Public financing and sustainability

30 March, 2020Ben Caldecott

Governments and government-backed entities will have an important role to play in helping to finance the transition to global environmental sustainability. Ben Caldecott looks at the opportunity for rethinking public finance and makes some recommendations.

The legs of people wading through a flood In the energy sector alone, meeting the Paris goal of keeping average global temperatures to well below 2°C could require US$1.5 trillion of additional investment per year from now until 2050. This is up from a total of around US$1.2 trillion of investment last year.

This story is replicated in other sectors. Private sector balance sheets are already constrained and probably unable to efficiently raise all the capital needed.

Further, at any given time in different parts of the global economy there will be challenges accessing capital cheaply and efficiently – even for profitable investments.

Access to capital

Poor access to capital can be the result of temporary or structural problems, or a combination of both.

In developing countries this is mainly the result of underdeveloped capital markets and poorly capitalised domestic financial institutions.

Developed economies – even those with the most sophisticated financial systems and deepest capital markets, like the UK – also face problems. These range from a lack of experience in underlying technologies through to temporary collapses in confidence.

Covid-19 makes all these issues much harder to deal with. And it will almost certainly increase the need for a dramatic scaling up of public financing for everything.

That includes the very capital-intensive longer-term transition required to tackle climate change and the other environmental challenges facing humanity.

The role of public finance

The pandemic increases the urgency of thinking through the role of public finance.

How should public financing be provided? Do the existing public finance institutions have the right mandates? And do they have the financing capacity to see us through the current crisis and beyond?

A quick government review of UK public financing and public finance institutions should be urgently undertaken to ensure we get this right. I set out what that could look like below, but first let’s look at what public financing covers.

What public financing covers

Infrastructure projects, from development through to operation

Many countries have very well established infrastructure banks, including:

KfW in Germany
Caisse des Dépôts in France
BNDES in Brazil
and the China Development Bank.

In the UK we don’t really have a state infrastructure bank and have instead relied heavily on the European Investment Bank.

Company growth and development

Business finance supports companies – from startups and small to medium enterprises (SMEs) through to large multinational enterprises.

In the UK the British Business Bank, established in 2014, helps to provide this function for startups and SMEs.

Personal finance

Public financing sometimes enables individuals to borrow for education and training, or home investments that provide public and private goods, such as energy efficiency.

The student loan system in the UK is a highly concessional form of public finance.

Export credit

Government guarantees and loans provided by Export Credit Agencies (ECAs) help companies export goods and services. The UK has the world’s longest running ECA, UK Export Finance (UKEF) established in 1919.

Insurance

Public finance supports insurance provision – particularly for risks that are uninsurable or prohibitively expensive to insure through private markets. For example, in the UK we have FloodRe to provide flood insurance coverage to domestic properties deemed at significant risk of flooding.

Development finance

Delivering combinations of the above – through Multilateral Development Banks (MDBs) and Development Finance Institutions (DFIs) – this focuses on developing and emerging economies.

The UK is a shareholder in many MDBs, including:

the World Bank
Asian Development Bank
Inter-American Development Bank
European Bank for Reconstruction and Development, and
Asian Infrastructure Investment Bank.

The UK’s DFI is the Commonwealth Development Corporation (CDC).

Here are some suggestions:

creating a publicly owned UK infrastructure bank, focused on providing concessional finance for large infrastructure projects – as well as very large but much more diffuse infrastructure programmes, such as energy efficiency in homes.
a much more expansive role for the British Business Bank, should include providing concessional transition loans and structures to help businesses make investments that help them deliver net zero – while making them the most productive and efficient in the world.
establishing new national revolving fund for energy and resource efficiency, similar to the Salix scheme for the public sector, but for the private sector.
expanding UK Export Finance’s products and services to support new and emerging supply chains much more proactively – and the products and services required to meet net zero carbon emissions globally.
new collective insurance schemes and mechanisms, including those that can help to scale up investment in domestic climate resilience.
CDC and MDBs becoming Paris aligned and being given significantly more capacity to support the transition in developing and emerging economies – where the future of the global environment will be won or lost.
the principle of avoiding carbon lock-in and stranded assets – public financing for companies in polluting sectors should support a proactive transition to net zero.

Dr Ben Caldecott is founding Director of the Oxford Sustainable Finance Programme and an Associate Professor at the University of Oxford, as well as Co-Chair of the Global Research Alliance for Sustainable Finance and Investment and a Senior Adviser to the Chair and CEO of the Green Finance Institute.