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The Pathway to Sustainable DevelopmentTHE WORLD BANK

Inclusive Green GrowthThe Pathway to Sustainable Development

Inclusive Green GrowthThe Pathway to Sustainable Development

© 2012 International Bank for Reconstruction and Development / International DevelopmentAssociation or The World Bank1818 H Street NWWashington DC 20433Telephone: 202-473-1000Internet: www.worldbank.org1 2 3 4 15 14 13 12This volume is a product of the staff of The World Bank with external contributions. The findings, interpretations,and conclusions expressed in this volume do not necessarily reflect the views of The WorldBank, its Board of Executive Directors, or the governments they represent.The World Bank does not guarantee the accuracy of the data included in this work. The boundaries,colors, denominations, and other information shown on any map in this work do not imply any judgmenton the part of The World Bank concerning the legal status of any territory or the endorsement oracceptance of such boundaries.Rights and PermissionsThe material in this work is subject to copyright. Because The World Bank encourages dissemination ofits knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long asfull attribution to the work is given.For permission to reproduce any part of this work for commercial purposes, please send a requestwith complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com.All other queries on rights and licenses, including subsidiary rights, should be addressed to the Officeof the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422;e-mail: pubrights@worldbank.org.ISBN (paper): 978-0-8213-9551-6ISBN (electronic): 978-0-8213-9552-3DOI: 10.1596/978-0-8213-9551-6Cover design: Richard Fletcher, Fletcher Design.Library of Congress Cataloging-in-Publication Data has been requested.

ContentsForeword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiAcknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiiiAbbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvOverview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1Greening growth is necessary, efficient, and affordable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4But obstacles are plentiful, and green growth is no substitute for good inclusivegrowth policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12The way forward: Good and inclusive growth policies tailored to real-world challenges . . . . 15Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 251 An Analytical Framework for Inclusive Green Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29Why not grow now and clean up later? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30Delaying action can be costly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32Is green growth really possible? The analytical basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34A real-world framework for green growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36What about welfare? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39Trade-offs and synergies between green policies and growth . . . . . . . . . . . . . . . . . . . . . . . . . 40Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 422 Influencing Firms, Consumers, and Policy Makers through Market andNonmarket Mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45Incentivizing: Providing effective market signals to spur green growth . . . . . . . . . . . . . . . . . . 47Informing and nudging: Using information and framing to influence economic actors . . . . . 52Imposing: Using rules and regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60v

viCONTENTS3 Green Innovation and Industrial Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65Innovation policies: Tailoring mixes of instruments to a country’s innovation potential . . . . 67Green industrial policies: Ensuring that the standard caveats apply . . . . . . . . . . . . . . . . . . . . 80Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864 Human Capital: Implications of Green Growth Policies for Labor Markets and JobCreation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91Green policies may create jobs, but are no substitute for sound labor markets . . . . . . . . . . . . 92But environmental regulation need not kill jobs either . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96Smoothing the transition to greener growth paths for the labor market . . . . . . . . . . . . . . . . . 99Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1025 Natural Capital: Managing Resources for Sustainable Growth . . . . . . . . . . . . . . . . . . . . . . 105Extractable renewable resources: Defining property rights and moving up thevalue chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107Cultivated renewable resources: Innovation, sustainable intensification, and integratedlandscape approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113Nonprovisioning services: Creating knowledge and markets for economic valuation . . . . . . 117Nonrenewable resources: Promoting rent recovery and reinvestment . . . . . . . . . . . . . . . . . . 123Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1276 Physical Capital: The Role of Infrastructure in Green Growth Strategies . . . . . . . . . . . . . . 133Infrastructure as the heart of green growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134Recognizing the need for efficiency: Meeting large unsatisfied infrastructure needswithin tight fiscal constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139Minimizing the potential for regrets and maximizing short-term benefits . . . . . . . . . . . . . . 149Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1507 Crafting a Green Growth Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153The challenges of developing a green growth strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154A step-by-step process for crafting a green growth strategy . . . . . . . . . . . . . . . . . . . . . . . . . 158Uncertainty and the need for robust decision making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169BoxesO.1 What is the aggregate economic support to the (over)use of natural capital?$1 trillion to $1.2 trillion annually . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9O.2 The many ways in which green policies can contribute to growth . . . . . . . . . . . . . . . . . . 11O.3 Why “grow dirty and clean up later” is misleading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16O.4 Morocco: The importance of political economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18O.5 “Green” cash transfers are helping poor communities in the Brazilian Amazon . . . . . . . 24O.6 Joining forces: A common platform to move forward on greening our economiesand growth processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241.1 Persistent concerns about local pollution in high-income countries . . . . . . . . . . . . . . . . . 321.2 An economic framework for green growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351.3 Using individual transferable quotas to revitalize fisheries . . . . . . . . . . . . . . . . . . . . . . . . 38

viiiCONTENTSFiguresO.1 The three pillars of sustainable development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2O.2 As incomes increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5O.3 As incomes increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6O.4 The Loess plateau, before and after the watershed restoration program . . . . . . . . . . . . . . 8O.5 Up-front investment costs for energy supply and energy efficiency couldbe substantial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10O.6 Reducing environmental degradation would provide substantial economic benefits . . . . 12O.7 Developing countries may have substantial unexploited potential in green exports . . . . 14O.8 Fossil fuel subsidies benefit primarily the rich . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151.1 The three pillars of sustainable development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311.2 Global pollutants and local, visible ones follow different paths . . . . . . . . . . . . . . . . . . . . 331.3 The denser the city, the lower the transportation emissions . . . . . . . . . . . . . . . . . . . . . . . 341.4 Green policies hold the potential to sharply boost output . . . . . . . . . . . . . . . . . . . . . . . . 37B2.4.1 Some regions are doing better than others in wealth creation . . . . . . . . . . . . . . . . . . . . . 532.1 Energy-reporting electrical outlet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55B2.6.1 A sudden shift to greener cars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57B2.8.1 Fuel efficiency standards are key to reducing emissions from the transport sector . . . . . 593.1a Green frontier innovation occurs mostly in high-income countries… . . . . . . . . . . . . . . . 693.1b ... with East Asia leading the way in developing regions .... . . . . . . . . . . . . . . . . . . . . . . 693.1c ... but worldwide green patents remain low . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 703.2 Green exports are growing, especially in the East Asia and Pacific region . . . . . . . . . . . . 713.3 Developing countries may have a substantial unrealized potential for producinggreen exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723.4 Green imports are vital worldwide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 723.5 Snapshot of technology creation and diffusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 744.1 Many developing countries need to increase their enrollment in technicaltertiary education . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1015.1 Current fishery practices are not sustainable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1075.2 Not enough wealth creation from natural capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1256.1 Urban densities determine cities’ options for greening . . . . . . . . . . . . . . . . . . . . . . . . . . 135B6.1.1 As income rises, will countries choose low energy consumption in road transport? . . . 1366.2 Upfront investment costs for energy supply and greater energy efficiency couldbe substantial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142B6.6.1 Access to basic infrastructure services has risen dramatically in Colombia . . . . . . . . . . 1436.3 Too few countries are implementing plans to mitigate against natural disasters . . . . . . 1487.1 Schematic for crafting solutions in the presence of deep uncertainty . . . . . . . . . . . . . . . 167TablesO.1 Some guiding principles for establishing green growth strategies . . . . . . . . . . . . . . . . . . . 17O.2 Financing mechanisms need to be tailored to the maturity of the localfinancial sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231.1 Potential benefits of green growth policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415.1 Poor soil quality and land degradation hurt economic growth . . . . . . . . . . . . . . . . . . . 1105.2 Impacts of payment for ecosystem services schemes on poverty reduction . . . . . . . . . . 1216.1 Sectors in which inertia and sensitivity to climate conditions are great . . . . . . . . . . . . . 1346.2 Gaps in access to infrastructure in developing countries remain large,particularly in Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

6.3 Effect of land use and density on use of public transport . . . . . . . . . . . . . . . . . . . . . . . . 1477.1 Inter-ministerial arrangements for coordinating on climate change strategyin selected countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1567.2 Channels through which green policies could contribute to growth . . . . . . . . . . . . . . . 1597.3 Some guiding principles for establishing green growth strategies . . . . . . . . . . . . . . . . . . 1617.4 Framework for measuring potential benefits from green growth policies . . . . . . . . . . . 164B7.3.1 Co-benefits of the Ouarzazate concentrated solar power project . . . . . . . . . . . . . . . . . . 165CONTENTS ix

ForewordInclusive green growth is the pathway to sustainabledevelopment.Over the past 20 years economic growthhas lifted more than 660 million people outof poverty and has raised the income levelsof millions more, but growth has too oftencome at the expense of the environment. Avariety of market, policy, and institutionalfailures mean that the earth’s natural capitaltends to be used in ways that are economicallyinefficient and wasteful, without sufficientreckoning of the true social costs ofresource depletion and without adequatereinvestment in other forms of wealth. Thesefailures threaten the long-term sustainabilityof growth and progress made on socialwelfare. Moreover, despite the gains fromgrowth, 1.3 billion people still do not haveaccess to electricity, 2.6 billion still have noaccess to sanitation, and 900 million lacksafe, clean drinking water. Growth has notbeen inclusive enough.This report argues that sustained growthis necessary to achieve the urgent developmentneeds of the world’s poor and that thereis substantial scope for growing cleaner withoutgrowing slower. Green growth is necessary,efficient, and affordable. It is the onlyway to reconcile the rapid growth requiredto bring developing countries to the levelof prosperity to which they aspire with theneeds of the more than 1 billion people stillliving in poverty and the imperative of a bettermanaged environment.Indeed, green growth is a vital tool forachieving sustainable development. But sustainabledevelopment has three pillars: economic,environmental, and social sustainability.We cannot presume that green growth isinherently inclusive. Green growth policiesmust be carefully designed to maximize benefitsfor, and minimize costs to, the poor andmost vulnerable, and policies and actionswith irreversible negative impacts must beavoided.Green growth also requires improved indicatorsto monitor economic performance.National accounting indicators like GDPmeasure only short-term economic growth,whereas indicators like comprehensivewealth—including natural capital—help usdetermine if growth is sustainable in the longrun.The Conference on Environment andDevelopment, held in Rio in 1992, focusedon inclusion and the environment but failedto mention growth. In the lead up to Rio+20,we are reminded that, in 1987, Gro HarlemBrundtland, then Prime Minister of Norway,framed the call for governments to changexi

xiiFOREWORDtheir approach to growth: “What is needednow is a new era of economic growth—growth that is forceful and at the same timesocially and environmentally sustainable.”Today, more than ever, we must payattention to the triple bottom line. Inclusivegrowth must be green. Green growth must beinclusive.Rachel KyteVice PresidentSustainable Development NetworkThe World Bank

AcknowledgmentsThis report was written by a team ledby Marianne Fay and Stéphane Hallegatteand composed of Marjorie-AnneBromhead, Alex Bowen, Michael Chaitkin,Mark Dutz, Atsushi Iimi, Urvashi Narain,and David Tréguer. Significant contributionswere made by Antonio Estache, Adrian Fozzard,Kirk Hamilton, Tim Kelly, MasamiKojima, Andreas Kopp, Somik Lall, EduardoLey, Marcelino Madrigal, Diego Rodriguez,Siddharth Sharma, and Adrien Vogt-Schilb.Geoffrey Heal acted as adviser to thereport, in addition to being a key contributorto developing the analytical framework.This report benefited from extensive discussionswith Milan Brahmbhatt. We gratefullyacknowledge the comments and adviceprovided by our peer reviewers: Rosina Bierbaum,Richard Damania, Uwe Deichmann,Vivien Foster, Jean-Charles Hourcade, MikeToman, David Popp, Thomas Sterner, JeffVincent, and Zhang Yongsheng. Other usefulinputs and suggestions were provided byZoubida Allaoua, Edward Andersen, JockAnderson, Ruben Bibas, Dan Biller, JamesBrumby, Christophe Crepin, JacquelineDevine, Casper Edmonds, Louis-GaëtanGiraudet, Céline Guivarch, Bernard Hoekman,Guy Hutton, Vijay Jagannathan, NalinKishor, Franck Lecocq, Robert Lempert,Robin Mearns, Aurélie Méjean, ChristopherNeal, Junko Narimatsu, Elisa Portale, ValentinPrzyluski, Riikka Rajalahti, ApurvaSanghi, Randeep Sudan, Nancy Vandycke,Xiaodong Wang, and Monika Weber-Fahr.Finally, the report drew on backgroundpapers produced for the inaugural con ferenceof the Green Growth Knowledge Platform(available at http://www.greengrowthknowledge.org) by Brian Copeland; StefanDercon; Jaime de Melo; Tony Gomez-Ibañez;Winston Harrington, Richard Morgenstern,and Daniel Velez-Lopez; Larry Karp andMegan Stevenson; Howard Kunreuther andErwann Michel-Kerjan; David Popp; GuidoPorto; Andreas Schäfer; Sjak Smulders andCees Withagen; Jeff Vincent; and Elke Weberand Eric Johnson.The report was edited by Barbara Karniand Laura Wallace.This report was sponsored by the SustainableDevelopment Network of the WorldBank under the leadership of Inger Andersenand Rachel Kyte.xiii

Abbreviations$ US$ unless otherwise indicatedAMMA African Monsoon Multidisciplinary AnalysesANSadjusted net savingsCO 2carbon dioxideCO 2-eq carbon dioxide equivalentCOMTRADE Commodity Trade Statistics databaseESCOenergy service companyESTDearly-stage technology developmentETSEmissions Trading SystemEUEuropean UnionGDPgross domestic productGGKPGreen Growth Knowledge PlatformGRPGreen Rating Project (India)GtgigatonsHPSHusk Power SystemsIEUAInland Empire Utility AgencyIFIinternational financial institutionITQindividual transferable quotaITSIntelligent Transport SystemsMCA4Climate Multi-Criteria Analysis for ClimateMDGMillennium Development GoalNO xnitrogen oxidesOECDOrganisation for Economic Co-operation and DevelopmentPESpayments for environmental servicesPERPperformance evaluation and ratings programPM10particulate matter up to 10 micrometersin sizexv

xviABBREVIATIONSPNKppmPPPPROPERPVR&DREDDRSPOSMESO 2TACUNEPUWMPVCWAVESPutri Naga Komodo (Indonesia)parts per millionpurchasing power parityProgram for Pollution Control, Evaluation, and Rating (Indonesia)photovoltaicresearch and developmentReducing Emissions from Deforestation and Forest DegradationRoundtable on Sustainable Palm Oilsmall and medium enterprisesulfur dioxidetotal allowable catchUnited Nations Environment ProgrammeRegional Urban Water Management Planventure capitalWealth Accounting and Valuing Ecosystem Services

OverviewKey Messages• Greening growth is necessary, efficient,and affordable. It is critical toachieving sustainable developmentand mostly amounts to good growthpolicies.• Obstacles to greening growth are politicaland behavioral inertia and a lackof financing instruments—not the costof green policies as commonly thought.• Green growth should focus on whatneeds to be done in the next five to10 years to avoid getting locked intounsustainable paths and to generateimmediate, local benefits.• The way forward requires a blend ofeconomics, political science, and socialpsychology—smart solutions to tacklepolitical economy constraints, overcomedeeply entrenched behaviors andsocial norms, and develop the neededfinancing tools.• There is no single green growth model.Green growth strategies will varyacross countries, reflecting local contextsand preferences—but all countries,rich and poor, have opportunitiesto make their growth greener andmore inclusive without slowing it.Our current growth patterns are notjust unsustainable; they are alsodeeply inefficient. As a result, theystand in the way of sustainable developmentand its objectives of social, environmental,and economic sustainability (figure O.1). Thepast 20 years have shown that the economicand social goals are not only highly compatible,but also largely complementary. Growthdrives poverty reduction (though the extentto which it does so depends on the degree ofinequality). And improved social outcomes,such as better health and education andgreater equality of opportunity, are good1

2 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE O.1SocialsustainabilityThe three pillars of sustainable developmentEconomicsustainabilitySustainabledevelopmentEnvironmentalsustainabilityNote: Economic and social sustainability, on the one hand, and social and environmental sustainability,on the other, have been found to be not only compatible, but also largely complementary.Not so with economic and environmental sustainability, as growth has come largely at the expenseof the environment—hence, the dotted line on this figure—which is why green growth aims toensure that economic and environmental sustainability are compatible.for growth. Not so with the economic andenvironmental pillars: for the past 250 years,growth has come largely at the expense of theenvironment. And environmental damagesare reaching a scale at which they are beginningto threaten both growth prospects andthe progress achieved in social indicators.What can be done to turn this situationaround? We argue that what is needed isgreen growth—that is, growth that is efficientin its use of natural resources, clean inthat it minimizes pollution and environmentalimpacts, and resilient in that it accountsfor natural hazards and the role of environmentalmanagement and natural capitalin preventing physical disasters. And thisgrowth needs to be inclusive.Inclusive green growth is not a new paradigm.Rather, it aims to operationalize sustainabledevelopment by reconciling developingcountries’ urgent need for rapid growthand poverty alleviation with the need toavoid irreversible and costly environmentaldamage. As such, efforts to foster greengrowth must focus on what is required inthe next five to 10 years to sustain robustgrowth, while avoiding locking economiesinto unsustainable patterns, preventing irreversibleenvironmental damage, and reducingthe potential for regret.Moreover, rapid action is needed to keepthe costs of greening growth manageable andavoid irreversible losses. This urgency appliesto developing and developed countries alike:• Developing countries—which will accountfor the vast majority of global growth inincome, infrastructure, and populationin the coming decades—need to choosewhether to build right or risk facing costlypolicy reversals in the future.• High-income countries—which, with 16percent of world population, still accountfor more than 75 percent of global consumptionand 41 percent of global emissionsof carbon dioxide (CO 2)—must actaccording to their responsibility. Mostimportant are changes in the patterns ofconsumption and production that boostdemand for green technologies. This isessential to stimulate technological innovationand the scale of production necessaryfor prices to drop and green technologiesto become competitive. Thus, Germany’saggressive solar feed-in tariff was criticalin boosting global demand for solarpanels, thereby reducing their cost.As to how to make growth greener, textbooksgoing back at least to the 1950s offerthe basic instruments, with environmentaltaxation, norms, and regulations being themain tools of a green growth strategy. Today,technology is making it easier to implementthese measures and monitor their impacts.However, making these measures workis complex in real-world settings plaguedby governance failures, market failures,and entrenched interests and behaviors. Itrequires complementary policies, includingpublic investments, innovation and industrialpolicies, education and training, labormarket reforms, and communication. Makingmatters worse is the urgency with which

OVERVIEW 3these policies must be designed and implemented,especially in the face of enormousuncertainty about the future climate andtechnology.Although we have much theoretical andempirical knowledge to draw on, greengrowth raises challenging questions, especiallywhen it comes to the developing world.For example, how can developing countriesavoid locking in unsustainable and inefficientsocioeconomic systems? Will technologyallow developing countries to pursue a lessenvironmentally damaging development paththan industrial countries did? What is thebest way to manage growth with scarce fiscalresources and limited planning and technicalknow-how? Is green growth just an aspirationalgoal—desirable from an environmentaland ethical point of view, but unattainablegiven competing economic needs?At heart, these are questions of economics,which is why the report takes an economicapproach—using the standard tools of mainstreamgrowth and environmental economics—withsome forays into what social psychologycan tell us about the determinantsof human behavior. Chapter 1 examineswhether green growth is, in fact, feasible andthe implications for welfare—the ultimategoal of economic policy. It argues that ourcurrent system is inefficient, thereby offeringopportunities for cleaner (and not necessarilyslower) growth. And it identifies the flaws inthe “grow now, clean up later” argument.The next two chapters tackle the crosscuttingissues of market and governance failures.Chapter 2 looks at the range of toolsthat can be marshaled to change behaviorwith respect to environmental and naturalresources—tools that aim to improve socialwelfare through greener growth. Theseinclude effective market signals, properlyframed and judiciously used information,and rules and regulations. Chapter 3 exploresthe need to navigate between market andgovernance failures through the careful useof innovation and industrial policies, such asresearch and development (R&D) subsidiesfor drought-resistant crops, national strategiesfor electric cars, and efforts to createnew green industries (such as China’s promotionof solar photovoltaic production).The subsequent three chapters focus onhuman, natural, and physical capital andtheir roles in a greener production function.Chapter 4 tackles the debate on whethergreen growth will create jobs, with politicalleaders keen to promote the idea of green jobsto reduce high unemployment levels. It findsthat, while there is surely potential to creategreen jobs, the net impact is what matters,and that will depend largely on the natureof the policy chosen and the soundness oflabor markets and the business environment.Importantly, evidence on past regulation suggeststhat fears about massive job losses aremisplaced.Chapter 5 reviews what we know aboutmanaging natural capital. Depending on thetype of resource (such as extractable or cultivatedrenewable), the tools include definingproperty rights, helping firms to move up thevalue chain, managing trade-offs betweenhigher growth and greener outcomes, andincorporating the economic values of servicesin policy decisions.Chapter 6 explores why infrastructure isat the core of inclusive green growth policies,underscoring the high potential for bothregret (given the tremendous inertia builtinto infrastructure investments) and benefits(given the need for massive increases in infrastructureservices in developing countries).Chapter 7 filters the key lessons through apolitical economy lens and provides a frameworkfor building an inclusive green growthstrategy—in light of the technical tools available,the need to maximize local and immediatebenefits while minimizing lock-in, and theuncertainties about the future climate andtechnologies.What are the overall messages of thereport?First, inclusive green growth is necessary,efficient, and affordable. It is necessarybecause sustainable development cannotbe achieved without it. It is efficient in thataddressing the market and governance failuresthat plague our economic systems willcreate plenty of scope for growing cleaner

4 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTwithout necessarily growing slower. The bestexample is the $1 trillion to $1.2 trillion currentlybeing spent on environmentally harmfulsubsidies for fossil fuel, agriculture, water,and fisheries. Green growth is affordablebecause many green policies pay for themselvesdirectly, and the others make economicsense once externalities are priced and ecosystemservices are valued.Second, greening growth is constrained bysocial and political inertia and by a lack offinancing instruments—not affordability, asis commonly believed. Entrenched behavior,special interests, and the complicated politicaleconomy of reform explain why measuresthat amount to good growth policies havenot yet been implemented. Also, many greengrowth measures require increased up-frontcapital. Yet the debate on financing remainsfocused on who pays what, rather thanon how to finance economically (let alonesocially) profitable investments.Third, greening growth should be carefullysequenced—not occur in one fellswoop—with priority going to what needsto be done in the next 5 to 10 years, bothto avoid getting locked into unsustainablepaths and to offer immediate, local benefits.Those benefits will help to reduce the costof the transition and facilitate the politicaleconomy of reform. Urban forms that arecreated today will affect city structures andhousing and transport options for decadesor even centuries. With urban populationsin developing countries set to increase by 1.5billion over the next 20 years, there is a windowof opportunity to affect urban patternsat low cost.Fourth, the search for solutions needsto shift from a search for more financialresources (difficult anyway amid today’s fiscalwoes) to “getting smart”:• Smart about learning the lessons of complexreforms to tackle difficult politicaleconomy questions, given that many greenpolicies trade immediate costs for later benefitsor redistribute benefits from one groupto another. Notable successes include tradereforms across the world, reform of fisheriesin Namibia, reform of the CommonAgricultural Policy in the European Union(EU), and progress on fossil fuel subsidiesin the Islamic Republic of Iran, where carewas taken to manage the losers and publicizethe benefits.• Smart about changing the behavior of consumersand firms and the view of societiesabout what constitutes social success andacceptable behavior. This entails combiningeconomic incentives with well-framedinformation and the marketing techniquesthat public health specialists (or car salesmen)commonly use.• Smart about developing the appropriatefinancing tools for the private sector, especiallysmall firms, for local governments(China’s cities are developing in a sprawlingfashion in part because land sales attheir peripheries are an important source ofrevenue for city governments; World Bankand DRC 2012), and for national governments,which are sometimes so fiscallyconstrained that they have to choose theinvestment with the lowest up-front cost(such as a thermal power plant) over onethat may be less expensive in the mediumterm (such as a hydroelectric plant in acountry with abundant water resources).Fifth, there is no single green growthmodel. Inclusive green growth strategieswill vary across countries, reflecting localcontexts, preferences, and resources, butall countries—rich and poor—have opportunitiesto green their growth withoutslowing it.Greening growth is necessary,efficient, and affordableNecessary: Making developmentsustainable requires inclusive greengrowthGrowth—even measured with such animperfect metric as gross domestic product(GDP)—is now recognized as a critical driverof poverty reduction (figure O.2, panel a;Ferreira and Ravallion 2009). It has resulted

OVERVIEW 5in an 80 percent increase in GDP per capitain developing countries over the past 20 years,despite substantial increases in population.Living standards have improved for many(figure O.2, panels b and c), with more than660 million rising out of poverty and remarkableprogress being made in literacy, education,life expectancy, malnutrition, and infant,child, and maternal mortality. And whileChina drove much of global poverty reduction,other countries that experienced growthalso saw poverty decline rapidly. Ghana, forexample, grew much faster than the Africanaverage and managed to reduce its povertyrate from 51 to 30 percent between 1990 and2005 (World Bank 2011c).Moreover, growth need not cause incomeinequality. The famous Kuznets curve argument,which posits that inequality firstincreases and then decreases with income, isnot supported by the evidence. Inequality hasincreased substantially in recent decades inChina, but also in the United States and mostof Europe. And it has declined in much ofLatin America (Milanovic 2010). Some countriesreduce inequality as they grow; otherslet it increase. Policies matter.Thus, the links between the economic andsocial pillars of sustainable development aregenerally self-reinforcing. But the story isnot so simple when it comes to the economicand environmental pillars. Economic growthcauses environmental degradation—or hasfor much of the past 250 years—driven bymarket failures and inefficient policies. Aswith inequality, overall environmental performancedoes not fi rst get worse and thenimprove with income—no Kuznets curvehere either. Of course, some local and visibleenvironmental public goods do worsen atfirst and eventually improve with income—typically local air quality. But this is not trueof local pollutants with invisible or long-termimpacts (such as the accumulation of pesticidesand toxic chemicals in land and water)or global pollutants (such as greenhouse gasesin the atmosphere). These often get worsewith higher income (figure O.3).Against this backdrop, some observers,mostly in high-income countries, have arguedFIGURE O.2 As incomes increase . . .% of the population living on$1 a day or lessfemale literacy rate(% of females ages 15 and above)mortality rate (deaths of childrenunder 5 per 1,000 live births)a. . . . Poverty recedes (poverty headcount and GDP per capita)10095908580757065605550454035302520151050–50 5,000 10,000 15,000 20,000 25,000GDP per capita ($, PPP)b. . . . Literacy rises (female literacy rate and GDP per capita, 2009)1201008060402020018016014012010000 5,000 10,000 15,000 20,000 25,000 30,000 35,000GDP per capita (2005 $, PPP)c. . . . Child mortality falls (mortality rate for children under fiveand GDP per capita, 2010)8060402000 5,000 10,000 15,000 20,000 25,000 30,000 35,000GDP per capita (2005 $, PPP)Source: For panel a, Ferreira and Ravallion 2009; for panels b and c, World Bank 2011c.

6 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE O.3 As incomes increase . . .country-level PM10 concentration(micrograms per cubic meter)CO 2 emissions(metric tons per capita)a. . . . Local and visible pollutants tend to decline (PM10 concentrationand income per capita, 2008)1801601401201008060402000 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000Source: For both panels, World Bank 2011c.GDP per capita (2005 $, PPP)b. . . . Global pollutants, such as CO 2 emissions, tend to increase(CO 2 emissions and income per capita, 2008)40353025201510500 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000GDP per capita (2005 $, PPP)against the need for more growth, suggestingthat what is needed instead is a redistributionof wealth (Marglin 2010; Victor 2008). Theypoint to the happiness literature, which suggeststhat above a country average of $10,000to $15,000 per capita, further growth doesnot translate into greater well-being (Easterlin1995; Layard 2005).While this argument has value, it remainsmore relevant for high-income countries,where average annual incomes hover around$36,000. Developing countries—with averageincome of around $3,500 per capita—arestill far from the point at which more wealthwill bring decreasing returns to well-being. Infact, in low-income countries, average incomeis only about $500 (World Bank 2011c). 1 Aredistribution of world income across richand poor countries—even if it were politicallyfeasible—would leave all with an income ofabout $8,000 per person per year.Further, even after the rapid growth of thepast decade, some 1.3 billion people do nothave access to electricity, 900 million do nothave access to clean water, 2.6 billion lackaccess to improved sanitation, and around800 million rural dwellers do not have accessto an all-weather road and are cut off fromthe world in the rainy season (Fay and others2010; IEA 2011). Even with the rapid declinein the share of people living in poverty, closeto 1 billion could still be living on $1.25 perday in 2015. With continued growth at aboutthe same speed as during the past 20 years,developing countries would account for abouthalf of the world’s income and consumption(but close to 90 percent of the world population)by 2050.Continued rapid population growth inseveral developing regions further complicatesmatters. Current projections are thatthe world will reach some 9 billion peopleby 2050. This implies that even more rapidgrowth is needed to tackle poverty, and moreaggressive social policies are needed to ensurethat children, especially girls, and mothersreceive the care, nutrition, schooling, andemployment opportunities they need. And, ofcourse, this demographic challenge puts furtherstresses on the environment, particularlybecause much of the rapid population growthis happening in environmentally fragile locations,notably in Africa.Thus, growth is a necessary, legitimate, andappropriate pursuit for the developing world,but so is a clean and safe environment. Withoutambitious policies, growth will continue todegrade the environment and deplete resourcescritical to the welfare of current and futuregenerations. And what about the argumentthat ambitious policies would be too costlyand destroy jobs? The evidence reviewed inthis report suggests that there is plenty of roomto green growth without slowing it.

OVERVIEW 7Efficient: Current patterns of growthare not only unsustainable, but alsowastefulThere is mounting evidence that our patternsof growth and consumption are unsustainableat the scale required by our current andprojected population. Much of this, however,is owing to inefficient production and consumptionand poor management of naturalresources.UnsustainablePopulation and income growth and theresulting increase in demand for food havedriven the expansion of agricultural productionaround the world. 2 Intensificationand productivity increases have helped tolimit ecosystem loss in many countries, butpoorly managed intensification has also exacerbatedagrochemical and water pollution,soil exhaustion, and salinity. Extensive farming,driven by large-scale expansion in someregions and poverty-level subsistence agriculturein others, has contributed to land degradationand deforestation; forest losses averaged5.2 million hectares annually between2000 and 2010, mostly in tropical—and,hence, more intensely biologically diverse—regions (FAO 2010). By 2008 one quarter ofthe world’s land surface was degraded as aresult of soil erosion, salinization, nutrientdepletion, and desertification (Bai and others2008).Income and population growth have alsostretched water supplies. Water withdrawalshave tripled in the past 50 years, leading towater scarcity and groundwater depletion(World Bank 2007b). Withdrawals are projectedto increase in developing countries byanother 50 percent by 2025, by which timeroughly 5.5 billion people—two thirds ofthe projected global population—will live inareas facing moderate-to-severe water stress(UNESCO and WWAP 2006).Growth has similarly strained ecosystems,with roughly 60 percent of ecosystem servicesnow of lower quality than 50 years ago(MEA 2005). Additionally, the current rateof species extinction, stemming mainly fromhabitat loss and degradation, is 100 to 1,000times higher than before humans walked theplanet (Pimm and others 1995). In 2008,875 species became extinct, and more than17,000 others are at high risk (IUCN 2009).Carbon dioxide emissions are accumulatingin the atmosphere, approaching a level thatwill make it impossible to maintain globalmean temperature below 2°C in excess ofthe preindustrial level, even though the probabilityof irreversible environmental changesis increasing with temperature (for example,rapid ice loss in Greenland and forest diebackin the Amazon). Carbon dioxide is alsoaffecting the world’s oceans. Because of globalwarming, we have already committed to highprobabilities of coral bleaching and mortalityby the late twenty-first century, which willsignificantly harm reef ecosystems (WorldBank 2010d). The concurrent acidification ofoceans, which absorb about one quarter ofthe excess carbon dioxide in the atmosphere,is threatening marine food webs and couldundermine the global fishing industry andfood security (Laffoley and Baxter 2009).Lastly, energy prices are likely to be highin the future, because oil resources that areeasy and cheap to extract and use have alreadybeen extracted, and the world is now turningtoward fossil fuels that are more expensive—and more damaging to the environment—suchas shale gas, tar sands, oil from deep offshorewells, or even liquefied coal. Without significantchanges in energy policy, the amountof resources the world economy will have todedicate to fossil fuel extraction and energyproduction is likely to increase substantially,making higher energy efficiency even moredesirable in the future than it is today.WastefulThe environment can be thought of as naturalcapital that is often ineffi ciently managed,with many precious resources wasted.Investing in natural capital—just likeinvesting in human or physical capital—istherefore good growth policy. The valueof the services provided by well-managedecosystems is illustrated by the impact ofreforestation and watershed restoration

8 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTprograms. In China’s Loess plateau, suchprograms were associated with a near doublingof household incomes as a result ofhigher-value agricultural production aswell as reduced frequency of landslides andflooding and increased resilience to drought(figure O.4; World Bank 2005b).This ineffi ciency stems partly from thefact that many natural resources are commonproperty, so consumption by one personprecludes consumption by another, andit is hard to exclude potential users. Openaccessregimes for common property createincentives to use up such resources asquickly as possible. Open access fisheries area classic example in which catch per fisherand per vessel has been declining steadilybecause of overfishing, and continued depletionthreatens the livelihood of more than100 million people and the food security ofmany more.Subsidies exacerbate common propertyproblems, yet substantial resources are allocatedto environmentally harmful price supportschemes (box O.1). Global subsidiesto fisheries are estimated at $10 billion to$30 billion and are partly to blame for thesixfold increase in the fleet capacity indexbetween 1970 and 2005 (World Bank andFAO 2009). 3 In Mexico, subsidies for energyused in irrigation, amounting to around 1percent of GDP, are exacerbating excessivegroundwater withdrawals and the depletionof key aquifers. India suffers from the sameproblem in addition to spending some 2 percentof GDP on a fertilizer subsidy overlyweighted in favor of nitrogen; the resultinguse of fertilizer is causing serious pollutionproblems.Production and consumption processesare often wasteful, too. This is particularlyobvious in the energy sector. Existing energyefficiency technologies can cost-effectivelyreduce energy use in new buildings by at least30 percent. In fact, making new buildings inChina more energy efficient would reduceenergy costs by more than 50 percent, whileincreasing construction costs by only 10 percent.Waste also plagues food production.Some 15 to 30 percent of food produced indeveloping countries is lost before it reachesthe market due to poor storage and transportfacilities. In high-income countries, meanwhile,one third of food is wasted throughlosses in supermarkets and homes and “platewaste”(Foresight 2011).The possibility of solving market andgovernance failures opens the way to policiesthat have both economic and environmentalbenefits and is at the heart of greengrowth strategies. (In that respect, greeninggrowth is first and foremost based on goodgrowth policies.) These market and governancefailures have long been understood,FIGURE O.4The Loess plateau, before and after the watershed restoration programSource: For the left-hand image, Till Niermann, March 25, 1987, http://en.wikipedia.org/wiki/File:Loess_landscape_china.jpg; for the right-hand image,http://digitalmedia.worldbank .org/slideshows/china1005/.

