What the World Bank can do about climate change

NEW HAVEN — Few institutions have shown as much versatility and adaptability as the World Bank. Initially founded to address global capital-market imperfections after World War II, the institution’s primary mission evolved over time to focus on fighting extreme poverty. But now that the World Bank is welcoming a new president this July, it should adapt again, this time to address climate change.

Poverty reduction, of course, should remain a high priority, considering that the COVID-19 pandemic has left many low-income countries in dire straits. But climate change has emerged as an equally important threat to these countries’ futures, as well as to the entire planet. Poverty reduction therefore must go hand in hand with the goal of addressing climate change.

But grounding these efforts in evidence-based research is easier said than done. One often hears that low-income countries should focus on climate change because they have the most to lose from its consequences (natural disasters, soil degradation, water shortages, and so forth). That conclusion may be right; but the argument is flawed, because it is based on a spurious comparison.

Policymakers in poor countries do not care whether they have more to lose compared to richer countries. Rather, their focus is on weighing policies that promote growth but harm the environment against green policies that may imply slower or even no growth. To paraphrase what one such official once told me when I questioned the wisdom of his government’s strategy to encourage oil and natural-gas extraction: “Who cares what the long-term trend is? We can do this for ten years, grow rich and then move on to other activities while using the proceeds to clean up.”

The wastefulness of this approach is self-evident, as are the large negative externalities it entails for the rest of the world. But the tradeoff for many low- and lower-middle income countries is real, especially when, like India and Indonesia, they are rich in coal deposits or, as in Nigeria, oil reserves. Giving up on growth in return for a cleaner, greener future is not something that many policymakers in such countries find acceptable.

Still, there is scope for considerable improvement, and the World Bank has the financial resources, credibility and convening power to make a substantial contribution. To do so, it must ensure that decisions are based on the best available evidence, rather than on untested claims or first principles. Policymakers and advisers should study the experiences of countries that have successfully reduced greenhouse-gas emissions, as well as absorbing the emerging body of academic research focused on developing countries.

For example, the US experience shows that emissions reductions were the result of stricter environmental regulation, not the outsourcing of “dirty” production activities to developing countries (the so-called pollution-haven hypothesis). This implies that carbon border adjustment taxes, often justified on a notional “leakage” hypothesis, will do little to improve emissions in advanced economies. Worse, they may deal a severe blow to some low-income countries’ exports. The lesson from the United States, then, is that a path to a greener planet should start with stricter environmental regulation.

Recent research by the Nobel laureate Economist Esther Duflo and co-authors offers a second, related lesson, based on data from one of the biggest polluters in the world: India. Contrary to what many may think, India has some of the strictest environmental regulations in the world. What it lacks is the ability to enforce them. Weak state capacity, reflecting inadequate institutions, unreliable contract enforcement, or outright corruption, can nullify the effectiveness of environmental regulations.

Duflo’s team shows how devising proper mechanisms to address these constraints can significantly improve emission outcomes. It is precisely here, in the design and implementation of policies to address institutional shortcomings, that the World Bank could add enormous value.

Another recent paper reports on a bold, decade-long effort by a team of researchers, in cooperation with the Indian state of Gujarat, to introduce India’s first cap-and-trade programme (it also happens to be the world’s first market-based programme to regulate particulate emissions). Remarkably, they find that the programme functioned smoothly and produced significant emissions reductions as well as cost savings (relative to an alternative, command-and-control-based regulation).

Such results are extremely promising. Interventions to create “markets” for emissions have proven successful in the US and Europe. If such programmes can take root in developing countries, a truly global solution to climate change will be within reach. Moreover, if just a couple of research teams can make so much progress, imagine what the World Bank could achieve with all its resources, expertise, and access to top policymakers.

Perhaps the most encouraging message from recent research is that interventions that meaningfully improve environmental outcomes in developing countries need not be excessively expensive. Another recent paper examines why India, with its generally warm climate and plentiful sunshine, has been slow to deploy solar panels. It turns out that local governments’ inability credibly to commit to the contracts they sign with producers impedes investment. Once investments in a solar plant are made, state governments have a strong incentive to renegotiate. Because solar suppliers anticipate this, investment in green energy ultimately falls short of where it could be. Intermediation by the federal government could help, resulting in much higher solar adoption.

Such examples show that substantive progress toward de-carbonisation in low- and middle-income economies is feasible without bankrupting the country or halting growth. But success requires knowledge, perhaps even more so than money. Hitting poorer countries with punitive carbon taxes, which even advanced economies like the US have been reluctant to adopt, should be a non-starter. Encouraging the green-energy transition with policies tailored to the institutional constraints prevalent in low-income settings is much more promising.

The World Bank has always prided itself on being not just another “bank”, but rather a “knowledge bank”. As it develops its climate agenda, it must remain true to that credo by adhering to the lessons of rigorous research and evidence.

Pinelopi Koujianou Goldberg, a former World Bank Group chief economist and editor-in-chief of the American Economic Review, is professor of Economics at Yale University. Copyright: Project Syndicate, 2023. 

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