More Bang for Its Buck: The World Bank Has to Modernize Its Approach To Enable Private Sector Investment
Published: July 10, 2023
Svenja Schulze - Federal Minister for Economic Cooperation and Development, Germany
The need for a new World Bank
Climate change, biodiversity loss, conflicts and pandemics simply cannot be addressed only at country level. Today’s global challenges require a broader intervention that takes into account global interdependencies and spill-over effects. The World Bank urgently needs to adopt a broader view, focussing not only on poverty reduction and economic growth but also on promoting a just transition: it needs to support countries worldwide in adopting more sustainable and climate-friendly ways of living, producing and consuming.
Moreover, the World Bank needs to play a bigger role in mobilizing resources for sustainable development. With regards to attracting private sector investments it currently lags far behind its potential. This is one of the reasons why, together with other Governors of the World Bank Group, I have called for a substantial overhaul of the World Bank’s business model. The World Bank has to become a true “Transformation Bank”. It needs to lead the way in creating the necessary pre-conditions and incentives for sustainable development – and in bringing all hands on deck!
Addressing global challenges by protecting global public goods – the earlier, the better!
The World Bank estimates that addressing climate change, conflict, and pandemics in developing countries will cost 2.4 trillion USD in public and private spending per year through 2030[1]. This figure might seem daunting but, as the World Bank rightly underlines, it is “a small cost compared to not addressing these issues.” Indeed, the sooner we make headway on facing these challenges, the more negative effects and future costs we will be able to avoid. Thinking ahead and investing in prevention pays off. Studies show that for every dollar invested in prevention and sustainability four dollars are saved long term on crisis reaction.
Mobilizing more private investment for sustainable development
But how can this substantial financing gap be filled? It is clear that no single institution can achieve this by itself – not the World Bank, and not even all the multilateral development banks combined. To raise the required capital, both domestic and international resources, as well as public and in particular private finance, will need to be adequately scaled up.
Private investment will not happen automatically. Appropriate policy decisions are needed to attract and guide private investors and channel their capital towards sustainable investments. As the new World Bank president, Ajay Banga has underlined that “the only way forward is to find a way to get the private sector to believe that [helping developing countries adapt to and mitigate climate change] is part of their future.” I welcome Banga’s plan to promote “informed risk-taking” by the World Bank so as to take on risks private investors cannot shoulder, thus encouraging them to get more engaged in climate transition and helping countries leapfrog fossil fuel energy sources. This is an important step in the right direction.
However, in order to mobilize private investment at scale, policy reforms are needed, in particular related to decarbonizing the energy, transport and agricultural sectors. To date, international development policy has not managed to mobilize adequate levels of private sector investment, in particular in climate-related areas. In 2020 only 13.1 billion USD was mobilized for climate finance – that is less than 0.5 percent of the above-mentioned required 2.4 trillion USD. Furthermore, instead of picking up speed, the rate of mobilization is slowing down.
In the renewable energies sector in particular, private investment remains far below its potential. This is all the more surprising as, in recent years, the cost of key technologies has been substantially reduced. The costs for electricity from utility-scale solar photovoltaics fell 85 percent between 2010 and 2020[2]. Renewable energy is increasingly becoming the lowest costing and thus theoretically the best commercial option.
Addressing policy barriers
One key factor holding back private investment is bad policies – policies that set the wrong incentives for investors. Governments spent about 577 billion USD on direct fossil fuel subsidies in 2021, contributing to toxic air pollution, inequality, inefficiency, and mounting debt burdens. The size of implicit subsidies is even higher[3]. In many countries, the tariffs imposed on sustainable goods are substantially higher than those for less environmentally friendly goods[4]. In most countries there are no feed-in tariffs for renewable energy. Sector regulation is often biased against renewable sector investments. These are just a few examples of widespread policy barriers that are limiting and blocking private sector investment in sustainable business opportunities.
Such inappropriate policies not only lead to missed business opportunities and lost economic growth. They also make it substantially more difficult and costly for the international community to reach the Sustainable Development Goals and international climate targets. Against this backdrop, it is incomprehensible that multilateral development banks currently only use a small fraction of their overall financing to support policy change. In the case of the World Bank, policy support only makes up a small fraction of its total climate financing.
Ramping up the World Bank’s policy support for global public goods
Structural reforms are thus urgently needed with regards to the modus operandi of the World Bank Group. With the largest policy-lending program of all the multilateral development banks and 110 country offices worldwide, the World Bank is well placed to deliver hands-on support for policy reforms and systematically help level the playing field for climate-neutral and socially sustainable growth.
There are some promising signs that the World Bank Group has started to head in the right direction. The Equitable Growth, Finance and Institutions (EFI) Vice Presidency, which accounts for 80 percent of the World Bank’s policy financing, has started ramping up its climate policy reforms. And the International Finance Corporation (IFC) has worked on “if-then” rules that will enable it to provide increased funding to countries with climate-friendly policies. However positive examples like these are still few and far between.