OVERVIEW 9BOX O.1 What is the aggregate economic support to the (over)use of natural capital? $1trillion to $1.2 trillion annuallyA compilation of estimates by international organizationsof aggregate support for the use of naturalcapital suggests an approximate total of $1 trillionto $1.2 trillion, consistent with McKinsey’s estimateof $1.1 trillion (McKinsey and Company 2011). Thissupport includes the following:• Fossil fuel subsidies: $455 billion–$485 billion. Thisincludes subsidies to fossil fuel production or usein Organisation for Economic Co-operation andDevelopment (OECD) countries ($45 billion to $75billion a year between 2005 and 2010) and consumptionin developing economies ($409 billion in2010; IEA 2011).• Water subsidies: $200 billion–$300 billion. Thisrepresents subsidies to groundwater extraction orirrigation infrastructure—estimated as the differencebetween the market value of water and thepart of costs covered by tariffs. Limited data areavailable, but Myers and Kent (2001) estimatewater sector subsidies at $230 billion in 2000 andMcKinsey (2011) cites estimates of $200 billion to$300 billion.• Fishery subsidies: $10 billion to $30 billion. Thisencompasses a wide variety of instruments such asfuel price supports, grants, concessional credit andinsurance, and direct payments to industry. Estimatesrange from $10 billion per year (World Bankand FAO 2009) to $27 billion per year (UNEP2011).• Transfers to agriculture: $370 billion. This representstotal support to the agriculture sector inOECD countries (OECD 2011a) and includes differenttypes of instruments, some environmentallyharmful, such as market price supports, but somenot, such as payments decoupled from productionlevels.While these estimates suffer from errors of inclusion(some of the OECD countries’ agricultural subsidiesthat were included are not environmentallyharmful) and exclusion (they do not include developingcountries’ subsidies to agriculture, estimated bythe OECD at about $200 billion for the few emergingeconomies for which data were available) andare therefore neither precise nor exhaustive, they dosuggest that substantial resources go to environmentallyharmful subsidies.and their persistence suggests that the difficultyof correcting them should not beunderestimated.Affordable: Much of green growthpays for itself, and an innovativeprivate sector keeps costs in checkEnvironmental policies should, in principle,improve social welfare and economic efficiencyby reducing excessive pollution andother environmental bads. Nevertheless, suchpolicies clearly have costs. They can hit taxpayerswho have to pay the bill (for subsidiesto renewable energy or public spending ongreen R&D) or producers and consumers ifthe policies mandate the use of more expensiveor less productive technologies (such asrenewable energy resources that are morecostly than fossil fuel). Environmental policiesalter relative prices and therefore changethe structure of demand, requiring costlyadjustments in the structure of production.Demand may decrease in sectors that havehigh capacity (coal production) and increasein sectors that have limited capacity (publictransport). As a result, efficiency may fall, atleast during an adjustment phase, jobs maybe lost, and the poor may suffer if compensatorymeasures are not adopted.Moreover, the up-front capital requirementsare high. The energy investmentsneeded globally to achieve greenhouse gasconcentration of 450 parts per million (ppm)carbon dioxide equivalent (CO 2-eq; the levelneeded to maintain a 50 percent chance ofnot exceeding global warming of 2°C abovepreindustrial temperatures) could amount to

10 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE O.5 Up-front investment costs for energy supply andenergy efficiency could be substantial(additional investment needed in the energy sector, both in energy supply anddemand, in 2030 to reach a 450 ppm and a 550 ppm CO 2-eq objective, according tofour global models)additional annual investmentin 2030 ($ billions)1,2001,0008006004002000550ppm450ppm550ppm450ppm550ppm450ppm450ppmMESSAGE TIAM-WORLD ReMIND IEASource: More information on these models can be found in the following sources: on MESSAGE, vanVliet and others 2012; on ReMIND, Luderer and others 2012; on TIAM-WORLD, Loulou and Labriet2008; on IEA, IEA 2011.Note: IEA (2011) does not provide estimates for a 550 ppm scenario.between $350 billion and $1.1 trillion peryear by 2030 (figure O.5). A 550 ppm targetappears much easier to achieve, requiringsome $50 billion–$200 billion of additionalinvestments per year, but an additional $75billion to $100 billion would still be needed toadapt to climate change (World Bank 2010d).Adding needed investments in water and landto energy, annual investments of $900 billionto $1,700 billion could be needed overand above business-as-usual requirements(McKinsey and Company 2011).But many of these capital investments willbe recouped through subsequent savings, sothe net financial costs will be much lower.For example, the high capital cost of windand solar energy or hydropower is offset bytheir low operating costs. Globally $1 spenton energy efficiency saves $2 through investmentsin new supply, with the savings evengreater in developing countries (World Bank2010d). As a result, the World Bank estimatesthat more than half the measures needed todecarbonize the energy systems of developingcountries would eventually pay for themselves,bringing the fi nancial costs down tobetween $140 billion and $175 billion peryear in 2030 or perhaps half a percentagepoint of developing countries’ GDP (WorldBank 2010d). In East Asia, the estimatedadditional net fi nancing required for a sustainableenergy path is $80 billion, not muchmore than the $70 billion the region currentlyspends on fossil fuel subsidies (Wangand others 2010; IEA 2008).Furthermore, determining affordability isabout more than a financial ledger. Green policiescan contribute to growth (box O.2) andboost a nation’s overall wealth. And they helpto reduce the damage done by environmentaldegradation, which is costly for an economy:equivalent to 8 percent of GDP across asample of countries representing 40 percentof the developing world’s population (figureO.6). As a result, benefits may well outweighthe costs (implying a negative net economiccost). $900 billion to $1,700 billion of greeninvestments in land, water, and energy couldyield economic returns of around $3 trillionper year, rising to $3.7 trillion with carbonat $30 per ton and no energy, agricultural,or water subsidies (McKinsey and Company2011).Thanks to such benefits, the net costsof greening growth appear manageable,although affordability will, of course, dependon the speed and ambition of the greening (asillustrated by the difference between the 450ppm and 550 ppm targets) and on the designof policies. But the worse the environmentaldegradation and existing inefficiency, thegreater the potential benefits to be obtainedfrom green policies.At the firm level, the cost of environmentalregulation to firms is typically modest, withcosts lower than expected thanks to the abilityof firms to adapt and innovate (chapter 3).As a result, there is no evidence that environmentalregulation systematically hurts profitability.While studies from the 1980s and1990s found negative impacts, more recentpapers find more positive results, partlybecause they allow a few years for fi rms toadapt and partly perhaps because we havebecome better at designing environmentalregulations that promote efficiency gains

OVERVIEW 11BOX O.2The many ways in which green policies can contribute to growthGreen policies and practices can contribute to growththrough three channels (see chapter 1). First, theycan help to increase the amount of natural, physical,and human capital available: Better-managed soil ismore productive. Well-managed natural risks resultin lower capital losses from natural disasters (Hallegatte2011). Healthier environments result in moreproductive workers: a recent California study showsa strong impact of air quality on the productivity offarm workers (Graff Zivin and Neidell 2011).Second, they can promote efficiency. For instance,imposing environmental taxes (taxing “bads”) andremoving distortionary subsidies creates fiscal spacefor governments to lower labor taxes or subsidizegreen public “goods” such as public transport orrenewable energy. In London, congestion taxes,besides reducing traffic, helped to finance investmentsin the aging public transport system, therebyincreasing effectiveness of the price signal by reducingthe costs or “disutility” associated with switchingfrom single-car use to public transport (Transportfor London 2008). And many firms—includinglarge multinationals such as Hewlett Packard, Cisco,Clorox, and FedEx—are finding that embracing sustainabilityhas improved the bottom line in part bypromoting greater efficiency (Nidumolu and others2009).Third, green policies stimulate innovation. Studyafter study reports that well-designed environmentalregulations stimulate innovation by firms, asmeasured by R&D spending or patents (see chapter3). Surveys of firms in the European Union identifyexisting or future environmental regulation as themain driver for the adoption of incremental innovations.Similarly, international sustainability standardscan help local firms to upgrade their environmentalpractices, a form of catch-up innovation. Indeveloping countries, green policies can also encouragethe adaptation and adoption of greener technologiesthat have been developed elsewhere.Finally, green policies also accrue non-growthgains to welfare. They can reduce inequality throughjob creation and poverty alleviation, and they canreduce output volatility by increasing resilience toenvironmental and economic shocks, like naturaldisasters or spikes in commodity prices. A modelingexercise suggests that half of the cost of climatepolicies to limit greenhouse gas concentration at 550ppm could be paid for by less vulnerability to oilscarcity (Rozenberg and others 2010).(Ambec and others 2011). Further, where revenuesfrom environmental taxes are used toreduce taxes on labor and income, the impacton GDP is likely to be neutral or positive, asfound in an analysis of seven EU countries(Andersen and others 2007, cited in Ambecand others 2011).Other ex-post analyses confirm this conclusion.The EU Emissions Trading Systemhas no negative impact on net importsin the aluminum, steel, and cement sectors(Ellerman and others 2010; Quirion 2011;Sartor 2012) or on the performance of Germanfirms in general (Anger and Oberndorfer2008). Meanwhile, the climate levy onU.K. firms seems to affect energy efficiency,but not economic performance and firm exit(Martin and others 2009).Refineries located in Los Angeles significantlyincreased productivity in thelate 1980s and early 1990s, a time ofdramatically expanded regulation in Californiaand decreasing refinery productivityin the rest of the United States. Interviewswith plant managers suggest productivityincreases resulted from a careful redesignof production processes to complywith the new regulations (Berman and Bui2001 and others). Similarly, the productivityof the Mexican food-processing industryincreased with stronger environmentalregulations (Alpay and others 2002, cited inAmbec and others 2011).Moreover, there is no evidence that environmentalpolicies have led to an exodus offi rms to “pollution havens” (locations withlax environmental policies). Tighter environmentalregulation may cause fi rms to relocate,but they will choose locations that aremore attractive overall, as pollution abatementcosts represent a small share of productioncosts for most industries (Copeland

12 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE O.6 Reducing environmental degradation would providesubstantial economic benefits(cost of enviromental degradation expressed as percentage of GDP equivalent)TunisiaJordanEl SalvadorGuatemalaSyrian ArabRepublicNepalLebanonColombiaMoroccoAlgeriaPeruBeninBangladeshEgypt, Arab Rep.PakistanIran, Islamic Rep.NigeriaCentral AfricanRepublicAverageChinaTajikistanGhana0 2 4 6 8 10 12cost of environmental degradation as% of GDP equivalentSource: World Bank 2004, 2005a, 2006a, 2006b, 2006c, 2006d, 2006e, 2006f, 2007a, 2007b, 2007c,2008, 2009, 2010a, 2010b, 2010c, 2011a, World Bank and DRC 2012.2012). Factors such as availability of capital,labor abundance, location, institutions, andagglomeration effects are more importantthan environmental policy in determiningthe location choice and competitiveness offirms.But obstacles are plentiful, andgreen growth is no substitute forgood inclusive growth policiesIf green growth is necessary, efficient, andaffordable, what is impeding it? Acrosscountries and income levels, a mix of governanceand market failures, complex politicaleconomy, entrenched interests and behaviors,and financing constraints are significantobstacles. Further, despite much rhetoric tothe effect, green growth is no panacea andwill not substitute for a good business environmentand the reforms that are needed topromote growth and protect the poor.When first-best recommendations meetsecond-best situationsMuch of green growth is about good growthpolicies—addressing market failures and“getting the price right” by introducing environmentaltaxation, pricing environmentalexternalities (such as carbon pricing), creatingtradable property rights, and reducinginappropriate subsidies. These measuresare critical for enabling the private sector toundertake needed investments and innovationsand for getting consumers to internalizethe true costs of their behavior. But as withall good economic policy making, textbookpolicy recommendations, however appropriate,must be applied with insights into behaviors,political economy, and governance andmarket failures. This is an enormous challengefor a variety of reasons.First, getting prices right may be difficultbecause of political or social acceptabilityissues. The benefits are usually diffuse anduncertain, while the costs (the burden of theprice increase) are immediate, visible, andoften concentrated on a vocal minority. Thisis why price changes can be achieved onlywhen political economy issues are managedwith appropriate complementary policies.Second, getting prices right may not besufficient because other market imperfectionscan prevent prices from being the silverbullet of environmental policies. These marketimperfections include the following:

OVERVIEW 13• Low price elasticity. The ability of pricesto trigger changes in behavior and technologyis sometimes limited by substitutionpossibilities: the responsiveness of driversto higher fuel prices is low in the absenceof alternative means of transportation. Theability of firms in the renewable energy sectorto respond to incentives will dependon whether transmission lines are builtbetween centers of consumption and production.In these cases, price-based policiesmay have to be complemented with directinfrastructure investments (such as publictransportation and transmission lines) andother policy actions, like changes in urbanplanning or in norms and regulations. Butif substitution capacity is limited by alternatives,their provision may increase theeconomy’s efficiency and boost income orpromote economic growth, making theprice increase more politically acceptable.• Missing markets or institutions. Specificinstitutional measures may be required totransform the “right price” into the rightincentive. Where tenants are paying energybills, for instance, owners and developershave little incentive to “build right” or toinvest in more energy-efficient appliancesunless they can recoup their investmentsthrough higher rents or sales price. This“principal-agent” problem can be tackledthrough information (such as energy efficiencylabels for homes), specific schemesto finance investments in energy efficiency,or norms (such as compulsory retrofit whenhomes are sold).• Lack of credibility and predictability ofprice signals. Governments cannot committo maintaining environmental priceinstruments over the long term, whichputs them in a poor position to encouragefirms to undertake long-term, risky investments(notably in R&D and long-livedinfrastructure).• Coordination failures and knowledge externalities.Prices are ill-suited to address the“classic” market failures usually invoked tojustify innovation and industrial policies.Think about electric cars whose developmentrequires coordination between electricityproviders, city planners, battery producers,and car manufacturers.Third, inertia and biases in behavior aresuch that many efficiency measures thatmight pay for themselves are not implemented.Household responses to higherenergy prices are often disappointing, andfirms do not always exploit all opportunitiesto improve efficiency (Gillingham and others2009; Allcott and Mullainathan 2010).Energy savings of 20–25 percent could beachieved through improved industrial processesin high-income and emerging economies(World Bank 2010d).Fourth, financing tools to tackle up-frontinvestments are inadequate. Take the case ofsolar, wind, or hydroelectric energy, whichis characterized by much higher capitalcosts than fossil-based energy, but extremelylow operating costs, or energy efficiencythat requires up-front investments in newequipment or add-ons whose costs are thenrecouped over time through energy savings.Even with agriculture or fisheries, a shift tomore sustainable practices typically resultsin lower returns and investments in earlyyears that are then offset by higher returns inthe future. The need for up-front fi nancingcan be a binding constraint for developingcountrygovernments (especially local oneswith limited access to capital markets and asmall tax base) and the private sector (especiallysmall and medium enterprises). Fewcountries have a well-developed banking sector,let alone energy service companies thatspecialize in financing investments in energyefficiency.No substitute for good growth policy:The private sector needs an enablingenvironmentGreen growth strategies are growth strategieswith the additional goal of fostering a betterenvironment. As such, they cannot substitutefor good growth policies: environmentalmeasures are unlikely to offset distortedlabor markets, illiquid financial systems, orpoor business environments.

14 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE O.7 Developing countries may have substantialunexploited potential in green exports(green and close-to-green exports as a share of total exports from developingcountries, 2000–10)% of total exportsfrom developing countries10864202000 2001 2002 2003 2004 2005 2006 2007 2008 2009 201 0green exportsclose-to-green exportsSource: Dutz and Sharma 2012, based on data from the Commodity Trade Statistics database(COMTRADE) and a six-digit proximity matrix based on COMTRADE.Note: Close-to-green exports are exports of goods that are not “green” but require similar skills—inthe way growing apples requires the same set of skills as growing pears so that a country that isgood at the former is likely to be good at the latter.A case in point is “green jobs,” a topic thathas attracted substantial attention followingthe recent global financial crisis. Advocatesstress that, in a situation of high unemployment,a green fiscal stimulus could effectivelyaddress recession-induced unemployment andset the stage for cleaner post-recession growthpatterns. The argument is attractive: althoughgreen projects may not be the most laborintensive or “shovel ready,” they have theadded advantage of carrying environmentalbenefits. That said, a fiscal stimulus—greenor not—is effective only if unemployment islinked to insufficient demand rather than tostructural issues (such as lack of skilled workersor a poor investment climate).Beyond stimulus effects, some countries—including Brazil, China, Germany, Japan, theRepublic of Korea, and Morocco—are lookingat green growth as a potential source oflonger-term growth through which to createnew markets. And even though not everycountry can become the world leader in solarpanels or wind turbines, developing countriesmay have substantial unexploited potentialin green exports (figure O.7). Many developingcountries have natural endowments thatcreate a potential comparative advantagein green activities (such as water resourcesand hydropower potential or insolation andsolar power potential). Realizing this potentialcould generate jobs and exports, therebyboosting growth and output.But green policies cannot address structuralconstraints to growth and employmentcreation, at least if deployed alone. They willnot be effective at creating green jobs wherelabor markets are distorted and regulationsdiscourage small business development. Theywill not offset an unattractive business environment.And where the labor force’s skillsare inappropriate for developing a competitivemanufacturing sector, environmentalpolicies can hardly replace education. Thus,a recent study of South Africa concludes that,while the idea of developing green industries(such as solar power) is appealing, it haslittle chance of succeeding unless structuralproblems such as regulatory obstacles to thecreation of small enterprises and the lack ofskilled workers are addressed (World Bank2011b).Skill shortages already appear to beimpeding the greening of growth. In Chinaand India, rural electrification programs aresuffering from a lack of skilled workers. Reasonsfor these shortages include a scarcityof scientists and engineers, the poor reputationand limited attractiveness of some sectorsimportant for the green transition suchas waste management, and a limited numberof teachers and trainers in environmental services(ILO and CEDEFOP 2011).In countries where the business environmentis not conducive to investment andgrowth, better economic policies must be thefi rst step. Lessons from trade liberalizationare telling: where labor mobility is limitedby skills and regulations and where investmentsin the sectors that benefit from tradeliberalization are impaired by inappropriatepolicies, both workers and the private sectortake longer to adjust. The benefits from moretrade take longer to materialize, and adjustmentcosts are much higher. Similarly, economicbenefits from green policies are morelikely to be large and immediate if economic

OVERVIEW 15policies are conducive to change and favorthe development of more environmentallyfriendly and more productive activities.The poor and vulnerable needsocial protectionWhile there is a general presumption that thepoor suffer most from environmental degradationand its impact, this need not imply thatthey would benefit automatically from greengrowth policies. For example, removing fossilfuel subsidies would clearly reduce the poor’spurchasing power unless compensated for byother measures.But subsidies are often regressive and canbe replaced by better-targeted transfers at afraction of the cost (figure O.8). By one estimate,the cost to the budget of transferring$1 to the poorest 20 percent of the populationvia gasoline subsidies is $33 (Arze delGranado and others 2010). Similarly, consumptionsubsidies for water and electricitycan usefully be replaced by connection subsidiesthat are invariably better targeted, as theFIGURE O.8 Fossil fuel subsidies benefitprimarily the rich(fossil fuel subsidy allocation, by income quintile, average across20 countries, various years)topquintile43%Source: Arze del Granado and others 2010.bottom quintile7%Q223%Q411%Q316%poor account for the majority of those withoutaccess to basic services.In sum, hopes that green growth will singlehandedlysolve countries’ employment, competitiveness,or poverty problems are probablyas unfounded as the fear that environmentalpolicies will lead to massive loss of jobsor competitiveness. Adjustment costs mayvary across industries because some sectorsare inherently more innovative than othersand tend to adapt better. Better regulation—particularly if supported by training, R&Dsupport, and the recycling of environmentaltaxes into other tax cuts—will help to minimizethese adjustment costs and maximizebenefits. Also needed are steps to protect thepoor from the potential downsides of greenpolicies and to ensure that they benefit fullyfrom the likely upsides.The way forward: Good andinclusive growth policies tailoredto real-world challengesSo greening growth requires good growthpolicies adapted to political economy realitiesand entrenched behaviors. It entails reformsin the patterns of pricing, regulation, andpublic investment that trigger resistance. Itrequires complex changes in behaviors andsocial norms because, even with efficiencygains and new technology, it is unlikely thatmiddle-class consumers (whether in rich or inpoor countries) can stick to current consumptionpatterns. And it requires knowing whento go for the politically expedient rather thanthe economically optimal, carefully deployingsocial marketing tools and making financialtools available.Complicating matters is the fact thatopportunities to green growth at a manageablecost are not evenly distributed over time.This creates urgency for some, though not all,green policies and is one of several argumentsfor why “grow dirty and clean up later” isnot a good option even for poor countries(box O.3).What follows is a three-prong strategy fortackling entrenched interests and behaviors,financing constraints, and the risk of lock-in.

16 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX O.3Why “grow dirty and clean up later” is misleadingMany argue that poor countries should focus on satisfyinghuman needs before attending to nature, especiallygiven their relatively small environmental footprint.This argument is misleading for several reasons.First, not all environmental goods are superiorgoods whose share in total consumption increaseswith income. Individuals who struggle to feed andhouse themselves may not see biodiversity protectionand climate change mitigation as priorities, but localenvironmental goods affect their daily lives, withsignificant impact on income and welfare. The lackof solid waste disposal, for example, is not merely anenvironmental issue. By clogging drains, it leads tohealth hazards and flooding, with serious economicand human consequences:• In Haiti, poor solid waste disposal is to blame forthe resurgence of diseases such as dengue and forvulnerability to storms.• In India, better solid waste disposal systems werea principal recommendation of the fact-findingcommittee established to investigate the causes ofthe 2005 Mumbai floods, which caused almost$2 billion in damages and killed an estimated 500people.Similarly, mismanaging water resources impairspeople’s ability to grow crops and feed their families.Where natural assets like soil quality, water,and standing forests serve as critical inputs intoeconomic production, good environmental policiesenhance income generation and poverty alleviation.Second, it may be impossible or prohibitivelyexpensive to clean up later. The loss of many environmentalassets—most obviously biodiversity—isirreversible. This is also the case with climate.Because greenhouse gases reside in the atmospherefor a long time, each emitted molecule will influencethe climate over decades (for methane), centuries(for CO 2), or longer. Irreversibility may also occurbecause of economic and technological lock-in. A lotof infrastructure is long lived, and today’s choiceswill be hard to reverse. Urban forms are largelydetermined when city populations are increasingrapidly and most buildings and transport systemsare being built. The consequences of developmentbased on a low-density, individual-vehicle transportationmodel are largely irreversible, as evidenced bythe current struggles of U.S. urban planners to densifyand develop public transport systems.Prong 1: Tailored strategies thatmaximize local and immediate benefitsand avoid lock-inGreen growth policies require governmentsto do a better job of managing both marketand governance failures. This is obvious inany discussion of green innovation or industrialpolicies, but also of the regulatory andmarket (“good growth”) reforms that areneeded, some of which are complex. Evensophisticated administrations may strugglewith market-based instruments, as experiencewith the European Trading System hasdemonstrated (Betz and Sato 2006). Optimalsolutions will differ across countrieswith varying degrees of institutional capacity,transparency, accountability, and civilsociety capacity. Therefore, green growthstrategies need to be tailored to a country’scircumstances, and “best practices” shouldbe imported with caution.Maximize local and immediate benefits. Inaddition to being tailored to local circumstances,strategies need to address the politicaleconomy of reform. Green growth strategiesshould aim to minimize transition costsby offsetting them to the extent possible, withvisible and immediate benefits. This impliesdesigning policies to maximize short-term,local benefits, such as increased efficiencyand productivity, safety and resilience, jobcreation, and poverty alleviation.Avoid lock-in. Governments cannot makeall of the changes needed at once: they havelimited resources and limited implementationcapacity to devote to complex problems; theyalso have limited political capital to defend

OVERVIEW 17TABLE O.1Some guiding principles for establishing green growth strategiesInertia and/or risk of lock-inand irreversibilityLOWER(action is less urgent)HIGHER(action is urgent)LOWER(Trade-offs exist between short-andlong-term or local and global benefits)• Lower-carbon, higher-cost energysupply• Carbon pricing• Stricter wastewater regulation• Reduced deforestation• Coastal zone and natural areaprotection• Fisheries catch managementLocal and immediate benefitsHIGHER(Policies provide localand immediate benefits)• Drinking water and sanitation, solid wastemanagement• Lower-carbon, lower-cost energy supply• Loss reduction in electricity supply• Energy demand management• Small-scale multipurpose water reservoirs• Land use planning• Public urban transport• Family planning• Sustainable intensification in agriculture• Large-scale multipurpose water reservoirspolicies against interest groups and politicalopposition. A focus on the sectors andinterventions that are most urgent—that is,those that can help to prevent irreversibilityor reduce inertia—is thus called for.Table O.1 illustrates the implications for prioritysetting of emphasizing local and immediatebenefits and urgency. While lower-carbonenergy from renewable sources is highly desirable,it is easier to build renewable plants later(even if this requires retiring thermal powerplants) than to try and reverse poor land-useplanning that has resulted in sprawling cities.Good land-use planning and urban publictransport can provide short-term benefits—forinstance, by reducing congestion and exposureto disasters and by favoring denser and moreenergy-efficient development. Table O.1 providesgeneral statements on a few green policies;this analysis needs to be carried out atregional, national, and local scales to take intoaccount specific contexts (see, for instance, anapplication to the Mediterranean countries inCMI 2012).Developing countries (especially lowincomecountries) should prioritize policiesthat (a) have a negative or zero economic costthanks to synergies with development (suchas developing hydropower where appropriate,implementing effective urban plans, or scalingup family planning policies to manage populationpressures and improve health and educationoutcomes), (b) have a positive economiccost but large direct welfare impacts (that is,when they target local environmental goodssuch as local air pollution or natural risks),or (c) are fi nanced from external resources(including through carbon trading).Actively manage the political economy ofreform. Managing the political economy ofreform also entails measures that target thosesegments of the population that would otherwiseoppose reforms. For example, in 2010the Islamic Republic of Iran increased domesticenergy prices by up to 20 times, reducingfossil fuel subsidies by some $50 billion–$60billion. It offset them with $30 billion in cashtransfers that benefited 80 percent of its population,thereby addressing the fact that oppositionto the reform of such subsidies usuallycomes from the middle class. The combinationof cash transfers with a well-orchestratedpublic relations campaign was critical to thesuccess of the reform (Guillaume and others2011).Understanding the sources of resistance toa reform helps to design the reform processin a way that minimizes this resistance (boxO.4). Sound information about winners and

18 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX O.4Morocco: The importance of political economyA sound understanding of the winners and losers ofpossible green growth strategies helps policy makersfi nd ways to address tough economic reforms—asMorocco has recently learned in its quest to overhaula universal subsidy system that rewards fossil fuelconsumption. By gaining insights into the politicaleconomy of reform, Morocco is now poised to reformits energy subsidy, which would sharply reduce fiscalcosts and facilitate a greener growth path.The problems with the energy subsidy are multiple.Its fiscal impact reached 5.5 percent of GDPin 2011, absorbing roughly 17 percent of the totalinvestment budget. It undercuts Morocco’s ambitiousmitigation goals by keeping the price of fossilbasedenergy products low, thus making renewableand efficiency investments less competitive. And it isregressive, with the wealthy benefitting the most.So why has Morocco hesitated to reform thesubsidy? A big reason is that the subsidy reformwas believed to be unpopular, although the governmenthad never done a survey to ascertain just howunpopular, among which segments of society, andwhether alternatives could motivate changes. Forthat reason, the World Bank offered to conduct sucha poll in 2010 using a nationally representative sampleof 1,600 households.The results are astonishing: more than 70 percentof the population was unaware of the existence ofenergy subsidies. Thus, the vast majority of buyersof 12 liter cooking gas bottles—a product as widespreadas bread—did not know that the real marketprice was more than DH 100 ($14) instead of thestandard retail price of DH 40 ($5.6). In addition,a large majority opposed the idea of reducing subsidies—althoughthis majority decreased once offereda well-targeted social program, and fell even furtherwhen the program was explained in detail. In theend, it was the wealthy that remained the groupmost opposed to reform.This simple exercise in revealing politicalawareness and preferences helped the previousgovernment develop a communication strategyover the medium term, starting from informingthe population of the existence of the subsidy systemand explaining its disadvantages. A communicationcampaign ensued in the fi rst months of2011, and the government elected in November2011 now has energy subsidy reform at the top ofits agenda.Box text contributed by Andrea Liverani.losers enables an information campaign to betailored to potential critics.One way of improving public decisionsand determining priorities is to inform decisionmakers of the value of the services providedby natural ecosystems, so that thisvalue can be compared directly with the economiccosts and benefits of their decisions.Indeed, most environmental assets do nothave widely accepted prices either for theirintrinsic value or for the services they provide(such as flood protection). As a result,decisions that involve a trade-off betweeneconomic interests and natural assets (suchas building a road through a rain forest) aredifficult to assess.Green accounting extends beyond thevaluation of natural assets and focuses on acountry’s stock of natural and other assets(its wealth) rather than on a flow measurelike GDP. By doing so, it helps to identifysituations in which economic growth doesnot create wealth (because natural assets areconsumed more rapidly than other assets arecreated) and is not sustainable. For instance,a green accounting exercise suggests thatChina’s growth would be much lower thanits official GDP growth of nearly 10 percent ayear if environmental depletion and degradationwere included. Indeed, calculations putChina’s adjusted net national income growthat about 5.5 percent a year (World Bank andDRC 2012).Prong 2: Measures that promote andincentivize smart decision makingEven though the information provided bygreen accounting can help inform and balancethe debates on political choices and

OVERVIEW 19public investments, it does not constitute anincentive for firms and individuals. To influencetheir behavior, additional measures arerequired, and it is here that governments canplay a critical role by ensuring that marketincentives promote green behavior on thepart of firms and individuals.Getting the prices right will influenceconsumer demand as well as firms’ choiceof production processes (for example, higherenergy prices will make firms use more energy-efficienttechnologies to minimize theirproduction costs) and products (to respond toconsumer demand that changes with relativeprices). But it will also make them innovate,develop, and implement new technologiesand processes.Getting prices right also has a central rolein shaping the built-up structure of cities.Land developers respond to price signals sothat higher land prices lead to higher density—enhancingproductivity spillovers andthe supply of affordable housing and managingdemand for transport. When “official”land prices do not reflect demand and aredepressed at the urban periphery, sprawl orsuburbanization likely will be excessive.But market incentives will not suffice. Forgreen policies to succeed, governments willneed all of the arrows in the public policyquiver.Informing and nudging to influenceindividuals and address behavioral biasesBehavioral biases limit the impact of marketincentives and complicate the design ofenvironmental policies. For example, oneexplanation for the large unexploited potentialthat exists in energy efficiency springsfrom the “cognitive myopia” that preventsindividuals from accurately weighing futurebenefits against immediate costs. Also, individualsmeasure gains and losses with respectto a reference point and weigh losses morethan gains (Tversky and Kahneman 1992);as a result, they tend to consider the cost ofnew environmental policy as a loss and todisregard environmental damages avoided.People are biased toward the status quo, tendto choose the default option, and have anaversion to ambiguity, resulting in a tendencyto delay decision making related to complexproblems such as climate change (Tverskyand Shafi r 1992). At the same time, peoplelike to “do the right thing” and are heavilyinfluenced by social norms.As a result, how messages are framed, whatvalues are appealed to, and how the neededefforts are presented are critical. When giventhe choice of voluntarily paying for a carbonoffset for an airline ticket, some 60 percentof Americans will do so regardless of politicalaffiliation. When the offset is referred toas a carbon tax, support falls from 60 to 25percent among Republicans (Hardisty andothers 2010). More generally, framing greenpolicies as a way to reach an ambitious andpositive social goal (such as becoming carbonneutral by 2050 or becoming a leader in solartechnologies) makes them more acceptable(and less prone to reversal at the next changeof government) than if they are perceived as aconstraint to economic development.Another approach showing promisingresults is tweaking “choice architectures” to“nudge” people to make better decisions forthe environment or other desirable outcomeswithout restricting their freedom of choice(Thaler and Sunstein 2008). To count asa nudge, the intervention must be easy andcheap, but not constitute a mandate. Changingthe default options—without changingthe options themselves—can be an efficientway to promote greener behaviors. In twocases where the default option offered by theelectricity provider was a cleaner but moreexpensive one, fewer than 5 percent of customersrequested a shift to a cheaper, butless green, source of electricity (Picherta andKatsikopoulos 2008).Policies that unleash the power of theprivate sectorFirms have a major role to play in providingsolutions to green growth. Through theircapacity to innovate and adjust their productionprocesses, fi rms are key to keeping thecost of green policy in check. This means thatgovernments need to influence the behaviorof firms by providing appropriate incentivesand regulations in addition to the right economicincentives.

