Implementing the recommendations of this paper will require a carefully judged political process designed to build trust and deliver substantive outcomes incrementally. The election of Donald Trump to a second term as US president reinforces the need for a shift of approach, but makes the politics even more difficult to manage.
This paper has put forward four main recommendations for the international policy community to help close the climate finance gap, with a particular focus on EMDEs.
These recommendations are:
- To undertake a regular, comprehensive and authoritative comparative assessment of the effectiveness of different ways of deploying public international finance to promote climate action.
- To develop new institutional models for deploying public international finance more effectively in support of climate action – specifically, through greater use of ODA from traditional donors in the form of genuine risk-bearing capital.
- Following from the above, to crystallize the clearest possible set of decisions guiding how the available public international finance should be allocated to climate action; and, linked to this, to establish a mechanism to hold key parties to account.
- To take decisive steps to address the possibility that moral hazard is distorting private investment decisions in favour of hydrocarbon-intensive assets.
These measures will not close the climate finance gap on their own, but they should make a significant difference. They also have the advantage of not depending on unachievable expectations for increases in the level of public international finance provided by traditional donors.
However, even these recommendations will be hard to achieve in the current geopolitical context, where the political capital necessary for any kind of coordinated international action is limited. There is already a fundamental lack of trust between the G7 and China, and between the G7 and countries in what is often called the Global South. The latter trust deficit has stemmed partly from the constraints on Western aid budgets arising from slow productivity growth and high public debt, making it hard to respond to requests for support from the Global South. But it has also been exacerbated by the strength of populism and far right political movements in the US and Europe, increasing the risk that any commitments made by major developed countries may not be honoured.
Countries will also need to redouble their efforts to eliminate perverse incentives for carbon-intensive investment, given the possibility of the US taking the opposite course.
The election of Donald Trump to a second term as US president is likely to reinforce the lack of trust between the advanced economies and the developing world, but also create additional distrust among the advanced economies, given his threat during the campaign to impose 10–20 per cent across-the-board trade tariffs.
While he has yet to define his detailed policies in the area of climate finance, Trump may repeat his previous action in withdrawing the US from the Paris Agreement. He is unlikely to increase US contributions to public international finance, particularly in the area of climate action. He may use the US’s vote at the World Bank and other MDBs to try to constrain such institutions from stepping up their conventional climate lending. In addition, his domestic policies are likely to slow the US economy’s shift away from carbon-intensive investment, and may even reverse the transition.
In these circumstances, the main recommendations in this paper have even more force for other countries that remain committed to stepping up climate action. These countries will need to do everything possible to make the best use of the public international finance they provide for climate action. They may also need to do more on a ‘coalition of the willing’ basis, given that universal agreements may be precluded by the stance of the Trump administration. Countries will also need to redouble their efforts to eliminate perverse incentives for carbon-intensive investment, given the possibility of the US taking the opposite course.
The increasing focus in the G7 on economic security, and on industrial strategies designed to preserve competitive strengths and help the West catch up with China on green technologies, is likely to continue during President Trump’s second term. As such, this is likely to complicate the net zero transition. In the long term, a focus on economic security and onshoring in the US and other G7 countries could disadvantage EMDEs, although some EMDEs could also benefit from Chinese efforts to diversify supply chains and avoid trade and investment restrictions. In the short term, higher tariffs on Chinese exports could lead to higher costs and hence to critical delays in the adoption of new technologies essential for the net zero transition.
Against this background, four components will be critical to gaining agreement on the above recommendations:
Getting the timing right
The tensions described above are central to the COP29 climate summit, under way in Azerbaijan at the time of writing. The success or failure of negotiations for the NCQG will be judged in large part by the overall climate financing figure that is eventually agreed (or not) at the summit. This could still be a large figure (notwithstanding the likely shift in US policy once the new Trump administration takes office), but even if that is the case, it is unlikely to meet the expectations of developing countries and civil society. A new climate finance goal will also be vulnerable to future shifts in US policy.
However, as the likely outcome for the NCQG becomes clear, there could be an important opportunity for countries seeking to bridge the gap between the different camps to instil the idea among negotiators that putting greater emphasis on how the available public international finance is used provides part of the solution. Ideally, increasing policy emphasis in this area would be institutionalized through a commitment in the final COP29 declaration to carry out the comprehensive assessment recommended above.
Developing a more realistic climate finance narrative
In support of this approach, it will be important to develop new themes in the debate, while dispelling a number of myths. A more realistic narrative should include the following points:
- There is no free money. All approaches to increasing public international finance ultimately lead to a call on ODA.
- Even with a good outcome, at the high end of expectations, at COP29, there is still going to be a shortfall in funding compared to what developing countries and civil society have sought.
