Climate change and the need for a transition to a low (or no) carbon economy: The role of Finance and Investment as an agent for change

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A DemanSide Perspective

I’m using this blog post to explore the role of Finance and Investment in facilitating the transition to a low carbon economy; from the demand side, in the context of Bangladesh’s garment sector.

If the finance sector is to be an agent for change in the transition to a low-carbon economy, the demand for such finance will be as important as its supply. In my (limited and small-scale) experience, the need for ‘changing finance to embrace longer term and more systemic thinking[1] will need as much attention on the demand side as the supply side.

Micro-Level Sustainability Transition

I was recently involved in a pilot project in Bangladesh, in partnership with an impact investment consultancy firm, that developed a support package for garment factories. The package included concessional loans and technical assistance to procure and install energy saving technologies in factories. Investments included installation of meters to track energy use, conversion to LED lighting, condensation recovery systems and enhancing the energy efficiency of sewing machines.

The pilot actually financed these investments through grants not loans in 3 pilot factories. The intention being to use the pilot to build a financial model that proved the ‘business case’ for making such investments. Once proved, the plan was to scale the pilot industry-wide with support from international impact investors and local banks.

And the case was proven. The results were celebrated and clear. Factories could, in theory, borrow to invest in energy-saving (climate friendly) technologies, which generated sufficient cost reductions to both pay back the loans at market interest rates, and generate a return on top of that – within a short 1-2 year time horizon.

However…

Stumbling Block

While the pilot factories seemed happy with their investments and the business case seemed water tight, it just wasn’t clear that factories would actually take out loans – even at concessional rates – to make such investments. Even with grant financing 2 of the 3 factories in the pilot weren’t over-keen on engaging in the project.

Why was this? Why weren’t we left convinced that business owners would make economically rational decisions on presentation of robust evidence? Three immediate possibilities came to mind:

1) Lack of long-term vision for their businesses which limits appetite for investment, even over a short time period.

2) Lack of capacity and expertise to maintain new equipment, and therefore generate a guaranteed return on investment; and

3) The role of government policy and regulation (or lack of) in generating the demand (or lack of) for such finance.

The literature provided further insight in recognising that the ‘socio-technical transition to an environmentally sustainable economy’ may encounter barriers of economic, social, political or behavioural–psychological nature.[2] Three possibilities for limited demand suggested by the literature (at the macro level) resonated with my observations (at the micro level):

1) Supply chain pressure.What would change if the outcomes of such investments were a condition of a brand’s commercial relationships with a factory?

2) Low awareness of problems or solutions due to the absence of factory environmental management systems. Whilst the installation of meters partly addressed this issue, I’m not sure that they generated sufficient ‘ownership’ among factory management; and

3) Transitions are not smooth and involve winners and losers. Did we sufficiently understand the dynamics within each factory management team, especially as procurement of new equipment was taken out of the hands of the factory? Stakeholder analysis might have helped us here.

Towards a Better Understanding

In summary, my key learning is that the design of this project should have paid more attention to ‘the social–institutional dimensions of innovations and transitions.’[3] At a minimum, the (clearly non-behavioural) economists designing the project might have explored the implications of bounded rationality[4] on the project’s viability. There are also world-class garment factories in Bangladesh, sitting alongside those reluctant or unable to change. What separates the two? What can we learn from the former?

Any other insights? What other factors may be blocking the demand side? And what can be done to address it?

 

 

 

[1] CISL notes for this module.

[2] van den Bergh, J. C. J. M., Truffer, B., & Kallis, G. (2011). Environmental innovation and societal transitions: Introduction and overview. Environmental Innovation and Societal Transitions, 1(1), 1–23

[3] ibid.

[4]The idea that in decision-making, rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision.’ https://en.wikiquote.org/wiki/Bounded_rationality.