20 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTUse information. Besides prices, firms aresubject to pressures from their customers,stakeholders, and investors, and this pressurecan be used to green their behavior. Promotingtransparency and access to informationon environmental impacts can create socialpressure to reduce these impacts. A 1996amendment to the U.S. Safe Drinking WaterAct requiring community drinking water systemsto report regulatory violations publiclyhas been sufficient to reduce the incidence ofsubsequent violations, even in the absence ofadditional financial incentives.In China, Indonesia, the Philippines, andVietnam, performance evaluation and ratingsprograms that reported emissions data andassessed plants’ environmental performancehelped a large number of plants initially ratedas “noncompliant” to rise to “compliant” (incontrast, plants rated as “flagrant violators”and “compliant” stayed in those categories).One reason these programs work is that theyprovide the information needed for civil societyand legal and political systems to act toreduce pollution. But it also works becausethey attract the attention of managers to efficiency-increasingopportunities, which canbe implemented at low or even negative cost.Impose where it makes sense. Market andprice instruments are sometimes difficult toimplement or to enforce, they lack predictabilityand credibility over the long term,and they may be inefficient when economicactors do not take them fully into account,such as not fully valuing fuel economy whenbuying a car (Greene 2010). This is why it issometimes easier to implement norms andregulations, as is done by Australia, Canada,China, the European Union, Japan, Korea,and the United States for car fuel efficiencystandards (An and others 2007).Use innovation and industrial policy, butwith caution. Prices are notoriously limitedinstruments for transforming economies ortriggering investments with long-term oruncertain payoffs. Since they depend on governmentactions, they have long-term credibilityand predictability issues. They alsocannot address the “classic” market failuresthat are usually invoked to justify innovationor industrial policies: increasing returns andknowledge externalities in new industries,information asymmetries, capital marketimperfections, and the coordination neededacross different sectors to permit a technologicaltransition. As a result, most countriesresort to some form of innovation and industrialpolicies in their growth strategies.Such policies need to be used with careand tailored to the country context. Today,frontier innovation and basic R&D are highlyconcentrated in high-income countries and afew large emerging economies. High-incomecountries have a critical responsibility to stepup their efforts on green innovation and itsdeployment as well as to take new technologiesto scale through demand-side policies.Failure to do so will severely compromisethe ability of developing countries to pursuegreen growth.In lower-income countries, capacity is oftennot sufficient for frontier innovation; what isneeded are policies to support the adaptationand dissemination of existing technologies.These technologies have been developedand tested in richer countries, making theirsupport through trade, dissemination, andindustrial policies less risky than the developmentof new technologies. The best way toaccelerate technology diffusion is to reducetrade barriers. In China, photovoltaic panelfabrication technologies were introducedmainly through the import of manufacturingequipment from Europe. Also critical arepolicies to increase adaptation and adoptioncapacity through education and training aswell as trade and industrial policies (such aslocal content requirements).Moreover, several developing countriesare pursuing green industrial policies—biofuelsin Brazil and solar energy in China andMorocco. Lessons from past successes andfailures of standard industrial policies areclear: governments should subject firms tocompetition, have clear sunset clauses, andfocus on well-identified market failures, spillover,or latent comparative advantages (forexample, solar potential in North Africa). But

OVERVIEW 21most green industries will require some typeof policy support, making a market test morecomplex to design (is a technology not competitivebecause the government is not pricingthe externality correctly or because the technologyis not the most competitive available?)and making it even more imperative for governmentto navigate carefully the twin risks ofpolicy and market failures. Typically, environmentalpolicy (such as a carbon tax) shouldaddress the environmental externality, whilethe standard tools of innovation and industrialpolicies are used to address knowledgeexternalities and other market failures such aseconomies of scale and coordination failures.Prong 3: Innovative financing tools thattackle higher up-front financing needsEven when environmental or green infrastructurepolicies and investments pay forthemselves, they can involve significant upfrontcosts and require specific financial tools.Innovative financing is therefore urgentlyneeded, especially where gains from betterenvironmental management cannot immediatelybe monetized.Resources are available but remain smallrelative to need, so they need to be leveraged.With respect to climate change mitigation,recent estimates suggest that a package ofpublic sources (including a redirection of subsidiescurrently destined for fossil fuels), multilateraldevelopment bank flows, and carbonoffset flows could leverage some $200 billionto $400 billion in 2020 in additional privateflows (MDB Working Group on ClimateFinance 2011). This is close to the expectedinvestment needed to reach a 550 ppm CO 2-eq target, but about half of what is needed toreach a 450 ppm CO 2-eq target. As for thebiodiversity market, offset and compensationprograms officially amount to some $2.4 billionto $4 billion per year, but may be muchbigger, given that most of the existing marketsare not transparent or analyzed enoughto estimate their size (Madsen and others2011).Increasing the role of the private sectoris critical. Many of the needed investmentscould benefit from public-private partnerships.Private participation in infrastructurehas grown at a steady pace (13 percent ayear) over the past 20 years but remains concentratedin a few middle-income countriesand a few sectors, namely, telecom and, to alesser extent, energy (World Bank and PPIAF2012). New investments in renewable energyare largely private (some $143 billion of the$211 billion invested in renewables in 2010),but 82 percent of private renewable energyinvestments that take place in developingcountries occur in Brazil, China, and India(UNEP and Bloomberg New Energy Finance2011). Yet the need for innovation, efficiency,and “smart investments” (smart grids, smarttransportation, and smart houses) makes therole of the private sector even more criticalin green growth policies than it already is intraditional infrastructure finance.Three weaknesses hold back private financingof infrastructure—green or not (MDBWorking Group on Infrastructure 2011):• The scarcity of resources to prepare projectsand bring them to a stage at whichthey are “bankable” (that is, attractive toprivate sectors). Developing-country governments—atleast those with limited experiencewith public-private partnerships—are often reluctant to borrow to prepareuncertain projects, while private investorsare unwilling to invest in preparing a projectthey may have to bid for and not win.• The mismatch between the tenor of thefunds available, with the preference ofinvestors for short-term funds and theneeds of infrastructure for long-term funds(15–25 years). Few countries have well-developedcapital markets or banking institutionsable to transform short-term depositsinto long-term products, and not enoughrefinancing tool options are available.• The challenge of cost recovery. The abilityto charge at full cost is behind the massiveexpansion in telecom services, but fewother infrastructure sectors are able to doso, although where they have, investorshave come, as they did in Colombia’s watersector. Solutions include measures to price

22 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTinfrastructure services close to cost recovery,while ensuring affordability for lowincomehouseholds.Another weakness springs from the additionalpolicy risk created by the fact thatthe profitability of green investments isoften dependent on public policies (such asfeed-in tariffs or environmental taxation).Thus, Spain’s retroactive reductions in solarfeed-in tariffs, Germany’s and France’s decisionsto reduce the amount of support forfuture projects, and the lack of progress ona U.S. energy bill all combined to depressthe private sector’s appetite for renewableenergy investments in 2010. As a result,clean energy share prices dipped, reflectinginvestor concerns, despite continued stronggovernment support for renewable energy inChina (UNEP and Bloomberg New EnergyFinance 2011).Renewable energy and energy efficiencyillustrate the need for innovative publicfinancing instruments (World Bank forthcomingb). Renewable energy is capital intensivewith a long payback period and may facethe technology risks associated with emergingtechnologies (such as concentrated solar) orunique resource risks (drilling for geothermal).Energy efficiency suffers from the factthat most local banks rely on balance sheetfinancing, rather than project-based financingthat is based on the cash flow generated by theinvestments. The result is that the customersmost in need of fi nancing (small businessesand households) are typically deemed notcreditworthy. And energy efficiency investmentstend to be small, with high transactioncosts, so that banks may not find them attractivein the absence of dedicated credit lines toincrease confidence and capacity and instrumentsto aggregate small deals.Furthermore, access to fi nancing is particularlyproblematic for small and mediumenterprises (SMEs), which account for a largeshare (60 percent in many countries) of pollutionand resource use. Some 65 to 72 percentof all SMEs (between 240 million and315 million firms) lack access to credit, witha particularly daunting picture in Asia andAfrica (Global Partnership for FinancialInclusion 2011). Even in the more sophisticatedmarkets, most firms find it tough toget credit for investments aimed at businessactivities other than expansion.How can these obstacles to green investmentsbe overcome? The public sector, internationalfinancial institutions (IFIs), andbilateral donors can help by providing fundsfor project preparation as well as concessionalelements for pioneer investments. Suchsupport can go a long way toward changingrisk-return profiles and giving investors moreconfidence in the long-term viability of theirprojects.More generally, well-designed publicfinance mechanisms help to mobilize privateinvestments in energy efficiency and renewableenergy (World Bank forthcoming b). Inthe case of renewable energy and energy efficiency,the following tends to have the greatestleverage:• Credit lines or guarantee instruments toengage private banks. The experience ofthe International Finance Corporation istelling: between 1997 and 2011 some $65million in concessional funding, primarilyfor risk-sharing facilities, generated$680 million in sustainable energy financeinvestments (IFC 2011).• “Fund of funds” under which the governmentinvests a relatively small amount oflong-term capital in a range of private, professionallymanaged funds that then investin clean energy or energy efficiency• Public funds to reduce interest rates forconsumer financing, typically throughfinancial institutions or utilities.In addition, energy service companies(ESCOs), which provide clients with energyauditing, propose energy-savings measures,and fi nancing, can help consolidatemultiple small transactions. ESCOs as anindustry often require public support toestablish: in China, it took more than adecade of support by the government andthe World Bank before the ESCOs grew toa $1 billion industry in 2007 (World Bank2010d).

OVERVIEW 23TABLE O.2 Financing mechanisms need to be tailored to the maturity of the local financial sector(context-dependent financing tools for clean energy in East Asia and the Pacific)Level of financial sector developmentIndicator Low Medium HighCountry income level Low income (e.g., Lao PDR) Middle income(e.g., Thailand)Upper middle income(e.g., Malaysia)Banking services Basic banks Full-range banks Universal banksNon-bank financial services None • Government bonds• Equity• Government andcorporate bonds• Equity• Alternatives (private equity,venture capital)Interest rate Administrative setting Largely market based Fully market basedAccess to finance for SMEs Limited Partial Readily availableAvailability of long-termfi n a n c i n gLimited (up to 1 year) Partial (up to 7 years) Full (up to 15 years)Risk management Weak Adequate RobustAppropriate cleanenergy financinginstruments• Lines of credit(liquidity support)• Concessional financing• Dedicated debt funds• Lines of credit(demonstration)• Partial risk guarantee• Lines of credit(demonstration)• Partial risk guarantee• Equity funds• Consumer financingSource: World Bank forthcoming b.Overall, the relevant mix of financinginstruments will depend on the market barriers(access to credit, transaction cost, or perceptionof risk), market segments (SMEs, largedevelopers, or polluters), and local context(such as the maturity of the local financial sector)in which they seek to operate (table O.2).In addition, payments for environmentalservices (PES)—whereby farmers and landownersare compensated for maintainingtheir land’s ability to provide ecosystem services(such as the regulation of water flows,water purification, control of soil erosion,and habitats for wildlife)—are promising, butunderutilized. Fortunately, efforts to developREDD+ are helping to develop PES schemes. 4In addition, in developing countries, policymakers have tried to design PES programs tobenefit the poor. But whether these schemesin fact benefit the poor depends on the natureof the scheme. Brazil appears to have beensuccessful in this regard, building on itsexperience in developing social safety nets forthe poor (box O.5).ConclusionsIn sum, this report approaches green growthfrom a pragmatic point of view. The currentmodel is not just unsustainable, it is inefficient.Improving it is good economics, so let’sfix market failures, internalize externalities,assign property rights, improve governance,and influence behaviors. But making greengrowth happen and ensuring it is inclusivewill also require an acute understanding ofpolitical economy and social psychology.As such, this report speaks primarily tothose who fear that greening growth maybe too expensive, may be too ambitious atan early stage of development, or shouldconcern only high-income countries. Tothem, the report makes a clear case thatgreening growth is neither unaffordable nortechnically out of reach, there are plenty of

24 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX O.5“Green” cash transfers are helping poor communities in the Brazilian AmazonAn innovative addition to the Brazilian Bolsa Família(family allowance) conditional cash transferprogram—the world’s largest and one of the bestregarded in terms of coverage and targeting—isbeing implemented for communities living insideprotected areas in the Amazon region.The Bolsa Floresta (forest allowance) rewards traditionalcommunities for their commitment to stopdeforestation by distributing payments for ecosystemservices to families, communities, and family associations.In order to be eligible to receive the grants,families must enroll their children in school, sign azero deforestation commitment, and attend a twodaytraining program on environmental awareness.Each eligible family receives a monthly stipend ofR$50 ($30), paid to the mother. Community associationscan also be eligible to receive payments of upto R$4,000 ($2,500) to support sustainable incomegeneration activities, such as honey production, fishfarming, and sustainable forest management.Investments for administrative support to communityassociations make up 10 percent of the totalpaid to families during the year. Bolsa Floresta isbeing implemented by the State Government ofAmazonas and the Fundação Amazônia Sustentável(Sustainable Amazonia Foundation). The funds aregenerated by the interest on an endowment initiallyestablished with contributions from the state governmentand private donors. Deforestation is monitoredon a yearly basis by the Amazonas State Secretariatfor the Environment and Sustainable Developmentthrough satellite imagery analyzed by independentinstitutions. The program currently benefits 7,614families in 15 protected areas, covering around 10million hectares of forests. The State of Amazonashas succeeded in halving the deforestation rate overthe past five years.Box text contributed by Adriana Moreira.BOX O.6 Joining forces: A common platform to move forward on greening oureconomies and growth processesHow does the World Bank’s definition of green growthas economic growth that is environmentally sustainablecompare to those advocated in recent majorreports on green growth? The OECD defi nes greengrowth as “fostering economic growth and development,while ensuring that natural assets continueto provide the resources and environmental serviceson which our well-being relies” (OECD 2011b). TheUnited Nations Environment Programme (UNEP)defines a green economy as “one that results inimproved human well-being and social equity, whilesignificantly reducing environmental risks and ecologicalscarcities” (UNEP 2011). Like the approach promotedin this report, these definitions are consistentwith sustainable development as an ultimate objectiveand with green growth or a green economy as ameans to reconcile its economic and environmentalpillars, without ignoring social aspects.So while the three reports differ in their focusand target audience, they are fully consistent intheir broad vision and policy advice. This commonvision is being developed further in the context ofthe Green Growth Knowledge Platform (GGKP), apartnership of the three institutions and the GlobalGreen Growth Institute. The GGKP—launched inJanuary 2012—is a global network of researchersand development experts seeking to identify andaddress major knowledge gaps in green growth theoryand practice. Through widespread consultationand world-class research, the GGKP aims to providepractitioners and policy makers with better tools tofoster economic growth and implement sustainabledevelopment (http://www.greengrowthknowledge.org).

OVERVIEW 25immediate benefits and a poor country canreap economic benefit from better environmentalmanagement. And although highincomecountries, which still account for 75percent of global consumption and a disproportionateshare of environmental degradation,absolutely have to implement ambitiousenvironmental measures, all countries willgain from starting early.Greening growth need not entail slowergrowth and is affordable. However, achievinga green economy overnight probably is not.The costs of greening growth will dependon the degree of ambition. Rapidly anddramatically decreasing our impact on theplanet would be quite costly. So, too, woulddelaying action for too long. Dramatic shiftswould entail much slower growth at least inthe medium run, and avoiding a brutal transitionis the main incentive to start acting asearly as possible.This report adds to the chorus started bythe Organisation for Economic Co- operationand Development and United Nations EnvironmentProgramme (UNEP) in recent reportssupporting the idea that inclusive green growthis good economics and good development policy(box O.6). While we are still far from beingable to price ecosystem services properly, theyclearly are valuable. As such, neglecting naturalcapital, like neglecting human and physicalcapital, is simply bad management, bad economics,and bad for growth.Notes1. The equivalent amount using purchasing powerparity (PPP) that allows for better cross-countrycomparisons of purchasing power is $6,000 PPPfor all developing countries and $1,300 PPP inlow-income countries.2. This section is based on World Bank (forthcominga).3. The fleet capacity index is the relationshipbetween the capacity of a fishing fleet to catcha particular quantity of fish and the quantity offish that it actually catches.4. Reducing Emissions from Deforestation andForest Degradation (REDD) is an effort to createa financial value for the carbon stored inforests, offering incentives for developing countriesto reduce emissions from forested landsand invest in low-carbon paths to sustainabledevelopment. REDD+ goes beyond deforestationand forest degradation and includes therole of conservation, sustainable managementof forests, and enhancement of forest carbonstocks (http://www.un-redd.org/).ReferencesAllcott, H., and S. Mullainathan. 2010. “Behaviorand Energy Policy.” Science 327 (5970):1204–05.Alpay, E., S. Buccola, and J. Kerkvliet. 2002.“Productivity Growth and EnvironmentalRegulation in Mexican and U.S. Food Manufacturing.”American Journal of AgriculturalEconomics 84 (4): 887–901.Ambec, S., M. A. Cohen, S. Elgie, and P. Lanoie.2011. “The Porter Hypothesis at 20: Can EnvironmentalRegulation Enhance Innovation andCompetitiveness?” Resources for the FutureDiscussion Paper 11-01, Washington, DC.An, F., D. Gordon, H. He, D. Kodjak, andD. Rutherford. 2007. “Passenger VehicleGreenhouse Gas and Fuel Economy Standards:A Global Update.” International Council onClean Transportation, Washington, DC.Andersen, M. S., T. Barker, E. Christie, P. Ekins,J. F. Gerald, J. Jilkova, S. Junankar, M. Landesmann,H. Pollitt, R. Salmons, S. Scott, and S.Speck, eds. 2007. “Competitiveness Effects ofEnvironmental Tax Reforms (COMETR).”Final report to the European Commission,DG Research, and DG TAXUD (SummaryReport), National Environmental ResearchInstitute, University of Aarhus.Anger, N., and U. Oberndorfer. 2008. “Firm Performanceand Employment in the EU EmissionsTrading Scheme: An Empirical Assessment forGermany.” Energy Policy 36 (1): 12–22.Arze del Granado, J., D. Coady, and R. Gillingham.2010. “The Unequal Benefits of FuelSubsidies: A Review of Evidence for DevelopingCountries.” IMF WP/10/02, InternationalMonetary Fund, Washington, DC.Bai, Z. G., D. L. Dent, L. Olsson, and M. E.Schaepman. 2008. “Proxy Global Assessmentof Land Degradation.” Soil Use and Management24 (September): 223–34.Berman, E., and L. T. M. Bui. 2001. “EnvironmentalRegulation and Productivity: Evidencefrom Oil Refineries.” Review of Economicsand Statistics 83 (3): 498–510.

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OVERVIEW 27Martin, R., U. J. Wagner, and L. B. de Preux.2009. “The Impacts of the Climate ChangeLevy on Business: Evidence from Microdata.”CEP Discussion Paper, Centre for EconomicPerformance, London School of Economics,London, U.K.McKinsey and Company. 2011. “Resource Revolution:Meeting the World’s Energy, Materials,Food, and Water Needs.” McKinsey GlobalInstitute.MDB (Multilateral Development Banks) WorkingGroup on Climate Finance. 2011. “MobilizingClimate Finance” Paper prepared at the requestof G20 Finance Ministers. http://climatechange.worldbank.org/content/mobilizingclimate-finance.MDB (Multilateral Development Banks) WorkingGroup on Infrastructure. 2011. “SupportingInfrastructure in Developing Countries.” Papersubmitted to the G20.MEA (Millennium Ecosystem Assessment). 2005.Ecosystems and Human Well-being: Synthesis.Washington, DC: Island Press.Milanovic, B. 2010. “Global Inequality Recalculatedand Updated: The Effect of New PPPEstimates on Global Inequality and 2005 Estimates.”Journal of Economic Inequality. DOI10.1007/s10888-010-9155-y.Myers, N., and J. Kent. 2001. “Perverse Subsidies:How Tax Dollars Can Undercut theEnvironment and the Economy.” InternationalInstitute for Sustainable Development,Winnipeg.Nidumolu, R., C. K. Prahalad, and M. R. Rangaswami.2009. “Why Sustainability Is Nowthe Key Driver of Innovation.” Harvard BusinessReview 87 (9, September): 56–64.OECD (Organisation for Economic Co-operationand Development). 2011a. Agricultural PolicyMonitoring and Evaluation 2011. Paris:OECD.———. 2011b. Towards Green Growth. Paris:OECD.Picherta, D., and K. V. Katsikopoulos. 2008.“Green Defaults: Information Presentationand Pro-Environmental Behaviour.” Journal ofEnvironmental Psychology 28: 63–73.Pimm, S. L., G. J. Russell, J. L. Gittleman, andT. M. Brooks. 1995. “The Future of Biodiversity.”Science 269 (5222): 347–50.Quirion, P. 2011. “Les quotas échangeables d’émissionde gaz à effet de serre: Éléments d’analyseéconomique.” Mémoire d’Habilitation à dirigerles recherches, Ecole des Hautes Études enSciences Sociales, Paris.Rozenberg, J., S. Hallegatte, A. Vogt-Schilb, O.Sassi, C. Guivarch, H. Waisman, and J-CHourcade. 2010. “Climate Policies as a Hedgeagainst the Uncertainty on Future Oil Supply:A Letter.” Climatic Change Letters 101 (3):663–69.Sartor, O. 2012. “Carbon Leakage in the PrimaryAluminium Sector: What Evidence after 6½Years of the EU ETS?” CDC Climat ResearchWorking Paper 2012-12, Caisse des Dépots,Toulouse.Thaler, R., and C. Sunstein. 2008. Nudge. NewHaven, CT: Yale University Press.Transport for London. 2008. “Central LondonCongestion Charging Impacts Monitoring:Sixth Annual Report, July 2008.” Mayor ofLondon, London. http://www.tfl.gov.uk/assets/downloads/sixth-annual-impacts-monitoringreport-2008-07.pdf.Tversky, A., and D. Kahneman. 1992. “Advancesin Prospect Theory: Cumulative Representationof Uncertainty.” Journal of Risk andUncertainty 5: 297–323.Tversky, A., and E. Shafi r. 1992. “The DisjunctionEffect in Choice under Uncertainty.” PsychologicalScience 3 (5): 305–09.UNEP (United Nations Environment Programme).2011. Towards a Green Economy: Pathways toSustainable Development and Poverty Eradication.Geneva: UNEP. http://www.unep.org/greeneconomy.UNEP (United Nations Environment Programme)and Bloomberg New Energy Finance. 2011.Global Trends in Renewable Energy Investment2011. Nairobi: UNEP.UNESCO (United Nations Educational Scientificand Cultural Organization) and WWAP (WorldWater Assessment Program). 2006. “Water: AShared Responsibility.” United Nations WorldWater Development Report 2, UNESCO,Paris. http://www.unesco.org/water/wwap/wwdr/wwdr2/table_contents .shtml.Van Vliet, O., K. Volker, D. McCollum, S.Pachauri, Y. Nagai, S. Rao, and K. Riahi.Forthcoming 2012. “Synergies in the AsianEnergy System: Climate Change, Energy Security,Energy Access and Air Pollution.” EnergyEconomics, in press. Published online February14, 2012.Victor, P. A. 2008. Managing without Growth:Slower by Design, Not Disaster. Cheltenham,U.K.: Edward Elgar.Wang, X., N. Berrah, S. Mathur, and F. Vinuya.2010. Winds of Change: East Asia’s SustainableEnergy Future. Washington, DC: World Bank.

28 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTWorld Bank. 2004. “Tunisia Country EnvironmentalAnalysis (1992.2003).” Report 25966-TN, World Bank, Washington, DC.———. 2005a. “Arab Republic of Egypt CountryEnvironmental Analysis (1992.2002).” Report31993-EG, World Bank, Washington, DC.———. 2005b. “China: Second Loess PlateauWatershed Rehabilitation Project.” ImplementationCompletion and Results Report 34612,World Bank, Washington, DC.———. 2006a. “Republic of Bangladesh CountryEnvironmental Analysis.” Report 36945-BD,World Bank, Washington, DC.———. 2006b. “Republic of Colombia: MitigatingEnvironmental Degradation to Foster Growthand Reduce Inequality.” Report 36345-CO,World Bank, Washington, DC.———. 2006c. “Republic of El Salvador CountryEnvironmental Analysis: Improving EnvironmentalManagement to Address Trade Liberalizationand Infrastructure Expansion.” Report35226-SV, World Bank, Washington, DC.———. 2006d. “Republic of Guatemala CountryEnvironmental Analysis: Addressing the EnvironmentalAspects of Trade and InfrastructureExpansion.” Report 36459-GT, World Bank,Washington, DC.———. 2006e. “Nigeria Rapid Country EnvironmentalAnalysis (CEA).” World Bank, Washington,DC.———. 2006f. “Pakistan Country EnvironmentalAnalysis.” Report 36946-PK, World Bank,Washington, DC.———. 2007a. “Ghana Country EnvironmentalAnalysis.” Report 36985-GH, World Bank,Washington, DC.———. 2007b. “Nepal Country EnvironmentalAnalysis: Strengthening Institutions and ManagementSystems for Enhanced EnvironmentalGovernance.” Report 38984-NP, World Bank,Washington, DC.———. 2007c. “Republic of Peru EnvironmentalSustainability: A Key to Poverty Reduction inPeru.” Report 40190-PE, World Bank, Washington,DC.———. 2008. “Tajikistan Country EnvironmentalAnalysis.” Report 43465-TJ, World Bank,Washington, DC.———. 2009. “Hashemite Kingdom of JordanCountry Environmental Analysis.” Report47829-JO, World Bank, Washington, DC.———. 2010a. “Central African Republic CountryEnvironmental Analysis: EnvironmentalManagement for Sustainable Growth.” WorldBank, Washington, DC.———. 2010b. “The Cost of Environmental DegradationCase Studies from the Middle Eastand North Africa.” Report 56295, WorldBank, Washington, DC.———. 2010c. “République du Bénin AnalyseEnvironnementale Pays.” Report 58190-BJ,World Bank, Washington, DC.———. 2010d. World Development Report:Development and Climate Change. Washington,DC: World Bank.———. 2011a. “Republic of Lebanon CountryEnvironmental Analysis.” Report 62266-LB,World Bank, Washington, DC.———. 2011b. “South Africa: Economic Update;Focus on Green Growth.” World Bank, Washington,DC.———. 2011c. World Development Indicators.Washington, DC: World Bank.———. Forthcoming a. How Environment SustainsDevelopment: The World Bank GroupEnvironment Strategy; Toward a Green, Clean,and Resilient World for All. Washington, DC:World Bank.———. Forthcoming b. Maximizing Leverage ofPublic Funds to Unlock Commercial Financingfor Clean Energy in East Asia. Washington,DC: World Bank.World Bank and DRC (Development ResearchCenter of the State Council, China). 2012.“Seizing the Opportunity of Green Developmentin China.” Supporting Report 3 forChina 2030: Building a Modern Harmonious,and Creative High-Income Society. Washington,DC: World Bank. http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2012/02/28/000356161_20120228001303/Rendered/PDF/671790WP0P127500China020300complete.pdf.World Bank and FAO (Food and AgricultureOrganization). 2009. “The Sunken Billions:The Economic Justification for FisheriesReform.” World Bank, Washington, DC; Foodand Agricultural Organization, Rome.World Bank and PPIAF (Public-Private InfrastructureAdvisory Facility). 2012. Private Participationin Infrastructure Database. World Bank,Washington, DC. http://ppi.worldbank .org/.

An Analytical Frameworkfor Inclusive Green Growth1Key Messages• It is inefficient either to pursue growth andonly later worry about its environmental consequences,or to promote environmental sustainabilityand subsequently worry about itsgrowth implications.• The analytical case for green growth is strong:green policies can indeed contribute to economicgrowth over the short term, if they aredesigned in an appropriate framework.• Green policies can contribute to growththrough four effects: an input effect (increasingproduction factors), an efficiency effect(bringing production closer to the productionfrontier), a stimulus effect (stimulating theeconomy in times of crisis), and an innovationeffect (accelerating development andadoption of technologies).• Green policies can also contribute to welfarethrough direct environmental benefits,through distributional effects (includingpoverty reduction and job creation), andthrough increased resilience to shocks(including natural disasters and commodityprice volatility). Welfare impacts will begreater if efforts are made to make greenpolicies inclusive.China grew at about 10 percent a yearover the past 30 years, transformingit from a poor country to theworld’s second-largest economy. Yet, theChinese government is now reconsideringthe strategy that permitted this economicmiracle in the hope of greening its developmentprocess (World Bank and DRC 2012).Two factors motivate this possible change inapproach. First, the cost of environmentaldegradation, estimated at 9 percent of grossdomestic product (GDP), is threatening botheconomic competitiveness and welfare. Asa result, China’s population is demandinga cleaner and safer environment. Second,China is looking for new sources of growth,supported by innovation and higher valueadded production, and wants to be an earlyThis chapter is based on Hallegatte and others (2011).29

30 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTmover in the race toward greener productionprocesses and products.China is not the only such country.Brazil, Indonesia, Mexico, Morocco, andTunisia are greening their growth process orlooking to use green industries as sources ofgrowth. Ethiopia is developing a green growthstrategy. Kenya is investing heavily in geothermalpower. And many other countries arehoping to better balance the environment andthe economic imperative of rapid growth.The reality is that the world needs greengrowth, and it needs it now. But what exactlydoes “green growth” mean? Green growthcan be thought of as economic growth thatis environmentally sustainable. More specifically,it aims to operationalize sustainabledevelopment by enabling developing countriesto achieve robust growth without lockingthemselves into unsustainable patterns. TheWorld Bank’s environmental strategy definesgreen growth as growth that is efficient, clean,and resilient—efficient in its use of naturalresources, clean in that it minimizes pollutionand environmental impacts, and resilient inthat it accounts for natural hazards and therole of environmental management and naturalcapital in preventing physical disasters.Importantly, green growth is not inherentlyinclusive. Its outcome will likely be goodfor the poor, but specific policies are neededto ensure that the poor are not excluded frombenefits and are not harmed in the transition.The welfare impacts of green policies will begreater if efforts are made to make the policiesinclusive.Greening growth is essential to achievingsustainable development and its objectivesof social, economic, and environmental sustainability(figure 1.1). Economic growth andsocial achievements are widely recognizedas complementary, but growth and environmentalsustainability are often perceived asantithetical. Greening growth would reconcilethe need for environmental sustainabilitywith that for economic growth and socialimprovement.Fortunately, many policies provide bothenvironmental and economic benefits.Informal settlements can pose economic,environmental, and social problems. Utilitiesoften refuse to serve them and insecureproperty rights discourage residents frominvesting in establishing connections to wateror electricity networks. Creating functioningland markets with secure land tenure helpsinformal settlers access solid waste removal,sanitation and drainage, and drinking water.It also increases welfare and labor productivity,both directly and indirectly, by givingsuch settlers greater access to credit and byallowing them to invest in small businesses,thereby increasing aggregate output. Oneexample of the environmental benefits ofa green growth policy is the World Bank–financed water quality and pollution controlproject around the Lake of Guarapirangain Brazil. Urban renewal and slum upgradingwere critical to improving water quality,which in turn provided a reliable water supplysource for the city of São Paulo.Most green growth policies are environmentalpolicies in the sense that their primaryobjective is to preserve the environment. Butnot all of them are. Policies that improveenergy security or reduce urban congestion,for example, may yield substantial environmentalbenefits even if doing so is not theirprimary objective.Many observers have argued that environmentalissues will “solve themselves” witheconomic development. This chapter examinesthe flaws in the “grow now, clean uplater” argument and discusses what growththeory and evidence reveal about the compatibilityof environmentally sustainablepolicies and growth. It investigates whethergreen growth is in fact feasible—beginningwith the analytical case for green growthbefore reviewing the implications for welfare,the ultimate goal of economic policy—andexplores how to identify trade-offs and synergiesimplied by a green growth strategy.Why not grow now and cleanup later?The “grow now, clean up later” argumentis based on the idea that environmentalquality first deteriorates with growth and

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 31then improves—an environmental Kuznetscurve. 1 In this framework, the environmenteventually improves as nationalincome rises because the environment is a“superior good” (a good whose consumptionincreases more than proportionatelywith income). 2 The framework implies thatpoor people care less about the environmentthan wealthier people, give priority to consumptionover environmental quality, andact upon these preferences. Once basic needshave been met, this argument goes, peopleplace greater weight on the environment,leading to investments in environmentalprotection and clean-up that increase environmentalquality, assuming appropriatecollective action proves possible. Economicgrowth will therefore automatically leadcountries to environmental protection.There are serious flaws in this argument.First, a distinction needs to be made betweenenvironmental impacts that affect welfarethrough income and consumption and thosethat affect welfare through the amenity valueof environmental assets. In urban areas, poorhouseholds that struggle to feed and housethemselves will indeed place a lower priorityon the amenities provided by a park thanwealthier households might. However, theycare deeply about the absence of solid wastemanagement and its results—dengue epidemics,clogged urban drains, and the destructionof their homes and small businesses by floods.In rural areas, protecting forests to prevent theextinction of rare animals may not be a priorityfor households that struggle to feed themselves(unless of course the poor can share inthe benefits from wildlife protection). But thesame households are likely to care about protectingsoil quality and managing water flows,which allow them to grow crops.Second, even when poor communities careabout the environment, they may not havethe “voice” to make their concerns heard.Policies implemented in developing countriesmay be more representative of the preferencesof the elite than of the poor or mayreflect institutional constraints, such as thoseimposed by poorly defined property rights (asin open access resources).FIGURE 1.1SocialsustainabilityThe three pillars of sustainable developmentEconomicsustainabilitySustainabledevelopmentThird, it is difficult to infer preferencesabout collective goods from individual behavior.Cities offer many more jobs and opportunitiesthan rural areas but also much higherlevels of local pollution. The fact that peoplemove from rural areas to cities does not meanthey would not prefer slightly fewer opportunitiesand higher environmental quality. Theirpreferences are not completely revealed bythe binary choice of “moving or not movingto the city,” because they do not have a continuumof choices of increasing opportunitiesand decreasing environmental quality.Fourth, because the influence of environmentalquality and welfare is often indirect,people may not link environmental problems(such as water or soil quality) to the healthproblems they confront. 3 Better information,not just higher incomes, may be neededif individuals are to demand higher environmentalquality at earlier stages of development.Even developed countries are onlybeginning to address the complex issue ofEnvironmentalsustainabilityNote: Economic and social sustainability, on the one hand, and social and environmental sustainability,on the other, have been found to be not only compatible, but also largely complementary. Not sowith economic and environmental sustainability, as growth has come largely at the expense of theenvironment—hence, the dotted line on this figure—which is why green growth aims to ensure thateconomic and environmental sustainability are compatible.

