Introduction

The global economy, despite all the huge bumps in the road, is delivering aggregate annual growth of 3–4%, leading to a doubling of output every generation. Yet the global economy is not delivering sustainable growth in two basic senses. In many parts of the world, growth has been deeply skewed in favor of the rich; and it has been environmentally destructive – indeed, life-threatening when viewed on a century-long timescale, rather than according to quarterly reports or 2-year election cycles. Climate change is the greatest environmental threat (though not the only one). Given the current trajectory of global fossil-fuel use, the planet’s temperature is likely to rise by 4 °C to 6 °C above pre-industrial levels, an increase that would be catastrophic for food production, human health, and biodiversity; indeed, in many parts of the world, it would threaten communities’ survival. Governments have already agreed to keep global warming below 2 °C but have yet to take decisive action toward creating a low-carbon energy system (Sachs and Du Toit 2015). The climate change and global warming that are mainly caused by greenhouse gas (GHG) emissions are beyond the “point of no return” that merit government intervention and the Sustainable Development Goals (SDGs) and the Paris Climate Agreement guide governments.

The big disappointment in the world economy today is the low rate of investment. In the years leading up to the 2008 global financial crisis, growth in high-income countries was propelled by spending on housing and private consumption. When the crisis hit, both kinds of spending plummeted, and the investments that should have picked up the slack never materialized. This must change. After the crisis, the world’s major central banks attempted to revive spending and employment by slashing interest rates. The strategy worked, to some extent. By flooding capital markets with liquidity and holding down market interest rates, policy makers encouraged investors to bid up stock and bond prices that created financial wealth through capital gains. Yet this policy has reached its limits and imposed undeniable costs. With interest rates at or below zero, investors borrow for highly speculative purposes. As a result, the overall quality of investments has dropped, while leverage has risen. When central banks finally tighten credit, there is a real risk of significant asset-price declines (Sachs 2016).

However, as monetary policy was being pushed to its limits, what went missing was an increase in long-term investments and financing infrastructure, especially in green energy projects. The public sector in most countries, especially in developing countries, cannot afford this huge investment gap; while on the other hand the private sector does not show enough interest. The main reason that the private sector is not interested in entering long-term financing of infrastructure projects, including green energy projects, is the low rate of return and the associated risks (Yoshino and Taghizadeh-Hesary 2018: 335–357).

In the aforementioned conditions, if we plan to achieve SDGs, we need to scale up the financing of investments that provide environmental benefits, through new financial instruments and new policies, such as green bonds, green banks, carbon market instruments, fiscal policy, green central banking, fintech, community-based green funds and etc. known as “green finance.”

Meanwhile, there are three challenges facing such a strategy: identifying the right projects, developing complex plans that involve both the public and private sectors (and often more than one country), and structuring the financing. To succeed, governments must be capable of effective long-term planning, budgeting, and project implementation.

The world needs massive investments in green energy systems, and an end to the construction of new coal-fired power plants. In addition, it needs considerable investments in electric vehicles (and advanced batteries), together with a sharp reduction in internal combustion engine vehicles. The developing world, in particular, also needs major investments in water and sanitation projects in fast-growing urban areas, while low-income countries, in particular, need to scale up health and education systems.

In the developing world, the largest infrastructure investment demand is in developing Asia. Developing Asia will need to invest $26 trillion from 2016 to 2030, or $1.7 trillion per year, if the region is to maintain its growth momentum, eradicate poverty, and respond to climate change (climate-adjusted estimate). Without climate change mitigation and adaptation costs, $22.6 trillion will be needed, or $1.5 trillion per year (baseline estimate). Of the total climate-adjusted investment needs over 2016–2030, $14.7 trillion will be for power and $8.4 trillion for transport. Investments in telecommunications will reach $2.3 trillion, with water and sanitation costs at $800 billion over the period. Figure 1 shows the climate-adjusted estimated infrastructure needs by sector and region between 2016 to 2030.

Figure 1:
figure 1

Climate-Adjusted Estimated Infrastructure Investment Needs by Sector and Region in Developing Asia and Pacific (2016–2030). (Percentage and $ Billion in 2015 Prices). (Source: Made by authors based on data from ADB (2017). Note: Asia and Pacific stands for ADB’s 45 developing member countries. *Pakistan and Afghanistan are included in South Asia. Climate change adjusted figures include climate mitigation and climate proofing costs, but do not include other adaptation costs, especially those associated with sea level rise)

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Developing Asia relies heavily on coal for power generation. Statistics from the World Bank’s World Development Indicators database show that in 2013, 66% of electricity was generated from coal-fired power plants in the region, compared to 14% in non-Asian developing countries and 32% in Organisation for Economic Co-operation and Development (OECD) countries. Large economies in the region explain most of the high percentage, such as the People’s Republic of China (75%), India (73%), Indonesia (51%), the Republic of Korea (41%), and Malaysia (39%). This poses significant local and global environmental challenges. While some countries have undertaken actions, considerable investment will be needed in the short to medium term to make the power sector greener through reducing emissions and switching to renewable energy (RE) (ADB 2017).