(Picture is my own – taken in Dhaka, Bangladesh)

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4 thoughts on “Climate change and the need for a transition to a low (or no) carbon economy: The role of Finance and Investment as an agent for change

  1. Thanks for your insights – believe it or not you don’t have to go to Bangladesh to find the same outcome. I’ve previously worked for a large corporate where the regulations required the audit to be undertaken to identify the savings and then it was hoped that the organization would proceed because the results would be identified. Guess what…..apart from some token efforts the rest were not taken up – even though the financials were there to support it. The comments such as if the government was serious they would have made the regulations also require a certain % of savings to be completed (or something similar). We have a way to go yet to achieve a low (or no) carbon environment…….

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  2. Thanks for sharing this example of the challenges of transition. I believe you are right that the behavioural aspects of change are an often greater factor in deciding the outcome of a programme like the one that you describe than the rational, economic factors that these schemes are often designed around. Not knowing the case, but knowing many like it, your conclusions look right, though I wonder if I could offer a few more to reflect upon.

    Firstly I would reflect that cultural differences / norms can have a significant bearing on projects like these. From my time spent working in the Middle East I remember in particular that attitudes towards conventional finance can be problematic for small businesses owners. Not only are the systems of loans and the legal and regulatory systems they depend upon far less developed, but there is also a legacy of religious and cultural norming that has made attitudes towards risk far more punctuated than in other contexts. I wonder if the same might be true in your case. Though of course micro finance has been tremendously successful in Bangladesh.

    I also wonder if those participating (or not) are also viewing the investment case against other opportunities and whilst the payback period of the loans on the equipment you described are relatively short, perhaps they are weighing this as an option against say using that capital to expand their operations or increasing their revenues or profitability by some other investment. Options which may be more conventional and understood by the factory owners than lower carbon and other sustainability goals.

    In addition to social norms there are other behavioural nudging techniques that might be put to good use in your example. One such technique is that of default options, and I wonder if the scheme might be more readily accepted if there is a greater range of choices available to each participant, but with a default made to the most sustainable options?

    Thanks for your post and I hope these reflections are useful.

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  3. I really enjoyed reading your inspiring post but at the same time agree with the challenges you highlighted in the comments. My experience with projects in Africa we found similar reasons for inability to translate benefits of the pilots to business as usual. One bright spot that we found was short term cost savings that improves cash flow, but it is really hard to find the improvements in this space due to capital cost. We experienced the in Africa small factories generally have energy as one of the biggest cost items on their books. We funded the pilot project to analyse their energy consumption practices and then identify specific recommendations including cheapest way to source any capital investment and cheapest way to finance them. As pilot was carried out through microfinance institution, we were able to underwrite small loans based on the business case developed during the pilot.
    I like the image on your blog, it is a good reminder that these issues are complex. Another aspect to build is as suggested in your post, relieve the pressure from supply chain. Motivation to drive towards low price counter any long-term investments. If their customer worked as a partner to consider this is as a joint long term business case then it could help to keep shift the focus away from short term thinking.
    Nevertheless, I think there are some really good insights from your posts that can be replicated. Thank you for sharing it.

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  4. Lindsey, hope you’re well. Another good blog …

    A few thoughts. Firstly I think this highlights the need for a stable and supportive political environment for businesses to operate, which promote long-term thinking and planning. Without strong governance, understanding of ownership rights and conviction from individual’s that risk adjusted investment will generate a return, we cannot expect businesses to invest for growth, whether sustainability related or otherwise. I read a good book a while back called Why Nations Fail which covered this well.

    Secondly, I think there needs to be real alignment and understanding from all involved on why such investments are being made – both the business and environmental case. This takes work and education, but sometimes (I hate to say) it’s just easier to move on and work with other people / factories where there is more personal conviction. Even when decisions make commercial sense irrespective of the environmental impact, individual’s alignment with regards the environmental benefit is critical. This is particularly the case where materiality of the project may be relatively low in the context of the broader project / factory, as may be the case here?

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