32 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTthe environmental damages of pesticides andchemicals.Fifth, although some dimensions of environmentalquality improve with averageincome, many others do not. Local environmentalissues with short-term, highly visiblemanifestations (such as local air and sometypes of water pollution) are usually resolvedspontaneously as countries develop. In contrast,global public goods with long-termconsequences (such as climate change or biodiversity)and local environmental issues withcomplex and less visible consequences can keepgetting worse (box 1.1).The case of Costa Rica illustrates thecontrast between local, visible pollutantsand global ones. In 1978, when per capitaGDP was about $2,200, emissions of nitrogenoxides (NO x) and sulfur dioxide (SO 2)peaked, before leveling off and then decliningslightly. Over the same period, however,carbon dioxide (CO 2) emissions continued torise (figure 1.2).Delaying action can be costlyMaking the “grow now and clean up later”argument even less palatable is the factthat it may simply be too costly to do so.Indeed, it may be more economical toreduce or prevent pollution at an early stageof growth than to incur the higher clean-upcosts at later stages, even when future costsand benefits are discounted. Acting early iscritical when the choice of technology andinfrastructure can “lock in” high-carbonor polluting lifestyles or economic structures.This issue is particularly relevant indeveloping countries, where most of theinfrastructure will be built in the next fewdecades.As for climate change, a variety ofexperts have studied the optimal timing ofaction (Nordhaus 1992; Wigley and others1996). Prematurely depreciating investmentscan be costly if climate change turns outto be less threatening than expected or ifthe discount rate used to calculate futurelosses is too low. But early action may wellresult in savings. Lecocq and others (1998)find that in the absence of perfect foresight,specific policies regarding green infrastructureand long-lived capital must be adoptedearly to achieve mitigation objectives at alower cost. Jaccard and Rivers (2007) showthat early action is preferable in long-livedBOX 1.1Persistent concerns about local pollution in high-income countriesComplex and “invisible” local environmental issuesdo not necessarily improve with income. In countrieslike France, efforts to understand the transfer ofpesticides to the environment (mostly water bodies)began only some 20 years ago, under the pressureof a European Union Directive regulating drinkingwater (Aubertot and others 2005). Soil contaminationis harder to monitor and can lead to severelong-term environmental and health hazards, as theexample of the insecticide chlordecone illustrates.Chlordecone, which was banned only recently,was used extensively in the French West Indiesfor more than 30 years, exposing the populationto severe health hazards (Multignier and others2010). The chemical remains in the soil for decades,polluting water and agricultural productions, andcontains known carcinogenics (Aubertot and others2005; Multignier and others 2010).In the United States, the Safe Drinking Water Actregulates only 91 contaminants, despite the fact thatmore than 60,000 chemicals are used within thecountry’s borders. Scientists have examined many ofthese chemicals and have identified hundreds associatedwith a risk of cancer and other diseases at smallconcentrations in drinking water, according to ananalysis of government records by the New YorkTimes (Duhigg 2009). The implication is that millionsof Americans are exposed to water that doesnot meet safety standards meant to protect againstcancer or other serious diseases.

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 33FIGURE 1.2 Global pollutants and local, visibleones follow different paths(relationship between GDP and emissions in Costa Rica,1970–2009)SO 2 and NO x emissions (thousand tons)70605040302010CO 2 emissions (right)NO x emissions (left)SO 2 emissions (left)004,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000GDP per capita (constant year 2000 $, PPP)Source: Based on data from the International Energy Agency, the JointResearch Center, and World Development Indicators.capital sectors, such as infrastructure andurbanization, even if marginal costs arehigher there. Denser cities have lower CO 2emissions from transportation (figure 1.3).But Gusdorf and others (2008) find thatinfluencing the shape and density of cities(“changing urban forms”) to make themless energy consuming is extremely costly.Developing countries would therefore dowell to prevent their cities from growing ina low-density manner dependent on automobilesif their target for the end of the21st century is to have high-density, energyefficientcities.One measure of the importance of earlyaction is provided by Davis and others (2010),who estimate that without early scrapping,existing energy infrastructure commits usto warming of about 1.3°C above preindustrialtemperatures. Introducing other types ofinfrastructure (including the capital that constrainsthe demand for transport, such as distantsuburbs) and non-CO 2gases, Guivarchand Hallegatte (2011) estimate this “commitment”at 1.7°C. These results imply thatkeeping the increase in global warming below2°C (the internationally recognized objectiveof climate policies [World Bank 2009])requires that almost all new infrastructurebe designed with climate change in mind7654321CO 2 emissions (million tons)and that urgent action be taken on long-livedinfrastructure. In the absence of such action,physical capital will have to be replaced earlier,at great cost.Another argument for early action has todo with the fact that the needed technologieswill not become affordable unless thereis sufficient demand to deploy them to scale.Countries or fi rms may be tempted to waitfor better and less expensive technologies tobecome available. But these technologies willbe developed only if serious commitments topollution reduction are made (Goulder andMathai 2000; Manne and Richels 2004; SueWing 2006). Early action is thus justified bythe technological changes that action wouldinduce. Developing these technologies is acritical role of high-income countries and themain reason why they need to act quickly onissues such as climate change.And even worse, some damages cannot bereversed. In such cases, investments in environmentalquality protection can be necessaryin the short term. In Kenya, for example,traditional forests are being destroyed.Replanting can restore the country’s watertower and other functions, but most biodiversitylosses are probably irreversible (Chapinand others 2000).Climate change itself may be irreversible.This irreversibility is a clear incentive for earlyaction, as the consequences of warming exceeding2°C are highly uncertain and potentiallysevere (Ambrosi and others 2003; Ha-Duongand others 1997; World Bank 2009). The 2°Cobjective, for example, is achievable only if significantemission reductions can be made before2030 (Meinshausen and others 2009; O’Neilland others 2009).If growing dirty now and cleaning up lateris not an option, then what is needed are jointgreen and growth policies. It is inefficientto pursue growth and then worry about itsenvironmental consequences or to promoteenvironmental sustainability and then worryabout its growth implications. But the possibilityto green growth has been questioned.The next section provides a framework toinvestigate the potential for greening growthwithout slowing it.

34 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE 1.3 The denser the city, the lower the transportation emissions(relationship between urban density and per capita emissions)8,0007,000Atlantaper capita transport emissions (kg CO 2 )6,0005,0004,000HoustonSan FranciscoLos Angeles3,000Toronto2,000RiyadhBrusselsBangkok1,000SingaporeBarcelonaSão PauloSeoulHong Kong, ChinaCuritibaManilaMumbaiTunis0Chennai050 100 150 200 250 300 350 400population density (persons per hectare)Source: Kenworthy and Laube 2001.Is green growth really possible?The analytical basisModern growth theory dates back to1956, when Robert Solow put forward aformal model that suggested that growthin output—GDP—comes from increasesin physical capital, labor, and productivity(box 1.2). In this model, physical capitalincreases thanks to investment. Laborincreases as a result of population growth,greater labor force participation, and betterhealth and education. And productivityincreases thanks to technological change—which can stem from investments in educationand research and development (R&D),economies of scale, and learning by doing.What is missing in this model, however, isthe notion that economic production dependsdirectly on the stock of natural resourcesand the quality of the environment—thatis, that the environment is a factor in theproduction function. This notion has beenaround at least since Malthus ([1798] 1965),but it was not until the early 1970s thatclassical growth theory was modified toembrace the environment— referred to as“natural capital”—as a factor of production(Dasgupta and Heal 1974; Nordhaus 1974;Solow 1974). 4 If the environment is consideredas productive capital, it makes sense toinvest in it, and environmental policies can beconsidered as investment.In this “greener” framework, environmentalpolicies increase economic output directlyby improving environmental conditions (forexample, better forestry management reducessoil erosion, leading to more productive agriculture).Failure to manage the environmentresults in the depreciation and destruction ofnatural capital, with direct adverse impactson output. Cleaning up the environmentalso increases human well-being directly, byimproving air and water quality and reducingexposure to natural hazards, although thesebenefits are not necessarily captured by conventional(GDP) statistics.Whether investing in the environmentincreases only the level of production or alsoits rate of growth is likely to depend on thecontext in which the investment is made.Where credit constraints limit output growth,investing in the environment will accelerate

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 35BOX 1.2An economic framework for green growthClassical growth theory (Solow 1956) assumes thatoutput (Y) is produced using technology (A), physicalcapital (K), and labor (L). The relationship canbe written as follows:Y = f (A, K, L).Growth in output results from increases in productionfactors (physical capital and labor) andproductivity, which rises as a result of technologicalchange, including changes in organization andpractices. In this approach, the environment plays noproductive role.The idea that economic production dependsdirectly on the stock of natural resources andthe quality of the environment—that is, that theenvironment is an argument in the productionfunction—has been around at least since Malthus(1798). It was further developed in the environmentaleconomics literature that took off in the early1970s. In this approach, the environment becomes“natural capital,” an input in economic productionand growth. The production function can thus berewritten as follows:Y = f (A, K, L, E),where E represents the environment (naturalcapital).To analyze the effect of green growth policies,however, growth models need to be modified toincorporate market failures and the fact that theeconomy is not at its optimal equilibrium. A fi rstmodification replaces the production function withthe production frontier—the maximum productionlevel possible with the available technology, physicalcapital, labor, and environment, assuming maximumefficiency. Actual production is given byY = y f (A, K, L, E),where y (a value between 0 and 1) measures the efficiencyof the production process.A second modification introduces P E, which canbe thought of as the effort dedicated to environmentalpolicies:Y = y (P E) f [A (P E), K (P E), L (P E), E (P E)].In this case, environmental policies can create synergieswith economic output by increasing productivecapital (K, L, and E), improving efficiency y , andaccelerating technological change by increasing A.Ultimately, it is welfare that matters, not output.This means that the model needs to account for theimpact of output on welfare (or utility, U). As investmentdoes not increase welfare directly, utility canbe modeled as depending only on the current levelof consumption, C, plus the direct effect of the environment,E:U = u (C, E).In practice, environmental policies can affectutility directly (positively or negatively), with effectsthat are not mediated by aggregate consumption orthe state of the environment such as distributionalimpacts or increased resilience. The utility functioncan thus be written as follows:U = u (C, E, P E).Distribution (how total consumption is distributedacross individuals) and volatility (how totalconsumption is distributed over time) affect welfareand can be influenced directly by environmentalpolicies. Everything else equal, many people favorstable consumption patterns and lower consumptioninequality; the utility function can thus include anaversion for risk and inequality.Sources: Hallegatte and others 2011 and World Bank.growth, because a higher production levelincreases income and savings. Where growthis limited by investment opportunities, it willfail to boost growth, because institutions arenot in place to allow investors to benefit fromtheir investment revenues. Where people areengaged in low-return activities, a limitedincrease in the production level may improvewelfare but will not spur economic growth,because these economic activities do not generatesufficient returns to allow households tosave and accumulate assets.A key question in this framework is theextent to which production factors are complementsor substitutes. If they are complements(or weak substitutes), protecting theenvironment is necessary to maintain economicproduction. If they are substitutes, in

36 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTprinciple, increased investment in physicalor human capital or technological changecan compensate for damage to the environment.In fact, the ability to do so appearslimited. 5 Food production requires soil andwater, even if technology and increased laborintensity can reduce the quantities needed.The low elasticity of substitution betweennatural capital and other inputs implies thata small percentage increase in natural capitalcan free large percentage quantities of otherinputs. 6While direct economic benefits from environmentalpolicies occur mainly over thelong term, green policies can also contributeto short-term economic growth because theworld’s economies perform far from theiroptimum levels. Indeed, many market failureshurt both the environment (by reducingthe effective supply of natural capital) andthe economy (by causing an extremely inefficientuse of natural resources). Correctingthese market failures, although sometimescostly, can increase efficiency and yieldbenefits that go beyond the environment.An example is urban congestion, which notonly causes air pollution but also reducesthe productivity and economies of scopecities provide. The reality is that the useand management of “natural capital” areplagued by extensive market failures, suchas unpriced externalities and poorly definedproperty rights.The problem for analysts is that modelsof economic growth usually fail to captureenvironmental contributions, partlybecause they generally ignore the role ofnatural capital and partly because theyassume a world with no market failures. Asthe potential for green policies to accelerateincome growth arises from market failures,such models cannot be used to assess theimpact of such policies.A real-world framework forgreen growthTo be useful for analyzing the effect ofgreen growth policies, a broader frameworkis needed that is modified to account formarket failures and other suboptimalities,such as the following:• Knowledge spillovers and economiesof scale that lead to underinvestment inR&D• Underutilization of physical capital orlabor, for temporary (crisis) or structuralreasons• Behavioral biases, such as the inabilityto make decisions about low-probabilityevents (Camerer and Kunreuther 1989;Tversky and Shafir 1992)• Other market failures, such as principalagentissues, information asymmetry incapital markets, and coordination failures.Actual economic output depends on the“production frontier” (the maximum productionlevel possible with the availabletechnology, physical capital, labor, and environment,assuming maximum efficiency)and on efficiency (how close the real-worldproduction system actually is to the productionfrontier).Green growth policies can thus be seen aspolicies that move the economy away fromsuboptimalities and increase efficiency—andhence contribute to short-term growth—while protecting the environment. Suboptimalitiesoften persist because removingthem is complex or requires large upfrontinvestments. Assessing the possibility to correctthese market failures requires devotingattention to their causes, to institutional andpolitical obstacles, and to transaction costs.How do environmental policies increaseconventionally measured GDP? They doso through four channels linked to input,efficiency, stimulus, and innovation effects.Figure 1.4 illustrates each of these effects.Input effectThe input channel works by increasing thequantity of natural, human (labor), and physicalcapital (arrow i in figure 1.4). Specifically,green policies can achieve the following:• Increase natural capital through bettermanagement of scarce resources. Individualtransferable fishing quotas, for example,

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 37FIGURE 1.4Green policies hold the potential to sharply boost outputoutputshifted production frontiermaximumoutputactualoutput(iii)(ii)production frontierenhanced efficiencysuboptimal productionZ(i)Z = composite of human (labor), physical,and natural capitalNote: Arrow (i) represents increase in factors of production. Arrow (ii) represents enhanced efficiency and stimulus effect. Arrow (iii) represents shift inproduction frontier.help maintain and even increase fi sheriesand thus the economic activity thatdepends on them (box 1.3).• Increase labor by improving health(Hanna 2011). Better environmental policiescan decrease atmospheric pollution incities, reduce the severity and incidence ofrespiratory diseases, increase labor effectiveness,and reduce days lost to illness. Astudy on the link between air pollution andlabor productivity on farms in Californiashows that a decrease in ozone concentrationsof 10 parts per billion (for an averagevalue of 50 parts per billion) increasedworker productivity by 4.2 percent (GraffZivin and Neidell 2011).• Increase physical capital by better managingnatural risks, which in turn leadsto lower capital losses from naturaldisasters (Hallegatte and others 2007).Protecting mangroves, for instance, notonly protects biodiversity, it can alsoimprove the resilience of coastal zonesto hurricanes and storm surges, therebyreducing economic losses caused bycoastal floods.Efficiency effectThe efficiency channel works by increasingproductivity, through correcting marketfailures and influencing behaviors, andby enhancing the efficiency of resource use(arrow ii in figure 1.4). One example isenergy efficiency. Many firms and householdsfail to make cost-effective energyefficiencyinvestments—probably becauseof market failures and behavioral biases(Gillingham and others 2009). Improvingthe insulation of new buildings is often costeffective,but firms and households oftenfail to do so because of a lack of informationand the fact that building and housingprices do not adequately reflect differencesin heating costs. Environmental policiesthat aim to reduce energy consumption andcarbon emissions may correct these market

38 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 1.3Using individual transferable quotas to revitalize fisheriesLack of property rights in the sea has led to overfishing—insome cases with devastating results. Theuse of individual transferable quotas (ITQs) can correctthis market failure, increasing both output andemployment in the fishing industry.ITQs operate by setting a cap on the total allowablecatch (TAC). The cap is set at a level that isconsistent with the long-term survival of the species(that is, less than the rate of growth of the fish stock).Once a TAC is set, it is divided into individual quotas,the amounts that particular boats or skipperscan catch. Only quota owners are allowed to fi sh.If the TAC changes from year to year, the numberof tons represented by the quota also changes, butthe fraction of the TAC assigned to individuals doesnot. These quotas are transferable: they can be sold,given, or bequeathed to others. (A related approachis that of “catch shares,” under which each boat orowner is entitled to a share of the TAC but the sharesare not transferable.)The value of the ITQ depends on the productivityof a fishery—1 percent of a thriving and productivefishery with large fish stocks is worth far morethan 1 percent of an almost-extinct fishery. The ITQsystem thus provides an incentive for quota owners(fishers) to invest in the long-run health of theirfishery. The quotas generally represent a substantialshare of fishers’ wealth; if they overexploit the fishery,they thus risk impoverishing themselves. Underthis system, they have an incentive to leave fish in thewater to breed and generate future catch, an incentivethey otherwise lack. ITQs align the interests offishers and the fishery, generally improving both thehealth of the fishery and the profits of the men andwomen who depend on it.Are ITQs making a difference? In studies of morethan 11,000 fisheries, 121 of which had institutedITQs, Costello and others (2008) and Heal andSchlenker (2008) find a substantial increase in catchwithin a few years of the implementation of ITQsand a significant decrease in the chance of a fisherycollapsing once it is managed as an ITQ. On average,within 17 years of implementing an ITQ, the catchat fisheries with ITQs rose by a factor of five, withyields of some fisheries rising by a factor of 200. Theinstitution of ITQs allows fisheries to prosper, generatingbetter livelihoods for the people who work inthem and more food for the world as a whole.failures or influence these behaviors, leadingto less environmental damage and toa more efficient economy, with a highergrowth potential.Stimulus effectThe stimulus channel can occur during aneconomic recession, when capacity utilizationand employment are low (also arrowii in figure 1.4). Large investments in greeninfrastructure increase demand, potentiallyincreasing employment over the shortterm (Zenghelis 2011). Underemploymentis not always related to demand, however;it can be structural, especially in developingcountries. 7 In this case, a stimulusmay prove costly and do little to increaseemployment.Innovation effectEnvironmental policies can shift the productionfrontier (increasing the potentialoutput the economy can produce) by acceleratingthe development and disseminationof innovation and creating knowledgespillovers (arrow iii in figure 1.4). 8 Giventhat investments in knowledge tend tobe lower than desirable in the absence ofpublic intervention, policies that encouragegreen technologies can thus usefullyincrease R&D (Acemoglu and others 2012;Fischer and Newell 2008; Gerlagh 2006;Otto and Reilly 2008). 9 (The opposite effectis also possible, as research on green technologiescould crowd out research on otherproductivity-increasing technologies [Poppand others 2009].) The innovation effect is

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 39illustrated by investments in R&D on photovoltaicpower motivated by the desire tomitigate greenhouse gas emissions. Successcould make photovoltaics competitive withfossil fuels, increase the supply of electricpower, and reduce the cost of providingelectric power to remote off-grid communities(see chapter 6).At the same time, the costs associatedwith environmental efforts create a trade-offbetween environmental protection and economicproduction. For example, environmentalefforts may have the following effects:• Reduced productivity, by causing producersto use more expensive or less productivetechnologies or by crowding outR&D in nonenvironmental domains.• Early retirement of physical capitalbased on polluting technologies (Grubband others 1995; Jaccard and Rivers2007). This effect can be represented asa decrease in capital or an increase incapital depreciation. In addition to thedirect cost, the increase in investmentneeded to replace retired capital reducesconsumption—and thus welfare—atleast over the short term.• Increases in the pricing of some goodsand services, altering relative prices.By changing the structure of demand,environmental policies may reduce theability of the structure of production tomeet demand. For example, policies mayreduce demand in some sectors that havea high production capacity (such as roadtransport) and may increase demand insectors that have more limited productioncapacity (such as public transportation).This effect can be measured aslower efficiency.These costs, and their assessment,depend on the defi nition of economic output.In a green accounting framework thatincludes valuation of ecosystem services, areduction in economic productivity becauseof environmental regulations can be morethan compensated for by a reduction inexternalities—through, for example, thepreservation of ecosystem services (a topicexplored in chapter 2).What about welfare?Ultimately, however, what matters is welfare,not output. The next step, therefore,is to broaden the framework to take intoaccount the impact of the environment onwelfare (or utility), which can be positive ornegative. Welfare can be assessed by viewingutility as depending on the current levelof consumption and the direct effect of theenvironment (through its health effects andamenity value).Welfare also depends on income distributionand employment. As such, analysts musttake into account the fact that environmentalpolicies may affect different social groups orregions differently. These policies may createjobs for some types of workers in someregions and eliminate jobs for other typesof workers in other regions. Because womentend to be more dependent on common propertyresources and more vulnerable to theimpacts of natural resource degradation thanmen (Foa 2009), environmental protectionand green policies can also help improve genderequality, with many economic and socialco-benefits. These distributive effects haveboth social and political economy implicationsthat may require the implementationof complementary policies to compensatelosers (see chapter 2). If compensatory financialtransfers are possible at zero cost andlabor markets are perfect, efficiency canbe separated from equity. If such transfersare impossible or costly and labor marketsare imperfect, it is necessary to pursue efficiencyand equity simultaneously, which mayrequire setting more modest goals (Goulderand Parry 2008).Analysts must also factor in the factthat environmental policies can increaseor decrease volatility. These policies cancreate shocks in the economy and candistort intertemporal trade-offs. But theycan also reduce potential risks to growthby increasing resilience to environmental

40 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 1.4Reducing vulnerability to oil shocks by increasing energy efficiencyThe vulnerability of the world economy to oil shockshas diminished since the 1970s (Nordhaus 2007).Possible explanations for this decline include thedecrease in the average oil intensity of world GDP;the increased flexibility of labor markets (in particularwages), so that pass-through inflation is lesslikely for a given monetary policy; a change in thenature of oil shocks (the 1973 and 1979 shocks followedsupply disruptions; the 2008 shock resultedfrom increased demand from emerging markets); andimproved confidence in monetary policy, which stabilizedinflationary expectations as a result of nearlythree decades of low and stable inflation (Blanchardand Gali 2010; Gregorio and others 2007).Specific energy security policies drove the decreasein GDP oil intensity. In some countries, higher taxeson gasoline consumption reduced oil consumption.In others, norms and regulations reduced energyconsumption by cars, industries, and the residentialsector.Over the longer term, climate policies may havesimilar results: by driving technological change andinvestment away from oil-intensive patterns, thesepolicies reduce oil consumption and vulnerabilityto oil shocks (Rozenberg and others 2010). Climatepolicies can thus reduce vulnerability to oil scarcityand uncertainty over oil reserves. In particular,such policies might reduce the obsolescence ofcapital in case of large changes in energy prices.Cities that are denser, less dependent on individualvehicles, and less energy consuming are also lessvulnerable to volatility in oil prices (Gusdorf andHallegatte 2007). Climate policies and other policiesaiming at higher efficiency in the use of naturalresources can thus increase the security and resilienceof the economy.shocks (such as natural disasters) or economicshocks (such as oil shocks or spikesin commodity prices) (box 1.4). 10 In sodoing, they can stabilize output and consumption,increasing welfare if risk aversionis accounted for.Trade-offs and synergiesbetween green policies andgrowthArmed with this framework for green growth,how do policy makers weigh the trade-offsbetween the costs (possible reductions ininvestments, income, and consumption) andbenefits (possible improvements on the environmental,social, and economic fronts)?Given that the net impact varies dependingon the policy considered, the context, andthe time horizon, 11 a start is classifying thepotential benefits of green growth policies, asdone in table 1.1. In a green growth context,any new policy should be examined for waysto maximize the potential for short-term benefitswhile minimizing the costs.Measuring the net impacts of green growthpolicies also requires capturing suboptimalconditions caused by market or governmentfailures or nonrational behaviors. Modelsbased on first-best assumptions (perfect markets,rational expectations, and so forth) canassess the costs of these policies in a perfectworld; they cannot be used to estimate theirbenefits.The balance between costs and benefitswill be affected by how they are defined. Ina narrow economic framework, a policy toprotect a mangrove forest has an economicopportunity cost (because it prevents shrimpfarming or tourism development, for example)and no direct benefit. In contrast, in aframework that includes the valuation ofecosystem services, the policy also has economicbenefits, including protection againstcoastal storms, the creation or maintenanceof a breeding ground for fisheries, and theavailability of wood for the local community.The “green accounting” approach incorporatesthe valuation of ecosystem services intonational accounts, thereby providing a much

AN ANALYTICAL FRAMEWORK FOR INCLUSIVE GREEN GROWTH 41TABLE 1.1Potential benefits of green growth policiesType of benefit Impact on welfare Channels through which policy affects welfareEnvironmental Increases welfare directly Improved environmentEconomic Increases welfare by raising income Increase in factors of production (physical capital,human capital, and natural capital)Accelerated innovation, through correcting marketfailures in knowledgeEnhanced efficiency, through correctingnonenvironmental market failures and influencingbehaviorsSocialIncreases welfare through distributional effects,reduced volatility, and other social indicatorsIncreased resilience to natural disasters, commodityprice volatility, and economic crisesJob creation and poverty reductionbetter measure of trade-offs than traditionalnational income accounting. As such, it iscentral to green growth strategies.In sum, although many observers fear thatgreen policies require incurring large costsnow for benefits that will materialize only inthe long term, the reality is that many of thebenefits can occur in the short and mediumterm. Moreover, green policies can contributeto growth. Action therefore needs to be takennow—at least on issues that carry a risk oflock-in and irreversibility—to minimizeregret and avoid costly policy reversals. Inthe next two chapters, we look at the crosscuttingissues of market and governance,beginning with the range of tools that can bemarshaled to change behavior with respect toenvironmental and natural resources—toolsthat aim to improve social welfare throughgreener growth.Notes1. Kuznets argued that as a country developsand national income rises, inequalityincreases, but once a certain national incomelevel is reached, inequality then declines. Hisnow disproved theory was extended to theenvironment, where it has also been rejected(Andreoni and Levinson 2001; Barbier 1997;Brock and Taylor 2010).2. Another common interpretation is that theenvironmental Kuznets curve reflects structuraltransformation of an economy. Aseconomies become more industrial, environ-mental quality deteriorates. But as economiesshift from industry to services, environmentalquality improves.3. In some cases, even specialists debate theimportance of these relationships.4. Later efforts to explicitly model the environmentinto an endogenous growth frameworkinclude work by Smulders (1994) andBovenberg and Smulders (1996); for a review,see Smulders (1999).5. Few studies examine the potential for substitutingother inputs for natural capital(Markandya and Pedroso-Galinato 2007).6. It may be possible to compensate for the lossof natural capital with other types of capitalin the short term but not the long term. Anexample would be increasing the use of fertilizerto compensate for soil degradation—a short-term solution that is not sustainableover the long term.7. For an illustration of this point in the contextof South Africa, see World Bank (2011).8. This argument on the impact of green policieson productivity is the macro-scale equivalentof the Porter hypothesis (Porter and van derLinde 1995), which states that regulationcan enhance innovation and business performanceat the micro scale (for a review, seeAmbec and others 2011).9. A frequently asked question is whether publicsupport of green innovation should targetgreen innovation or general innovation. Theopposite question—can green innovationpolicies accelerate innovation in general?—isposed here.10. Hallegatte (2011) suggests that developmentcan increase or decrease risk, depending

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Influencing Firms, Consumers,and Policy Makers through Marketand Nonmarket Mechanisms2Key Messages• Because economic incentives promote efficientsolutions, “getting the prices right” iskey to greening growth without slowing it.Complementary policies will be needed tomitigate negative distributional impacts.• Economic incentives cannot induce all of thechanges needed to protect the environment,given market failures, behavioral biases, andpolitical economy considerations.• Other tools—such as information judiciouslydeployed to influence economic actors, andnorms and regulations—are also needed.The starting point in greening growthis an understanding of why so muchof traditional economic growth hasbeen “non-green”—that is, why the worldis not using environmental assets efficiently,a reality that is harming economic growthand the environment.For economists, achieving greener growthis fundamentally about changing the incentivesthat have led to environmental degradationand depletion—that is, “gettingthe prices right.” The reasons markets arefailing to appropriately price the environmentand thus create incentives to encouragegreener growth are many (Sterner 2003).They include institutional and policy failures;market failures, such as externalities,the public-good nature of many environmentalgoods; and missing or incompleteproperty rights (box 2.1). With a commonpool resource like a fishery or a shared aquifer,for example, the lack of property rights(such as individual quotas) can lead to overexploitationand ultimately a collapse of theresource.For psychologists, achieving greenergrowth is about compensating for behavioralbiases, tailoring information and messagesto the way people learn, and improving theway in which environmentalists and economistscommunicate the costs and benefits ofgreener behaviors. Examples include socialmarketing campaigns that changed socialnorms around water usage in Australia or45

46 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 2.1 Institutional and market failures that help explain why growth is oftenenvironmentally unsustainableGrowth may be environmentally unsustainablebecause of institutional and policy failure. Institutionsand governments may themselves face badincentives, driven by political economy. Or they maylack information on the overall impact of the policiesthey promote. Subsidizing energy “to benefit thepoor” is a classic example—the subsidy encouragesenergy consumption, thereby increasing emissionsof local air pollutants that often disproportionatelyaffect the health of the poor. Moreover, it is generallythe nonpoor who benefit most from energy subsidies,because they can afford an energy-intensivelifestyle.Alternatively, market failures may be to blame.Under some technical assumptions, competitive marketsare an efficient means of allocating goods. Butreal markets deviate from the ideal in a multitudeof ways that can have severe consequences for theenvironment and social welfare. Examples includethe following:• Externalities. These are uncompensated damagesimposed by one economic agent on another. Forexample, a factory owner can maximize profitsfrom production by releasing untreated effluentsinto a river rather than incurring the costs oftreatment. But the resulting water pollution candamage the health of people drinking the waterdownstream. This health damage is external to theprofit-maximizing decisions of the factory owner,with the result that the social benefits from productionare less than private profits.• Public goods. Many environmental assets have apublic-good nature—they provide services, suchas amenities or the regulation of water flow, thatare nonrival (one person’s enjoyment of the amenitydoes not decrease another person’s enjoyment)and nonexcludable (there is no practicalway to prevent people from enjoying an amenitysuch as a beautiful view). The result is that publicgoods are typically underprovided by private markets,because there is no way for private actorsto appropriate all the benefits from providing thepublic good.• Information asymmetries and agency problems. Ifdifferent agents have different information, environmentalimpacts can result. Factory ownerstypically have much more information about pollutants,treatment measures, and treatment coststhan environmental regulators, which can reducethe effectiveness of regulation. Landlord-tenantrelationships lead to a type of agency problemwith regard to energy efficiency: If the landlordpays the energy bills, the tenant has no incentiveto conserve energy; if the landlord owns the furnacebut the tenant pays the energy bills, the landlordhas no incentive to invest in a more efficientfurnace.• Missing or incomplete property rights. For commonpool resources (for example, a fishery or ashared aquifer), the lack of property rights (suchas individual quotas) can lead to overexploitationand ultimately the collapse of the resource. Froman economic perspective, overexploitation manifestsitself as dissipation of resource rents: in theabsence of quotas, exploitation efforts by users ofthe common pool drives up costs to the point atwhich economic profits drop to zero.Source: Sterner 2003.littering behavior in the United States. So forpsychologists, incentives also matter but theymust be tailored to how people process informationand react to it.Unfortunately, inappropriate incentives,or the lack of incentives, led to the currentwidespread inefficiency in the way naturalresources are used. This chapter examinesthe range of tools that can be marshaledto increase effi ciency by changingbehavior with respect to the environmentand natural resources—tools that aim toincrease social welfare through greenergrowth. The tools fall into the followingareas:• Incentivizing: providing effective marketsignals to spur green growth• Informing and nudging: using informationand framing to influence economicactors• Imposing: using rules and regulations.

