Is it feasible to publicly fund the global energy transition?

The hockey stick of doom is the graph of the stock of atmospheric carbon that governs the degree of planetary warming. The system of dynamic equations that govern the stock of atmospheric carbon, global temperatures, ice sheet cover, and sea levels describe the earth’s self-regulatory system since the origin of life on our planet — we just discovered them in the twentieth century. They are expected to work the same way on any planet with carbon, oxygen, water and organic life. What fossil modernity has done is dramatically accelerate the accumulation of carbon in the atmosphere, leading to anthropogenic climate forcing. Unless we can act collectively to not only cut down the rate of carbon emissions but to actually reduce the stock of atmospheric carbon, the global climate is going to get very, very harsh indeed: thermal burdens will make large parts of the global south virtually unlivable thereby triggering massive population pulses to the north; sea levels may rise quite dramatically, posing an unprecedented risk to coastal communities world wide; the climate will not only become warmer but dramatically more unstable, with much higher frequencies and amplitudes of extreme climate events like heat waves, droughts, flooding, hurricanes, snowstorms, and so on; our food supply will be at greater and greater risk as the century proceeds, in turn posing existential risks to human civilization at the planetary scale.

So, we’re riding up the hockey stick to our doom. The question is: what will it take to get off it?

Technical solutions are already feasible and widely understood. What is required to get off the hockey stick of doom is a wholesale remaking of global energy systems, food production and land use patterns: transportation, housing and industry have to be electrified and made more energy efficient; clean energy from renewables and nuclear power plants has to replace dirty energy from coal, oil and gas; food production and land use have be transformed from carbon emitters into carbon sinks. Make no mistake — this is a considerable undertaking. The problem is that we don’t have an effective world government that can plan, fund and implement global decarbonization.

The real problem is one of political economy. It is not simply a matter of global coordination — although that remains a hard problem, especially in light of the new cold war discourse that has taken hold of the minds of Western elites since Martin Wolf kicked it off a few years ago. It is also not just a matter of the United States and the European Union getting their own act together — the West no longer accounts for the bulk of carbon emissions. In every nation, there is a dirty energy coalition of actors committed to resisting what to them is an existential threat. In the United States, one of the major parties is still in thrall of the oil and gas interests. Then there are the stranded nations like the oil monarchies of the Persian Gulf and petrostates like Russia who have everything to lose from an energy transition. Even in countries where fossil interests are limited, there are coalitions strongly opposed to deep decarbonization.

But beyond the problem of global cooperation, beyond stranded industries and nations and their power, beyond captured politicians and their parties, the main blockage is the threat of greenwashing and half-measures masquerading as solutions. While paying lip service to capping global warming at 2ºC, the Biden administration — and even Senator Warren — have only come up with non-solutions. The reason is not that they are stupid. They are certainly smart enough to figure out that the scale of their proposals is an order of magnitude too small. The reason is that the actual scale of the transformation required runs smack into politico-moral commitments to fiscal discipline. Behind this blockage is the idea that the whole thing needs to be directly funded by the taxpayer.

Because tax dollars are politically expensive, $2 trillion over the next decade is the limit of what Democrats interested in reelection can propose even if they are convinced that the plan is an order of magnitude too small relative to what is required to decarbonize at scale — $10-20 trillion over the next 10-20 years. Similar assumptions about public financing and fiscal discipline have prevented other nations in the West from coming up with credible plans.

While the advanced industrial nations are caught up in old ways of thinking about public finance, the developing nations have no such luxury. MMT or not, they actually cannot afford the scale of public investments required to decarbonize. While the West’s problems are largely political and intellectual, the nations of the southern half of the globe face hard constraints: they have limited institutional capacity for large scale projects; their capacity to raise tax revenue is much more limited; they have poor credit in London and face higher financing costs; their restive populations have little patience for elite desiderata — they want food, running water, electricity, clothing and shelter — the environment and the Western intelligentsia be damned.

According to the IMF’s Fiscal Monitor, the nations of the globe are differentially-situated with respect to fiscal capacity. The median high income country raises 40 percent of GDP in tax revenue. The median for middle income countries is 28 percent. For low income countries, it is just 18 percent. Even if public investment were a feasible political economy solution in the rich world, it just won’t work in the southern half of the globe.

The second constraint on publicly-funded decarbonization is the already high debt levels across the world. In the advanced economies, the median level of gross debt is 70 percent of GDP. In middle income countries, it is 64 percent; in poor nations, 48 percent. These numbers make it seem as if low income countries have greater fiscal room than high income countries. But this is not the case because they have relatively smaller tax bases, as you can see from the previous graph.

Indeed, a rough measure of fiscal room is the ratio of tax revenue to gross debt. By this measure, the high income nations of the north still have greater fiscal room than the low income nations of the south.

