An ‘equal effort’ approach to assessing the North–South climate finance gap

Abstract

This study employs a number of Integrated Assessment Models to determine what the optimal financial transfers between high-income and developing economies would be if climate mitigation effort, measured as mitigation costs as a share of gross domestic product, were to be divided equally across regions through a global carbon market. We find these to be larger than both current and planned international climate finance flows. Four out of six models imply that a North–South annual financial transfer of around US$400 billion is required by 2050, while the other two models imply larger sums, up to $2 trillion. However, the outlook for multi-country carbon markets is not encouraging at the moment. We thus review some potential sources of funds that might be used to fill the climate finance gap, including public aid, private investment, development banks, and special climate-related facilities. We find the shortcomings of public climate finance appear particularly hard to overcome, and argue that expanding private finance, either in the form of Foreign Direct Investment or through the issuance of ‘green bonds’, appears to be a more promising direction.

Policy relevance

Climate change is a profoundly asymmetric development issue, as countries at lower stages of development are likely to suffer disproportionate climate damages and mitigation costs. High-income countries have agreed to mobilise $100 billion a year by 2020 ‘to address the needs of developing countries’. However, scaling up climate finance has been slow and, more importantly, targets have not been chosen on the basis of a ‘scientific’ assessment. This article presents a novel, model-based analysis of the ‘equal effort’ inter-regional climate finance that could provide useful insights to policy makers in future negotiations. The gap identified by comparing models’ projections to current and planned financial flows is large but not prohibitive. In particular, private investment appears to be the most likely channel to fill the gap, although various public policies need to be implemented to improve the risk/return profile of low-carbon investment opportunities.

Keywords:

• carbon markets
• climate finance
• equitable development
• integrated assessment models
• North–South flows

JEL classification:

• F30
• Q54
• Q56

Acknowledgements

The authors would like to thank Simon Dietz, Luca Taschini, LIMITS partners, and three anonymous referees for useful comments. Alex Bowen and Emanuele Campiglio also gratefully acknowledge the support of the Grantham Foundation and the UK's Economic and Social Research Council. All errors are exclusively our own.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. ‘LIMITS’ stands for ‘Low climate IMpact scenarios and the Implications of required Tight emission control Strategies'.

2. Integrated assessment models are large-scale numerical models that simulate the dynamic interconnections among the economy, climate, and the energy system. Details of the ones participating in LIMITS can be found in Kriegler et al. (2014).

3. For the purposes of this article, high-income economies include North America, Europe, and Pacific OECD (plus Rest of the World for WITCH and REMIND). Emerging economies include Africa, China+, India+, Latin America, Middle East, Reforming Economies, and Rest of Asia. For more details see Tavoni et al. (2014).

4. Beyond 2020, regions are assumed to maintain a rate of emission intensity improvement broadly consistent with the one achieved through their pre-2020 action. See Supplementary Online Material of Kriegler et al. (2014).

5. A concentration of 450 ppm CO₂e is consistent with a probability of greater than 67% of remaining below the 2 °C ceiling. Temporary overshooting of targets is allowed.

6. More generally, an extensive literature exists on climate burden-sharing mechanisms and equity in the distribution of abatement costs (Höhne, Den Elzen, & Escalante, 2014; Rose, Stevens, Edmonds, & Wise, 1998) and a number of rules have been suggested to find a cost allocation agreement that could be perceived as fair by both high-income and developing regions, based on convergence of per capita emissions, carbon intensity, historical responsibility, grandfathering, or a combination thereof.

7. As in Tavoni et al. (2014), we compute regional mitigation costs using the following: consumption losses for models with a macroeconomic component (MESSAGE, REMIND, and WITCH); abatement costs (IMAGE and GCAM); and energy system costs (TIAM-ECN).

8. Comparing regional mitigation costs with global mitigation costs helps to control for the differences in projected global mitigation costs (cumulated over 2020–2050) across models, which are pronounced. Projections range from 0.51% of global GDP (IMAGE and GCAM) to 5.84% (WITCH).

9. With the exception of GCAM, the results of which are not comparable with those of the other models.

10. This result confirms the relevance of trade-of-terms effects. However, the issue of whether exporters of fossil fuels should be compensated for the loss incurred because of changes in trade patterns is not likely to affect our results on North–South flows. A calculation looking at the difference between climate finance inflows and fossil fuel exports suggests that, while their regional distribution would be affected, the overall flows to developing regions would only change marginally.

11. A precise comparison between sources of climate finance and LIMITS results is not possible. While the carbon market in LIMITS model can be thought of as providing budget support to regions with projected financial inflows, with no explicit requirement to use them for low-carbon investment, the sources and channels we discuss in this section are unequivocally directed to investment. Additionally, the highly aggregate nature of LIMITS models prevents us from distinguishing between different types of flows (public and private, for instance). Finally, in the LIMITS models, financial flows take place only from 2025/2030 onwards, while current commitments and projections of climate finance seldom go beyond 2020.

12. For a more detailed discussion of source and channels of public climate finance, see Gupta et al. (2014) and Bowen (2011).

13. Data source: OECD DAC (available at http://www.oecd.org/dac/stats/).

14. According to Climate Funds Update, of a total of $34 billion pledged for climate funds by February 2015, only $15.7 billion (46.2%) have been deposited so far, and only $1 billion (3%) disbursed. See http://www.climatefundsupdate.org/data.

15. ‘Unlabelled’ green bonds are bonds whose proceeds are employed for climate-related activities but are not formally categorised as ‘green’. The outstanding amount of ‘labelled’ green bonds in 2015 was around $66 billion.

Additional information

Funding

The research leading to these results has received funding from the European Union Seventh Framework Programme FP7/2007–2013 under grant agreement no. 282846 (LIMITS).