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 47Incentivizing, informing and nudging, orimposing—some combination of the threeis likely to be needed. Determining the bestmix requires a solid understanding of howindividual decisions are made and framed.Behavioral economics and social psychologythus provide indispensable insights intohow to green growth. Economists will ignorethem at their peril.Incentivizing: Providing effectivemarket signals to spur greengrowthEconomic incentives promote efficientsolutionsEconomic incentives—traditional price andquantity instruments—are critical to promotinggreen outcomes, because they changebehavior in a manner that typically leads toleast-cost solutions. The intuition behind thisapproach can be seen in markets for tradablepollution emission rights. Because pollutingfirms use different technologies for production,their pollution abatement costs differ,often markedly. Firms with high marginalabatement costs therefore tend to prefer topollute more and purchase permits fromfirms that have low marginal abatement costsand find it profitable to invest in less pollutingprocesses and sell their pollution rights. Thistrade allows the market to minimize the overallcost of achieving a given pollution target.Economists recommend a variety ofincentive-based instruments to reduce environmentaldamage and depletion—such astaxes, tradable permits, subsidies, depositrefundschemes, and refunded emissionpayments—that focus on either price orquantity. In the case of carbon dioxide(CO 2), for example, the debate has centeredon emission taxes, subsidies, and tradableemission permits.Price instruments. These instrumentsaim to change behavior by ensuring that theprices paid for goods and services reflect theirfull social costs, including externalities. Tothe extent that environmental taxes replaceother distortive taxes (say, on labor), therecan be a double dividend. Countries in theOrganisation for Economic Co-operation andDevelopment (OECD) have imposed some375 environment-related taxes and about250 environment-related fees and charges(OECD 2006). However, about 90 percent ofrevenues from these taxes comes from taxeson fuels and cars (OECD 2011). The majorityof OECD countries also tax water usagein agriculture. Although they appear to haveimproved water efficiency, these price instrumentsstill fall short of full cost recovery(OECD 2010, cited in OECD 2011).In addition to reflecting social and environmentalcosts in prices through taxes,“full-cost pricing” implies the phasing out ofharmful subsidies, such as subsidies on fossilfuels, fisheries, forestry, water use, landuse, and agriculture. These subsidies not onlyencourage carbon emissions, resource depletion,and environmental degradation, theyalso distort trade and strain public fi nance.Reforming them should be a high priority,although it may not be easy.Quantity instruments. Unlike pollutiontaxes and subsidy reforms, which affectexisting markets, quantity instruments (suchas tradable permit schemes) create new marketsfor pollution allowances by affecting thecosts of production. Once these new marketsreach equilibrium and the permit priceis determined, the cost of acquiring pollutionpermits affects the costs of production in amanner equivalent to a pollution tax. Tradablepermits or quotas have also shown goodresults in managing renewable environmentalassets, notably fisheries.“Cap and trade” schemes for pollutionemissions have become the dominantmarket-based approach to controlling oxidesof sulfur (SO x) and nitrogen oxides (NO x) inthe United States, in the European Union’sEmission Trading Scheme for CO 2, and inmany other jurisdictions. The basic principleis that regulators determine the totalallowable emissions per year (the cap) andallocate permits to polluters based on a varietyof schemes (including “grandfathering”based on historical emissions or auctioningof all permits); fi rms are then free to trade

48 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTpermits. The evidence on the efficiency of theU.S. SO xtrading scheme is positive: marketshave been liquid and permit prices (hence,total cost to firms) have been lower thanoriginally estimated (Fullerton and others1997). Moreover, international experiencewith CO 2emission trading schemes suggeststhat they can be used to assign a price to pollutingemissions from large sources, althoughimplementation can be difficult (box 2.2).Price versus quantity instruments.Although price schemes and cap and tradeschemes are theoretically equivalent instruments,they have distinctive characteristicsin practice (World Bank 2010). For example,permit systems create certainty regardingemission reductions but uncertainty aboutprice; taxes provide certainty regarding pricebut uncertainly about emission reductions.They also differ regarding economic andadministrative efficiency and their ability togenerate revenues (theoretically both do, butin practice countries have tended to allocatepermits free of charge). As such, many jurisdictions,particularly in Europe, have optedfor hybrid schemes to control carbon emissions:tradable permits for large emittingsectors and taxes for smaller sectors characterizedby many actors, such as transport.But imperfect markets and politicaleconomy complicate mattersAlthough in theory, economic incentive–based instruments are the most effective, inpractice, market imperfections and politicaleconomy mean that additional measuresmay be needed to make these instrumentsmore efficient. One well-known case concernsinnovation and long-lived investments,for which prices are not always efficient (seechapter 3). But there are other circumstancesBOX 2.2Lessons from CO 2emission trading schemesA review of existing and proposed carbon tradingschemes in Alberta, Australia; the European Union(EU); New Zealand; Switzerland; Tokyo; and theUnited States (both national and state-level schemes)shows that these schemes are complex to implementbut can be used to create a price of carbon for largeemitters. To implement them effectively, policy makersshould keep in mind the following dos and don’ts:• Targets. Ambitious long-run targets are neededif firms are to invest in reducing their carbonfootprints.• Allocation. Free allocation of permits to producersin the electricity generation sector should beavoided, because it leads to windfall profits at theexpense of consumers (electric utilities are typicallyfree to pass costs along to consumers). Freeallocation to new entrants should also be avoided,because it risks locking in high-carbon footprints(by, in effect, subsidizing a new source of emissions).The EU Emission Trading Scheme is reducingthe free allocation of permits.• Start-up. Trading schemes have tended to overallocatepermits in the initial phase, leading to a pricecollapse. Allowing permits to be banked—that is,allowing permits from one period to be used insubsequent periods—can overcome this problem,but this solution simply carries forward the surpluspermits into the next phase. Other options includeestablishing a price floor, with cancellation of anyunsold permits, or initially using a fixed price toaid the collection of data on emissions and abatementcosts that can then be used to determine thesubsequent allocation.• Offsets or links to other trading zones. Tradingoutside the permit scheme can help reduce permitprices, but doing so runs counter to policy goalsto reduce domestic emissions and provide incentivesfor innovation in achieving this reduction.• Support to carbon-intensive sectors. Concernsabout the competitive impacts on carbon-intensivesectors will lead to lobbying for financial supportto these sectors. Any support should be time limited,and communicated as such, to reduce fiscalcosts and provide incentives for firms to invest inless polluting technologies.Source: IEA 2010.

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 49in which narrow reliance on incentive-basedinstruments is misplaced. These includecases when:Feasible alternatives are lacking. For pricingmechanisms to be successful in addressingenvironmental issues, feasible alternativesmust be readily available or easily broughtto market. One example is high fuel prices,which will be more effective at reducing individualcar use if public transport is availableor cities have been designed in such a waythat walking or cycling are options. Anotherexample is the emissions pricing scheme ofthe U.S. acid rain program, which successfullyreduced SO 2because the required technologieswere available and well understood(Zysman and Huberty 2010). In this case,prices were a powerful incentive for adoptingexisting alternative technologies.Market imperfections exist. Prices maybe ineffective incentives because of marketimperfections or imperfect contracts. Forexample, contracts may need to be designedin a particular way to address the principalagentproblem (the difficulty of motivatingone party [the agent] to act on behalf ofanother [the principal]). An example is whenbuilding owners are responsible for insulationand heating systems but tenants pay energybills; if owners cannot transfer the cost ofhigher energy efficiency through higher rents,they will under-invest in energy efficiencyregardless of energy prices.Another example is flood insurance if it isnot “risk-based”—that is, if the premium isnot calculated as a function of the risk level,which is itself based on the characteristicsand location of the asset. Insurance that is notrisk-based creates a moral hazard problem, asit reduces incentives to invest in prevention.Households or businesses investing in riskmitigation improvements (such as a reinforcedroof or windows) are not rewardedfully for their investments. Moving towarda “risk-based” premium would encourageprudent behavior. However, this approach isdifficult to implement with one-year insurancecontracts, because investing in riskmitigation produces benefits over decades—meaning that a homeowner who sells hisor her house may not be able to recoup thebenefits from the investment. In this case,attaching a long-term insurance contract tothe property rather than the owner couldhelp create the right incentives (Kunreutherand Michel-Kerjan 2012).Prices are difficult to change. The factthat so much pricing is currently inefficientsuggests complex political economy considerations.Whether it takes the form of preferentialaccess to land and credit or accessto cheap energy and resources, every subsidycreates its own lobby. Large enterprises (bothstate owned and private) have political powerand lobbying capacity. Energy-intensiveexport industries, for example, will lobby forsubsidies to maintain their competitiveness.In emerging economies, industries that arelikely to be most affected by climate changepolicies are export-based industries, whichare also the most influential and most able tooppose environmental policies (Mattoo andothers 2011; Victor 2011). Thus, governmentsneed to focus on the wider social benefits ofreforms and need to be willing to stand up tolobby groups (box 2.3).In considering pricing reforms or theintroduction of new taxes, policy makersneed to consider social impacts. Increasingenergy prices, for example, has far-reachingimpacts, because energy is used pervasively inproduction and in households. And althoughenergy subsidies almost invariably benefit therich much more than the poor, their removalcan have devastating impacts on the purchasingpower of the poor (Arze del Granadoand others 2010). 1To prevent this from happening, policymakers need to adopt complementary policies,such as the use of existing safety nets(where available), alternative short-term mitigationmeasures and subsidies, and energypricingsolutions. In middle- and high-incomecountries, social safety nets can be used forcompensation. In low-income countries,where safety nets are often lacking, ad hocmeasures are frequently necessary. Informationto target support is often not available,especially in urban areas, where geographictargeting is very inefficient (Kanbur 2010).

50 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 2.3The political economy of subsidy reformWhat lessons have been learned about subsidyreform? An analysis of the political economy of subsidyreform—which looks at the few attempts thathave been successful—suggests the need for carefulanalysis of the likely social impact of the reform andimplementation of a program of appropriate supportfor those affected (Nikoloski 2012). Other elementsof success include political will and institutionalcapacity, as well as an effective communications andoutreach strategy that explains the justification forthe reform and the benefits to be derived from it.As for the timing and pace of the reform, there isno clear lesson as to whether “big bang” or gradualapproaches are more successful.Another study, which focuses on petroleum productsubsidies, confirms the importance of addressingthe political logic that led to subsidy creation andeither compensating the political interest that wouldotherwise oppose reform or finding a way to insulatethe reform from its opposition—advice that appliesto any subsidy reform (Victor 2009). In addition, itis critical to ensure the transparency of the costs andpurpose of the subsidy. Reforming a subsidy may beeasier if all members of society are fully aware of thecosts they are paying and the extent to which they orothers are benefiting.Moreover, the political economy ofreform will likely require compensatorytransfers to the middle class. In the IslamicRepublic of Iran, for example, where thelaw that reformed fuel and food subsidiesstipulated that 50 percent of the revenuesraised had to be redistributed to households,the initial thought was to target the bottom30–50 percent of the income scale. Inthe end, 80 percent of households receivedsignificant transfers (Guillaume and others2011)—no doubt contributing to the successof the reform.In the end, the redistributive impacts of acarbon price scheme depend on how revenuesfrom the scheme are used. Compensatorymeasures can offset unwanted distributionaleffects. However, such schemes require theinstitutional capacity to manage the classicalchallenges of redistributive policies: politicalacceptability, imperfect information and targeting,and behavioral issues.To be effective, incentives mustreflect behaviorsDesigning effective environmental policiesrequires a good understanding ofhow behaviors are determined and howthey can be influenced. 2 The hypothesis ofrational behavior—under which price-basedinstruments are optimal—is only a roughapproximation of how people actually makedecisions. In practice, individuals make decisionsin a variety of ways: “by the head”(based on calculation), “by the heart” (basedon emotion), and “by the book” (based onrules) (Weber and Lindemann 2007). Alternativeor complementary policies and measuresare therefore needed to address behavioralbiases or changes in values and preferences.Four types of behavioral biases areparticularly important. First, “cognitivemyopia” prevents people from accuratelybalancing future benefits and immediatecosts and from assessing the desirabilityof reductions in immediate benefits inexchange for future gains (Ainslie 1975;Benartzi and Thaler 2004).Second, individuals are inconsistent intheir treatment of time (Ainslie 1975): theyapply high discount rates to costs and benefitsthat will occur at some point in thefuture, discounting much less when bothtime points are in the future and one occurslater than the other, in a kind of “hyperbolicdiscounting.” These biases explain why itis difficult to implement policies that entailimmediate costs but future benefits even ifthe result is a net (discounted) gain. A classicexample is the failure of consumers to buymore energy-efficient appliances even when

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 51future energy savings would more than compensatefor higher up-front purchase costs(Gillingham and others 2009).Third, individuals suffer from “lossaversion”—that is, they weigh losses morethan gains, evaluating both relative to a referencepoint (Tversky and Kahneman 1992).If individuals use the current situation as thereference point, they will consider the cost ofenvironmental policy as a loss and weigh itmore heavily than the gain (averted environmentaldamages). If the reference point is thefuture, when the loss is the environmentaldestruction, they will weigh it more heavilythan the gain (the averted cost of environmentalpolicies). Weber and Johnson (2012,16–17) make the following observation aboutfarmers:Skillful insurance salespeople have long knownthat they need to move a farmer’s referencepoint, away from its usual position at the statusquo, down to the level of the possible large lossthat could be incurred in case of drought. Byfocusing the insuree’s attention on the severity ofthe possible loss and resulting consequences, allsmaller losses (including the insurance premium)are to the right of this new reference point, makingthis a decision in the domain of (forgone)gains, where people are known to be risk averseand will choose the sure option of buying theinsurance.Fourth, individuals have an aversion toambiguity, which causes them to delay makingdecisions (Tversky and Shafir 1992). 3Aversion to ambiguity is particularly problematicfor environmental issues, such as climatechange, that involve huge uncertainties:while it disappears if decision makers regardthemselves as expert in a domain (Heath andTversky 1991), few people consider themselvesexperts in environmental policy.Different behavioral changes can betriggered by different learning processes—such as learning by being hurt, being told,and observing and imitating (Weber andJohnson 2012).Learning by being hurt. Learning bybeing hurt refers to learning from personalexperience. Because recent events have astrong impact, which recedes over time(Hertwig and others 2004), reactions tolow-probability, high-severity events oftenappear erratic. In particular, people usuallyoverreact when a rare event eventuallyoccurs (Weber and others 2004). Forinstance, extremely ambitious flood defenseprojects were designed after each big floodin New Orleans, but none has been completedso far, as public interest in the issuefaded a few years after each event. Thistendency to overreact to recent events andthen forget needs to be taken into accountin developing green growth strategies, especiallyfor disaster risk management (Hallegatte2011).Learning by being told. Learning bybeing told involves the absorption of objectiveinformation. For instance, hydrometeorologicaldata can be collected and analyzedto generate quantified risk assessments thathelp individuals make informed choices. Butproviding information will not be enoughto induce appropriate risk management orenvironment-friendly behavior, becausepeople treat abstract information on distantevents differently from concrete, emotionallycharged information linked withreal-world experience (Trope and Liberman2003). So what is needed is a combinationof communication tools that accounts forthis bias and practical information on whatneeds to be done—for instance, rules tosave energy or water or how to react in caseof disasters.Learning by observing and imitating.Learning by observing and imitating hasthe concreteness that “being told” does nothave, making action more likely. One way ofencouraging learning by observing and imitatingis to help individuals compare theirbehaviors with more environment-friendlyones and to provide them with feedback ontheir consumption and with tips on how tochange their behaviors. In one experiment,an Internet-based tool that combined feedbackon past consumption, energy savingtips, and goal setting was used to encouragehouseholds to reduce their energy consumption.Households with access to thetool reduced their direct energy consumptionby 5 percent; household without accessto the tool increased their consumption by

52 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENT0.7 percent (Abrahamse and others 2007).Indicators are thus critical—even when theyare imperfect—because they allow individualsto monitor their effort.All of these biases vary with cultureand education (Weber and Hsee 1998). Forinstance, individuals with greater abilityto reason with numbers are more likely torely on calculation-based processes to maketheir decisions (Peters and others 2006).This diversity means that policy makers mayneed to align their approaches with the cognitivebiases present in a given country orpopulation. 4Informing and nudging: Usinginformation and framing toinfluence economic actorsMany motives other than price signals driveindividuals’ behavior. It is therefore criticalthat information on the environmental consequencesof their actions go beyond price.Information needs to be framed in a mannerthat accounts for behavioral biases andthe ways in which people learn and makedecisions. Governments have a role to playto ensure that the required information isproduced and disseminated effectively. Fortunately,they can rely on the experiencegained from decades of public health campaigns.However, a vibrant civil society willbe essential to ensure that action followsinformation.Informing to influence policy makers:The role of green accountingEnvironmental assets are seldom tradedthrough markets and thus do not have readilyidentifiable prices. In such cases, developmentdecisions (such as building a road through arainforest) are often made with incompleteinformation. As a result, they may not maximizesocial benefits. Given that the outputsof environmental projects generally do havea readily identified economic value—a roadmay increase the access of farmers to marketsand thus increase food production—it is vitalthat economic values for environmental assetsbe comparable to other economic values.Environmental valuation can help in anumber of ways:• It estimates people’s willingness to payfor environmental goods and services orwillingness to accept compensation forthe loss of an environmental asset (Boltand others 2005; Ley and Tran 2011).• It assesses the value of the services providedby natural ecosystems. Becauseecosystem services are typically providedas externalities—for example, an uplandforest provides water regulation servicesto lowland farmers—the natural systemsproviding these services may be at riskwhen decisions are made that ignore theflow of services from natural areas andtheir benefits to people.• It establishes the schedule of marginalbenefits associated with the provisionof different quantities of environmentalgoods and services—such as changes inthe volume of pollution emitted. Thisinformation is useful when setting taxrates on environmental “bads” or whendetermining total quota sizes, such asthe number of pollution emission permitsthat will be issued in a given time period.• It facilitates “green accounting” (box 2.4),which focuses on a country’s stock ofassets (its wealth) rather than relying ona flow measure such as GDP. As such, itpromotes good economic management,identifies situations in which economicgrowth is not wealth creating (becausethe growth degrades natural resourcesfaster than it creates wealth), and assesseswhether a country’s economic trajectoryis sustainable. However, green accountingand environmental valuation are not substitutesfor price signals, because they donot affect incentives faced by individualsand firms.Informing and nudging to influenceindividuals: Tackling behavioral biasesGood design and careful interventions canhelp align individual preferences with socialgoals and address behavioral biases.

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 53BOX 2.4What is “green accounting”?All accounts serve two purposes: a scorekeepingpurpose, providing indicators on how well youare doing, and a management purpose, providingdetailed statistics so that anybody who does not likethe “score” has the information to understand anddo something about it.In standard national accounting, GDP is measuredas the market value of all goods and servicesproduced by a country within a specified timeperiod. Changes in GDP indicate whether the economyis growing, but not whether this growth is sustainable.In particular, the use or misuse of naturalcapital is not taken into account.Green accounting extends national accounts toinclude the value of the damage and depletion of thenatural assets that underpin production and humanwell-being. In particular, net saving, adjusted forthe depreciation of produced assets and the depletionand degradation of the environment, indicateswhether well-being can be sustained into the future.Negative net saving indicates that it cannot, becausethe assets that support well-being are being depleted(Asheim and Weitzman 2001; Dasgupta and Mäler2000; Hamilton and Clemens 1999).At the regional level, East Asia and South Asiahave exhibited strong wealth creation over more thana decade. In contrast, Sub-Saharan Africa, wherethe depletion of oil and minerals has been offsettingsavings by the public and private sectors, displays aworrisome trend (figure B2.4.1). At the country level,China’s near 10 percent annual GDP growth is beingpartly offset by environmental depletion and degradation,reducing its adjusted net national incomegrowth to an estimated 5.5 percent (World Bank andDRC 2012).With green accounting, the scorekeeping indicators(such as wealth accounts) can be used alongsideGDP to better assess how well a country is doingfor the long term. It also provides detailed accountsfor management of natural capital, which manycountries have adopted over the past 20 years—especially for water, energy, and pollution. However,few countries have adopted the revised macroeconomicindicators.FIGURE B2.4.1 Some regions are doing better than others in wealth creation(net saving by region, 1975–2008)15a. Genuine saving rates in LCR, MNA and SSAb. Genuine saving rates in EAP, ECA and SAR1035530% GNI0–5–10% GNI25201510–15–20197519781981198419871990yearLatin America &Caribbean (LCR)Middle East & NorthAfrica (MNA)199319961999200220052008Sub-Saharan Africa (SSA)50197519781981198419871990East Asia &Pacific (EAP)South Asia (SAR)199319961999200220052008yearEurope & Central Asia (ECA)Source: World Bank 2011.Note: GNI = gross national income.(continued next page)

54 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 2.4(continued)A new partnership—Wealth Accounting andValuing Ecosystem Services (WAVES)—is expandingefforts to account for ecological services. Botswana,a WAVES partner country, has defined one of itsoverarching objectives as to continue to grow whilediversifying away from diamonds (which currentlyaccount for about 35 percent of national income)and eradicating poverty. Several natural resource–based sectors are being tapped to play a lead rolein this development strategy, including nature-basedtourism, mining (especially coal for export), andirrigated agriculture.Water plays a critical role in Botswana’s development,given its scarcity; the increasing relianceon shared, international water resources; and thewater-intensive nature of sectors identified foreconomic growth and diversification. A key componentof WAVES in Botswana will be the establishmentof water accounts—physical supply and useaccounts as well as monetary accounts (for supplycosts, tariffs paid, and the value of water in differentuses). Water accounts will enable Botswanato answer the following questions: Is there enoughwater in the right places to support the diversificationstrategy? What are the economic tradeoffsamong competing users? How can incentivesfor water efficiency be created? In the wake of therecent privatization of water under full cost recoverymanagement, what will happen to poor households’access to water resources? The answers tothese questions are critical for helping policy makerschart the best path forward.Avoiding fear mongering. Given cognitivemyopia and people’s tendency to weighemotion-filled consequences more heavilythan abstract consequences, policy makersmay be tempted to scare people into adoptingenvironment-friendly behavior. Using“catastrophism” to make people changetheir behavior is ineffective, however, for tworeasons. First, fear is only briefly effective.Once people get used to the problem, theyrevert back to their initial behavior (Weber1997). For example, farmers informed aboutweather risks have a tendency to implementone mitigating measure (such as buyinginsurance), after which they consider theirvulnerability problem solved, without consideringhow additional action may help.Second, people have only a limited abilityto worry; an increase in worry about onehazard decreases worry about other hazards(Weber 1997, 2006). This means that a policybased on fear leads to competition amonghazards, and success in one area (for example,climate change) comes at the cost of failurein others (for example, water pollution).Greening default options. An importantbehavioral bias that environmental policymakers can use to their advantage is thetendency of people to stick with the defaultoption (box 2.5). In European countries,where organ donation is the default option,more than 85 percent of people are organdonors. In contrast, in neighboring countrieswhere people must designate themselves asorgan donors, less than 30 percent of peopledo so (Johnson and Goldstein 2003). Inthe United States, automatically enrollingemployees in saving programs and requiringthem to opt out if they preferred not to participateincreased participation from 37 percent(under the opt-in design) to 86 percent(Madrian and Shea 2001).Using nudging. In recent years, behavioraleconomists and the behavior change communityoverall have stepped up their interestin the potential role of nudges to influencebehaviors. This approach advocates tweaking“choice architectures” to nudge peopleto make better decisions about their health,the environment, or other desirable outcomeswithout restricting their freedom of choice(Thaler and Sunstein 2009). To count as anudge, the intervention must be easy, inexpensive,and voluntary. Nudges are increasinglybeing used to stimulate green behaviors;studies show promising results. For example,an electrical outlet (designed by MuhyeonKim) that displays how much power it isusing makes people more conscious of theirenergy use (figure 2.1). The Danish Nudging

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 55BOX 2.5Changing the default option to spur the use of renewable energyTo spur, rather than coerce, the purchase of renewableenergy, policy makers could rewrite the defaultelectricity purchase contract to include a minimumshare of electricity produced from renewable sources.Consumers would have to opt out to purchase theirelectricity without this constraint, at a lower cost.A study of the impact of such “green default”in electricity provision provides support for thisapproach (Picherta and Katsikopoulos 2008). Itlooked at two cases in which electricity providersoffered green options with more renewable energyand a higher price as the default option. In bothcases, fewer than 5 percent of customers decided toshift to less expensive, less green options.FIGURE 2.1Energy-reporting electrical outletSource: Webster 2012.Note: Designer Muhyeon Kim has designed a switch that displays how much power it is using. Research has found that people are more conscious of theirenergy use when they can see it in action.Network even hosts a Web site, iNudgeYou.com, dedicated to sharing applications andstudy findings.Framing decisions judiciously. The wayeconomic actors react to policies dependson many factors, including how the policy ispresented, or framed. Firms know this well,which is why they rely on marketing toolsand branding in addition to price signals. Bypriming or framing personal behavior as partof a larger social goal, the public and privatesectors can induce people to behave in moreenvironment-friendly ways, particularly whenthey act as groups, as group decisions havebeen found to be made with less selfishnessthan individual decisions (Milch and others2007). By framing environmental protectionas a “social project,” policy makers canmake individuals think in terms of social andcollective goals. For example, surveys showthat many passengers are willing to pay morefor flights to account for the environmentaldamage that flying causes. However, theirwillingness to do so depends partly on whatthe surcharge is called: simply relabeling acarbon “tax” as a carbon “offset” increasesits acceptability (Hardisty and others 2010).In addition, people are more likely toaccept increases in energy prices if they perceivethem as needed to reach an ambitious

56 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTand positive social goal than if they perceivethem as top-down government decisions toreduce oil imports or protect the climate.Germany presented its decision to graduallyreplace its nuclear plants with renewableenergy sources as a collective national projectthat positions it as a leader in the transitiontoward a greener economy. This framingmakes it more likely that the public will acceptthe resulting increases in the price of electricity.It also reduces the risk that the decisionwill be reversed by the next government.The certainty afforded by the decrease in thechance of policy reversal increases incentivesfor long-term investments in research anddevelopment and new technology.It may be more efficient to change the valuesrelated to the emotional part of decisionsthan to count on prices and other policiesto counteract emotion-based decisions. Forinstance, many consumers prefer big and inefficientcars for status-related reasons. As longas such cars provide status, raising their pricemay not reduce consumers’ desire to ownthem. For this reason, price mechanisms maybe less effective than efforts to make greenand efficient cars a status symbol (Griskeviciusand Tybur 2010). Ideally, price mechanismsand behavioral changes can reinforce eachother, as recent trends in French car purchasesshow (box 2.6).It may also be more efficient to influenceconsumer behavior through advertising thanthrough price—witness the hundreds of billionsof dollars firms spend every year toadvertise consumer products (Bertrand andothers 2009). What is true for commercialconsumption choices is likely to be true forenvironmental behaviors.Informing and nudging to influencefirms: Enabling public pressure andfocusing managers’ attentionInformation allows citizens or governments toput pressure on businesses—the goal of programsthat collect and disseminate informationabout firms’ environmental performance.This approach has been deemed the “thirdwave” in environmental regulation, aftercommand-and-control and market-basedapproaches (Tietenberg 1998). Studies showthat it is making significant inroads in termsof environmental benefits.One type of disclosure program relies onemissions data without using them to rate orotherwise characterize environmental performance.Regulations requiring U.S. electricutilities to mail bill inserts to consumersreporting the extent of their reliance on fossilfuels led to a significant decrease in fossilfuel use (Delmas and others 2007). Anothertype of scheme involves reporting regulatoryviolations. A policy of publicly disclosing theidentity of plants that are noncompliant or“of concern” spurred emissions reductions ina sample of pulp and paper plants in BritishColumbia (Foulon and others 2002).Performance evaluation and ratings programs(PERPs) report emissions data and usethem to rate plants’ environmental performance.Examples include China’s GreenWatchprogram; India’s Green Rating Project (GRP);Indonesia’s Program for Pollution Control,Evaluation, and Rating (PROPER); thePhilippines’ EcoWatch program; andVietnam’s Black and Green Books initiative(box 2.7). These programs—which requireno enforcement capacity or even a welldefinedset of environmental regulationsbut do require an active civil society, localactivism, or both—are particularly helpfulin developing countries, where weak formalinstitutions make traditional enforcement ofenvironmental regulations difficult. Thanksto advances in information technology, theadministrative cost of such programs (mainlydata collection and dissemination) is falling(Dasgupta and others 2007).Public disclosure can improve environmentalperformance through a variety ofchannels. It can have the following effects(Powers and others 2011):• Affect demand for fi rms’ products (outputmarket pressure).• Affect demand for publicly traded companies’shares and the ability of suchcompanies to hire and retain employees(input market pressure).• Encourage private citizens to sue polluters(judicial pressure).

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 57BOX 2.6Modifying car buyer behavior in FranceFrom 2003 to 2009, the average emissions of newcars in France decreased, dropping precipitously in2008 when the government introduced a “feebate”that increased the price of high-energy and reducedthe price of low-energy-consuming cars (figureB2.6.1). The average willingness to pay for a reductionof 10 grams of CO 2per kilometer increased by€536 during the period. This shift in preferencesaccounts for 20 percent of the overall decrease inaverage CO 2emissions of new cars—of which 34 percentis related to the type of cars on the market and46 percent to price effects (gasoline prices and thefeebate). The biggest preference changes occurredamong young people and rich people.FIGURE B2.6.1 A sudden shift to greener cars(average CO 2emission of new cars in France, 2003–09)160155compulsoryenergy labelsfeebategrams per kilometer150145140135130Jan-03Jul-03Jan-04Jul-04Jan-05Jul-05Jan-06Jul-06Jan-07Jul-07Jan-08Jul-08Jan-09observed emissionstrendSource: Durrmeyer and others 2010.BOX 2.7How are PERPs faring in developing countries?Performance evaluation and ratings programs(PERPs)—which are increasingly being usedthroughout the world—appear to generate environmentalbenefits. Indonesia’s Program for PollutionControl, Evaluation, and Rating (PROPER) spurredsignificant emissions reductions in wastewater discharges(García and others 2007, 2009). A qualitativeevaluation of PERPs in China, Indonesia, thePhilippines, and Vietnam found that in all programsexamined a large number of plants initiallyrated “noncompliant” rose to “compliant” overtime (in contrast, plants rated “flagrant violators”and “compliant” tended to remain in these categories)(Dasgupta and others 2007). This evidence isconsistent with the findings of other studies thatconcluded that performance ratings led to improvementsamong plants with moderately poor performancerecords but not among plants with eithervery bad or good records (García and others 2007;Powers and others 2011).

58 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENT• Build support for new pollution controllegislation or more stringent enforcementof existing legislation (regulatorypressure).• Enhance pressure from communitygroups and nongovernmental organizations(community pressure).• Provide new information to managersabout their plants’ discharges andoptions for reducing them (managerialinformation) (Blackman and others2004; Tietenberg 1998).The impact of information disclosure goesbeyond its effect on environmentally consciousconsumers. Even when environmental concernsare low and consumers are unlikely orunable to change their consumption patterns,disclosure can create an incentive for businessesto reduce their environmental impacts.Imposing: Using rules andregulationsPrice-based instruments such as taxes andpolluting permits are generally consideredpreferable to norms and standards, underthe simplifying assumptions of economicmodeling (competitive industry, no enforcementcost, and so forth) (Baumol and Oates1988; Morgenstern and others 1999). Thismay not be the case when additional complexitiesare considered (Helfland 1999).When enforcement costs and politicaleconomy constraints (such as reaction againstincreases in fuel prices) are factored in,standards-based solutions may be more efficientthan incentive-based solutions in somecontexts. Moreover, introducing a new standardmay prove easier, especially in sectorsthat are already regulated, than increasing(or introducing) prices. In such cases, existinginstitutions can be relied upon to enforce newnorms, and complex policy making may notbe necessary.That said, the enforcement costs of normsand standards should not be underestimated.Enforcement of a norm on emissions or atrading scheme requires the establishment ofemission measurement and reporting systems,which are costly to create and operate.Norms and regulations can also havenegative side effects, by favoring incumbentfirms at the expense of new entrants, therebyreducing the ability of the economy to innovateand grow (Copeland 2012). To avoidsuch a risk, policy makers must design environmentalregulation in a way that does notcreate additional barriers to entry into markets,especially for small firms, which areoften innovative and create the most jobs.Policy makers must also avoid the risk ofa rebound effect. Promoting water conservationtechnologies may increase the acreageof crops requiring irrigation, resulting in anincrease in total water consumption (Pfeifferand Lin 2010). Improving the fuel efficiencyof automobiles, by making it cheaper to drive,leads to an increase in car use, reducing by30 percent any energy gain reaped byimproved technology (Sorrel and others 2009)(box 2.8).BOX 2.8What is the best way to promote vehicle fuel economy?Are incentive-based measures or norms and regulationsmore effective in increasing individual car fueleconomy? Proponents of incentives argue that higherfuel prices are more efficient than stricter fuel efficiencystandards. The latter, they contend, increasethe costs of new vehicles, causing car owners (includingorganizations with fleets) to wait longer to replacetheir cars. The result is that fuel consumption remainsthe same rather than decreasing as owners continueto drive aging, and therefore less fuel-efficient, cars.In addition, when car owners do purchase more fuelefficientcars with unchanged fuel price, their abilityto drive more for the same price can result in reboundeffects, thus reducing energy savings and leading toincreased traffic congestion. In contrast, fuel taxescause car owners to drive less, thereby not onlydecreasing local pollution but also reducing trafficcongestion and accidents. In addition, by increasing(continued next page)

INFLUENCING FIRMS, CONSUMERS, AND POLICY MAKERS 59BOX 2.8(continued)tax revenues, fuel taxes can potentially allow other,more distorting taxes to be reduced without affectingthe budget.Proponents of fuel efficiency standards argue thatconsumers may not appropriately value fuel economywhen buying a car (Greene 2010). If consumers undervaluefuel economy, fuel efficiency standards willimprove welfare. They also argue that opposition tofuel taxes makes their imposition difficult politically.The debate over which approach is better ultimatelydepends on the mitigation burden that shouldbe borne by the automobile sector—that is, pickingan appropriate carbon price as the basis for fueltaxes. The problem is that there is no consensus asto what could constitute an “appropriate” carbonprice. Moreover, the carbon prices that have beenimplemented in the industrial sector (for example,the European Union’s Emission Trading System) arenot high enough to trigger manufacturer’s investmentsin the technologies needed to dramaticallyreduce emissions (Vogt-Schilb and Hallegatte 2011).In such a situation, fuel efficiency standards, likethe ones implemented in Australia, Canada, China, theEuropean Union, Japan, the Republic of Korea, andthe United States (An and others 2007), are a reasonablesecond-best solution, particularly when they areannounced early enough to let manufacturers adapttheir investments plans accordingly (figure B2.8.1).Standards are best applied in combination with priceincreases to minimize the risk of rebound.Figure B2.8.1 Fuel efficiency standards are key to reducing emissions from the transport sector(historical fleet CO 2emissions and current or proposed standards, 2000–25)300250grams CO 2 per kilometer, normalized to NEDC2001501005001995199719992001200320052007200920112013201520172019202120232025yearUS-LDV US-Car California-LDVCalifornia-Car Canada-LDV Canada-CarEuropean Union Australia JapanChina Korea,Rep. MexicoSources: International Council on Clean Transportation; An and others (2007).Note: The NEDC is a driving cycle used in Europe to assess car emissions. LDV = light duty vehicle.

