Maximising the public-private investment multiplier

By Alain de Janvry and Elisabeth Sadoulet, Professors at the University of California at Berkeley and Senior Fellows at the FERDI
 

Development-finance

At the FERDI-IDDRI conference on “Development, Climate and Security” held in Paris on January 15, 2018, Barbara Buchner from the Climate Policy Initiative reported on the state of global climate finance flows for mitigation and adaptation. She made two points. First, finance is under-invested to combat climate change if the COP21 target in temperature increase is to be met. Second, private investment’s role in complementing public investment in climate finance is large, with an estimated 2/3 private for 1/3 public in current total contributions. This stresses the fundamental part private investment can play in meeting the COP21 objectives, particularly at a time when governments face multiple demands on public expenditures.

With public investment targeted to induce private investment, this raises the issue of public investment’s effect as a private investment multiplier. A useful way of thinking about the under-investment issue is consequently how to target public investment to maximise the public-private investment multiplier.

For mitigation, this would be public investments creating incentives for private investment in renewable sources of energy such as wind and solar, as well as disincentives to investment in non-renewables such as coal and petroleum. Private investments in renewable sources of energy are not only profit-making but also sources of positive externalities in reducing emissions. The fiscal costs of the public expenditures that make private investment profitable are justified by the internalisation of the corresponding externalities.

For adaptation, this would be public investments inducing complementary private investments in building the resilience of activities that are sources of livelihood for the poor. Care must be given for the induced private investments in adaptation not to contradict the effort at mitigation. We see the importance of increased investment in adaptation most particularly in a developing country’s agriculture sector. It is the sector on which most of the world’s poor depend for their livelihoods, directly as farmers and farm workers or indirectly with activities related to agriculture through forward, backward and final demand linkages. What we would like, then, is to maximise the public-private investment multiplier for an agriculture more resilient to climate change in countries where it harbors most of the poor.

Focusing on the public-private investment multiplier is thus a useful conceptual framework to think about global investment in climate finance. It helps look beyond the role of public transfers to reduce or adapt to emissions to their role in generating income opportunities that mobilise private investment for that same purpose

Four aspects of these multipliers deserve attention. They need to be:

            Understood: Multipliers originate in behavior, and we need to understand what motivates behavioral changes in private investment in response to changes in public investment.

            Measured: For this, causality needs to be carefully established in the public-private investment relation. Experimentation and structural modeling will typically be necessary for this.

            Amplified: Complementary policies and programmes can be introduced to facilitate private response to the incentives created by public investment, and correspondingly increase the multiplier effect.

            Used: Improved knowledge of the corresponding multiplier can incentivise higher levels of public investment.

What does this mean in practice? We have few reliable measurements of the public-private investment multiplier in a developing country’s agriculture sector for activities related to adaptation to climate change. We present two here.

One is the CGIAR (Consultative Group for International Agricultural Research) investment in making crop varieties resilient to climatic events such as droughts, floods and extreme temperatures. The SwarnaSub1 rice variety generated by public research is tolerant to extended flooding. A randomised controlled trial in eastern India shows that CGIAR (public) investment in agricultural research helps reduce yield losses under flooding in farmers’ fields (Emerick et al. 2016). Reduced downside risk induces farmers, in turn, to re-optimise their own (private) investments – using more fertiliser and more labor-intensive transplanting methods to generate higher yields in normal years. With an average of one year of floods for every three normal years, the yield multiplier is two: expected gains in normal years secured by private investment equal the avoided losses in flood years secured by public investment. This multiplier can be further enhanced by facilitating farmer response to risk reduction. Knowledge of the multiplier creates powerful incentives to put more public money into research on technologies for adaptation to climate change.

The other example is use of index insurance to reduce farmers’ production risks. Index insurance ties payouts for climate shocks to observable indicators — such as weather station measurements of climatic events and average area yields often measured by satellite — as opposed to claims of losses that need to be verified (Carter et al. 2017). Index insurance is typically subsidised through public transfers due to low private uptake at market price. This is the case for Mexico under the CADENA programme. The government provides smallholder farmers with free index insurance coverage for catastrophic droughts as a form of social protection, avoiding costly expenditures in relief programmes. Index insurance has been shown to provide enhanced shock-coping capacity to farmers, enabling them to avoid decapitalisation of productive assets and to resume normal production in years following a disaster. But it also has been shown to induce greater risk-taking in private investment by farmers. They use more inputs and engage in riskier but more profitable activities. Here again, a large multiplier of public on private investment has been evidenced through numerous field experiments to establish causality. The multipliers can be amplified by complementary interventions such as nudges to invest, access to credit and technical assistance.

Understanding, measuring, amplifying and using public-private multipliers can be not only a source of more private investment in climate finance, but also an incentive for governments to invest more in public climate finance. This allows governments to engage in results-based management of public expenditures, and it helps mobilise a private constituency with a stake in more public investment in climate finance. Public expenditures respond to political incentives, and political incentives are created by expected private gains from greater public investments in climate finance. Thus, greater attention should be given to the multipliers of public on private investment in climate finance. This may indeed be one of the most effective approaches to help reduce the current under-investment in climate finance to meet the COP21 temperature objectives.



References

Carter, Michael, Alain de Janvry, Elisabeth Sadoulet, and Alexandros Sarris. 2017. “Index Insurance for Developing Country Agriculture: A Reassessment.” Annual Review of Resource Economics 9: 421-38.

Emerick, Kyle, Alain de Janvry, Elisabeth Sadoulet, and Manzoor Dar. 2016. “Technological Innovations, Downside Risk, and the Modernization of Agriculture.” The American Economic Review 106(6): 1537-1561.