To help finance such programs in Asia and other regions, the multilateral development banks – such as the World Bank, the Asian Development Bank, and the African Development Bank – should raise vastly more long-term debt from the capital markets at prevailing low interest rates. They should then lend those funds to governments and public–private investment entities.

Governments should gradually raise levies on carbon taxes, using the revenues to finance low-carbon energy systems. Also, the egregious loopholes in the global corporate tax system should be closed, thereby boosting global corporate taxation by some $200 billion annually, if not more. The added revenues should be allocated to new public investment spending.

Sustainable development is not just a wish and a slogan; it offers the only realistic path to global green growth and high employment. It is time to give it the attention – and investment – it deserves.

Green Finance, Energy Security, and Sustainable Development

Since the Industrial Revolution, finance has been a powerful enabler of human progress. The purpose of the global financial system is to allocate the world’s savings to their most productive use. When the system works properly, these savings are channeled into investments that raise living standards; when it malfunctions, as in recent years, savings are channeled into real-estate bubbles and environmentally harmful projects, including those that exacerbate human-induced climate change (Sachs 2014).

Effective financial markets should also channel more global savings from high-income countries with relatively weak long-term growth prospects to low-income regions with relatively strong growth prospects, owing to new opportunities to leapfrog development with smart, information-based infrastructure. Just a decade ago, hundreds of millions of rural Africans lived outside the flow of global information. Now, with the rapid spread of broadband, once-isolated villages benefit from online banking, transport services, and ICT-enabled agribusiness and health and education programs.

To seize the benefits of these new technologies at scale and to avoid investments that aggravate cascading environmental crises, the finance industry will need to understand how the SDGs will reshape the investment landscape. The time has come to embrace the concept of true long-term investing, which requires marshalling the capacity of institutionally mobilized capital to support investment opportunities that will secure a sustainable future for all.

We know that enormous public and private investment is required for the transition toward a low-carbon and green economy, to win the global fight against poverty and disease, and to provide high-quality education and physical infrastructure worldwide.

Today’s savvy investors, and the financial industry as a whole, need to look beyond today’s market prices and policies to the market prices and policies of the future.

For example, today there is no global price on carbon to shift energy investment from fossil fuels to RE; but we know that, in order to keep global warming below the 2 °C limit, such a price is coming soon. As stewards of long-term capital, today’s investors cannot ignore the coming carbon price and the shift toward green and RE sources. That means devising practical ways to finance and encourage the required shift.

We believe that financial leaders want their industry to play a vital role in sustainable development, and we urge them to contribute actively to the unique opportunity that the current situation represents.

Apart from the role of RE projects in reducing the carbon emissions level in line with SDGs, another reason for the development of RE projects is raising energy self-sufficiency (domestic production of primary energy [including nuclear]/domestic supply of primary energy × 100) (Yoshino et al. 2017)) and energy security by diversification of energy resources. Too much reliance on limited resources of energy (coal, oil, or gas) will reduce the resiliency of the economy and make it more prone to energy price fluctuations. Several studies (see, inter alia, Hamilton 1983; Barsky and Kilian 2004; Taghizadeh-Hesary et al. 2013, 2016; Taghizadeh-Hesary and Yoshino 2016) have evaluated the impacts of oil price fluctuations on various macroeconomic indicators and generally found that increases in oil prices are disruptive to economic growth and create inflation for most oil-importing countries.

In a more recent study, Taghizadeh-Hesary et al. (2017) showed that after the Fukushima nuclear disaster in Japan in March 2011, which resulted in the shutting down of nuclear plants and substituting nuclear power with fossil fuels, energy security in Japan suffered. Their findings revealed that the absolute value of elasticities of oil consumption in some economic sectors decreased after the disaster because of an increased dependency on oil, which endangered the country’s energy security. They suggested that to raise energy self-dependency and energy security, Japan needs to diversify its energy supplies. As a result of eliminating nuclear power generation and substituting it with fossil fuels, energy self-sufficiency fell from 19.6% in fiscal year 2000 to 8.6% in fiscal year 2013 (MIAC 2015). Before the 2011 disaster, Japan was the third largest consumer of nuclear power in the world, after the United States (US) and France. In 2010, nuclear power accounted for about 13% of Japan’s total energy supply (Taghizadeh-Hesary et al. 2016). In 2012, the nuclear energy share fell to 1% of total energy supply (and contributed at a similar level to primary energy consumption in 2013 as only two reactors were operating for a little more than half of the year) (Taghizadeh-Hesary and Yoshino 2015).