60 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTThe efficiency of market-based instrumentsis compromised by the existence ofmarket failures that cannot be fi xed. Emissionintensity standards, for example—whichare widely considered to be less effective thanemission taxes—can be preferable in sectorswhere production has positive external consequences(for example, knowledge creation,transportation), because they generally haveless of an impact on output. Emission intensitystandards can also improve social welfarerelative to emission taxes in the presenceof market power (Holland 2009). The ideathat a unique carbon price in the economyis the optimal policy has been challenged insituations in which future carbon prices areunpredictable (Vogt-Schilb and Hallegatte2011); technologies exhibit lock-ins, makingit difficult to disseminate new technologicaloptions (Kalkuhl and others 2011); or labormarkets or revenue-raising taxes are distortionary(Richter and Schneider 2003).Norms and standards are usually costlyin economic terms. They should not beimplemented without a detailed analysis oftheir costs and benefits—but predicting andmeasuring the economic cost of regulationsand norms is difficult. For instance, a pollutionregulation can increase productioncosts for industries and lead to reduced outputand employment, but it can also favormore labor-intensive technologies and createjobs. A study of pulp and paper mills, plasticmanufacturers, petroleum refiners, andiron and steel mills in the United States findsthat the impact of regulation on employmentis industry specific and the overall impactinsignificant (Morgenstern and others 2002).When they target local public goods, regulationscan even lead to net economic gains—by reducing health impacts from pollution,decreasing health costs, and increasing laborproductivity, for instance.In an analysis of U.S. environmental regulations,Morgenstern and others (1999) findthat ex ante estimates of total (direct) coststend to exceed actual costs, suggesting thatenvironmental regulations may be less costlythan usually predicted. The overestimation oftotal costs arises not from an overestimationof per unit abatement costs (how much it coststo reduce pollution by one unit) but fromerrors in the quantity of emission reductionsachieved (how much pollution is reduced by agiven regulation). This finding suggests thatif regulation costs are often overestimated, somay their benefits.In sum, rules and regulations are generallyconsidered second-best solutions in situationswith perfect markets (markets with perfectinformation and competitive industries). Inthe real world, where settings are imperfect,they can be a useful complement to pricebasedincentives. In the next chapter we lookat the need to navigate between market andgovernance failures through the careful useof innovation and industrial policies.Notes1. In a review of energy subsidies across morethan 30 countries, Arze del Granado andothers (2010) estimate that it costs $33 totransfer $1 to poor households through agasoline subsidy. The figure is high becausethe vast majority of gasoline is consumed byhigher-income households.2. Weber and Johnson (2012) provide a comprehensivereview of this issue in a backgroundpaper for this report.3. The Ellsberg paradox (Ellsberg 1961) showsthat when faced with a choice between risk(which is represented by known probabilities)and uncertainty (in which probabilitiesare not available) decision makers display apreference for risk. This tendency is knownas ambiguity aversion.4. This is a different issue from cultural differences,which may make certain policiesunacceptable (rather than ineffective) inparticular countries. For example, Londonsuccessfully adopted congestion charges,whereas such schemes are considered exclusionaryin France, which explains why theyhave not been applied in Paris to date.ReferencesAbrahamse, W., L. Steg, C. Vlek, andT. Rothengatter. 2007. “The Effect ofTailored Information, Goal Setting, andTailored Feedback on Household Energy Use,

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Green Innovation andIndustrial Policies3Key Messages• Innovation and industrial policies are potentiallyuseful tools to spur green growth, asthey can correct market (environmental andnonenvironmental) failures, but they shouldbe designed to minimize risks from captureand rent-seeking behaviors.• More advanced countries need to investin frontier innovation through researchand development; lower-income countries(with more limited technological capacity)should focus on adapting and disseminatingtechnologies already developed anddemonstrated.• Although green growth and trade interact,it is not through the much publicized butseldom observed “pollution haven” effects.Green policies create opportunities for developingexports of green products; meanwhile,imports facilitate the adoption of greener,more efficient technologies.Brazil has supported the developmentof a biofuel industrial sector fordecades. China is subsidizing researchand development (R&D) and industrial productionof photovoltaic (PV) panels, most ofwhich it exports. Morocco is investing publicresources in producing electricity fromconcentrated solar power and plans to sellrenewable energy to Europe. In all threecases, the policy objective is both to produceenvironmental benefits and to create growthand jobs.These countries are not alone in pursuingsuch approaches. Indeed, most countries tapthese types of environmental policies—whichreally amount to green innovation policiesand green industrial policies. Some commonlyused policies include R&D subsidiesfor drought-resistant crops, national strategiesfor electric cars, and efforts to create newgreen industries such as China’s promotion ofsolar PV production.Why are these policies even needed? Gettingprices right is critical to addressing environmentalexternalities and providing theright signal for economic agents to modifytheir consumption, production, and investmentpatterns. But as chapter 2 showed,65

66 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTdoing so is diffi cult because of behavioralquirks, political reasons, market or contractimperfections, and low price elasticities(how responsive quantities demanded orprovided are to a certain price change).And prices are notoriously limited instrumentsfor transforming economies or triggeringinvestments with long-term or uncertainpayoffs. Indeed, they are ill-suited to addressthe “classic” market failures usually invokedto justify innovation and industrial policies:knowledge externalities, latent comparativeadvantage and increasing returns, informationasymmetries, capital market imperfections,and the coordination needed acrossindustries to permit a technological transition(box 3.1).Further, for green growth, getting theprice right requires pricing externalities,which requires government intervention.Future government policies (on carbon pricesor pollution limits) determine the size andBOX 3.1Market failures that can justify innovation and industrial policiesMany market failures may justify the broad innovationpolicies and more targeted innovation andindustrial policies that aim to support a specificgreen industry, firm, or technology:• Knowledge externalities and capital market imperfections.Absent government intervention, knowledgespillovers create a gap between the privateand social returns to producing knowledge thattypically leads to under-provision of knowledge.And this is amplified by information asymmetryin capital markets. Competitive innovation projectsmay struggle to find financing, making it difficultfor new businesses and activities to start.This is especially true because young businesseshave more difficulty securing financing than largeestablished companies, even though they may bevery innovative.• Latent comparative advantages and increasingreturns. Latent comparative advantages—thatis, future as opposed to current comparativeadvantages—are sometimes cited as a justificationfor industrial policies (Harrison andRodríguez-Clare 2009; Khan 2009; Rodrik2004). Industrial policies may be warrantedif the advantage includes learning or increasingreturns to scale, which require support atan early stage. When two or more technologies(some not even invented) are substitutes, profitmaximizinginnovators may focus on improvingthe productivity of existing technologies(“building on the shoulders of giants”) becausethe market for these technologies is large and thereturns are higher. Support—through productionsubsidies or trade protection—can be providedto foster new technologies.• Coordination failures. Industrial policies maybe warranted to address coordination failureswithin and across industries (Murphy and others1989; Okuno-Fujiwara 1988; Pack and Westphal1986; Rodenstein-Rodan 1943; Trindade 2005).The idea is that developing a comparative advantagein an activity can depend on another activityin the region or country. (Morocco is hopingto develop a concentrated solar industry, whichrequires creating the demand, the needed transmissionlines, and the domestic supply chain forthose parts in which Morocco can develop a competitiveadvantage—such as mirrors.) An industrialpolicy through which the government actsas the precommitment mechanism can solve thisproblem (Rodrik 2004). The same argument holdsfor “soft” industrial policies—policies that supportparticular clusters by increasing the supplyof skilled workers, encouraging technology adoption,and improving regulation and infrastructure(Harrison and Rodríguez-Clare 2009).• International rent shifting. Some industries arecharacterized by fixed costs or indivisibilitieslimiting the number of entrants and creatingoligopolies, with significant rents for installedbusinesses. A classic example is the competitionbetween Airbus and Boeing (Baldwin andKrugman 1988; Helpman and Krugman 1989).Depending on the case, it can be welfare enhancingto either introduce specific taxes to captureand redistribute the rent or support new entrantsto increase competition and reduce rents.(continued next page)

GREEN INNOVATION AND INDUSTRIAL POLICIES 67BOX 3.1(continued)• Spatial, redistributive, and political economy motivations.Industrial policies are frequently used topromote regional balance and stimulate job growthand other economic activity where unemploymentis worse, the population poorer, or a geopoliticalreason exists to promote production in an area(such as Manaus in Brazil). Industrial policies arealso used to smooth economic transitions—when,for example, structural change or trade liberalizationleads to unemployment and workers find itdifficult to shift from sunset to sunrise industries.In this case, an industrial policy can support adeclining industry to mitigate transitional costsand allow time for retraining and shifting workerstoward growing industries.profitability of the future green market. Butbecause they cannot credibly commit tofuture policies, governments create policyrisks for green firms. It thus makes sense forgovernments to share risks through investmentsubsidies. To the extent that such subsidiesreduce the future cost of green policies,they enable today’s governments to influencefuture policies: it is more likely that carbonprices will be implemented in the future ifinexpensive low-carbon alternatives are available(Karp and Stevenson 2012).For these reasons most countries resortto some form of innovation and industrialpolicies in their growth strategies. But giventhe mixed record of these policies—rife withboth successes and failures—green growthstrategies must heed the lessons from innovationand industrial policies over the pastdecades.This chapter explores the concepts ofgreen innovation and industrial policies andidentifies their main benefits and potentialpitfalls. It fi nds that they represent potentiallyuseful tools for facilitating greengrowth, provided that they are tailored tocountry contexts and that care is taken tonavigate between the risks of market andgovernance failures.Innovation policies: Tailoringmixes of instruments to acountry’s innovation potentialGreen innovation, which includes both thecreation and commercialization of newfrontier technologies and the diffusion andadoption of green technologies new to thefirm, is critical to greening growth processes.1 Achieving greener growth requiresboth green innovation policies, supportedsometimes by more targeted industrial policies,and environmental policies to createdemand where the traditional environmentalexternalities are not fully reflected in marketprices (box 3.2).Green frontier innovation is growing fairlyrapidly, albeit from a small base. But thelion’s share of this growth is in high-incomecountries, raising concerns about the abilityof developing countries to access and adaptnew technologies tailored to their needs. Afew large middle-income economies— Brazil,China, India—can become significant frontiergreen innovators; they are already leading inincremental process innovation in the wind,solar, and biofuel markets. Other countriesneed to rely on global frontier innovationefforts while developing the capacity to identify,adapt, and absorb relevant technologiesthat are new to their firms.The challenge is to combine innovationand environmental policies to make themeffective and ensure that they are suitablybalanced among policies that support frontierinnovation (relevant mostly for moretechnologically advanced countries); policiesthat promote catch-up innovation and theadoption and spread of suitably adapted technologies;and policies that improve domesticabsorptive capacity, including strengtheninglocal skills.

68 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 3.2Shedding light on green innovation, technologies, and industrial policiesGreen innovation is the development and commercializationof new ways to solve environmentalproblems through improvements in technology, witha wide interpretation of technology as encompassingproduct, process, organizational, and marketingimprovements. In addition to frontier (new-to-theworld)innovations, this defi nition includes catchup(new-to-the-fi rm) innovations—also known asabsorption—which covers the diffusion (both acrossand within countries), adoption, adaptation (to localcontexts), and use of green technologies.Green technologies comprise many fundamentallydifferent technologies to achieve more resourceefficient,clean, and resilient growth. They includetechnologies needed to achieve the following goals:• Reduce pollution and achieve greater resourceefficiency in buildings (thermal insulation andnew materials, heating, energy-efficient lighting);production processes (new uses of wasteand other by-products from firms); agriculture(from improved and resilient crop and livestockbreeds, water management, and farming systemsto mechanical irrigation and farming techniques);and infrastructure and urban design (such as landuse zoning).• Mitigate climate change through a cleaner energysupply (wind, solar, geothermal, marine energy,biomass, hydropower, waste-to-energy, hydrogenfuels); low-carbon end use (electric and hybridvehicles, climate-friendly cement); and carboncapture and storage.• Reduce vulnerability and adapt to climate changewith tools for understanding climate risks, betterearly-warning systems, and climate-resistant technologies(sea-walls; drainage capacity; reductionsin the environmental burden of disease; water, forest,and biodiversity management).• Support wealth creation from the more productiveand sustainable uses of biodiversity, includingnatural cosmetics, pharmaceutical products, othersustainable bioprospecting, nature-based tourism,more sustainable production of plants and livestock,and ecosystem protection.Green innovation policies are policies seeking totrigger green innovation by encouraging innovationbroadly (horizontal policies) or supporting a specifictechnology (vertical policies).Green industrial policies are policies aiming togreen the productive structure of the economy bytargeting specific industries or fi rms. They includeindustry-specifi c research and development subsidies,capital subsidies, and tax-breaks; feed-in tariffs;and import protection. They do not includepolicies targeting demand (such as consumer mandates),which can be met by imports without changinglocal production.In practice, green innovation and industrial policiescan be difficult to separate. Brazil’s support forbiofuels relies on a range of policy tools from broadinnovation to targeted industrial policies, with theultimate goal of triggering innovation. Germany’ssupport for solar photovoltaic power amounts toinnovation policy using industrial policy tools. Bothcountries would likely consider these efforts as partof their environmental policies.Source: Dutz and Sharma 2012 and World Bank.Frontier innovation and catch-upinnovationSince the mid-1990s green frontier innovationhas increased substantially worldwide,mostly in high-income countries (figure 3.1a).In recent years the gap between developedand developing countries for green patents—those based on key greenhouse gas–mitigationtechnologies—continued to widen, withthe richer countries granted some 1,500patents in the United States compared withonly 100 patents granted to poorer countries.Within the developing world the EastAsia and Pacific region has by far the largestnumber of patents; the Middle East andNorth Africa has the smallest number of patents(figure 3.1b). China, in 10th place globallyin number of patents filed in more thanone country, is the only emerging economyrepresented among the top 10 “high-quality”innovating countries (Dechezleprêtre andothers 2011). The number and share of green

GREEN INNOVATION AND INDUSTRIAL POLICIES 69patenting remains very small—less than1 percent—in both developed and developingregions (figure 3.1c).In the developing world a few technologicallysophisticated countries are surfacingas significant innovators; appropriategreen innovation policy in these countriesis likely to differ from appropriate policyin other developing countries. A group ofnine emerging economies (Argentina, Brazil,China, Hungary, India, Malaysia, Mexico,the Russian Federation, and South Africa)accounted for nearly 80 percent of all U.S.green patent grants to developing countries,over 2006–10. 2 And unlike the less technologicallysophisticated countries, these “highflyer” economies display a sharp upwardtrend in green patenting, with their greenpatent grants more than doubling between2000–05 (30 grants) and 2006–10 (morethan 70 grants).But even if there is little capacity for frontiergreen innovation in most developingcountries, substantial capacity may exist forcatch-up green innovation through the adoptionand adaptation of green technologies aswell as indigenous base-of-pyramid innovations,aimed at meeting the needs of poorconsumers (box 3.3).Trade data suggest that there is substantialpotential for catch-up innovation. Environmentalgoods constitute a nontrivial andrising share of exports (3.4 percent in developingcountries in 2010, 6 percent in highincomeregions; figure 3.2). But, except forthe East Asia and Pacific region, the shareof green exports has not been rising, suggestinga need for greater diffusion of greentechnologies. The policy implication of thistrend depends on the extent to which itrefl ects some underexploited comparativeadvantages in developing countries thataccount for lower levels of home productionand export of green goods and services,whether driven by specific market orpolicy failures. Information on the extentto which weaker environmental regulationsin many developing countries account forthese differences could suggest appropriatepolicies.FIGURE 3.1A Green frontier innovation occurs mostly inhigh-income countries…(number of green patents granted in the United States, developingversus high-income countries)high-incomecountriesdevelopingcountries0 1,000 2,000 3,000 4,000 5,000 6,000number of green patents granted2006–10 2001–05 1996–2000Source: Dutz and Sharma 2012, based on data from PATSTAT (the European Patent Office’sWorldwide Patent Statistical Database).FIGURE 3.1B . . . with East Asia leading the way in developingregions . . .(number of green patents granted in the United States, by developingregion)number of green patents granted604530150MNAAFRLAC SAR ECA EAPregion2006–101996–2000 2001–05Source: Dutz and Sharma 2012, based on data from PATSTAT (the European Patent Office’sWorldwide Patent Statistical Database).Notes: Total U.S. Patent Office grants in OECD green technology areas. Developing regions areAFR (Africa), EAP (East Asia and Pacific), ECA (Europe and Central Asia), LAC (Latin America and theCaribbean), MNA (Middle East and North Africa), and SAR (South Asia).

70 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE 3.1C . . . but worldwide green patents remain low(green patents granted as a percentage of all patent grants in the UnitedStates, by region)percent1.21.00.80.60.40.20ECA LAC SAR EAP developing highincome1998 2004 2010Source: Dutz and Sharma 2012, based on data from PATSTAT (the European Patent Office’s WorldwidePatent Statistical Database).Note: Ratio of three-year moving averages of U.S. Patent Office grants in OECD green technologyareas to all U.S. Patent Office grants.Even if developing countries are notincreasing their exports of green products,they could have substantial potential formoving into green industries to the extentthat they are producing nongreen goods thatuse inputs or technologies similar to thoseused to produce green goods. The concept of“proximity” between products is useful forexamining this broader capability for greenexports. 3 For example, a country with theability to export apples will probably havemost of the conditions suitable for exportingpears but not necessarily the conditions forproducing electronics. Indeed, trade in greenand close-to-green goods is about three tofive times that of green goods alone, withEast Asia and Pacific and Latin America andthe Caribbean countries on par with highincomecountries (figure 3.3). This differencesuggests a potential for developing exportsin green products.As for green imports, studies show that, asa share of all imports, they are as importantBOX 3.3What are green base-of-pyramid innovations?Base-of-pyramid innovations are defined as innovationsthat meet poor consumers’ needs. They includeformal innovations for the poor—namely, innovationsby global and local formal private companiesand public institutions, whether fully privately provided,supported by public subsidies, or producedthrough public-private partnerships (such as medicinesfor neglected diseases and seeds for “neglected”soil types and climates). They also include informalinnovations by local grassroots inventors, largelythrough improvisation and experimentation. Oftenfacilitated by co-creation with poor consumersthemselves, the innovations typically seek to bettermeet the needs of poor households at dramaticallylower costs per unit, aided by signifi cant scale-upin volumes. They thus seek “to do more (products)with less (resources) for more (people)” (Prahaladand Mashelkar 2010). Three examples are describedbelow.Aakash Ganga (“river from sky”). In Rajasthan,India, ancient rainwater harvesting systems havebeen modernized to collect safe drinking water.This low-cost adaptation in arid regions has spurredadditional innovations, generating many co-benefitsfor efficiency and inclusiveness:• Automation of the traditional surveying systemwith satellite imaging, which shortens design time,minimizes earthwork, and reduces material costs.• Creation of a numbering plan for reservoirs,which facilitates co-investments.• Inducement of demand for stretchable roofs,which has spurred more innovation.• Introduction of accounting transparency, whichhas spurred policy debate on broader inequities inwater affordability.Novel uses of rice husks. Rice husks are one ofIndia’s most common waste products. Husk Power(continued next page)

GREEN INNOVATION AND INDUSTRIAL POLICIES 71BOX 3.3(continued)Systems (HPS), winner of the 2011 Ashden Awardsfor sustainable energy, has adapted and converted abiomass gasification using diesel technology into asingle-fuel rice husk gasifier for rural electrification.Households stop using dim kerosene lamps whenthey get HPS electricity, thereby saving on kerosene(and reducing CO 2emissions) and facilitating eveningstudying and other productive activities. TataConsulting Services sells a $24 Swach (“clean” inHindi) water filter that uses ash from rice milling tofilter out bacteria. It is intended for rural householdsthat lack electricity and running water.Affordable green housing. In Mexico, Vinte specializesin building affordable, sustainable housingfor low- and middle-income families. Its researchand development in new technologies helped it introduceinnovations such as home designs that reduceenergy costs by 75 percent.Source: Dutz and Sharma 2012.in developing countries as they are in highincomecountries, indicating the internationaltransfer of green technology asembodied in green consumer products (figure3.4). Inasmuch as some of these products areused as inputs, this also indicates the greeningof the input mix, which may reflect adoptionand adaptation of technologies by localfi rms. For instance, the purchase of manufacturingequipment in international marketsis the main channel through which Chineseproducers acquired the technologies andskills necessary to produce PV panels (de laTour and others 2011). And the importing ofgreen products may be a response to domesticdemand-side green policies in developingcountries. However, there has not been anysignificant upward trend in any region.The dissemination of green technologiescan be accelerated through policies thatincrease adaptation and adoption capacity(such as education in relevant disciplines,especially sciences and engineering) andthrough trade and industrial policies (suchas local content requirements and technologytransfers). A good example is the successof the high-speed train program initiatedin the Republic of Korea in 1993 by thepurchase of the French Alstom TGV (train àgrande vitesse). The contract included technologytransfers (partly through trainingKorean workers in France) and the localizationof 50 percent of manufacturing inKorea (Lee and Moon 2005). Today, KoreaFIGURE 3.2 Green exports are growing, especially in the East Asiaand Pacific region(export of green goods and services as a percentage of all exports,2000, 2005, 2010)percent76543210MNASARECAAFRSource: Dutz and Sharma 2012, based on data from COMTRADE + OECD list of environmental sixdigitharmonized system categories.Note: Developing regions are AFR (Africa), EAP (East Asia and Pacific), ECA (Europe and Central Asia),LAC (Latin America and the Caribbean), MNA (Middle East and North Africa), and SAR (South Asia).LAC2000 2005 2010EAPis among the five top world competitors inexports of high-speed trains. In Moroccothe contract for high-speed trains andthe Casablanca tramway included a localfactory (created by Alstom and Nexans)specializing in railway beam and wire production,which will produce for the localand international markets.developingcountrincome-high-average countryaverage

72 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE 3.3 Developing countries may have a substantialunrealized potential for producing green exports(export of green versus green plus close-to-green goods and servicesfrom developing regions, as a percentage of all exports from developingregions, 2000–10)percent108642020002001200220032004green exports (as share of total)2005Source: Dutz and Sharma 2012, based on data from COMTRADE.20062007200820092010yearclose-to-green exports (as share of total)FIGURE 3.4 Green imports are vital worldwide(imports of green goods and services, as a percentage of all imports,2000, 2005, 2010)percent86420SARAFRECAEAP MNA LAC developingcountrincome-high-average country2000 2005 2010averageSource: Dutz and Sharma 2012, based on data from COMTRADE and OECD List of environmentalsix-digit harmonized system categories.Note: Developing regions are AFR (Africa), EAP (East Asia and Pacific), ECA (Europe and Central Asia),LAC (Latin America and the Caribbean), MNA (Middle East and North Africa), and SAR (South Asia).Green imports from higher-income countriesmay not, however, meet the needs ofpoorer consumers in low-income countries.In principle, home-grown base-of-pyramidinnovations can offer a complementary supplyof relevant green technologies (box 3.3).But few green base-of-pyramid innovationshave been sufficiently scaled up to date, suggestingthe need for more focused policyefforts in this area.The adaptation of green technologies tolocal conditions is also critical for developingcountries. Using green technologies efficientlyrequires them to be more varied thannongreen technologies, given the significantvariance of the underlying environment bylocality. For instance, turbine designs need tobe adapted to work efficiently in India, wherewind speeds are lower than in Europe. Suchadaptations can yield important co-benefits,including more sustainable corporate cultures(box 3.4).Fostering innovationThe policy instruments relevant to promotingthe development, dissemination, andadaptation of green technologies will differdepending on the maturity of the technologiesand the market failures the policies seekto address. No single green bullet exists, socountries will need to employ a mix of instruments(figure 3.5).Policies to foster innovation should aim tostrengthen entrepreneurship and local fi rmabsorptive capacity, support new knowledgecreation and commercialization, and supportdiffusion and adaptation of existing knowledgeto new local contexts. The importanceof each and the modalities used depend on acountry’s level of technological sophisticationand implementation capacity.Strengthening entrepreneurship andabsorptive capacity: The importance ofskills and the broader business environmentFor fi rms to understand and assimilate thediscoveries of others as well as create newtechnologies, they need strong absorptive

GREEN INNOVATION AND INDUSTRIAL POLICIES 73BOX 3.4Rapidly growing champions of “new sustainability”In principle, the home-grown green ideas of companiesto reduce costs, motivate workers, and shapetheir business environments by forging new relationshipsshould make it easier for their peers in developingcountries to emulate such approaches. Severalexamples are described below.Century Energy (Colombia) develops small-scalehydroelectric power plants in Colombian river basins,diverting fast-rushing stream water without the needfor reservoirs and thus avoiding displacement. In thenext 5 years it plans to develop up to 10 facilities,adding 250 megawatts of capacity to Colombia.Energy Development Corporation (the Philippines)pioneered the use of watershed managementand recharge reinjection in its geothermal powerplants as a way to extend the economic life of its facilitiesand reduce maintenance costs. These practiceshave since been mainstreamed across the industryand are now a regular part of industry regulation.Equity Bank agricultural financial products(Nairobi, Kenya) worked with mobile telecom providerSafaricom to create a mobile banking systemon its existing platform. The system offers credit forinputs and supports farmers throughout the valuechain of production, transport, processing, andmarketing. It has partnered with groups such as theInternational Fund for Agricultural Development toreduce its risks when lending to smallholders.Jain Irrigation Systems (Jalgaon, India) adapteddrip irrigation systems to meet the needs of smallholderfarmers. The company works closely withcustomers to teach “precision farming” (optimizingthe balance among fertilizers, pesticides, water, andenergy to increase output) and uses dance and songto explain the benefits of drip irrigation to illiteratefarmers.Natura Organic Cosmetics (São Paulo, Brazil)worked transparently with rural communities andlocal governments to adapt its formal business practicesto the local context. It tapped traditional knowledgeabout how to extract raw materials sustainably(receiving the Forest Stewardship Council certificatefor these raw materials), and then educated suppliersin sustainable sourcing and production practices(such as reusing, refi lling, and recycling packagingand adopting a new green plastic derived from sugarcane, which is eventually expected to reduce greenhousegas emissions by more than 70 percent). Thecompany also gives bonuses to workers who findways to reduce the firm’s impact on the environment.Source: IFC 2010; World Economic Forum 2011, cited in Dutz and Sharma 2012;and Russell Sturm (personal communication).capacity. Absorption is a subset of innovationthat focuses on the use of new-to-thefirm technologies rather than the creationand commercialization of new-to-the-worldtechnologies. Absorption of existing technologiescan be improved by tackling thecross-cutting business environment constraintsthat impede experimentation, globallearning, and attracting and retaining talent,as well as enhancing human capital inthe public and private sectors.An important starting point is to ensurethat the business environment does not constrainentrepreneurship and innovative behavior,whether green or complementary to green.Many cross-cutting policy measures are vitalfor creating a business environment that spursand enables entrepreneurs and firms to create,commercialize, absorb, and adapt knowledge.They include the following:• Policies to overcome the stigma of failureand encourage opportunities forreentry and renewed experimentation.Making it easier to wind up businessesis one of the best ways to get more peopleto try new ideas, even though doingso involves difficult legal reforms andchanges in attitude toward debt. Closinga terminally ill business takes fewer than10 months and allows more than 90 centson the dollar to be recovered in Singapore,Tokyo, or Toronto. By contrast, in Mumbaiit still takes on average 7 years to recoverroughly 20 cents on the dollar (World Bank2012). Other policies include publicizing

74 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE 3.5Snapshot of technology creation and diffusionmarket deploymentTechnology-neutralcompetitionTGCcarbon trading (EU, ETS)Stimulate market pullvoluntary (green)demandMature technologies(e.g., hydro)Continuity, RD&D, create marketattractivenesscapital cost-incentives, investment taxcredits, rebates, loan guarantees etcLow cost-gaptechnologies(e.g. wind onshore)Imposed marketrisk, guaranteedbut decliningmarket returnPrototype &demonstration stagetechnologies (e.g., 2ndgeneration biofuels)High cost-gaptechnologies (e.g., PV)Stability, low-riskincentivesprice-based: FIT, FIPquantity bassed : tendersDevelopment Niche markets Mass market TimeSource: IEA 2008 (Deploying Renewables: Principles for Effective Policies © OECD/International Energy Agency 2008, figure 1, page 25).Note: FIT= feed-in tariffs; FIP = feed-in premiums; PV = photovoltaic; RD&D = research, development, and demonstration; TGC = tradable green certificate.innovative role models (such as India’sTata Group’s awarding of an annual prizefor the best failed idea) and reducing thesunk costs of trying to commercialize anidea, such as removing impediments todeeper rental and resale markets.• Policies to facilitate global connectivityand learning. Here the emphasis shouldbe on linking up with internationalconsortia and helping firms insert intoglobal value chains. International mobilityof workers was critical to the rapiddevelopment of wind energy capabilitiesin China and India. Suzlon, the leadingIndian wind turbine manufacturer,established R&D facilities in Germanyand the Netherlands to have its workerslearn from European expertise. Goldwind,the leading Chinese manufacturer,sent employees abroad for training. 4Learning networks were also critical inthe development of China’s PV panelindustry. 5 Mexico’s Green Supply ChainsProgram—a public-private partnershipprogram—highlights a way to diffuseeco-effi ciency techniques to small- andmedium-size enterprises. 6• Policies to increase the livability and“stickiness” of cities to attract and retaintalent. Dense urban-industrial agglomerationsspur technological upgradingand productivity growth by opening upopportunities and stimulating suppliesof capital and skills. China’s establishmentof special economic zones, followedby a range of support by nationaland local governments for further industrialdeepening in its three major urban/industrial agglomerations and in anumber of inland cities, highlights how

GREEN INNOVATION AND INDUSTRIAL POLICIES 75a mix of instruments can be used (Yusufand others 2008).In addition, green innovation, like innovationin general, depends on people whoare able to generate and apply knowledgein the workplace and society at large.Required innovation skills include basicskills (reading, writing), technical skills(science, engineering), generic skills (problemsolving, multicultural openness, leadership),managerial and entrepreneurialskills, and creativity and design skills. 7 Thegreen economy requires greater emphasison design and multidisciplinary teamwork,strategic leadership and adaptability,and knowledge of the sciences (CEDEFOP2009; OECD 2011).Even advanced developing countries arefar behind high-income countries in the shareof professionals engaged in creating knowledgeand managing research projects. Highincomecountries like Denmark and Finlandhave about 15 researchers per 1,000 employees.By contrast, China, Mexico, and SouthAfrica each has fewer than 2 researchers per1,000 employees. And in developing countriesthe business sector plays a much smaller rolein the national R&D system than the highereducation and government sectors. In theUnited States, four of five researchers workin businesses. By contrast, in Chile, China,Mexico, Poland, the Slovak Republic, SouthAfrica, and Turkey the number of researchersper 1,000 employees in industry is lessthan 1. Developing country firms need moreindividuals with research and related creativityskills in the workforce if they are to playa greater role in accessing green technologiesand adapting them for local use.Thus, policies are needed to strengthenmarket signals so that tertiary education institutionsand technical and vocational educationand training systems are better attunedto fi rm demands. These institutions shouldensure that the costs of skills upgrading areshared by students, employers, and the governmentin line with benefits, and that periodicindependent and transparent nationalassessments are adopted to ensure quality andconsistency (OECD 2009). In West Africa aneffort to better monitor monsoon variabilityand impacts illustrates solutions to buildrelevant skills in a developing-country setting(box 3.5). This case highlights the needto attract West African scientists trained inBOX 3.5African monsoon multidisciplinary analysesWest Africa is extremely vulnerable to weather andclimate variability because of its dependence on rainfedagriculture, on which 80 percent of the Sahel’spopulation relies. The African Monsoon MultidisciplinaryAnalyses (AMMA) is a research projectfunded by agencies from Africa, the EuropeanUnion, France, the United Kingdom, and the UnitedStates to better monitor West African monsoon variabilityand the impacts on society and the environment,including on climate. To do so, the AMMAcommunity was created in 2002. It now comprisesmore than 600 people from 30 countries, including250 in Africa, among them 80 African PhDstudents. The AMMA community has establishedlocal university research programs in climatology,agronomy, and related social science fields, and hasconvened functional research teams to build newcapacity for improved early-warning systems. Theseteams and programs will continue to train cohortsof African specialists, thus cultivating a communitywhose mutual interest in AMMA–related issues willhelp ensure sustainability.AMMA has done fairly well in building a partnershipbetween the international community andAfricans in phase one (2002–10). The main challengefor phase two (2010–20) is clarifying the needsof users (farmers, hydropower and flood managers,and health care professionals) and identifying whatscience can offer. Stronger user demand shouldincrease political support for scientific resources.Source: Thorncroft 2011.

