India and 55 other countries recently submitted targets for greenhouse gas emission reduction to the United Nations Framework Convention on Climate Change (UNFCCC). That was the easy part. The hard part, how to finance this lower carbon route to economic growth, is the big challenge now.
There are two extreme solutions. The first is to make rich countries fund this effort. By one estimate, it will take 0.4% of high-income countries’ gross domestic product (GDP) to do so. The fate of the Millennium Development Goals and promises made to fund them (0.7% of gross national income) illustrates that this will not happen. The second option is for developing countries to unilaterally move to a low-carbon economy. That will require cutting back on energy-intensive growth, redesigning cities and giving up much else. Because both “options” are expensive, they don’t find many takers.
The middle ground is that of going in for innovative financial solutions. It has been estimated that adaptation to climate change requires anywhere from $28 billion to $100 billion per year. Mitigation efforts will require an additional $139-175 billion per year. In contrast, the Clean Development Mechanism (CDM) under UNFCCC and 20 other bilateral and multilateral climate funds can provide at most $9 billion per year from 2008 to 2012. The funding gap is as high as $158-266 billion per year. In Copenhagen, there was a niggardly offer of $100 billion a year.
Illustration: Jayachandran / Mint
These figures give the impression that the CDM is hopeless before the task at hand. This is misleading. Carbon markets suffer from inefficiencies at the moment. For example, the 20 climate funds mentioned above pretty much operate on their own. The result is that administration and transaction costs are relatively high. Streamlining these can deliver more. Then, there is the issue of taxing high carbon footprint sectors: air travel, logging and other areas in developed countries. A recent study by Samuel Frankhauser and Nat Martin in the journal Energy Policy points out that the burden of carbon taxes falls disproportionately on developing country suppliers of carbon credits. Finally, carbon markets don’t have the liquidity of financial markets. That is because they are fragmented along national lines: Unless they are linked, efficiency gains in them will remain illusory.
At the moment, most private sector financing efforts are directed towards mitigation efforts. That makes sense as there are right incentives for doing so. Adaptation is the stepchild as the requirements for that are localized. But adaptation too requires a big chunk of money. That is where the real challenge lies for climate financing.
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