A large body of literature estimates the effect of energy security drivers on RE deployment using import dependence as a proxy for energy security, which is an approach that ignores the potential effect of other energy security strategies, such as the diversification of energy sources. Using a panel data for the energy sector across 21 European Union (EU) member states, Lucas et al. (2016) investigated the effect of different energy security concepts on the development of RE. Their primary findings confirmed that (i) RE deployment is a consequence of a combination of energy security strategies including environmental concerns rather than being solely caused by a shift toward more sustainable energy policies; and (ii) among the different energy security strategies, the diversification of energy sources through RE deployment is a more coherent strategy than using RE to reduce dependency.

Hence, increasing the share of green energy resources in the energy basket not only reduces the emissions in line with the SDGs and the Paris Agreement but also increases the energy security level.

How to Fill the Green Finance Gap?

In recent years, several new methods for financing green projects have been developed, including green bonds, green banks, and village funds. Green banks and green bonds partially have the potential to help clean energy financing. The advantages of green banks include improved credit conditions for clean energy projects, aggregation of small projects to reach a commercially attractive scale, creation of innovative financial products, and market expansion through dissemination of information about the benefits of clean energy. Supporters of green bonds believe that it can provide long-term and reasonably priced capital to refinance a project once it has passed through the construction phase and is operating successfully (NRDC 2016).

Although the aforementioned methods were somehow helpful for development of low-carbon/green projects, the data suggests they are inadequate. Global energy investment totaled $1.8 trillion in 2017, a 2% decline in real terms from the previous year, according to the World Energy Investment 2018 report (IEA 2018a). More than $750 billion went to the electricity sector while $715 billion was spent on oil and gas supply globally. Global energy investment in 2017 failed to keep up with energy security and sustainability goals. After several years of growth, combined global investment in renewables and energy efficiency declined by 3% in 2017 and there is a risk that it will slow further this year. This could threaten the expansion of green energy needed to meet energy security, climate and clean-air goals. For instance, investment in renewable power, which accounted for two-thirds of power generation spending, dropped 7% in 2017 (IEA 2018b).

Clearly, fossil fuels still dominate energy investments. A major concern in the transition to low-carbon energy provision, therefore, is how to obtain sufficient finance to steer investments toward RE (Mazzucatoa and Semieniuk 2017). Due to the limitations of the Basel capital requirements on lending by financial institutions, and because banks consider most RE projects to be risky, banks are reluctant to finance them. On the other hand, banks resources are coming from deposits and deposits are usually short to medium term. Allocating bank resources to green infrastructure projects that require long-term finance will make maturity mismatch for banks. Hence, relying on banking finance is not a solution for financing green projects; we need to look for new channels of financing this sector to fill the financing gap for such projects. Bank lending should be allocated to safer sectors and businesses.

One possible solution is to stimulate non-bank financial institutions’ investments in green projects (See Chap. 10, “Stimulating Non-bank Financial Institutions’ Participation in Green Investments” by Gianfrate and Lorenzato of this Handbook). These institutions, including pension funds and insurance companies are keeping long-term financial resources that are suitable for green infrastructure investments. Institutional investors are (the largest) suppliers of capital to listed companies, managing almost $100 trillion asset in OECD countries alone (World Bank 2015). Because of their size and their role as a conduit of savers’ climate concerns to the capital markets, institutional investors are ideally positioned to steer corporate capital allocation toward more sustainable uses.

As for emissions trading and carbon pricing schemes, according to recent estimates (World Bank 2017), as of 2016, 40 countries have a carbon pricing system in place, and that number is expected to increase significantly over the next few years following the climate change agreement reached in Paris in 2015.

From the current systems of carbon prices in place, “carbon price risk” emerges as a new form of political risk for both companies and investors. Such risk is related to the probability of the emergence of future international climate agreements and of national policies. The timing and extent of carbon-related policies will dramatically determine when and which real and financial assets will be affected. The risk is not merely political, but technological as well, as there is uncertainty about possible future technologies that might affect the speed and scope of the transition toward a low-carbon economy. This aspect further influences investors’ ability to form long-term expectations about assets to be invested in (Chap. 10, “Stimulating Non-bank Financial Institutions’ Participation in Green Investments” by Gianfrate and Lorenzato).