- The focus in recent years on pushing for the largest possible increase in public finance has been driven to some extent by the difficulty of agreeing priorities between different uses of public international finance: for instance, between adaptation, mitigation, and loss and damage; or between climate goals and other SDG goals. Yet agreement cannot be delayed any longer, as having a clear but realistic plan, albeit one that involves painful compromises, is better than having no plan at all.
- The international policy community can no longer afford to ignore the big differences in impact and effectiveness associated with deploying public international finance through different international institutions and in different forms (debt vs equity vs guarantees vs insurance; traditional MDB finance vs de-risking).
- While the private sector has a critical role to play in closing the climate finance gap, both in terms of expertise and funding, its objectives are not always aligned with the wider public interest. This understanding needs to be factored into the way private sector resources are deployed, and into the role they are expected to play.
- The role of the private sector is to bear risk as well as provide liquidity. If investments go wrong, the private sector cannot expect to be bailed out by the public sector. Private investors will seek risk-adjusted returns comparable to what can be achieved through other investments. As a result, in a number of areas, private sector financing will be too expensive and may have to be replaced by finance from public international and domestic sources willing to accept lower risk-adjusted returns. This further underscores the need for public international finance to be deployed in a more disciplined way.
While many of these points are widely understood across the international policy community, it is likely that some advanced-economy governments will need to take the lead in setting out what will be seen by many as hard truths. While this will not be popular, it is a necessary step to put the discussion on a more realistic and ultimately effective track. The prospect of the incoming Trump administration in the US may also lead to a more receptive audience.
Deal drivers
Several ‘exchanges’ or ‘bargains’ between leading parties could be introduced in the eventual COP29 declaration to help underpin a successful compromise. These could include:
- All parties agreeing that the success of the revised financing strategy should be measured by outcomes rather than inputs.
- An implicit or explicit exchange in which advanced countries agree to deploy a substantially larger proportion of their development finance to provide risk-bearing capital, while recipient countries agree to do all they can to reduce the risks being faced (e.g. by cutting and repurposing hydrocarbon subsidies, and by enhancing transparency and regulatory certainty). Such an exchange would potentially be underpinned by contractual commitments.
- Another implicit exchange in which the MDBs and other international climate finance institutions agree to collaborate on a comparative assessment of the most effective ways of deploying international finance, and to embed the results in their behaviours. In return, ODA providers could agree to provide finance in the most flexible way possible.
Implementation mechanisms
The final component would be the establishment of workable institutional mechanisms and governance structures to deliver on the four recommendations.
With respect to the first three recommendations, establishing new international institutions is typically time-consuming. It is best, where possible, to build on structures that already exist, although sometimes the need for new institutions is unavoidable. Given the focus on finance and the range of national and international institutions that would need to be involved, the G20 would be the preferred body to own and oversee delivery of the four recommendations (although scepticism on the part of the incoming US administration towards multilateral approaches may mean that more reliance has to be placed on non-universal coalitions of the willing).
To undertake the comprehensive assessment of uses of public international finance that this paper proposes, the next country to assume the presidency of the G20 – South Africa – should establish an independent commission similar to that which produced the independent G20 review of capital adequacy frameworks. Such an initiative would need strong support from a wide range of international institutions. This would be a temporary and relatively low-cost solution, particularly if philanthropic climate foundations agreed to support elements of the work.
Once recommendations were produced, it would be critical to follow up with a longer-term framework to ensure decisions are made and that institutions and countries are as far as possible held to account for their delivery.
The G20 has attempted to establish accountability mechanisms before, for example with the 2010 Framework for Strong, Sustainable and Balanced Growth. These efforts have had mixed success, as priorities quickly change with each G20 presidency. It will therefore be critical to keep the overarching accountability framework as simple as possible, with a maximum of three or four high-level targets and clear agreement on how delivery of these would be measured. The framework should also be designed in such a way as to encourage refinement and updating of the targets and measures over time in the light of experience on what is most effective in holding countries to account.
An international institution, or group of institutions, should be tasked by the international policy community with delivering a regular report on progress against the chosen targets. To be useful, this reporting mechanism will need to be as independent as possible. So while the drafters of the progress report should consult extensively with the World Bank, other MDBs, the IMF and climate funds, none of these institutions should be tasked with delivering the report. One option may be to task the OECD – or another international organization without an operational role in climate finance – with this responsibility.
The fourth main recommendation, on preventing moral hazard, is more straightforward. It could be implemented through a clear statement from G20 finance ministers/leaders, or a subset of them if the US is not willing to join, and then followed up through policy guidance adopted in the relevant IFIs and national bodies.
