Private enterprises are poised to play a critical role in the fight against climate change. Not only does climate financing provide a means for realizing lucrative returns on private capital, but it is also in the best interest of private enterprises to adopt new technologies and reform their operating models and supply chains to mitigate the impacts of climate change on their business. However, as per widely available empirical evidence, the twin objectives of reducing environmental degradation and driving economic growth tend to be mutually exclusive, thus making it harder to achieve both at the same time. Therefore, the key challenge lies in designing policies that balance these competing priorities, especially in the context of low- and middle-income countries, as the developmental pathways that they choose to take will ultimately decide whether the goals of the Paris Agreement will be met or not.
Data is one of the most important inputs into any decision-making process. Therefore, the availability of reliable data and peer-reviewed research is critical for stakeholders such as policymakers and development finance institutions (DFIs) to design the most cost-effective policy and financial instruments for climate change mitigation. The lack of such data from developing countries makes it imperative that academia and think-tanks focus their efforts and energies on topics and questions that are most relevant for policymakers, DFIs, and other key actors. This was the theme of the panel discussion ‘What don’t we know? Directions for Research on Private Enterprises and the Green Recovery’, organized as part of the 3rd Annual Conference of the Private Sector Development Research Network. This conference was hosted by the Center for Development Economics and Policy, School of International and Public Affairs at Columbia University from 9th – 10th December 2021. The discussion was moderated by Eric Verhoogen, Professor & Co-Director, Center for Development Economics and Policy, Columbia University and the panel consisted of Seema Jayachandran, Professor, Northwestern University, Arik Levinson, Professor, Georgetown University, and Susan M. Lund, Vice President, Economics and Private Sector Development, International Finance Corporation.
There is ambiguity over the net effects of economic growth drivers on the environment but improved regulatory capacity and adoption of energy-efficiency measures can ease the trade-offs in the short-term
Dr Jayachandran remarked on the ambiguity over the net effects of the engines of economic growth, such as growth in agricultural productivity or growth in the services sector, on the environment. For example, researchers have found that intensification of agriculture in Uganda resulted in decreased deforestation, due to higher productivity and lower land use, but the opposite happened in The Gambia. Similarly, money transfers to low-income households in Mexico increased deforestation because it increased the consumption of energy- and land-intensive products such as beef and milk in these communities, and the problem was observed to be worse in the poorer areas.
Dr Jayachandran also stressed upon the need to acknowledge potential trade-offs between economic progress and environmental protection and to realize that the challenge is always going to be in ensuring economic progress in the least energy-intensive manner and without damaging the environment. To emphasize this point, Dr Jayachandran quoted the example of a study carried out in China in which productivity of firms upstream and downstream of a water pollution monitoring station was measured. It was observed that because government officials had an incentive to enforce regulations upstream of the monitoring station, the firms downstream of the station recorded a 40% higher Total Factor Productivity (TFP). One way of easing these trade-offs is to focus on the low hanging measures in the near-term. These include measures such as:
- Improving regulatory capacity: The environmental harm from economic activities entails externalities, and therefore there is a need for taxes or regulations to correct these externalities. However, differences have been observed between rich and poor countries in their capacity to effectively regulate such externalities. These differences arise due to weakness in regulation, primarily because of administrative capacity, and possible corruption in the enforcement of regulations. Some of the ways in which these barriers can be overcome is through the adoption of technology (e.g., Brazil uses satellite imagery to manage its regulation on deforestation in the Amazon) and reorganizing regulatory enforcement to reduce the capacity for corruption (e.g., using 3rd party officials to conduct audits and surveys). These regulations should ultimately result in pushing the frontier – more productivity but at the same time not harming the environment and complying with the regulations. Undoubtedly, there will be some reallocation of production, with more of it happening amongst firms that are able to thrive and be competitive in a strong regulatory environment.
- Adopting energy efficient technologies and products: Energy efficient technologies and products, by using less energy per unit of production, inherently reduce the energy intensity of economic activities. However, there is evidence on the consumer side that credit constraints can be a big problem. Information barriers also prevent consumers from adopting such technologies and products. Furthermore, it has been observed that a lack of competition in emerging markets is not driving out firms that are less energy efficient, and consequently unproductive. Therefore, more research is needed on what are the main constraints and how to remove them.
The need of the hour is to formulate separate policy instruments for income equality and positive environmental outcomes; achieving both outcomes with a single policy is challenging
Dr Levinson talked about how most of the focus so far has been on green recovery from non-private enterprises such as the World Bank, President Biden’s Build Back Better plan, and so on. Typically, private enterprises tend to focus only on profits; pollution and inequality are externalities and not their concern as per classical economics. Therefore, the onus falls on NGOs, governments, and development banks to combine these goals. There are linkages between these twin objectives, but these linkages are complex. For example, it is well-known that poor underrepresented communities are more polluted. However, it’s not clear if this environmental injustice is specifically because of economic activities or merely a symptom of broader social inequalities. If it’s symptomatic, does it make sense to regulate the environmental symptom or is it futile given the underlying disease of social inequality? Another example is how the costs of some of the environmental regulations imposed on private enterprises have fallen disproportionately on poor, underrepresented communities. Such regulations typically raise prices, which adversely affects the marginalized communities. In summary, the twin goals are in competition and the net effect is complicated – poor, underrepresented communities get a disproportionate share of the benefits and costs of such regulations.