Another important factor that needs to be considered for filling the green financing gap is the role of green central banking. The responsibility for financial and macroeconomic stability implicitly or explicitly lies with central banks, which therefore ought to address climate-related and other environmental risks on a systemic level. Furthermore, central banks, through their regulatory oversight over money, credit, and the financial system, are in a powerful position to support the development of green finance models and enforce an adequate pricing of environmental and carbon risk by financial institutions. It is important to consider how financial governance policies through central banks, as well as other relevant financial regulatory agencies, can address environmental risk and promote sustainable finance (Dikau and Volz 2018).

The role of fiscal policies in increasing the rate of return of green projects for elevating the share of the private sector’s investment in these projects is crucial. Countries can widely use tax relief or tax credit to promote renewable energy deployment. The US uses production tax credit extensively for the promotion of wind energy and investment tax credit for solar energy. A company could use these tax credits to reduce the deductions from income taxes or corporate taxes in exchange for investment in renewable energy. The US has extended its production tax and investment tax credit policies until 2020 (See Chap. 19, “Implications of Fiscal and Financial Policies on Unlocking Green Finance and Green Investment” by Dina Azhgaliyeva, Zhanna Kapsalyamova, and Linda Low).

Another incentive and support for renewable energy deployment through fiscal policies could be returning the tax revenue originated from the spillover effect of private investments in green energy projects. Several studies discuss the spillover effects of green energy projects to other sectors and the gross domestic product of the region. The spillover effect can increase the tax revenue of local or central governments from that region, which countries could further refund partially or entirely to the private-sector investors in order to increase the rate of return of these projects (Yoshino and Taghizadeh-Hesary 2018).

For small and medium-sized green projects, community-based funds and village funds could be a suitable solution. The Hometown Investment Trust (HIT) funds is a new source of community-based trust funds created to support solar and wind power. The basic objective of the HIT funds is to connect local investors with projects in their own locality, where they have personal knowledge and interests. Individual investors choose their preferred projects and make investments via the internet (Yoshino and Kaji 2013). One of the major applications of HITs in Japan relates to wind and solar power projects, which have raised money from individuals (about $100 to $5,000 per investor) interested in promoting green energy. Through these funds, many Japanese people invest small amounts of money in the construction of wind power and solar power. Advertisements of each wind and solar power project on the internet play an important role in pushing people to invest in these projects. Internet marketing companies provide the platform for investment in these projects and are able to market these projects. Local banks have started to use the information provided by HIT funds. If these projects are done properly and are received well by individual investors, banks can then start to grant loans for those projects. In this way, renewable projects (wind and solar), most of which are considered risky, can be supported by HIT funds until they are able to borrow from banks. The use of alternative financing vehicles, such as HIT funds, has therefore assisted the growth of solar and wind projects in Japan, where the finance sector is still dominated by banks (Yoshino and Kaji 2013; Yoshino and Taghizadeh-Hesary 2014). HIT funds have expanded from Japan to Cambodia, Viet Nam, and Peru. They are also attracting attention from Thailand’s government, Malaysia’s central bank, and Mongolia. Venture capital markets are generally not well developed in many countries including in many Asian economies, and the financial systems of many developing countries are still dominated by banks. However, internet sales are gradually expanding and the use of alternative financing vehicles such as HIT funds will help risky sectors to grow (Yoshino et al. 2019).

An example for community-based green finance is the Hokkaido Green Fund, that was established in 2000 to finance wind power projects in northern Japan, and funded by individual investors and donations. As it was difficult to raise money from banks, only 20% of total investment was financed by banks and the other 80% was obtained from individual investors and through donations. A community wind power corporation runs wind power and sells electricity to the company that supplies power to the region. In many cases, the price of power produced by wind is 5% higher than that of other forms of electricity, but users are willing to pay the extra to save the environment. More than 19 wind power projects have been constructed in northern Japan using a similar method. There are also examples of solar power projects in Japan where local governments put money (seed money) into the community fund as an incentive for private investors.

Last but not least, new financial technologies (“fintech”) can offer the potential to unlock green finance technologies, such as blockchain, the Internet of Things, and big data, developed over the same timeframe as the Paris Agreement and the SDGs. According to Nassiry (Chap. 14, “The Role of Fintech in Unlocking Green Finance” of this Handbook), three broad areas for the possible application of fintech to green finance are: blockchain applications for sustainable development; blockchain use-cases for renewable energy, decentralized electricity market, carbon credits, and climate finance; and innovation in financial instruments, including green bonds.