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February 22, 2024
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Can private finance drive climate action?

The Chief Economic Adviser in the Ministry of Finance recently published a set of essays. The essays cover five broad topics.

These are ratings agencies and their methodologies, which the essay says are opaque and unfair; inequality, which the essay argues should focus on the equality of opportunity; exports; climate change; and the 2023 G20 which recommended ‘blended finance’ that ropes in the private sector as well for paying for fossil fuel reduction.

This last idea appealed to politicians who’d much rather spend on short term political objectives than on long term public goods. But from a purely economics point of view it doesn’t make much sense. So it’s not going to happen in any meaningful way.

Indeed, it’s the climate equivalent of CSR whereby the private sector is supposed to take up the slack in government public goods spending. Indian CSR, as we know, mandates large companies to spend two per cent of their average annual profit over the last three years on socially responsible projects.

Not all companies, though. Only the ones with a net worth of ₹500 crore or more; or turnover of ₹1,000 crore or more; or if the net profit of the company is ₹5 crore or more. Such companies can now join the climate finance tamasha.

But they are very few given the size of what has to be raised. In fact, even on a global scale, with all of the world’s companies participating, this will not make an appreciable difference to what’s actually needed to switch away from fossil fuels.

To begin with, no one knows how much is needed. All we can say with any confidence is that it’s a very large sum, running into trillions of dollars over several decades.

Two problems

The idea also runs afoul of two major concepts in economics. One is the free-rider problem. The other is the incentives structure. The two complement each other.

The free-rider problem occurs when a large number of persons or companies contribute less than what they must because they think others will contribute more than they need to. It’s like ticketless travel.

This is a consequence of the incentives structure, which is poorly designed and allows perverse outcomes. Basically if you can get away with it, you will not pay.

Now comes the biggest problem of all, which is that it is impossible to design an incentives structure that can get rid of the free-rider problem on such a large scale — 190 countries, millions of companies and trillions of dollars.

That is, all that politically appealing stuff about equity must stop. It won’t work. The climate will keep worsening.

The answer lies in national and small initiatives to finance the switch away from fossil fuels, not these gigantic plans that make you feel good but are designed to fail.

India needs to focus on thermal power and automobiles, the two worst offenders. One pumps out carbon, the other pumps out benzene particles. Fortunately, we are doing both but not sufficiently energetically. This is what needs to change.

Thank god these essays are a separate volume. Until recently the CEAs had started inserting their private views into the Economic Survey. That was an extraordinarily egregious and egotistic intrusion into a formal document prepared by the government for Parliament.

This is your last free article.

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