The most important variable ignored by this measure is the borrowing cost faced by sovereigns. Interest rates have never been lower, of course. But here again, the nations of the north and south are differentially situated. Low income countries face higher borrowing costs than the high income nations with their more developed institutions — above all, the rule of law. This applies not only to sovereigns but also private borrowers. The result, as the United Nations Development Program (UNDP) argued in 2013, is that the financing costs of the same project is considerably higher in developing countries. For instance, ‘in a developing country with higher financing costs, wind power generation cost becomes 40 percent more expensive than that of gas because of the upfront capital intensity of wind technologies.’

Financing costs are even more prohibitive for solar if you were to try to fund it without any leverage:

These constraints have forced the minds of researchers working at multilateral institutions. They have come to realize that the most efficient utilization of the third world state’s capacity is for it to absorb risks that global investors cannot bear. That’s the UN’s ‘theory of change’ behind the push to ‘derisk’ renewable energy investments:

The theory of change underlying the framework is that one of the main challenges for scaling-up renewable energy technologies in developing countries is to lower the financing costs that affect their competitiveness against fossil fuels. As these higher financing costs reflect barriers and associated risks in the investment environment, the key entry point for policymakers to foster renewable energy technologies is to address these risks and thereby lower overall life-cycle costs.

In a recent paper, Daniela Gabor argues against the ‘derisking’ paradigm. She suggests that it is a technique for ‘commodifying infrastructure assets’ in the interest of global finance — which sounds quite right. But she also claims that the “‘development as de‐risking’ paradigm narrows the scope for a green developmental state that could design a just transition to low‐carbon economies” — which leaves open the question of how this ‘green developmental state’ would be financed. And if the idea is to re-institute capital controls and modernize behind a wall of tariff protection and financial repression, it is not clear why that would work given the abject failures of the midcentury postcolonial modernization states across the global south. In general, it is striking how much the decarbonization agenda has brought us back to the modernization agenda of the 1960s — as we anticipated at the GND seminar at Johns Hopkins.

The real value of Gabor’s paper is, paradoxically, not in her critique of the ‘derisking’ paradigm, but in its conceptualization. She offers a revealing schematic of the strategy being pushed by the World Bank, the IMF and the UN. So there are thousands of projects that need to be funded. For each project, step one is to ask whether it can be privately funded without any public intervention — if it can, leave it to the market; if it cannot, go to step two. If there is a blockage that prevents a private solution, can it be fixed by regulatory changes? If it can, that’s all that’s required. If it can’t, go to step three, which is where the de-risking business comes in. Is the project exposed to risks that institutional investors cannot bear? If so, absorb those risks on the public balance sheet and let the rest be absorbed by global institutional investors. Finally, if none of this works, fund it directly from tax revenue or loans to be paid off with said tax revenue. The trick is to utilize the risk-bearing capacity of global institutional investors — which requires the financialization of green projects.

This is an efficient way to utilize scarce tax revenue. Something like this is absolutely necessary to accomplish decarbonization in the third world under conditions of combined and uneven development. Even in the rich nations of the advanced industrial world, it is a promising strategy to efficiently use politically-expensive tax dollars. The real alternative is not that of the progressive fantasy — publicly funded worldwide deep decarbonization underwritten by a reconstructed global financial system under democratic control — because progressives are not even in a position to impose their visions in their own countries as of writing, even within the social democratic parties they call home. The real alternative is the wholesale failure of the decarbonization agenda, not so much because of outright climate denial, but rather because we mistake verbal assent by the adults for seriousness.

Ted Fertik knows how to reframe the point I was trying to make on Twitter. The same solutions don’t apply to states and all projects — we need a basic typology of states and projects.

Ted Fertik @tedfertik

@DanielaGabor @policytensor @JWMason1 Will also read the paper! @policytensor’s typology makes intuitive sense to me tho. Treat high npv and low npv projects differently; treat high fiscal capacity and low fiscal capacity states differently. US doesn’t have to offer much (any?) subsidy to capital for many projects

Ted’s last point is that the United States is in the most favorable position given the plumbing of the global financial system. That’s quite right. A market-based system, properly designed, works to the American advantage quite unambiguously. But what is a good design?

The real issue is who gets to make the decisions in Gabor’s red blocks. The system as conceived is ripe for manipulation. If we let the BlackRocks of the world dictate these decisions, or if we let politicians plot with technocrats without media scrutiny, we are inviting abuse. That would undermine the moral economy of the global decarbonization agenda. This is part of the reason why Albert Pinto and I insisted on an FDA for Green Finance. Greenwashing is such a significant threat to the decarbonization agenda that the stamping function cannot be left to private players; certainly not to interested parties like “independent” credit rating agencies or institutional investors. We saw how that worked out in the 2000s. Also, the clock is ticking faster and faster. This needs attention right now. Financial intermediaries have already made a mockery of ESG. They cannot be trusted not to screw it up. It has to be a Congressionally-mandated agency that decides the green ratings.

The path to a sustainable future is a long one. It itself needs to be sustainable. In the US, we have to sustain the policy agenda over at least three administrations. Greenwashing destroys the moral economy of the energy transition, thereby inviting its premature arrest. Social democracy cannot afford it at this juncture. The Biden people need to go back to the drawing board and come up with something serious. Not only in terms of scale. But in terms of basic design principles.