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Internalisation makes developing countries more attractive

09 August 2010 #Environment

Investments in the realm of climate change tend to be focussed mainly on financial returns - not surprising as the very nature of an investment is to make a return. However, there is an increasing need to focus on the social and environmental benefits along with the financial benefits as climate change-related impacts begin to affect all aspects of society. This is especially true in developing countries, where these impacts are likely to be experienced first and most severely.

The traditional definition of an investment has resulted in a lack of effort and attention in investments in rural areas of developing countries, especially in Africa. Investments in these types of projects may not have spectacular financial returns, if any, but have positive social and environmental returns. For example, decentralised renewable energy generation options circumvent the need to invest in laying down a capitally intensive grid system. The indirect benefit to the environment results from leapfrogging old dirty energy generation technologies to newer and clean forms of energy generation. Socially, implementation of such technologies simultaneously acts as an education tool and provides simple amenities such as access to electricity, which have far reaching and proven benefits such as improved access to healthcare and education and increased economic productivity, all of which are a means out of poverty.

In the majority of cases, these types of projects are not economically feasible. Why, then should any consideration be given to them? If the environmental impacts associated with traditional energy generation were internalised (ie. the cost of remediating associated carbon emissions) into the cost of energy, the economics of such projects would make sense, not to mention the avoidance of capital requirements for the grid infrastructure. In the same way, internalisation of indirect social benefits would also contribute to the economics of such projects. Understandably, internalisations of costs and benefits are more easily said than done, resulting in market failures. What, then, is the solution to this dilemma?

It is up to the public sector and the multilateral development institutions to lead the way in implementing these projects whilst incorporating indirect and external costs and benefits to show that there are clear overall benefits. Taking on the initial risk will pave the way to developing such projects to show that they can be done, which will result in creation of innovative business models that will enable the private sector to enter the sector confidently and move beyond financing these projects through aid. Methods for internalising the environmental costs, such as the EU ETS, are part of the solution; although to deploy these models in small scale in developing countries would be unfeasible at present.

Written by The EIC Environmental Investment Network.

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