Failure to reach net zero is not an option. How can the transition finance gap be closed?
The stakes are high, and failure is not an option. Emerging markets need to transition to net zero as soon as possible, and that means raising additional finance.
Our study explores two routes to raising the USD94.8 trillion required for emerging markets to reach net zero by 2060:8
These two contrasting scenarios emphasise the importance of developed market support for emerging market transition. In reality, a route between these two paths is probably the most likely.
If emerging markets raised the capital themselves, the study assumes that 75 per cent would come from households via higher taxes, and 25 per cent would be borrowed. This split reflects the relative share of consumption and investment spending in these economies.9
Self-financing a net-zero transition would take a significant sum away from emerging market households: USD2 trillion annually; close to the amount currently spent on food and drink each year.10 Emerging markets’ household consumption – the money available to spend on everyday needs – could fall by around 5 per cent on average between 2021 and 2060. In total, between now and 2060, emerging market household consumption could be reduced by USD79.2 trillion.11
8 Please see the executive summary for an explanation of why this study assumes emerging markets will reach net zero in 2060. 9 Currently in the developing world consumption is approximately twice the size of investment - 67/33% - however investment rates fall as countries develop so 75/25% is a more accurate split for 2021-2060. 10 Source: The Global Consumption Database published by the World Bank. 11This is a figure for all emerging markets. For the purposes of this study, we have used the UNFCCC’s division of emerging markets and developed markets (referred to as ‘annex 1’ and ‘non-annex 1’ countries).
This means these households would have less money to spend on essentials such as food, clothing, housing, energy, health and education. Health and education, key to building better futures, are likely to be hit first. Many people in emerging markets are already living in extreme poverty, defined by the World Bank as surviving on less than Int$ 1.9012 per day. In some parts of Africa, 70 to 80 per cent of the population live below this poverty line.
Emerging markets are bearing the brunt of climate change that has largely been caused by developed countries. They cannot be expected to carry the weight of transition. The impact associated with inaction is becoming clearer every day, and the industrialised economies must now step up. This is not about them ‘saving the day’. Rather, it is about embracing global opportunities and mitigating global risks that impact everyone everywhere.
This financing pathway could make a successful transition impossible, as emerging markets would be unlikely to be able to raise this huge amount of capital – USD94.8 trillion – alone.
Emerging markets do not have the same access to finance as their developed counterparts, partly because many have a lower degree of monetary sovereignty – the exclusive right of a state to control its own currency.13 Governments are also grappling with the cost of COVID-19 and looking to rebuild their economies, many of which are based on carbon-intensive industries, as quickly as possible. Taking the self-financing route almost certainly means a failed net-zero transition and a resulting climate emergency.
12 The international dollar (Int$) is a currency unit used by economists and international organisations to compare the values of different currencies. International dollar comparisons between countries have been adjusted to reflect currency exchange rates, but also adjusted to reflect purchasing power parity (PPP) and average commodity prices within each country. An international dollar would buy – in the relevant country - a comparable amount of goods and services that a US dollar would buy in the US. 13 Monetary sovereignty includes essentially three exclusive rights for a given state: the right to issue currency, that is, coins and banknotes that are legal tender within its territory; the right to determine and change the value of that currency; and the right to regulate the use of that currency, or any other currency, within its territory.
Emerging markets cannot be left behind in the race to net zero or be expected to sacrifice their economic development and prosperity.
The fairest and most achievable route is developed market financing: wealthier countries providing the USD94.8 trillion needed – the equivalent of 2.7 per cent of annual GDP for the developed world – through a combination of public and private sector financing. Developed market governments have the means to make the necessary grants as most emerging markets do not have enough domestic finance available. Our study also reveals that providing this financing would benefit developed economies.
This financing model would see the public sector provide grants of just under USD300 billion annually – a total of USD11.8 trillion between 2021 and 2060 – mainly for investment into energy efficiency in transport and buildings. The split among developed countries’ contributions would be in line with GDP but, realistically, these grants will only cover a minor portion of the finance needed.
The private sector will need to bridge the remaining gap, supplying loans of just over USD2 trillion annually – a total of USD83 trillion between now and 2060 – for power sector investment and energy efficiency investment across industry, transport, and buildings. This finance would not be spread evenly over the period: a greater proportion will be needed earlier on in the transition.
The assumed split between public and private sector financing is based on the private sector providing the investment required by the power sector (on the basis that it is easier to make tangible returns on electricity infrastructure) and a percentage of the investment required for energy efficiency across industry (100 per cent), transport (80 per cent) and buildings (20 per cent) – a total of USD83 trillion.
The public sector would then provide the remaining percentage of the investment required for energy efficiency across transport (20 per cent) and buildings (80 per cent) and other public expenditure required (early scrappage costs and environmental subsidies) – a total of USD11.8 trillion, following the USD44.4 trillion offset of carbon tax revenues and household environmental tax.14
This approach would delay the pain of paying for net zero, making it more likely that emerging markets will move at the speed required. Moving quickly also has other benefits: spending now will help to boost the post-COVID economy, and governments can take advantage of current low interest rates. It is likely that some public support would be required to incentivise the private sector to make the necessary loans without charging high interest rates.15
14 Figures derived from the IEA data on energy efficiency have been used for these calculations. 15 This idea – that public support would be needed to incentivise the private sector to make the necessary loans without charging high interest rates – is assumed implicitly in the economic modelling.
If emerging markets are to transition to net zero in time to meet global climate change goals we need action and we need it now. As it stands, there is simply not enough money flowing towards net-zero transition in the developing world. We must leverage the private sector and take the capital sitting in the north and put it to work in the global south. This is not about aid; it is a commercial matter. The finance community must support existing renewable energy infrastructure platforms in the global south as well as developing new structures required to enable private sector capital to flow at a market-by-market level. And solutions need to be creative. Investors prefer big projects, but emerging markets require financing to support decentralised energy systems – so we need to find a way of mobilising private sector capital into smaller investments.
Developed market financing could mean household consumption in emerging markets would be 4.5 per cent higher on average each year between 2021 and 2060 (compared to self-financing) and emerging market GDP would be 3.1 per cent higher on average each year between 2021 and 2060.
This could mean emerging market consumption is USD1.7 trillion higher on average annually, and USD68.6 trillion higher cumulatively between 2021 and 2060.
However, it’s not just emerging markets that would benefit economically. If developed markets provided finance for emerging market transition, it would boost the global economy. Our study shows that global GDP would be USD108.3 trillion higher cumulatively between now and 2060 compared to emerging markets’ self-financing.16
16 The costs of climate risks are not factored into the model, so in fact under a failed transition (baseline scenario) GDP would be a lot lower, and the benefits of transition compared to baseline would actually be much greater.
Arranging the additional financing is a critical issue. This study assumes that commercial banks create new money when they advance loans, and so additional lending to emerging markets will not affect rates of lending or interest charged to companies in developed markets. The small share of funding that comes from public sources would need to be provided by central banks if governments were to avoid interest charges; however, the response to COVID-19 showed that this is possible, if the low-carbon transition is viewed as a crisis that requires an urgent response. It is noted that increased rates of money creation could fuel inflation in emerging markets where product demand in the real economy rises, but the modelling results showed only limited impacts that are outweighed by changes in energy prices. Exchange rate movements remain uncertain, but an appreciation of emerging markets’ currencies is another possible outcome in the developed market financing pathway.
The developed market financing approach is an opportunity for private investors to help drive a just transition, moving assets from developed to emerging markets with the help of the right policies and regulation to support sustainable industry, infrastructure, transport and energy systems.