Let me highlight which levers I consider to be of utmost importance with regards to bringing the World Bank up to speed in enabling private sector investments related to climate protection:
1. Adopting a “One World Bank Group” approach
The three institutions of the World Bank Group – the World Bank, the International Finance Institution (IFC) and the Multilateral Investment Guarantee Agency (MIGA) – need to work together more closely. To address global challenges, we need close co-operation between the public and private sectors. Therefore, a joint approach by the public and private sector arms of multilateral development banks is necessary.
Under the “One World Bank Group” approach that I am advocating all three institutions would provide coordinated support to (client) countries: They should base their interventions on joint and complementary analyses (using tools such as the Country Private Sector Diagnostics (CPSDs) and Climate Change and Development reports (CCDRs)). And they should deploy their respective instruments with a view to creating synergies. This approach would help the Bank to better identify and effectively address constraints to private investment.
2. Creating new markets which are attractive for private investors
For example, in order to incentivize private investment in the generation of renewable energy at scale, countries need to invest in the required infrastructure (e.g. transmission lines), put in place new regulatory frameworks (e.g. C02 emission standards, feed-in tariffs) and engage in risk mitigation (e.g. guarantees such as first-loss tranches). Such a market creation approach is also at the core of the Just Energy Transition Partnerships (JETPs) between the G7 and several climate-ambitious developing countries. Market creation is fast becoming the new paradigm for private sector mobilization. With private sector investment being particularly important in countries which have few public resources at their disposal, the World Bank (Group) should quickly follow suit.
3. Providing policy-based lending and improving incentives to protect global public goods
The World Bank has to move from an approach focused on incentivizing individual transactions to one aimed at market creation: that is, it needs to help create a policy environment that is conducive to attracting private investment in public goods such as climate protection. To encourage private investors to invest in climate-neutral technologies and environmentally friendly innovations, appropriate incentives have to be in place. A successful market creation approach requires the synergetic deployment of various instruments: regulatory and fiscal reforms (e.g. reduction of fossil subsidies, feed-in tariffs, and emission standards), training and capacity development for state institutions and utilities, and targeted risk-taking for private investments, as well as complementary public investments.
To support and accelerate market creation, the World Bank Group should systematically set up policy-based lending programs. These programs would provide both technical and financial support to interested partner countries for implementing ambitious reforms and transformative policies that promote sustainability. These could be fiscal, regulatory, trade and financial policies designed to increase desired private investment. The countries engaged in the G7 Just Energy Transition Partnerships (JETPs) would be a good choice of countries to start with.
The World Bank needs to put in place more and better incentives to help countries implement policies that advance sustainability and protect global public goods. Although such transformational reforms bring many benefits, some countries might still be reluctant to request funding from the World Bank. One reason is that policy reforms can often be politically challenging even if they are economically smart and indicated. Another reason is that client countries fear a zero-sum game: they fear that, for example, money borrowed to invest in climate protection will then no longer be available for other urgent national development goals.
The World Bank should therefore provide additional financial support to countries that are willing to undertake particularly transformational policy reforms. Ex-ante analyses of potential reform outcomes – both positive and negative – should be pro-actively supported in order to strengthen the arguments for reforms and develop adequate mitigation measures. Intense policy dialogue with partner countries based on such evidence is another crucial component. Last but not least, concessional loans should also be used. Such “global public goods credits” should also be available to middle-income countries. After all, countries like Brazil and India are key for advancing efforts to protect biodiversity and the climate. Hence it is in the global interest to support them on this path.
4. Streamlining co-financing
Lastly, the World Bank management and shareholders should set up a co-financing arrangement between the World Bank and donor institutions focused on policy-based lending for climate action. Currently, a total of 81 funds exist to support climate financing. This highly fragmented set-up is difficult for borrowers to navigate and is not conducive to producing the best impact. Support to borrowing countries should be better aligned for better reach and higher impact. Systematic co-financing arrangements would contribute a great deal here.
In order to avoid cumbersome coordination regarding the type of reforms to be supported (the so-called prior actions[5]), the World Bank Management and shareholders should work together on a joint understanding about the kinds of reforms that are truly transformational. Co-financing could also improve the overall concessionality of the package, e.g. by providing co-financing on grant terms. This would be particularly important, given that many countries are confronted with high levels of debt and a shrinking fiscal space. Germany stands ready to support climate policy-based lending in a systematic way.
Time for change
As German governor for the World Bank, I will continue to advocate for these reforms with World Bank President Banga. And I hope that, at the next Annual Meeting in Marrakech in October, all stakeholders will agree to take concrete steps towards putting these recommendations into practice. Because there is no time to lose: We need to make the World Bank Group fit for the future and help it reach its full potential! Evolution is essential – the future of mankind on this planet depends on it.
[1] Source: https://blogs.worldbank.org/voices/innovative-financing-solutions-can-meet-both-old-and-new-challenges
[2] Source: https://www.irena.org/publications/2021/Jun/Renewable-Power-Costs-in-2020
[3] Source: https://www.worldbank.org/en/news/press-release/2023/06/15/trillions-wasted-on-subsidies-could-help-address-climate-change
[4] Source: Joseph S. Shapiro, 2021, https://academic.oup.com/qje/article/136/2/831/6039348
[5] Prior actions are lending requirements that must be met upfront, i.e. before disbursement