VENICE, July 9, 2021 – Thanks to the Italian G20 Presidency for holding this important discussion. It’s critical that fiscal policies work to integrate climate and development goals.
The pandemic hit at a time when people in developing countries were already falling behind in terms of poverty rates, median per capita income, and debt sustainability. The response to the pandemic is leaving them further behind, with governments of advanced economies spending and borrowing heavily; using their central banks to buy their own long-duration assets with short-term liabilities to commercial banks; and vaccinating a large share of their populations.
Along with China, advanced economies are recovering earlier and stronger than developing countries. The immediate priority for developing countries is widespread access to vaccines that match their deployment programs. This will require advanced economies to release their vaccine options, and the Task Force on COVID-19 Vaccines called for the G20 to share doses, provide financing to close the residual gaps, including for the ACT-Accelerator, and remove all barriers to export of inputs and finished vaccines. Even as that is accomplished, development faces years of setback and struggle. Low interest rates and bond yields in advanced economies and China are driving strong consumption and investment, and higher asset prices, but this boom hasn’t extended into productive investment in developing countries. Adding further to the development gap, many developing countries also suffer from fragility, human rights violations, food insecurity, lack of transparency, weak currencies, inflation, and the unfunded requirements of climate change.
The developing world faces particular fiscal and financial challenges with the adoption by many countries of the goal of net-zero emissions. For the developing countries that have or will have sizeable greenhouse gas emissions, the cost of transitioning to lower-carbon economies is large compared to their annual investment budgets. For the 75 IDA countries, adaptation to climate change is more a pressing challenge than current emissions, yet the cost to properly prepare for climate events is large compared to their budgets. The climate response will be especially hard for developing economies that are yet to achieve universal access to electricity amid growing populations and other development needs. This financial burden will be even harder given the significant debt overhang and the need to build human capital during the recovery. Fiscal policy can provide some of the necessary funding, but it’s clear that developing countries will also need more external flows, as Secretary Yellen and Governor Carney noted in the G30 report.
Today, I will address three related issues: 1) the need for a more integrated approach to climate and development; 2) the need for balanced incentive structures; and 3) the need for more support from the G20 for the world’s poorest economies, especially through the ongoing IDA20 replenishment.
1. Green, Resilient, and Inclusive Development
Developing countries were facing growing structural weaknesses long before the arrival of COVID-19. The pandemic has aggravated them. The World Bank found that the pandemic pushed nearly 100 million people into extreme poverty in 2020. Also, during the pandemic, inequality in income, jobs, education, and access to basic services grew wider for people in many developing countries.
We have proposed an approach called GRID – Green, Resilient, and Inclusive Development. It addresses these development and climate imperatives in an integrated manner, and can help make recovery more broad-based, with the aim of shared prosperity and sustainability. To achieve this, we need to integrate climate and development, assess how climate change and carbon reduction impact a country’s development path and priorities, and identify the most impactful mitigation, adaptation, and resilience-building actions to improve development outcomes. This approach will only work if it is multi-sectoral in scope, based on deep country dialogue, and tailored to country-specific needs.
2. Incentive structures
The foundation for integrating climate and development is a country’s incentive structure. Finance ministries play the central role in building an economy’s incentive structure and helping it change. A balanced incentive structure requires designing implementable, integrated policies and making complementary investments. In this case, the desired direction for the incentive structure is to make economic growth greener, resilient, and more inclusive. Such policies need to take into account political-economy constraints, yet recognize the need for major fiscal policy changes and transformations; at the Bank we’re looking carefully at examples from all over the world and building country programs that can work in the special economic and political circumstances facing poorer countries.
Finance ministries everywhere should be taking a hard look at their tax and subsidy regimes and putting in place policies that avoid distortions and minimize deadweight losses. They should start by reassessing exemptions and finding mechanisms to improve the quality of spending across all types of expenditure. Fossil fuels tend to be subsidized both explicitly, and implicitly through tax exemptions. If the use of fossil fuels continues to be subsidized despite its impact on greenhouse gas emissions, it encourages individuals and firms to continue to overuse such fuels. The longer such subsidies remain in place, the more the economy adapts to their existence and the greater the political obstacles and economic disruptions caused by their removal.
As tax-rate increases are considered, all options that help to broaden the tax base should be exhausted as well. Once subsidies are reduced, the evidence suggests that raising domestic revenue from environmental taxes tends to be less distortionary—and less likely to hamper growth—than labor taxes. This is especially the case when the starting point for environmental taxes is low, as is the case for many developing countries.
As countries work toward their climate goals, there will need to be diagnostics and metrics that help assess the incentive structure. A key aspect of this assessment is to measure the various forms of emissions within countries and work toward the recognition of a common value or price for carbon emissions. This will help countries embed the consideration of climate change costs into economic decision-making; prioritize their policy changes (for example, reducing explicit and implicit subsidies on the mining and burning of coal); and create the right incentives to reduce carbon emissions.
Given the importance for economic efficiency of trade in raw materials, finished goods, and services, it will be important to signal a commitment to long-term convergence in the value of decarbonization – especially given the substitutability of goods and services and the responsiveness of trade to prices. Policy proposals regarding current and future carbon reduction incentives are essential to help set expectations for private sector firms, investors, and consumers on the direction of travel needed to meet the Paris Agreement goals. They are also important in inviting the huge investments needed to develop and adopt climate-friendly technologies, improve land use, strengthen renewable energy systems, and increase transport efficiency.
The necessary first step is the political will to reduce greenhouse gas emissions by changing the incentives in the tax and subsidy structures. Carbon taxes have emerged as the most impactful explicit carbon pricing instrument. As new decarbonization technologies emerge, emissions trading systems and carbon credit markets may develop in ways that allow emissions by some in return for reductions by others. To make this work, however, will require new transparency and accountability systems.
In considering carbon taxes and other incentives for carbon reduction, it’s important to recognize that climate adjustment may create adverse impacts on some groups in the short and medium term, such as job losses in coal mines to economic losses for investors. It’s important to account for technological constraints, capital adjustment, switching costs, and economic rigidities in designing such measures and strive for a “just transition” toward lower-carbon pathways.
To help the incentive structure work, complementary investments should be ramped up. Green, Resilient, and Inclusive Development will depend on significant investment in human, physical, natural, and social capital. These investments should be made in ways that will be mutually reinforcing.
3. Resources for the world’s poorest countries
Much of the hard work ahead will have to be done at the country level, building on global knowledge and advocacy. We are making the GRID approach operational through financing, multidisciplinary expertise, and support for implementation, while wholeheartedly considering the interests of people in poorer countries.
Developing countries will need much more support in the years to come. For the poorest countries, the IDA20 replenishment will be especially important in addressing climate change issues. For middle-income countries, IBRD, IFC and MIGA, are each channeling significant resources to address climate challenges. Other development partners are also contributing to such support in significant ways, and we are collaborating closely.
We look forward to working with all of you to intensify our efforts and deepen engagements to help developing countries meet their goals. Thank you.