76 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTbetter-equipped universities in high-incomecountries and the need to ensure enough localdemand for established scientific and researchfacilities.Promoting frontier innovation: Approachesdepend on extent of local technologicalsophisticationPolicies for frontier innovation include bothsupply-side “technology-push” elements(which reduce the costs of knowledge creationin advance of commercialization) anddemand-side “market-pull” elements (whichincrease revenues from sales after commercialization).Key recommendations toguide the design of such policies include thefollowing:Limit local technology-push supportto countries with enough technologicalcapabilities. Government funding for earlystageand pre-commercialization technologyis a vital element of many innovation systems,including direct funding of public labsand universities; grants, matching grants,and soft loans (which give the governmentcontrol over what research is conducted);and indirect R&D tax subsidies (which allowfirms to choose the most profitable researchopportunities, switching some marginal projectsfrom unprofitable to profitable). All thesetools have their drawbacks. Grants allowcoordination of research efforts with little orno duplication but may fail to integrate informationfrom markets about what consumerswant and are willing to pay for. They alsorun the risk of crowding out private R&Dfunding and need to be transparently allocated.Tax incentives may promote distortingtax avoidance rather than productive investmentin countries with a weak tax enforcementsystem.Despite these drawbacks, supply-pushR&D support, through direct or indirectgovernment funding, may generate newfrontier innovations more effectively thandemand-pull policies such as feed-in tariffsand regulations—at least where localtechnological capabilities and good governancemechanisms exist. For wind power,the marginal million dollars spent on publicsupport to R&D in wind power technologygenerated 0.82 new inventions, whereas thesame amount spent on demand-pull policiesinduced, at best, 0.06 new inventions (Dechezleprêtreand Glachant 2011).Consider carefully structured publicprivatepartnerships as only one of manymeasures to foster early-stage financing.Much of the investment needed for greengrowth will come from private business.Many of these investments face uncertaincash flows and require significant risk takingbecause they involve new technologies,including new business models. Once newideas with commercial potential have progressedto the proof-of-concept stage, furtherfi nancing and mentoring support for earlystagetechnology development (ESTD) arerequired.The range of ESTD finance optionsincludes both public and private resources.At this early stage, private sources are typicallyrestricted to internal financing (personalsavings and retained earnings), friends andfamily, angel investors (successful wealthyentrepreneurs), venture capital (VC), privateequity, and private corporations (which fundideas developed in-house, operate their ownVC units, and acquire young start-up companies;see box 3.6). Among these sources,private equity and VC are uniquely suited tofinance climate-friendly investments that arerisky and fairly small. Although they will notprovide more than a fraction of the resourcesneeded, they can fill a key niche for drivinggreen innovation.However, developing the private equityand venture capital market for climate- andenvironment-friendly investments in emergingmarkets is hindered by capital marketand carbon market barriers. These barriersinclude high management expenses, ashortage of good fund managers, long timehorizons for investment returns and regulatoryuncertainties, and the uncertainty ofraising capital and having profitable exitopportunities for new technologies withno track record of historical returns. Thepublic sector and international financialinstitutions can assist in capitalizing such

GREEN INNOVATION AND INDUSTRIAL POLICIES 77BOX 3.6“Pinstripe greens”: Private financiers making millions from clean-tech venturesAlthough global venture capital investment in greenenergy declined with the 2008/09 recession andshares in clean-tech businesses have recently underperformedthe wider market by a large margin, aworld of U.S. solar titans, German wind moguls,Brazilian biofuel magnates, and Chinese batterytycoons has emerged over the past decade. Oneoften hears that green energy could be the biggesteconomic opportunity of the 21st century. In 2010the global clean energy sector (wind farms, solarparks, and related technologies) attracted a record$243 billion in new investment, nearly 5 times thevolumes of 6 years earlier. Between 2000 and 2010the global market for solar and wind power rosefrom $6.5 billion to $132 billion, the number ofhybrid electric car models jumped from 2 to 30, andthe number of certified green buildings grew from3 to 8,138. Examples of private green financinginclude the following:• Khosla Ventures is a venture capital firm foundedby Vinod Khosla in 2004. Its clean-tech portfoliospans utility-scale and distributed generation,electrical and mechanical efficiency, batteries,building materials, plastics and chemicals, agriculture,cellulosic alcohol, and advanced hydrocarbons.The portfolio also includes investments ina low-emission engine (with Bill Gates) and twobladedwind turbines (with Goldman Sachs).• Bloomberg New Energy Finance is a provider ofanalysis, data, and news about clean-tech, includingrenewable energy, energy-smart technologies, carbon,carbon capture and storage, renewable energycertificates, nuclear, power markets, and water.The company, founded by Michael Liebreich in2004, has generated more than $1 billion in profitsin 2011.• Suntech is a Chinese company founded in 2001by Dr. Zhengrong Shi and floated on the NewYork Stock Exchange in 2005. It is the world’slargest producer of solar panels, with solar modulesinstalled in more than 80 countries (and alow-carbon museum in Wuxi, west of Shanghai,opened by Al Gore).Source: Dutz and Sharma 2012.funds by anchoring new funds, fi nancingnew fund development, supporting pioneerinvestments, and supporting improved carbonpayments. Even more important willbe helping with the structure, management,and exit routes for venture capitalinvestments—for example, by providingequity contributions to increase potentialreturns or reduce potential risks, whichwould play a helpful demonstration role ifthere is enough deal flow. 8 But experiencesuggests that the government role should berestricted to that of fi nancial backer, andnot manager, with funds administered professionally,free of bureaucratic burdens,and independent of political interference(Lerner 2009).But capital market–based, arms-lengthforms of finance that structure and price eachtransaction on its merits require deep financialmarkets, which most developing countriesstill lack. Moreover, a number of otherfactors—such as government R&D expenditures,the extent of patenting by entrepreneurialfirms, and national environmentaldeployment policies designed with the longtermperspective of creating a market forenvironmental technologies—appear to bemore important in affecting the amount ofprivate financing of frontier innovation in theclean-tech sector. 9Provide global support for bottom-ofpyramidand neglected technologies. It isnot advisable for countries with weak technologicalcapabilities and no comparativeadvantage in creating frontier technologiesto dedicate significant public resources tothis objective. But given the global nature ofbenefits from many green innovations, stable,long-term global public spending on R&Dshould be increased and channeled into programsthat facilitate the development andadoption of technologies applicable to developingcountries.

78 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTPrize funds and advance market commitments—alsocalled purchase guarantees—can be useful market-pull mechanisms forpromoting R&D in neglected technologies.• Prize funds are most appropriate whenobjectives can be well defined but thetechnologies are unknown. They may beparticularly relevant for promoting moreradical green innovations likely to be fosterednot through the traditional linearR&D approach but rather through outof-the-boxnew knowledge, involvingco-creation and codesign by scientists,engineers, entrepreneurs, producers, andusers from different disciplines.• Advance market commitments work bestwhen key characteristics of the desiredtechnology are known and can be specifiedin a contract, typically for fairlyhomogeneous technologies rather thanthe more differentiated ones required forgreen growth. Although to date they havebeen used to provide affordable access tohealth care in low-income countries, theymay help stimulate innovations and accessto a few affordable green solutions—suchas a nutrient-fortified staple food crop orimproved storage technologies in contextsof land and water scarcity, climatechange, and declining crop yields.Promoting catch-up innovation:Facilitating technology access andstimulating technology adoptionPromoting green growth in developingcountries is typically more about catch-upinnovation and the diffusion and adaptationof already-existing technologies than aboutfrontier innovation. Relevant policies needto facilitate access to existing technologies,as well as stimulate their uptake.Policies to facilitate access to green technologies.The best way to facilitate access togreen technologies is through openness tointernational trade, foreign direct investment,technology licensing, worker migration, andother forms of global connectedness. Manygreen technologies are embodied in technologylicensing agreements and in equipment,machinery, and imported capital goods.Some are knowledge-based processes orbusiness models that diffuse through movementsof people attached to multinationalcorporations or from the diaspora. Somecan be recreated by emulating imported finalgoods, copying lapsed patents, or studyingand inventing around patents that are stillin effect. Technology and skill transfer alsooccur through the purchase of manufacturingequipment on global markets, because suppliersusually provide worker training withtheir equipment. This channel was critical inthe ability of Chinese producers to becomeworld leaders in PV panel production (de laTour and others 2011).Other underused policies to boost accessto existing technologies include patent buyouts,compulsory licenses, patent pools, andopen source approaches. A patent buy-outincreases access to existing or future productsthat already benefit from adequate innovationincentives. Making it easier for countriesto issue compulsory licenses under appropriatecircumstances can help ensure moreaffordable access to patented green innovationsby poorer households in low-incomecountries. 10Patent pools provide a one-stop voluntarylicensing service that combines multiple patentsand licenses them, with patent holdersgetting royalties on the sales of adapted, moreaffordable products, and generic manufacturersgetting access to broader markets. Anexample is the Medicines Patent Pool, fundedby the international drug-purchasing facilityUNITAID, which increases access to HIVmedicines in developing countries. In opensource development, a body of original informationis made available for anyone to use.Usually, any party using the original materialmust agree to make its enhancements publiclyavailable. Open source projects are inherentlyroyalty free. Both of these approaches couldbe used for neglected seeds for drought-prone,saline environments, or other green solutionsfor lower-income countries.However, and perhaps most important,countries should avoid imposing tariffson renewable energy technologies and

GREEN INNOVATION AND INDUSTRIAL POLICIES 79subsidizing fossil fuels, given that most studiesshow that these tools do more than patentprotection to limit the transfer of cleantechnologies (Barton 2007 and CopenhagenEconomics 2009, as cited in Hall and Helmers2010). A World Bank (2008) studyfinds that eliminating tariff and nontariffbarriers in the top 18 developing countriesranked by greenhouse gas emissions wouldincrease imports by 63 percent for energyefficientlighting, 23 percent for wind powergeneration, 14 per cent for solar power generation,and 4.6 percent for clean coaltechnologies. 11Policies to stimulate adoption of greentechnologies. Green technologies are oftenmore costly for firms to adopt and are notalways immediately more attractive to endusecustomers. When feasible, ensuring thatprices reflect the environmental externalityand removing subsidies that favor browntechnologies are the best tools with which toencourage the adoption and spread of greeninnovation.When prices cannot be adjusted, demandpulltechnology-deployment innovationpolicies (standards, regulations, public procurement)are needed. Demand-side policiesinclude guaranteed feed-in tariffs for renewables,taxes and tradable permits for emissionspollution, tax credits and rebates for consumersof new technologies (compact fluorescentlight bulbs), comparison labeling (to informconsumers about the relative efficiency ofproducts), endorsement labeling (“CFC–free”), government regulations (limits to pollutingemissions from industrial plants), andindustry-driven standards (home and officebuilding insulation). In contrast with radicalinnovation, demand-side policies appearto be effective in spurring firms to introduceincremental environmental innovations andadopt existing technologies.Indeed, European Union surveys showthat firms in most countries identify existingor future environmental regulations, followedby market demand from customers,as the main driver behind adopting incrementalprocesses (Dutz and Sharma 2012).In high-income countries as a whole, moststudies report that well- designed environmentalregulations stimulate innovation byfirms, as measured by R&D spending or patents.That said, the induced innovation maynot be enough to fully overcome the addedcosts of regulation (Ambec and others 2011).As for designing environmental regulations,studies emphasize the need for stability, predictability,and a focus on end results ratherthan means—allowing firms to choose themost cost-effective approach to meet the endresult.Voluntary sustainability standards forproducts and processes can help local firmsupgrade environmental practices, a form ofcatch-up innovation for business practices.Roundtables and other multi-stakeholder initiativesprovide new ways to manage naturalresources more sustainably and efficiently.The best-known are international initiativesthat group together producers, processors,traders, and other actors in a commodity’ssupply chain with banks and civil societygroups concerned about the harmful impactsof agriculture and aquaculture expansion.They aim at building consensus and settingvoluntary standards on what constitutesresponsible production and processing, alongwith promoting proven management practicesto reach the set targets. Linking local firmsto the global value chains of multinationalcorporations that have adopted sustainabilitystandards helps leverage international marketpressures (box 3.7).Finally, a better financial infrastructurecould significantly boost green technologyabsorption. In a study on adopting efficientstoves, small biogas plants, and efficienttobacco barns for commercial farmers inMalawi, Rwanda, and Tanzania, financingemerged as the main stumbling block for allprojects because of high start-up costs (Barryand others 2011). A study of low-incomecountries finds that higher financial intermediationsignificantly helps non-hydroelectricrenewable energy generation per capita,because investment in renewable energy isconstrained in environments where accessto long-term loans is limited (Brunschweiler2010). Regarding China, a study cites access

80 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 3.7 Voluntary standards support the sustainable management of South Africandeep-sea fishing and Indonesian palm oilA highly visible and credible certification that deep-seahake fishing was sustainably managed by the internationalnongovernmental standards organization (theMarine Stewardship Council) constrained local regulatorsin South Africa from allowing excessive newentry of fishers, which would have depleted stocks.It also led to restructuring of the equity structuresof companies to meet the country’s Black EconomicEmpowerment goals.For palm oil there was no comprehensive,agreed-upon sustainability standard that producerscould adopt, despite the crop’s impact on deforestationand biodiversity loss. On top of environmentaland social risks, this uncertainty raised the cost ofWorld Bank loan preparation and monitoring andadded potential reputation risk issues, affecting theavailability and pricing of Bank financing. Thanks toguidelines issued by the Roundtable on SustainablePalm Oil (RSPO)—supported by the Indonesia PalmOil Producers Association, Unilever, the Hong Kongand Shanghai Banking Corporation, the World WildlifeFederation, Oxfam, the International FinanceCorporation, and other key members—the share ofRSPO-certified palm oil has risen to 11 percent ofthe total market. To raise this share to the next level,broader government support in the consuming countriesis needed to complement achievements drivenby consumer activism.Source: Levy and others 2011; IFC 2010; RSPO 2012.to financial credit and quality of after-salesservice as key barriers to adopting solar homesystems (D’Agostino and others 2011). And astudy on Europe’s reconstruction after WorldWar II emphasizes that the largely bankbased,relationship-based fi nancial systemsprovided vital support for lower-risk technologyabsorption by firms (Wolf 2011).Green industrial policies:Ensuring that the standardcaveats applyMany countries include green industrial policiesthat target industries, firms, or technology-specificinnovation and production intheir environmental policy mix, from feed-intariffs for PV solar energy to tax breaks forinnovative fi rms in specifi c environmentalindustries and green procurement (box 3.8).But given that this approach is vulnerable topowerful lobbies, rent-seeking behavior, andcostly mistakes caused by information asymmetries,there is no consensus on whether itis desirable.Moreover, while industrial policies cantransform an economy’s structure, the debateover whether they are effective instrumentsfor accelerating growth continues. Someargue that industrial policies played a keyrole in the rise of Japan and other Asiancountries (Chang 2006); others consider thiscatch-up a consequence of large investments(and a catch-up in capital intensity) in countrieswith high levels of education and institutionalcapacity (Krugman 1994). Whateverthe case, it is critical to not blindly apply thelessons from East Asia to countries with verydifferent characteristics, including low educationlevels and weaker institutions.Whether even Asia’s industrial policieswould have passed a cost-benefit analysisis unclear (Harrison and Rodríguez-Clare2009; Noland and Pack 2003). But becausegreen industrial policies offer environmentalbenefits, they could be desirable even withno net positive impact on growth or job creation.For instance, whether or not Brazil’sethanol policy accelerated economic growthor created jobs, there is little doubt that itled to the creation of a dynamic biofuel sectorthat would, in the absence of that policy,probably not exist (or would at least be muchsmaller; Karp and Stevenson 2012). For theirpart, the biofuel policies of Europe and theUnited States can be considered examples ofgreen industrial policies that failed to generateeven an environmental benefit, as theyare generally considered to have harmed theenvironment.

GREEN INNOVATION AND INDUSTRIAL POLICIES 81BOX 3.8The role of green procurementWhen governments look for ways to influence theeconomy to achieve greener growth, public procurementstands out as a viable tool. For this reason,both industrial and developing countries arenow pursuing green public procurement. In recentyears many countries—Brazil, China, the Republicof Korea, Turkey—have implemented green initiativesto protect the environment and mitigate emissions(OECD 2010; Thomson and Jackson 2007).Green procurement is estimated to have accountedfor 6 percent (Korea) to 60 percent (Sweden) of totalpublic procurement in 2005 (OECD 2007).The preferences of governments for green productsin the early stages can help firms reduce productioncosts. They can also have dynamic effects in relevantmarkets. New companies can be motivated toenter the market, leading to further market development.If the market evolves rapidly, private users ofsimilar products will also be educated to use greenerproducts. In addition, the dynamic market developmentmay lead to significant economic competitivenessin such technological domains. For instance, aFrench company that invested in R&D to developan environment-friendly paint for public road signsalso developed other paint products that now leadthe market (OECD 2007).Governments can take advantage of standardraisingdemonstration effects and the provision ofa guaranteed demand to foster markets of greenproducts, change technological standards, generategreen jobs, adapt public assets (such as buildingsand infrastructure), and take a lead in educatingconsumers and firms to engage in more sustainableconsumption and production. From a global welfareand climate change perspective, such procurementshould not discriminate against foreign suppliers.Whether green environmental policies aredesirable, many countries, mostly middle andhigh income, are actively engaged in policiesthat support specific industries. Some of thesepolicies aim to provide direct environmentalbenefits (biofuel production in Brazil, concentratedsolar power in Morocco). Others aimto produce related upstream goods and services(solar PV panels in China, high-speedtrains in Europe). It is worth exploring themotivations for green industrial policies andthe lessons from past experience with standardindustrial policies.What role for green industrial policies?Green industrial policies can be implementedfor multiple reasons. All these reasons arelinked to different market failure or policyobjectives.Compensate for the uncertainty in futureenvironmental policy and promote newindustries and technologies. Most countriesthat adopt green industrial policies claim todo so to take advantage of a latent comparativeadvantage, create jobs, and pursue newsources of growth. The underlying argumentis that prices are not enough to address thestandard market failures that hamper newindustries (such as increasing returns, coordinationfailures, and underdeveloped financialmarkets).Even if prices were to fully reflect theenvironmental externality, current and newgreen industries would face many challenges.Pricing policies are politically vulnerable,and the lack of credible long-termcommitments and regulatory uncertaintydiscourages the private sector from makinglong-term investments in green industries.Witness the European carbon emissiontrading scheme, which effectively created acarbon price but did little for environmentalinnovation (Borghesi and others 2012;Rogge and others 2011). When long-terminnovation, deployment, and productionscale-up is needed, pricing policies may needto be complemented by innovation and moretargeted industrial policies (Vogt-Schilb andHallegatte 2011), as with PV solar energy inGermany and China (box 3.9).Level the playing fi eld. The risk of pollutionleakage from countries with strictenvironmental regulations to laxer countrieshas been used to justify green tradebasedindustrial policies. 12 The fear is that

82 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 3.9Comparison of photovoltaic support policies in Germany and ChinaGermany and China are emerging as leaders in theglobal photovoltaic (PV) market, thanks to developinga dual industry composed of vertically integratedfirms and segment specialists (Grau andothers 2011). Public support aims to trigger costreductions through economies of scale and additionaltechnological innovation. It is directed atthree activities:• Direct R&D to support innovation. Both Chinaand Germany provide support to R&D, especiallyto promote radical innovation that is not theusual focus of the private sector. But this supportremains limited, with only 1 percent (in China)and 3 percent (in Germany) of the total supportthese countries provide to PV panel production(Grau and others 2011).• Standard environmental policies to supportdeployment. Both China and Germany are usingfeed-in tariffs to support the large-scale deploymentof PV modules. The German example pointsto the inherent risks resulting from a stable, longtermcommitment to buy electricity from PV.When the price of PV modules dropped in 2009,the sudden surge in profitability led to a rush toinstall PV modules, inflating the total cost of theprogram and jeopardizing its existence.• Investment to support manufacturing plants.Investment to support manufacturing plantsembraces direct subsidies, reduced taxes, publicguarantees, and reduced-interest loans. NeitherChina nor Germany links investment support tospecific innovation requirements.Striking the right balance among the three formsof support is critical for reducing costs. But supportschemes are further complicated by informationasymmetries between the industry and the governmentand by market power exerted by differentactors in the industry.Has public support made a big difference? Thereis little doubt that it helped achieve the large reductionin solar panel costs, which yielded global benefits.But there are growing concerns that this supportis increasingly focused on the interests of domesticproducers rather than global welfare objectives.In Germany the issue is whether hefty feed-intariffs mainly benefit Chinese PV manufacturerswho export to Germany. But Chinese producers areconcentrated in the downstream segments of the PVpanel supply chain, which are highly labor-intensiveand are where the country has a comparative advantage(de la Tour and others 2011). These downstreamsegments have limited margins and smallprofits compared with upstream segments, suchas silicon production, where industrial countries,including Germany, still dominate. (Germany alsomanufactures some of the machinery used in Chinafor PV production.) In China the issue is whetherthe policy leads to the import of mature technology,thus preventing the takeoff of an internal innovationcapacity for more radical technology changes.stricter environmental regulations in onecountry may cause “dirty” industries tomove to pollution havens rather than adoptcleaner processes. There is little support forthis argument in the current context. Pollutionabatement costs represent only a smallfraction of production costs for most industries.And while environmental regulationmay cause firms to move from a particularlocation, the destination location chosenlikely has other draws (skilled labor, goodbusiness environment, and a well-developedfinancial sector).And studies show that the impact ofcurrent environmental regulations on fi rmcompetitiveness remains limited. Quirionand Hourcade (2004) calculate that in theEuropean Union, a €20-per-ton CO 2taxhas a lower impact on marginal cost thaninterannual exchange rate variations, evenin energy-intensive industries and withouttax revenue recycling. Econometric studiesfound no negative impact of the EU EmissionsTrading System (ETS) on net importsin the aluminum, steel, and cement industries(Ellerman and others 2010; Quirion2011; Sartor 2012). Anger and Oberndorfer(2008) reach the same conclusion onGerman fi rms and the EU ETS. Panel datafrom the U.K. production census suggest

GREEN INNOVATION AND INDUSTRIAL POLICIES 83that the climate change levy (an energy tax)had a signifi cant impact on energy intensitybut no detectable effects on economicperformance or on plant exit (Martin andothers 2009).Empirical evidence fails to support thenotion of “pollution havens” (Copeland2012), though this could change if environmentalpolicies, such as carbon taxes, becomemuch stricter. Should this happen, trade policiesmay become an important complementto environmental policies: specific trade policies—frombilateral and multilateral agreementson environmental regulation to bordertax adjustments, with or without revenuetransfers to the exporting country—can helplevel the competitiveness playing field.Smooth the transition. Countries may optto use industrial policies to support ailingindustries to facilitate the political economyof a green transition. Japan supported decliningtraditional industries to make the transitiontoward high-productivity, high-skillindustries more acceptable for the population.In the same manner a green strategymay need to include some transitional supportto (declining) energy-intensive industries.This component of the green growthpackage can be a requirement for its politicalacceptability, despite its cost. The aim of suchsupport would be to smooth the transition,help businesses adjust their production technologies,and help workers adapt by movingto other industries—while ensuring that anypublic support remains transitory, with clearsunset clauses.Heeding the lessons of the pastThe desirability of innovation and industrialpolicies—green or not—cannot be assessedwithout analyzing a country’s economic situation,the benefits it can expect from thesepolicies, and its ability to avoid capture byvested interests. Experiences around theworld with these policies show that the followingsix lessons are key.First, the relevant policy interventiondepends on what market failure needsaddressing (Baldwin 1969). Designingindustrial policies requires that the governmentbe able to identify and analyze marketfailures (Pack and Saggi 2006). To do so, thegovernment may need information on whichfirms and industries generate knowledgespillovers or benefit from economies of scaleand dynamics effects (for example, learningby doing). Without a clear understanding ofthe market failures that need to be corrected,innovation and industrial policies will beinefficient or detrimental, particularly if theyare used as a substitute for an enabling businessenvironment.Second, horizontal (or output-based) policiesshould be favored over vertical policies(“picking winners” or at least the winningtechnology) when possible. Vertical policiesshould be contemplated only when technologiesor solutions have been demonstrated inother contexts or are justified by industry ortechnology-specific characteristics.But applying this recommendation togreen growth policies may be challenging.For example, absolute technology neutralityhardly applies as a guiding principle ofclimate policy (Azar and Sanden 2011). Anexample is feed-in tariffs (payments of acost-based rate to energy producers for theelectricity they generate from renewableresources), which can be designed to offerthe same premium for any low-carbon electricity,thereby freeing electricity producersto choose the technology. But in the presenceof learning-by-doing, a higher feed-intariff may be desirable for the technologywhose potential is estimated to be larger(del Rio Gonzalez 2008; Johnstone and others2010).In the early 2000s, advocates of feed-intariffs to support PV electricity production(rather than other carbon-free technologies,such as wind power) pointed to the largepotential of this technology, its fairly highinitial cost, and the improvements expectedfrom learning-by-doing, which made itunlikely to be picked up under horizontalsupport to any carbon-free electricity productiontechnology.Fortunately, picking winning technologiesmay be less risky for developing countries

84 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTimplementing green growth, as they may beable to choose environmental technologiesalready developed and tested in high-incomecountries. This fact may partly explain whydeveloping countries adopt environmentalregulations at earlier stages of developmentand at lower cost than developed countries(Lovely and Popp 2011). Examples includetechnologies with large potential for economiesof scale (such as solar PV) and technologiesbroadly used in industrial countries (suchas low-sulfur fuels or wastewater treatmenttechnologies). Technology support may alsobe less risky when a latent (that is, futurerather than current) comparative advantagecan be observed in an objective manner—forinstance, renewable energies that depend onnatural endowments, such as the potentialfor solar energy in North Africa and hydropowerin Central Africa.Third, the desirability of innovation andindustrial policies depends on the balancebetween market failure and governmentfailure. These policies need strong institutions,because they are vulnerable to captureand rent seeking and to inefficient micromanagementof the innovation and investmentprocess (Laffont 1999; Rodrik 2005).In climate policy, rent-seeking behavior islikely to influence policies even in countrieswith high institutional capacity and appropriate“checks and balances” (Anthoff andHahn 2010; Helm 2010). Neven and Röller(2000) identify factors that make such problemsmore likely: sharply partisan politicalsystems, weak governments, and absence oftransparency. But rent capture remains possibleeven in the most efficient, balanced,and transparent country, because industriallobbies are powerful actors in any economy(box 3.10).Fourth, successfully using innovationand industrial policies requires the capacityto remove support when it is no longer justified, especially if one technology provesless promising than expected. Regardlessof their ability to “pick the winner,” thereare plenty of political economy reasonsto explain why governments find it difficultto interrupt support when a project orbusiness fails. One option is to make supportconditional on some market test. EastAsian countries used export competitiveness,an indicator difficult to manipulate bylocal firms. They were fairly ruthless in terminatingsupport to underperformers andmade continued protection in the domesticmarket contingent on export performance(World Bank 1993).Subjecting green policies to a markettest is more challenging than with standardindustrial policies (Karp and Stevenson2012). When the market does not price theenvironmental externality—that is, in theabsence of complementary price policies—a market test cannot be used to decidewhether the supported technology is theappropriate one. For instance, R&D subsidiesor feed-in tariffs that help the solarpanel industry reach scale and technologymaturity may need to be permanent to makethe industry competitive in the absence of acarbon price. The profitability of the lowsulfurrefining industry will depend onpermanent subsidies in the absence of regulationson vehicle sulfur emissions. Contraryto classical industrial policies, whichare supposed to be temporary because theycorrect temporary market failures (such asincreasing returns to scale), green industrialpolicies may need to be permanent if theyare supposed to correct permanent marketfailures (such as an environmental externality).To avoid this issue it is preferableto use price-based instruments to correctpermanent environmental externalities andindustrial policies to cope with transientexternalities.Fifth, the benefits from innovation andindustrial policies vary depending on thescale of assessment. When these policiesmake it possible to create a domestic industrywith significant market share, local benefitscan be large in terms of jobs and income. Butthe assessment can be completely different atthe global scale if market shares are gainedthanks to public support at the expense ofmore efficient foreign producers. The desirabilityof these policies should be evaluatedin view of trade-offs, especially if ambitious

GREEN INNOVATION AND INDUSTRIAL POLICIES 85BOX 3.10Lessons from a “green” industrial policy: U.S. biofuelsIn recent decades, concerns about national energysecurity, dwindling reserves of easily recoverablepetroleum (and oil price hikes), and health andsafety have prompted many industrial countries tolook for renewable energy alternatives, includingbiofuels. The U.S. biofuels program offers usefullessons on green industrial policies—two of whichappear particularly relevant for developing-countrypolicy makers.First, biofuel industrial policies have mixed consequencesfor competition among technologies. Therelationship between fi rst-generation (ethanol, primarilyfrom corn and sugar) and second-generation(or cellulosic) biofuels, which are being developed toprevent higher food prices and land use changes, haslong been viewed as a cooperative process. By developingan infrastructure for handling large volumesof biomass and constraining fuel refi ners to blendincreasing quantities of biofuels in fossil fuels, producersof fi rst-generation biofuels would naturallypave the way for a new generation of biofuels. Buta recent study suggests that first-generation biofuelswould be a tough competitor for the nascent industryof next-generation biofuels (Babcock and others2011). And the difficulty of the nascent technology isheightened by the fact that “declining industries aregenerally more successful in forming lobby groupsand securing policy concessions from governments”(Damania 2002).Second, the reversibility of a policy (and thusthe risk from capture) depends on the instrumentused. Producers of biofuels used to be supportedthrough subsidies (or, equivalently, tax breaks).In the United States the corn-based ethanol taxcredit has been complemented by an import tariffon all sources of ethanol, with the tax credit workingwith federally mandated blending minimums toensure a domestic market for ethanol. U.S. ethanolsubsidies are estimated to have cost taxpayers $6 billionin 2009 (Karp and Stevenson 2012). They likelyimposed significant costs on developing-country suppliersthat are more efficient—such as Brazil, whichuses sugar cane as a feedstock (though in 2009/10,Brazil imported small amounts of ethanol from theUnited States due to high food demand for sugarand competing crops worldwide). The subsidiessharply pushed up corn prices, though part of thatincrease could have been avoided if the U.S. markethad been open.The phasing out of the U.S. tax credit (and tariff)at the end of 2011 marked the end of the taxpayer’ssupport to biofuels. But the support by the consumerstill remains, through the blending requirement ofincreasing amounts of ethanol. What is worrisomeis that the consumption mandates appear far moredifficult to reverse than direct subsidies—whichwere subject to annual review by legislative bodiesin the United States and in most European Unionmember states. With consumption mandates, biofuelpolicies are less susceptible to public fi nance pressure.Although the amounts at stake are substantial,the fact that the burden is spread across millions ofconsumers reduces the political pressure to relieveit. Indeed, substantial coordination would be neededon the consumer side to stand up against the mandatesif warranted from a cost-benefit perspective.policies in a few countries lead to escalatingsupport globally, beyond what is justified bymarket failures.Sixth, green growth is about synergiesbetween economic growth and environmentalprotection. And more targeted innovationand industrial policies represent a wayto capture these synergies. Indeed, if andwhere these policies can promote growthcost- effectively and provide environmentalbenefits, it is possible that they can be developedto generate synergies between economicand environmental objectives.In sum, a balanced view of costs, potentialbenefits, side-effects, and risks is needed toanalyze the desirability of green innovationand industrial policies. The fact that thesepolicies have influenced the structure of severaleconomies suggests that they are optionsfor transforming economies and bringingthem toward more environment-friendlypatterns. But the potential for costly failureand waste of scarce public resources alwaysneeds to be factored into any policy decision.In the following three chapters, we explorethe three key inputs in a greener production

86 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTfunction—human, natural, and physicalcapital—beginning with labor markets andwhether green growth creates jobs.Notes1. This section is based on Dutz and Sharma(2012), a background paper produced forthis report.2. Indicators of technological sophistication(R&D personnel per capita) as well as the scaleof the R&D sector (total R&D personnel) wereconsidered in making this distinction.3. Hausmann and Klinger (2006) show that ascountries change their export mix, there isa strong tendency to move toward relatedgoods rather than to goods that are fartheraway, where “relatedness” or “proximity” ofproducts is defined at the global level.4. See Popp (2012), who highlights the work ofLewis (2007) documenting how both countrieswent from having no wind turbine manufacturingcapacity to having almost completelocal production in fewer than 10 years.Sauter and Watson (2008) highlight this as acase study of “environmental leapfrogging,”explaining how the adoption of cutting-edgetechnologies was facilitated by the creation oflearning networks.5. See Popp (2012), who highlights internationalmobility of workers as a more importantsource of information than foreign directinvestment or licensing, and de la Tour andothers (2011) for the underlying analysis.6. The initiative, led by the Commission forEnvironmental Cooperation, established bythe North American Free Trade Agreement,included the environmental authority ofthe state of Queretaro and the GlobalEnvironmental Management Initiative, anonprofit organization of leading U.S. multinationalcorporations focused on environmentalsustainability. It is a 10-weekeco-efficiency educational training programemphasizing learning-by-doing with a commitmentby participating small and mediumsizeenterprises to generate and implementpollution prevention projects, with recommendationsfor change made by the participantsthemselves. Investments related to theimplementation of the improvement projectswere provided by individual participants,who became convinced of their value. Lyonand van Hoof (2010) find that the averageparticipant generated a project with a netpresent value of more than $150,000, saved1,900 cubic meters of water and 42,000 Kwhper year of electricity a year, reduced CO 2emissions by 61 tons a year, and cut wastedisposal by 1,455 tons.7. Chapter 4 addresses the labor market–relatedquestions concerning skills.8. See chapter 4 of Zhang and others (2009) foran overview and recommendations of policiesto strengthen the ecosystem for the venturecapital industry in China, and see chapter 7of Dutz (2007) for India.9. Regression results (based on comprehensivedeal-level data on high-growth financing andenterprises seeking investment in the cleantechsector over 2005–10 in 26 countriesincluding Brazil, China, the Czech Republic,and India) suggest that deployment policiessuch as feed-in tariffs and tradable certificates,government R&D, and firm-level patentingare associated with higher levels of investmentin clean-tech industries than short-term fiscalpolicies such as tax incentives and rebates.No significant correlation is found betweenpublic investment loans or public financingof venture capital and the amount of privatefinancing of innovative ventures (Criscuoloand Menon 2012).10. Henry and Stiglitz (2010) document howthe United States used the threat of a compulsorylicense to manufacture Cipro duringthe anthrax scare following September11, 2001.11. The assessment is based on first-roundapproximations rather than full general equilibriumeffects.12. This is a different issue from the rise inimported emissions to high-income countriesfrom developing countries, which is associatedwith their general deindustrialization.In 2008, China emitted about 1,400 MtCO 2through its production of exported goods;the United States imported goods amountingto about 600 MtCO 2of emissions.ReferencesAmbec, S., M. A. Cohen, S. Elgie, and P.Lanoie. 2011. “The Porter Hypothesis at20: Can Environmental Regulation EnhanceInnovation and Competitiveness?” DiscussionPaper 11-01, Resources for the Future,Washington, DC.

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90 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTChampions. Geneva: World EconomicForum.Yusuf, S., K. Nabeshima, and S. Yamashita.2008. Growing Industrial Clusters in Asia:Serendipity and Science. Washington, DC:World Bank.Zhang, C., D. Z. Zeng, W. P. Mako, and J. Seward.2009. Promoting Enterprise-Led Innovationin China. Directions in Development.Washington, DC: World Bank.

