Climate activists take part in a demonstration at the COP29 climate summit, in Baku, Azerbaijan, on Nov. 14.Sean Gallup/Getty Images
Aidan Hollis is professor of economics at the University of Calgary and a co-author of a new paper from the Institute for Research on Public Policy on improving climate finance.
A common strategy for avoiding action on the climate crisis is to claim that it doesn’t matter what Canada and other rich countries do when carbon emissions in developing countries keep growing. But like many exasperating rationalizations, this one has a grain of truth: The share of emissions in high-income countries has been shrinking for years, and is now under 30 per cent. At the same time, less wealthy countries have been insisting that they not be handcuffed on their growth path by climate regulations – and Donald Trump’s commitment to pulling the United States out of the Paris Agreement will make things even worse.
The refusal to take any action can only damage everyone. The alternative, of course, is to recognize that rich countries must not only reduce their own carbon emissions, but – recognizing their own responsibility and greater financial capability – also help less wealthy countries. And that is an important theme of the COP29 summit in Baku, Azerbaijan, where developing countries are seeking more than US$1-trillion in climate finance annually.
Unfortunately, the emphasis on how much money is needed has resulted in a lack of focus on the actual mechanics of climate finance. The result is that a large share of climate finance consists of pre-existing development aid now “green-tagged” as climate-related.
Generally, most climate financing is built on a development model, in which a development bank or aid agency chooses projects to receive loans or grants through a lengthy review process. This differs radically from the central and most effective policy approach by which most rich countries are reducing greenhouse gases at home: the use of incentives.
Incentives take different forms, but the key feature is that they directly connect prices to emissions. For example, the European Union’s Emissions Trading System establishes an effective price per ton of CO2 – currently around €65 – emitted by industrial enterprises, similar to Canada’s carbon pricing. In the U.S., where taxes were politically infeasible, the Inflation Reduction Act incentivized the generation of solar or wind power by creating a subsidy of US$26 per megawatt-hour produced.
Climate financing offered to developing countries could similarly include subsidies tied to outcomes, such as renewable power generation or cleaner industrial production. If rich countries use incentives at home, they will probably work just as well abroad, although for developing countries, they should be carrots, rather than sticks. But Europe is currently exploring using the latter: a “carbon border adjustment tax,” to penalize developing countries that do not have a carbon-pricing scheme. This fails to acknowledge Europe’s own contribution to the stock of carbon in the atmosphere.
There are many benefits of tying payment to performance. First, and most importantly, people tend to work toward an outcome if getting paid is dependent on delivering it. If getting paid depends on submitting an application for a grant or a loan, then a solid application is what will be delivered – but if getting paid depends on generating clean electricity, then clean electricity will be generated.
Second, applying for a grant or loan is complex and time-consuming. The Green Climate Fund, an international climate-financing organization, offers a perfect illustration. The programming manual for applicants is 218 pages long and is accompanied by an appraisal guide of 298 pages, which has nine additional appendices. Applications, which may consist of 100 densely written pages in English, are costly and are often written by high-priced consultants, thus effectively excluding smaller projects. And the evaluation process is equally expensive and lengthy, though that is necessary to avoid fraud.
In contrast, when payment is tied to results, such extensive review is unnecessary; if the project doesn’t deliver, the firm doesn’t get paid. That reduces upfront costs and opens up access to smaller firms that lack the credit history to qualify for a large grant or loan.
Third, when payment is tied to results, it is easier to justify the use of scarce taxpayer dollars. Politically, it is all too easy to criticize funding for climate projects abroad when there are so many needs at home, so it is essential that projects deliver measurable outcomes.
Finally, we need the lowest-cost solutions. That becomes much easier when outcomes are systematically measured. Indeed, it is possible even to use auctions to determine which firms need the smallest subsidy per unit of emissions reduced.
Addressing the climate crisis seriously will take real resources. But given the real constraints every country, including Canada, is facing, we must use the most efficient mechanisms – and that means implementing strong incentives to drive the action on which our collective future depends.