Dr Levinson also explained how current policies that try to achieve these two objectives at the same time effectively fail to do so. He quoted the example of electricity pricing and how utilities across the world have adopted a two-part tariff: the fixed tariff (to recover the investment in power plants and distribution lines) and the variable tariff, which is essentially the marginal cost of supplying one additional unit of electricity. In theory, the fixed tariff should be much higher than the variable tariff, as power generation entails very high initial upfront investment while the marginal cost of generating an additional unit of power is much lower. However, in reality, it is the other way round and utilities are charging a higher variable tariff and a lower fixed tariff. This scheme ends up working in a redistributive manner and puts more pressure on those who consume more electricity as they are presumed to be richer. This is problematic because of several reasons:
- It is inefficient as people are not paying the marginal cost for what they are consuming.
- For climate reasons, we want people to switch to electricity – but if that electricity is priced disproportionately, it disincentivizes people in private enterprises from making environmentally helpful choices.
- It also does a poor job of addressing the underlying inequality because there are a lot of rich people who don’t use much electricity as they might be away on trips or off to work, their children might not be at home, and they are more likely to have energy efficient appliances.
Ultimately, out of concerns for inequality, utilities end up charging inefficient prices for this key environmental good that not only exacerbates pollution but also does a bad job of protecting the low-income rate payers.
Pollution taxes: a potentially better solution than energy efficiency standards?
Dr Levinson also argued for pollution taxes as a cost-effective way of regulating the environment, as they cause the most reduction in emissions per dollar spent. While the opponents of pollution taxes claim that such taxes fall disproportionately on low-income households (HHs), Dr Levinson stated that this claim can be misleading for two reasons. First, if the revenue generated from pollution taxes can be targeted towards low-income HHs, such taxes can be made progressive. Second, the opponents of pollution taxes propose energy efficiency standards as a viable alternative. However, it must be kept in mind that energy efficient appliances and products cost more to purchase while costing less to operate. Since low-income HHs typically have a lower utilization of these products, they turn out to be more costly for these households as the initial high investment is not offset by future energy savings. Thus, energy efficiency standards turn out to be more costly and achieve less environmental equality than pollution taxes and are ultimately worse for low-income HHs.
Looking ahead: focus areas for research
In her address, Susan Lund talked about the immense business opportunity that climate financing represents in developing countries – to the tune of $23T. However, there is not enough clarity on how firms in emerging markets will respond. Capturing this opportunity will require a deeper understanding of what climate change risks these firms face, what drives their response, what mechanisms are available to them, and how their actions will affect the broader economy and market they operate in. Therefore, this creates huge demand for knowledge, and based on IFC’s experience, there are three key areas where research is needed:
- Going beyond research in advanced markets: It is well-understood that the battle against climate change is going to be won or lost in developing economies. Therefore, it is crucial to know how findings from advanced markets apply to these economies as some of the problems and solutions are unique to these economies. Firms in developing countries often behave differently than those in advanced economies because of institutional and policy contexts. Thus, a lot more research and understanding are needed into how the social, institutional, and environmental contexts in these countries shape the behaviour and response of firms. In the case of Africa for example, half of the continent’s potential GHG emissions by 2050 will come from firms that haven’t been built yet. Building these firms to green standards will require a lot of targeted research into what are the incentives, costs, and regulatory, institutional, & infrastructural barriers to leapfrogging ahead.
- Going beyond the energy transition: A large share of GHG emissions don’t come from the energy sector but from how we make and produce the food and goods that we consume. Therefore, this opens a lot of research possibilities into mitigating emissions from agriculture and manufacturing. Green manufacturing and circular economy are thus some of the areas that need to be investigated in greater detail. More clarity is needed on which technologies in which contexts can create a win-win situation in greening manufacturing and where there are trade-offs to be made. Furthermore, it is essential to understand what government incentives, subsidies, or other mechanisms are needed to get firms to adopt green technologies.
- Going beyond mitigation mechanisms to adaptation: There is also a need to think about climate risks in adaptation measures. This is particularly relevant for firms in lower- and middle-income countries given the weather variability and climate impacts are going to be more extreme. There is not a lot of information available on adaptation either in developing or advanced markets. Therefore, an additional body of literature on how firms adjust to changes in business conditions and factors such as new competitors, products, technologies, and market regulations will be crucial.
Sagun Tripathi (MBA 2023) worked for more than eight years in the energy sector, across different geographies – the US, Germany, and India – and functions – R&D, consulting, strategy, and operations – before coming to LBS. He is passionate about climate action and how sustainable energy holds the power to transform lives in the developing world. Sagun is an intern for the Wheeler Institute, contributing to the creation of content that amplifies the role of business in improving lives.
The Private Sector Development Research Network is a community of institutions with an active research agenda on Private Sector Development. The PSD Research Network is a collaboration between the Wheeler Institute, CDC Group, Center for Global Development, European Bank for Reconstruction and Development, IBD Invest, International Finance Corporation, International Growth Centre and the Think Tank ODI which aims to promote the exchange of ideas and facilitate collaboration.