By João Carlos Ferraz, Associate Professor, Institute of Economics, Federal University of Rio de Janeiro
New economic activities may be required for the sustainable, competitive and inclusive development trajectory of a nation. But in their early stages, the economic attractiveness of many of these new activities is unknown. Uncertainty prevails as investment projects have no track record of costs and returns, demand is not guaranteed, and the institutional framework may not be consolidated. In short, infant industry challenges may apply, which is when new policy and public institution practices should come into play. And increasingly, emerging societal development challenges like climate change, are creating a pressing need for innovative policy solutions.
But what is innovation in public institutions? Policy innovations may come in diverse shapes and forms; they can be new solutions to address a pre-existing challenge or alternative approaches to tackling an emerging one. Some may result in short-lived experiences (pilot projects that are never scaled up); others can be both immediately relevant and long lasting. Drawing from Schumpeterian literature, policy innovation can be defined as changes in processes – including organisational procedures – and products that a public agency offers to society. For policy beneficiaries, these are product innovations, but, when taken up, they imply process changes in the recipient organisation. Moreover, policy innovations can be of radical or incremental nature depending on the extent of the changes they imply for policy benefactors and beneficiaries. Nonetheless, a necessary pre-condition for the emergence and application of any type of innovation is the mobilisation of dynamic policy capabilities.
“We analysed how the Brazilian Development Bank developed and implemented financial innovations to foster the local wind industry and their suppliers, and the exogenous and endogenous factors behind the bank’s actions and outcomes.” #DevMatters
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The capacity of a public organisation to innovate depends on specific external and internal factors. The former may be related to market and technology trends, the local economic scenario, and existing political and policy frameworks. An array of endogenous factors may also come into play (i) accumulated past experiences; (ii) financial resources and product portfolio; (iii) strategic priorities and their alignment with policy directives; (iv) process and organisational procedures and (v) civil servants’ abilities to identify challenges and explore solutions to foster emerging economic activities.
A recent study I co-authored looks at how development banks can support sustainability-building initiatives through innovative finance. We analysed how the Brazilian Development Bank (BNDES) developed and implemented financial innovations to foster the local wind industry and their suppliers in 2010, and the exogenous and endogenous factors behind the bank’s actions and related outcomes. We found that BNDES was successful in temporarily lowering project investment costs (and, later, providing market-oriented solutions) and in shaping the emergence and consolidation of a local supply industry through the accreditation of suppliers. BNDES provided financing to 80% of the 15.4 GW wind capacity installed up to 2019 in Brazil – a 15-fold increase from 2010 that led to lowering carbon emissions by about 80 million tons. Moreover, between 2001 and 2018, investment costs per kW decreased from US$ 3,258 to US$ 1,823. Out of BNDES’ US$ 15.2 billion of disbursements during this period, loans amounting to around US$ 12.7 billion were directed at equipment acquisition.
More than 100 companies are currently part of the wind energy supply chain. Brazilian suppliers are competitive in quality and delivery time, and turbines incorporate the best available technologies. Local efforts have been directed at adapting equipment to local production and value chain conditions, and in parallel ensuring on-time delivery. However, local capabilities, ranging from basic research to the design of state of the arts devices, are still lacking which constitutes a major challenge for the Brazilian supply industry.
The Brazilian case suggests that development-oriented finance innovations are necessary conditions for the emergence and consolidation of sustainable industries but, to be effective, policy innovations depend on the alignment of a complex web of exogenous and endogenous factors. Public institutions must be aware and prepared to explore temporary windows of opportunities locally and internationally. In the case of Brazil, these windows were the availability of international wind park operators and manufacturers; the technological trajectory of wind turbines; an economic climate conducive to energy demand; the coherence of policy directives and, the convergence of actions taken by the relevant executive agencies.
“Development-oriented finance innovations are necessary conditions for the emergence and consolidation of sustainable industries but, to be effective, policy innovations depend on the alignment of a complex web of factors.” #DevMatters
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On one hand, without such conditions, Brazil’s wind energy most probably would not have taken off, even if a development-oriented finance institution were present – it is very unlikely that its isolated actions would have found strong resonance in the real economy. On the other hand, without proper development-oriented finance conditions, favourable exogenous factors per se would not constitute sufficient conditions to ensure the emergence and consolidation of the wind industry and its local suppliers.
This case study shows that development-oriented finance innovations were a result of (i) strategic priorities aligned with policy directives; (ii) a balance sheet capable of absorbing liabilities and the availability of finance on a sufficient scale to meet growing demand; (iii) organisational procedures based on the principle of segregation between credit and project evaluation; (iv) the capacity to design and implement terms of credit and accreditation procedures alongside the industry’s evolution; and (v) the existence of a reliable and trustworthy network with relevant actors (public and private). Impersonal collective decision-making processes and a qualified team of professionals backed these endogenous factors, with the knowledge and network connections to learn, explore and evaluate the economic, financial, market, and technology opportunities to foster development.
However, this was just one case. We still know very little about what constitutes the dynamic capabilities of public institutions, and how and why they come about. Valuable experiences must exist worldwide, deserving further and immediate investigation. We need more conceptually sound and evidence-based research to better understand and draw lessons, or at least inspiration, on how public institutions must tackle emerging development challenges and better serve the public interest by explicitly investing in policy innovation capabilities.