developing economies’ response to the new push for net zero emissions has rightly focused on rich countries fossil fuel hypocrisy. As Vijaya Ramachandran, of the Breakthrough Institute, and Todd Moss, of the Energy for Growth Hub, have Noted, advanced economies are calling on developing countries to phase out coal and natural gas while continuing to depend on the latter source of energy in particular. The failure of the rich world to shell out the necessary finances compounds the hypocrisy.

But the fears of developing countries are misplaced. Perhaps they should be concerned not that there will be too little climate finance, but rather that there will be too much, especially from the private sector.

An implicit market – funding in exchange for reducing fossil fuels – underpins the intellectual consensus on climate change: the rich provide the funding while the poor turn to renewables. But while ten years ago it was incumbent on the governments of rich countries to raise the money, now the private sector is expected to do so.

This market is problematic for two reasons: implicit political condescension and imminent economic risks.

Condescension can be summed up bluntly: “We rich people have a messy politics, but not the poor. ”

For example, when protesters in France pushed back fuel tax increases in 2018 and 2019, discussion focused on the difficulty of climate action and the need to accept the removal of these taxes as a consequence. understandable of democratic politics. But such latitude ends where the Global South begins. There, finance is sort of a silver bullet that overcomes social and political barriers to climate action.

Indian government retreat on his planned agricultural sector reforms, following a 15-month protest by farmers, shows just how flawed this view is. One concession that farmers extracted from the government was to prevent any effort to reduce the large electricity subsidy they receive. The subsidy is devastating in terms of CO2 emissions, soil quality, water availability and air pollution. But reducing it will be devilishly difficult, with or without external funding.

The economic risks of the market are greater. Climate change offers investors the opportunity to do good for global society without sacrificing profits. ESG credit, which combines awareness and capital, has become a major financial fad.

But more and more evidence suggests that this activity displays all the pathologies associated with manias and financial bubbles. Tariq Fancy, former head of investments at BlackRock, has spelled them. The opportunities for green projects in developing countries are overestimated. Questionable ESG standards and ratings lead to uncertainty over how to measure the ESG effect of funding, as well as doubts about borrower incentives, given the lenient and deferred nature of penalties for non-compliance. Since funding is fungible, some companies may obtain ESG funding only to divert other sources of funding to non-ESG activities.

If trillions of dollars in climate finance go to emerging markets, flows could amount to 5-10% of the GDP of these economies, similar to the financing surges that preceded the Asian financial crisis of 1997 and the 2013 “taper tantrum”. Unregulated private capital flows of this magnitude will lead to overheating, volatility, reckless lending and overvalued exchange rates. Eventually, when mania is seen for what it is, costly consequences will ensue: capital flows will reverse and production and the financial sector will collapse. We’ve seen this film country after country before and we know how it ends. Wrong.

Turkey is just the latest example of financial globalization gone awry. Long periods of private financial inflows accommodate, rather than discipline unsustainable macroeconomic policies, until the inflows suddenly become outflows, as they invariably do.

Of course, if interest rates start to rise in advanced economies, capital will become more expensive for poorer countries. But to the extent that there is still sufficient liquidity flowing through the system, the risks associated with large-scale ESG and climate finance are real. A cynical view is that private climate finance could end up damaging poorer economies and produce little positive climate outcome, while allowing the financial sector to put on its somewhat tarnished reputation with a patina of green.

Conventional wisdom is that the next financial crash will come from the collapse of the cryptocurrency bubble. But climate finance can present a more serious risk. Financial markets are naturally wary of cryptocurrencies and the like, as they realize that these are inherently risky assets (if they can be called assets), the type of investors they attract, and the type of investors they attract. the smell of Ponzi that hangs over them. In contrast, ESG investing seems more serious and less risky, and its perceived social good halo could easily lull regulators into leniency and inattention.

As Mark Twain aptly warned, “It’s not what you don’t know that’s killing you; it is what you know which is not the case. Private climate finance could be the next financial bubble – and the world needs to realize the danger. – © Project union

Arvind Subramanian, Principal Investigator at Brown University, is a Non-Resident Distinguished Fellow at the Center for Global Development


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