Design of Green Investment Schemes

The third leg of Kyoto’s flexible mechanisms, International Emission Trading – buying and selling of Assigned Amount Units (AAUs) – is starting to lumber into action. Ominously, apart from the stool, three legged creatures rarely make it.

What will give this limb the muscle and the agility to be an effective way of achieving Kyoto targets without compromising environmental aspirations? Much thought is going into greening at the moment, and the buzz words are Green Investment Scheme (GIS).

A Green Investment Scheme might work like this. A government with a surplus under Kyoto sells twenty million AAUs for €6 each, thus raising €120 million. The buyer government says that the seller has to spend that money on further cutting greenhouse gas emissions. So the government sets up a fund with the money and issues grants to companies and entrepreneurs to support the building of wind farms, growing of energy crops, insulation in housing, etc.

The stake are high as regards the design of Green Investment Schemes since the value of the combined Kyoto surplus of Central and Eastern Europe could well be tens of billions of Euros. Hundreds of thousands of dollars have already been spent on “capacity building”[1] and consulting programmes to design CEE governments on developing GIS. Sadly the work to date on GIS is rather dull and unimaginative and doomed to failure.

The future is like this. Look at the wild successes of the World Bank’s Romanian Fund for Energy Efficiency. Look at the Hungarian Regional Development Fund scheme. Look at Soviet economics. Schemes to promote a political goal by throwing money at them don’t work and are not efficient.

Telltale signs of failure are: the schemes often fail to spend the funds available; very high costs of administration compared to the amounts of funds under management; the projects supported do not have a wider impact by stimulating change beyond the projects themselves. A lot of money ends up in the wrong hands.

Everyone knows that when the state distributes money it’s likely to be a disaster. Projects are not funded on the base of merit or need. Cash goes to the provider of the highest kickback. Or alternatively it’s so squeaky clean that no one qualifies and the process is so bureaucratic that the business opportunity has passed by before the funds are awarded.

GIS, as with other subsidy schemes, risks being victim to a five-point fallacy:

1. We moan: “Not enough is happening in such and such a space”
2. Therefore we say: “Let’s throw money at it”
3. We throw money at it
4. Nothing much happens
5. Hmmm

Why do we want to throw money at a space? There is a simple belief that it will solve problems. Without this money the project will not happen or will not happen so soon. So with money surely the project will happen. Of course, it is just water in sand.

GIS presents an opportunity to get back to basics and think about what really stimulates investment in greenery and to identify the bottlenecks which can be cheaply removed. Because you can be sure that lack of cash is not a bottleneck. There is plenty of cash around. There is no shortage of money in any of the countries of Central and Eastern Europe. And given the prevalence of Mercedes and BMWs people are clearly looking for things to do with their money.

So assuming that there is no shortage of cash why is it not flooding into green investments happening?

Well, fossil fuels are subsidized. Mining is subsidized. There is no working green certificate scheme. The green power systems are highly corrupt. There is no energy policy. The regulatory system is in flux. The laws are poorly drafted. The permitting process is corrupt. Grid operators abuse their monopolies for connections. Entrepreneurs cannot write business plans. Bankers do not understand the risks. People are unwilling to spend money on premium green products. These are some of the many reasons why green investments do not happen.

Consider two responses to this situation.

Imagine a guy driving along the road after a storm. He comes to a tree which has fallen across the road. Stops. “Hmm, how do I get past this,” he wonders. So he goes back and buys a 20 litre military tank engine and fits it into his car. Then he goes and replaces the wheels with tractor wheels. And lo and behold at a cost of €100,000 he easily drives over the tree, crushing it beyond recognition. This is the European Union Solution.

There is another guy. Driving along a road after a storm. He also comes to a tree which has fallen across the road. Stops. “Hmm, how do I get past this,” he wonders. So he calls his mate who has a tractor. The tractor driver comes along and pulls the tree out of the way, clearing the road. The guy drives on.

A green investment scheme which is just about subsidizing green investments is like the first guy, the stupid one with money to waste. You throw money at a problem because you just cannot figure out how to solve it in a better way.

There are good reasons why the first solution is better. It’s good for political headlines, shows you are doing something big. And it’s good for your cronies, the people who trade in tank engines and tractor tyres. And it avoids politically tough decisions. So we have the EU and the World Bank et al subsidizing CEE governments so that they can avoid making tough political decisions.

The second solution shows how money can be spent much more effectively. If, for example, the risks of a project are too high, subsidise the marginal cost of the capital rather than the investment itself. If bankers find it hard to understand the risks, train them in understanding it, rather than just diluting away the risks with cheap cash. If the grid company complains about the unreliability of green power supply, call their bluff by sending them on a fact-finding trip to a country where the problem has been addressed. Information, communication, training, skills, and covering marginal costs – targeted very carefully – can be much more effective than blanket funding of capital equipment, especially if supported by political leadership.

All this assumes that there is time to work out sensible solutions and combine some thinking with pragmatism.

Of course, if one really believes that green investments would flow from market reforms and good regulation, then the logical thing would be to pay the proceeds of AAU sales to Members of Parliament to make them vote for the right regulations, and leave the rest to the market.

© Vertis Environmental Finance 2005

[1] “Capacity Building” This is consultancy speak. Usually it is a game whereby a concerned Government of Country A pays consulting firm C (which happens to be from country A and which knows nothing whatsoever about country B), to go to Country B and tell government officials in Country B how to live their lives. Grant administrator of Donor Government A gets a nice kick-back from Sales Agent of firm C. Consultants of C employ keystrokes ctrl+c followed by ctrl+v a great deal. Then they go home. But it can be used very effectively, too.

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