Human Capital: Implications ofGreen Growth Policies for LaborMarkets and Job Creation4Key Messages• Green growth cannot substitute for goodgrowth policies, and employment is noexception: shortcomings in labor marketswill not disappear with the adoption of environmentalpolicies.• But even if green jobs will not be a panacea,environmental regulation need not kill jobseither, and the net balance can be positive.• To smooth the impacts on labor markets ofthe transition to green growth, policy makersneed to tackle potential skill shortagesand impediments to worker mobility—bothof which have constituted barriers to othertypes of economic adjustment, such as tradeliberalization.For many countries the promise of newsources of growth and job creation iswhat lies behind the attractiveness ofgreen growth. They look at Brazil, China,Denmark, India, and Japan—world leadersin exports of green products, who createdentirely new industries in wind, solar, andbiofuels. They hear about the promised doubledividend of a green fiscal stimulus that cancreate jobs in the short run while laying thefoundations for a more sustainable future.For others the fear of diminished competitivenessand job losses remains one ofthe main barriers to pursuing green growth.They worry that tightening environmentalpolicies could lead to industries relocatingin countries with laxer environmental policies(so-called “pollution havens”)—and thatthese policies will lead to trade wars.Yet, to some extent, this is an olddebate—one that centers on the complexrelationships between environmental regulationand competitiveness, and the ensuingjob impacts. The topic of “green jobs” is justthe latest round, prompted by global economicworries.This chapter is based on Bowen (2012), except section “. . . and Learn from the Lessons of Trade Adjustment,” whichdraws from Porto (2012).91

92 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTDoes green growth create jobs? The supportersargue that green policies are “a newengine of growth” and “a net generator ofdecent jobs” (UNEP 2011). The recent globaleconomic downturn triggered many proposalsfor “green” fiscal stimuli to promotegrowth and job creation (Pollin and others2008). The Organisation for Economic Cooperationand Development (OECD) alsosuggested that investing in green activities hassubstantial potential to create jobs (OECD2011b). Chinese analysts estimate that measuresto save energy, protect the environment,and replace polluting industries with hightechfirms would lead to the net creationof some 10 million jobs over the next 5–10years, and that exports of green goods couldcreate some 4–8 million jobs (CCICED 2011,cited in World Bank and DRC 2012).But the critics claim that the potentialis overestimated and that environmentalpolicies may actually hurt labor markets(Michaels and Murphy 2009; Morriss andothers 2009). A recent study of South Africafinds that while developing green industries isappealing, it has little chance of succeedingunless structural problems (regulatory obstaclesto creating small enterprises, a lack ofskilled workers) are addressed (World Bank2011a). Similarly, investments to promoteresearch and development (R&D) in greenindustries will do little if educational andfinancial systems produce few skilled workersand little risk capital.To shed light on this debate, this chapterexplores the net impact of green job creation—thatis, whether more jobs will be createdthan lost—and the relationship betweenlabor markets and green growth policies. Itfi rst discusses what exactly green jobs are,then moves to the factors that influencewhether green growth policies lead to jobcreation, and finishes with measures neededto smooth the transition to greener growthpaths for labor markets.The key finding is that environmental policieswill lead to substantial job creation onlyif other inefficiencies—including those oflabor markets—are tackled. In other words,green growth policies are no substitute forgood growth policies. But while green growthmay not be the answer to chronic unemploymentand low competitiveness, fears thatenvironmental regulations would result injob losses and lower competitiveness are misplaced—indeed,odds are that the impactswill be quite moderate. Meanwhile, betterregulations (particularly those supported bytraining) support for R&D, and tax recycling(that is, using revenues from environmentaltaxes to reduce other taxes) will help minimizethe risks posed by green growth policiesand maximize co-benefits.Green policies may create jobs,but are no substitute for soundlabor marketsA fi rst hurdle in framing the debate is thatthere is no agreement on how to define“green” jobs, even among economists. Thislack of definition matters because it complicatesthe debate on the desirability of greenpolicies.Defining green jobs…As “employment in ‘green’ industries”Some definitions of green jobs are fairly narrow,including only jobs with an identifiableenvironmental focus or employment in industries(or specific projects) whose productsare deemed to be of environmental benefit.This would include employment in renewableenergy, energy efficiency, and environmentalservices or in developing less carbon-intensiveproducts (such as building railways).For the United Nations Environment Programme(UNEP), job content, as well as thecharacteristics of industry goods and services,also matters (UNEP 2008). UNEP definesgreen jobs aswork in agricultural, manufacturing,R&D, administrative, and serviceactivities that contribute substantiallyto preserving or restoring environmentalquality. Specifically, but not exclusively,this includes jobs that help to protectecosystems and biodiversity; reduce

HUMAN CAPITAL 93energy, materials, and water consumptionthrough high-efficiency strategies; decarbonizethe economy; and minimize oraltogether avoid generation of all formsof waste and pollution (UNEP 2008). 1This definition takes a broad industry perspective,extending beyond employment innarrowly defined environmental services. Inprinciple it embraces employment in producingany goods and services that have smalleradverse environmental impacts than closesubstitutes.Some definitions focus on industries producingenvironmentally desirable outputs.The OECD/Eurostat defines the environmentalgoods and services industry as “activitiesthat produce goods and services to measure,prevent, limit, minimize, or correct environmentaldamage to water, air, and soil, aswell as problems related to waste, noise, andecosystems. This includes technologies, products,and services that reduce environmentalrisk and minimize pollution and resources”(OECD 1999). For example, air and resourcepollution management would qualify.Using the OECD’s definition, green jobsconstitute a small but signifi cant share oftotal employment—about 1.7 percent oftotal paid employment in Europe (EuropeanCommission 2007). That is probably ahigher fraction than a global estimate alongUNEP lines would suggest; as UNEP notes,much of the documented growth in greenjobs has so far been in developed countries. 2Employees in many jobs might find thattheir jobs are not counted as “green” despitethe nature of the goods and services thatthey help produce. For example, jobs in thecar industry are excluded, even though somemay be devoted to developing low-carbonvehicles.As “the employment consequence ofgreen policies”Some definitions of green jobs follow a differenttrack, focusing on what happenswhen public policies to correct environmentalexternalities are introduced—openingthe possibility of including jobs createdand destroyed across the whole economy.In effect they try to answer the question,“What are the employment consequencesof introducing green policies (such as capand trade) relative to a baseline case?” Thisapproach requires implicit or explicit economicmodeling of the policies.Some studies in this vein count only jobsdirectly created by the policies—that is,“direct” employment effects. They focus onthe specific labor requirements of technologies(“bottom-up” estimates, using simplespreadsheet-based analytical models in conjunctionwith engineering estimates). 3 Animportant issue is the timing and durationof job creation. There is a key distinctionbetween construction, manufacture, andinstallation—where jobs may be fairly shortlived—andongoing operation, maintenance,and fuel processing—where the length ofjobs depends on the durability of the relevantplant.Other studies include both jobs createdand jobs destroyed in sectors disadvantagedby green policies—that is, indirect and netemployment effects. This net concept ofemployment change is crucial for evaluatingthe overall labor market impacts of environmentalpolicies. It can be done throughinput-output tables or general equilibriummodeling. They include jobs created by theaggregate demand generated by the extradirect and indirect employment (“induced”employment effects). This approach allowsjobs to be counted as green if they are createdby green policies, even if they are in sectorswith no obvious direct relationship toenvironmental objectives (such as communication)or with only a secondary relationship(such as fi nancial services). It also includesother economic feedbacks and mechanismstriggered by environmental policies, thushopefully capturing jobs lost owing to higherprices and lower real wages, lower finaldemand, and lower investment. But manystudies do not follow through with thisnetting-out process.Another approach considers different timehorizons—the further the time horizon, themore economic variables can be adjusted.

94 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFor example, a study of the impact of carbonprice policies on U.S. industry considersoutcomes along four time scales (Ho andothers 2008):• The very short run, where fi rms cannotadjust prices and profits fall accordingly.• The short run, where firms can raiseprices to reflect the higher energy costs,with a corresponding decline in sales as aresult of product or import substitution.• The medium run, when in addition tothe changes in output prices, the mixof inputs may also change, but capitalremains in place, and economy-wideeffects are considered.• The long run, when capital may be reallocatedand replaced with more energyefficienttechnologies.It concludes that employment consequencesof green policies differ strongly,depending on the time horizon. Short-termemployment losses mirror output declinesand are substantial in energy-intensive sectors,but gains in other industries would fullyoffset those losses in the longer term.But few studies account for labor marketrigidities and other obstacles to job creation,and yet they may impair any positive effectof green policies. As the World Bank studyon South Africa (World Bank 2011a) noted,green policies cannot correct all the problemsholding back job creation—such as skill mismatchesand the dualism (insider-outsider) ofthe job market. Thus, the scope for green jobcreation is limited in the absence of paralleleconomic policy changes.Evaluating the impact of green policieson jobs: Gross versus net job creationWhat is the overall job creation impact ofgreen policies in developing countries? Fewstudies have explicitly focused on this, andthose that have suffer from many definitionalissues, making comparisons difficult.4 They also fail to look at economywideeffects. That said, the few that doexist suggest that climate-change policiesin general and renewable energy policies inparticular can generate considerable extraemployment:• In South Africa, a study finds that an“energy revolution” scenario—that is, ascenario with a strong transition towardrenewable energy—creates 27 percentmore jobs than the International EnergyAgency’s business-as-usual scenario and5 percent more than the growth-withoutconstraintsscenario (Rutovitz 2010).• In India, a study finds that low-carbonemployment is one of the key co-benefits ofpromoting the renewables sector. It notesthat solar power is more labor- intensivethan wind power and better able to meetIndia’s requirements for small-scale, offgridpower. Biomass, green transport, andpublic works in water and forest managementare also attractive ways of achievingboth employment and environmentalobjectives (GCN 2010).• In China, a study emphasizes the possibleemployment losses from the plannedsharp reduction in the energy intensity ofChinese industry, but notes that this couldbe outweighed by increased employmentin renewables and—quantitatively, muchmore important—the shift of the Chineseeconomy toward services and away fromheavy industry (GCN 2010).• In Brazil, a study argues that renewableenergy sources have a stronger potentialin Brazil than is envisioned in officialstudies and government policies, both incontributing to CO 2mitigation and generatingjobs (GCN 2010).What is the record of green fiscal stimulion job creation in developing countries? Theevidence is scant, but a few studies do showsome job creation, with substantial variationin jobs created per dollars spent.• In the Republic of Korea, forest restorationgenerated nearly eight times asmany jobs per dollar as the least laborintensivegreen objective, “vehicles andclean energy” (Barbier 2009).• In China, biomass spending was foundto be nearly 30 times more effective ingenerating jobs per dollar than wind

HUMAN CAPITAL 95power (UNEP 2008). That suggests thatthe focus on renewable energy and lowcarbonmanufacturing prevalent in studiesfor Europe and the United States maymiss the opportunities for employmentcreation from changes in land managementand agriculture in developing countries,where these economic sectors arefairly more important.• In Latin America, water network rehabilitationand expansion in Honduras ismuch more effective (by a factor of morethan 10) in creating jobs than hydroelectricschemes in Brazil, with ruralelectrification in Peru falling in between(Schwartz and others 2009).While useful, these studies have limitations.They do not discuss the capital constraintsthat may hamper the (public orprivate) investments needed to create thegreen jobs. They assume people will moveseamlessly from one sector to another andignore labor market rigidities. They tend tofocus narrowly on the energy sector whengreen growth options (even when limited toclimate change concerns) exist in other sectorsthat may be more labor-intensive. Andthey do not always distinguish betweensubstitution (using more labor and lesscapital, energy, and other inputs) and lowerproductivity (using more inputs to producethe same amount of output). This distinctionmatters because capital-labor substitutionis desirable, at least for countries withexcess labor supply, large unemployment,and limited access to capital; lower productivityis not.Another question worth asking iswhether green spending is a good way ofcreating short-term employment during acrisis. The argument in favor of green fiscalstimuli is that they can both create jobs andlay the foundations for more sustainablegrowth. But experience suggests the needto look across the range of possible greenworks (from renewable energy to reforestation)as not all are equally labor-intensiveand “shovel-ready.”To begin with, if employment creationis the objective, higher spending in sectorswith lower capital intensities than eitherconventional or renewable energy—such asreforestation programs or even educationand health services—may be more effective.But there may be tradeoffs betweenrapid employment creation and “greenness.”Road building, for example, is fairlylabor-intensive and can help to provide valuableinfrastructure, but it is not particularlygreen. And some sectors, such as energy,will not top the list for sustainable rapid jobcreation, given that they require a long leadtime for replacing capital.And programs that yield larger employmenteffects tend to lead to more employmentgains for largely lower skilled workers, so thatthe long-term growth effects are fairly small.Long-term development, including sustainabledevelopment, requires more of a focus ongrowth-enhancing infrastructure investment,which is not necessarily labor-intensive.More analysis is needed of how globalmarkets will affect job creation—leakages ofgreen jobs and spending to other countriesdepend on endowments of skills, existingindustry structure, the nature of the technologiesnewly deployed, and the ways thatcomparative advantage is exploited (GCN2010).The last point is a useful reminder thatgeneral equilibrium effects matter. Yet theseare largely ignored in the green jobs literature.That may be particularly misleadingfor developing countries, as the next sectiondiscusses.The effect of green policies onemployment depends on labor marketstructure and the specific policyconsideredThe problem with studies that discuss jobmarkets is that they tend to either modelthem as perfectly competitive, and thusadapting instantly to all shocks with noinvoluntary unemployment (the neoclassicalmodel)—or as having involuntary unemploymentthat could be cleared with a fiscalstimulus (the Keynesian model). The first setof assumptions implies that green jobs are

96 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTlikely to displace as many jobs elsewhere inthe economy. 5 The second, that there willbe no crowding out of jobs by green fi scalstimuli.Neither approach is realistic. Mostdeveloping countries have surplus laboreconomies, so estimates limited to directemployment creation in the green jobsliterature might be less misleading fordeveloping countries than for industrialeconomies closer to full employment. Butit is more complicated in “dual” economieswith modern and traditional sectors or inthree-sector economies with a traditionalrural sector and both formal and informalurban sectors characteristic of many developingcountries (Harris and Todaro 1970;Mazumdar 1976). In that case the (skilled)formal urban labor market is often veryshallow and green job creations can havecrowding-out effects on other activities.So knowing how best to model how theaggregate labor market works—and, indeed,how the macroeconomy as a whole works—iscrucial to properly assess overall (net) job creation.Babiker and Eckaus (2007) illustratethe value of the implicit or explicit macroeconomicframework, showing how climatepolicy could increase unemployment in thepresence of real wage rigidities or barriers tothe sectoral reallocation of labor. Guivarchand others (2011) highlight that climate policycosts depend significantly on labor marketrigidities and that policy cost estimatesare much higher in models with imperfectlabor markets. Overall, labor market impactscan also be influenced by how the revenuesfrom other environmental taxes are used, asthe literature on the “double dividend” fromenvironmental taxation shows (Fullerton andMetcalf 1997; Sartzetakis and Tsigaris 2007).Studies tend to show that if tax revenues areused to reduce payroll tax—a tax on laborsupply—employment will fall by less or evenincrease.The key point is that the overall effects ofgreen policies on employment depend on thecharacteristics of the economy’s labor marketsand the nature of the policy interventions,including their funding, not just the inputrequirements of rival energy technologies.Indeed, underemployment can have multiplecauses, and the consequences of green policieswill differ depending on these causes. Itthus helps to consider the implications of awider range of theories of underemploymentand labor market adjustment in differenttypes of economy (box 4.1).But environmental regulationneed not kill jobs eitherA major fear being voiced in the green jobsdebate is that environmental regulation—needed to price externalities and encouragefirms to change their production processes—will destroy jobs.A tale of two antithetical hypotheses:the “pollution haven” and “Porter”hypothesesFor the past 20 years the debate on theimplications of environmental policies oncompetitiveness (and jobs) has revolvedaround two antithetical hypotheses: the“pessimistic” pollution haven hypothesis,which contends that firms will flee locationswith strong environmental regulations; andthe “optimistic” Porter hypothesis, whichargues that environmental regulation willlead to innovation (Porter and van der Linde1995). In the latter, innovation reduces thecost of regulation (weak Porter hypothesis)and may lead to increased competitivenessand profitability (strong Porter hypothesis).What is the latest thinking on this issue?As chapter 3 reported, there is no evidencethat environmental policies have systematicallyled to job losses because of an exodusof firms to pollution havens. Tighter environmentalregulation may cause fi rms to relocate,but they will choose locations that aremore attractive overall, as pollution abatementcosts represent a small share of productioncosts for most industries (Copeland2012). Factors such as availability of capital,exchange rates, labor abundance, location,institutions, and agglomeration effects aremore important than environmental policyin determining firm location and competitiveness.Empirical evidence from existing

HUMAN CAPITAL 97BOX 4.1A framework to estimate the impacts of green policies on jobsHow can policy makers determine if green policieswill create jobs? The following provides a frameworkto assess labor market consequences, exploringwhat would happen in an economy with two sectors:a clean one and a dirty one. The products areimperfect substitutes that are produced with manyinputs, including labor. The first two cases explorethe impact of green growth policies that focus onthe demand side, and the rest deal with policies thatfocus on the supply side.Case 1. Demand deficit and a green stimulusIn this case the economy is typified by “Keynesian”unemployment—that is, with insufficient overalldemand. The green policy involves a fiscal stimuluswith spending focused on the clean sector. Whatwould happen? Greater demand for the clean sector’sproduct would stimulate greater employment in theclean sector, in turn pushing up wages in this sector,and thus increasing final demand. Increased demandin the labor market would put upward pressure onwages throughout the economy, possibly causing aslight decline in employment in the dirty sector. Overall,employment would be expected to rise as long asjob creation in the clean sector outweighs the (indirect)job losses elsewhere, facilitating a virtuous outcome.Case 2. A green paradox: demand deficit and agreen stimulus meet a skills deficitHere again we have a Keynesian economy, butthere is a skills deficit in the clean sector. The greenpolicy involves a fiscal stimulus with spendingfocused on the clean sector. Higher demand for theclean sector’s products would feed into higher wagesacross the economy, because employment in the cleansector cannot expand, but overall employment levelswould not expand much, and may even decline. Thus,the green fiscal stimulus would be largely ineffectual,generate higher wages, and create little (if any)additional employment. (In an open economy thegreen stimulus may trigger imports, in which case itwould have little impact on employment.)Case 3. Pollution regulation with virtuous initialconditionsNow the green policy involves a pollution tax tocorrect a pollution externality in the dirty sector, andthere are no wage or price rigidities in the economy.Faced with an emissions tax, the optimum responsewould be a contraction of output and an investmentin pollution abatement. What would happen? Theregulations would be expected to destroy jobs inthe dirty sector, given that the tax raises productioncosts with the dirty technology and the price of thesegoods rises. As a result, demand for the clean substitutegood rises and employment in the clean sectorincreases—imparting incentives to reduce the externalityeither through new production techniques orend-of-pipe abatement, which would boost jobs inpollution abatement.This scenario suggests that overall employmentwould increase when there exists a close and cleansubstitute produced with more labor-intensive technologyor when abatement is feasible and more laborintensivethan dirty production (on the margin). Thissituation might apply to economies such as Japan’s orthe Republic of Korea’s that are well endowed withlabor skills and technology for cleaning up.Case 4. Pollution regulation with immiserizinginitial conditionsThis is similar to the previous case but with twokey differences: no clean substitute for the dirtygood, and pollution abatement is either far toocostly or unavailable, or is highly capital intensive.Production and employment in the dirty sectorwould decline, with little or no offsetting increasein cleaner jobs. This situation most likely applies toeconomies reliant on extractive industries—such asartisanal mining, where pollution abatement is typicallyfar too costly for the small producers and thereis no clean substitute available for the mineral.Case 5. Renewable resource regulations—restorerents but not necessarily jobsHere we have a classic open-access commonpropertyresource such as a fishery. Entry occursuntil the payoffs from harvesting decline to zero (orto the opportunity cost). If there is a tax or restrictionon harvesting, this would lower employment butincrease resource stocks and the payoffs. Thus, whileemployment may decline, economic returns increaseand environmental benefits accrue. Conversely, if thepolicy were accompanied by expenditure on ecosystemrestoration, there would be offsetting changes inemployment, with ambiguous net impacts.The bottom line is that the labor market consequencesof green policies depend on the policy underconsideration, technological parameters, and thestate of the economy. There are cases where a givenpolicy can create jobs, and other circumstanceswhen it can destroy jobs.Box text contributed by Richard Damania.

98 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTregulation or environmental taxes confi rmsthis result (Anger and Oberndorfer 2008;Ellerman and others 2010; Martin and others2011; Morgenstern and others 2002; Quirion2011; Sartor 2012). But this evidence is basedmostly on existing regulations in developedcountries, and future research needs to ascertainwhether these results extend to developingcountries and to more ambitious environmentalpolicies than have been applied todate.For sectors intensive in natural capital—with which many developing countries arewell endowed—the pollution haven hypothesisis even less likely. After all, without soundenvironmental policies, the increased pressurescoming from trade could rapidly depletenatural capital, and then the short-term benefitsfrom increased trade would be wipedout by the subsequent collapse of the resourcebase of the activity (Copeland 2012).The reality is that stringent environmentalprovisions are essential for guaranteeingthe long-term sustainability of the economicactivities (and jobs) that depend on naturalcapital. If a natural resource base is wellmanaged, it can be used to create jobs (movingup the value chain by creating a downstreamprocessing sector, for instance) andseize opportunities in global markets.At the firm level, studies show that theimpact of more stringent environmental regulationon productivity and competitiveness ismodest and sometimes even positive, thanksto innovation (Ambec and others 2011). Thelarge body of literature triggered by the seminalpaper by Porter and van der Linde (1995)supports the weak version of the Porterhypothesis: innovation does reduce costs.Further, recent studies have found anincreasing number of cases where environmentalregulation had positive impacts onprofits (Ambec and others 2011). This may bedue to the fact that regulators have becomebetter at designing smart regulatory policies,as well as that the models used to assess theeffects of environmental regulation on innovationand competitiveness were refi ned toaccount for the lagged structure of innovation(essentially they wait a few more yearsto evaluate the impact, giving the firm moretime to adapt).Thus, the overall effect of environmentalregulations on jobs is likely to be limited.In the United States, an econometric studyof highly regulated industries fi nds that theimpact of stringent environmental regulationson U.S. jobs was negligible in most cases—across all industries, 1.5 jobs were created per$1 million spent in additional environmentalspending, with a standard error of 2.2 jobs(Morgenstern and others 2002).Types of adjustment needed acrosscountriesThere is much variation across developingcountries in the likely ease of transition toa low-carbon growth pathway. Chapter 3shows that developing a comparative advantagein the production of equipment for lowcarbonelectricity depends on the manufacturingbase of the country and on whetherthere are scale and learning economies in thetechnology. Some countries have a comparativeadvantage in particular renewable energysources because of natural endowments.Brazil has the right climatic conditions andsoils to give it a substantial cost advantagein biofuels, though other characteristics ofthe Brazilian economy also help, in additionto being very well endowed in hydroelectricpotential (Kojima and Johnson 2005).Developing countries that produce a highlevel of greenhouse gas emissions per unit ofGDP face a more difficult challenge of structuraladjustment. They are the ones in whichmore labor is likely to have to be reallocatedfrom greenhouse gas–intensive activities,either by switching technologies within anindustry or by moving labor between industrysectors. Given the importance of CO 2emissions from energy production, energyintensiveeconomies will compose a large partof this group.Endowments of fossil fuels combined withindustrial development strategies that havefavored carbon-intensive industry make atransition to low carbon much more challenging(EBRD 2011). If such economies

HUMAN CAPITAL 99impose a carbon tax, the standard economicpolicy instrument to internalize the greenhousegas externality, the relative returns todifferent factors of production are likely tochange. The few empirical studies focusingon how carbon taxation might affect factorreturns suggest that the incidence of a carbontax is likely to be regressive when emissionabatement measures are capital-intensive,requiring complementary policies (Fullertonand Heutel 2007, 2010). Countries such asKazakhstan and Mongolia, with a muchlarger-than-average proportion of the laborforce in mining and energy supply, are morelikely to suffer as a result of this adjustmentand also from the difficulties of reallocatingdisplaced labor to other sectors. Chapter 3discusses how industrial and other sectorspecificpolicies can facilitate this transition.Smoothing the transition togreener growth paths for thelabor marketPolicy makers need to worry about skillsthat can limit job creation…To what extent are the skills needed in thelabor force for greener growth being altered?This matters because if the skills requiredare unavailable, that could place a majorobstacle in the way of the transition to greengrowth.Overall, “green restructuring” bringswith it the usual challenges to policy makerstrying to facilitate restructuring and reducethe labor market adjustment costs, includingthose from a changing skill mix. Manyof the expanding industries are likely to beusing new products and processes, reflectingthe transition to low-carbon technologies,so the generic skill requirements of many ofthe newly created jobs are likely to be higherthan average, as they have to allow forassimilation of unfamiliar tasks and workingmethods and “learning-by-doing.” Buta larger proportion of jobs in the renewableenergy sector and in energy efficiency arelower skilled than in the fossil fuel energysector (Pollin and others 2009). Contraryto the coal industry—which employs manylow-skill workers in developing countries—the oil and gas industries tend to have fairlywell-paid workers and a large proportion ofhighly qualified engineers and technicians.Perhaps the most thorough study of greengrowth and skills so far is ILO/CEDEFOP(2011), which reports and synthesizes theresults of 21 country reviews. It notes that thedemand for skills is being affected in threeways by the transition to green growth:1. Induced structural change across industriesincreases the demand for skillsspecific to expanding industries such asrenewable energy and reduces the demandfor skills such as those for coal mining.2. Some new occupations are emerging—such as photovoltaic (PV) fitters andcarbon-footprint assessors—though thereappear to be fairly few unique greenskills.3. The content of many jobs in current industriesis changing, as companies focus onachieving better energy efficiency, switchingfrom fossil fuel sources to renewableenergy, and producing capital equipmentfor expanding green industries. In agriculture,low- and no-till agriculture andreduced use of fertilizers and pesticideswill entail changes in farmers’ practices,as will increased production of biofuelcrops and efforts to increase forestcover—a development likely to have themost pervasive effects on labor markets,particularly in developing countries.What is worrisome is that skill shortagesmay already be impeding the transition togreen growth (box 4.2). In 2011 the OECD(2011a) drew attention to widespread skillshortages in energy-efficient constructionand retrofitting, renewable energy, energyand resource efficiency, and environmentalservices. Many countries have reportedspecific bottlenecks, such as the shortage ofskilled PV workers in Germany and the lackof design engineers for smart grids in theUnited Kingdom. Karp and Stevenson (2012)identify similar shortages in developing countries.In India, maintaining and operating the

100 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 4.2 Shortage of skills and inadequate training provisions can undermine greenprogramsThe problems that can arise when training provisionis not up to the challenge of the induced structuralchange are illustrated by Australia’s experiencewith a new Home Insulation Program introduced inFebruary 2009 as a key part of the government’s fiscalstimulus.The program was designed partly to generatejobs for lower skilled workers in the housing andconstruction industries. At the start of the programonly supervisors were required to satisfy one of threeminimum competences—prior experience in the insulationindustry, qualifications in an approved trade,or insulation-specific training. The program provedpopular. At its peak, demand was running at almost2.5 times the anticipated level and some 1.1 millionroofs of 2.7 million eligible were insulated. But fires,fitters’ deaths, and reports of fraud underminedpublic confidence, and the program was canceled inFebruary 2010. A subsequent sample of inspectionsrevealed that nearly 30 percent of installations hadsome level of deficiency. Investigations showed thatlow skill levels in the industry, inadequate provisionof training, and poor management of the programwere among the factors responsible.The importance of competent project managementand national policy making in this case is areminder of the key role of higher level managementand planning skills in a policy-induced transition togreen growth that is likely to take sustained effortand policy credibility over a long period.Source: Australian National Audit Office 2010.renewable energy systems deployed by theRemote Village Electrification is complicatedby the lack of skilled workers (IEA 2010).In 2001 China started the TownshipElectrification Program to bring electricityto rural communities using solar PV, smallhydro, and wind. While installation appearsto be working well, there are problems withmaintenance and operation, partly becauseof a lack of qualified electricians. Reasonsfor these reported shortages include theunderestimation of the growth of certaingreen sectors, the general shortage of scientistsand engineers, the low reputationand attractiveness of some sectors importantfor the green transition such as wastemanagement, and a shortage of teachersand trainers in environmental service (ILO/CEDEFOP 2011).Many of the skill shortages alreadyreported in connection with green growthstrategies appear to result from generic failingsin education and training. And theyreflect long-standing issues such as the lackof functioning universities and researchcenters, the mismatch between students’choices of discipline and the needed skills,the lack of incentives for employers to investin developing the transferable skills of theirworkforces, the lack of access for the disadvantagedto time and finance for training,and the stickiness of relative pay rates.Fortunately, there is a potential for synergiesbetween green policies aimed at skilldevelopment and growth policies aimed atincreasing labor capital, worker education,and labor productivity. Figure 4.1 shows thatmany developing countries need to increasetheir enrollment in technical tertiary education.Such an increase would accelerategrowth and help with skill limitations createdby green policies.…and learn from the lessons of tradeadjustmentGreen growth is about transforming ourproduction and consumption processesfrom a dirty, environmentally unsustainablemodel to a sustainable one. Like any structuraltransition it inevitably entails transitioncosts, which green growth policies must seekto minimize. As such, the trade literature,which has extensively documented adjustmentcosts associated with trade liberalization,offers interesting insights.

HUMAN CAPITAL 101Adjustment costs, whether stemmingfrom trade shocks or a transition to greengrowth, are fundamentally driven by factorimmobility—sluggishness in capital or labormarket adjustments. 6 These costs would bezero were workers able to adjust instantlyto the changing demand for skills (movinginstantly from one industry to another) andwere firms able to instantly modify theirfixed capital following changes in carbonprices or pollution standards.In the real world, labor markets are sluggish,as experience with trade liberalizationshows. Trade liberalization creates anddestroys jobs within industries. But the flowof labor across sectors—from shrinking toexpanding ones—is slow. In Brazil it tookseveral years for workers displaced from deprotectedindustries to be absorbed by sectorswith comparative advantages (Muendler2010). In addition, large wage differencespersist among workers with similar qualificationsand status across industries, suggestinglimited mobility of workers across industries(if workers were mobile, they would switch tothe highest paying industry until wages equalized).This “industry-effect” explains a largefraction of wage differences across workers,and prevails in both developed and developingcountries, for skilled and unskilled workers(Krueger and Summers 1989).What does this sluggishness stem from?Slow labor market adjustments reflectdemand-side (industries requiring specificskills) and supply-side (worker characteristics)factors. Whether sector-specific knowledgeand training are a bigger impedimentto mobility than labor market frictions (thetime and costs associated with search andmatching) depends on the extent to whichworker experience is specific to each sector(Cosar 2010; Dix-Carneiro 2010). And thereappears to be significant variation in themobility of different types of workers, withlower adjustment costs for younger workersand skilled workers. The policies needed tohelp transition may thus differ by country(depending on the nature of the adjustment)or by affected worker categories (dependingon age, skill, and so on).FIGURE 4.1 Many developing countries need to increase theirenrollment in technical tertiary education(enrollment in engineering, manufacturing, and construction in tertiaryeducation as a percentage of the total population, 2009)percent1.81.61.41.21.00.80.60.40.20.00 5,000 10,000 15,000 20,000GDP per capita ($,PPP)Source: Authors based on UNESCO Institute for Statistics, http://stats.uis.unesco.org/unesco/ReportFolders/ReportFolders.aspx (accessed March 18, 2012); World Bank 2011b.Note: PPP = purchasing power parity.As for capital stocks, a shift towardgreener production processes is likely torequire substantial changes, as firms mayneed to invest in new product lines, machines,and equipment. Yet, as experience with tradeadjustment shows, the process may be quitecostly—for example, following Argentina’strade reform, the required capital adjustmentaveraged 14.5 percent of firms’ capital stock(Bet and others 2011). Thus, the capacity ofeconomies to adjust to green policies may belimited by capital constraints, which couldaffect labor demand.Because adjustment costs are a direct functionof factor immobility, efforts to increaselabor or capital mobility will be critical. Andsupport policies should be targeted to facilitatingthe transition rather than cushioningpotential losses. Simple unemployment insurancetends to hamper reallocation and skillformation. But employment subsidies can beuseful if made conditional on working in theexport-oriented (or green) sector (a form ofindustrial policy; see chapter 3).

102 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTUltimately, the cost of the transition willdepend on the overall economic policy frameworkand the extent to which it facilitates theemergence and growth of new sectors andfirms. So the ability to carry out and reap thebenefits of a green growth policy will dependon good economic policy.In sum, fears that environmental regulationswill lead to massive job losses or loss ofcompetitiveness are probably as unfounded asthe hope that green jobs will single-handedlysolve countries’ employment problems. Thatsaid, it is vital to invest in human capital toaccelerate growth and to green growth. Thisis one of the inputs to economic production.Natural capital is another critical input, andthe next chapter will look at why it is importantto invest in this domain, too.Notes1. UNEP also includes a provision that “greenjobs need to be decent jobs” (UNEP 2008).2. At the same time developed countries areresponsible for, by far, the largest share ofthe stock of greenhouse gases in the atmosphere.They have also probably made adisproportionate contribution to long-livedsolid waste. So some of the green jobs reflectthe unsustainability of developed-countryeconomies.3. See Kammen and others (2004) and Wei andothers (2010) for a review.4. Further, studies use a range of methods,reflecting the different definitions of green jobcreation discussed above, differ in coverage ofcountries and sectors and as to whether theyinclude gross or net effects and whole valuechain effects, and make varying assumptionsconcerning economic growth and businessas-usualscenarios (Bacon and Kojima 2011;Fankhauser and others 2008; GCN 2010;GHK 2009; Kammen and others 2004; Weiand others 2010). The few studies of developingcountries conclude to significant job creation,but offer no analysis of the net impact(see box 4.2).5. In such models implementing carbon pricingwill tend to both redistribute labor to lowcarbonactivities and reduce overall laborsupply due to the higher relative price ofcarbon-intensive goods and services. Therecan be net job destruction, depending on howthe revenues from carbon pricing are used asin a study of the potential implications of acap-and-trade system for the United States,which found significant reductions in laborinput in 29 of 35 U.S. industries without revenuerecycling (Goettle and Fawcett 2009).6. For instance, Guivarch and others (2011)model economic transaction costs due to aclimate policy with different levels of rigidityin the labor market, finding that mitigationcosts are much larger when labor marketimperfections are considered.ReferencesAmbec, S., M. A. Cohen, S. Elgie, and P. Lanoie.2011. “The Porter Hypothesis at 20: CanEnvironmental Regulation Enhance Innovationand Competitiveness?” Discussion Paper11-01, Resources for the Future, Washington,DC.Anger, N., and U. Oberndorfer. 2008. “FirmPerformance and Employment in the EUEmissions Trading Scheme: An EmpiricalAssessment for Germany.” Energy Policy36: 12–22.Australian National Audit Office. 2010. “Reporton the Home Insulation Program.” AuditorGeneral Report 12, 2010–11, Canberra.Babiker, M. H., and R. S. Eckaus. 2007.“Unemployment Effects of Climate Policy.”Environmental Science & Policy 10: 600–9.Bacon, R., and M. Kojima. 2011. “Issues inEstimating the Employment Generated byEnergy Sector Activities.” Background paperfor the World Bank Group energy sectorstrategy, World Bank, Washington, DC.Barbier, E. B. 2009. “A Global Green New Deal.”Policy Brief, United Nations EnvironmentProgramme, Geneva.Bet, G., I. Brambilla, and G. Porto. 2011. “TradeReforms, Wages and Employment with LaborMobility and Capital Adjustment Costs.”Working Paper, Universidad Nacional de LaPlata, Buenos Aires.Bowen, A. 2012. “Green Growth, Green Jobs,and labor Markets.” Policy Research WorkingPaper 5990, World Bank, Washington, DC.CCICED (China Council for InternationalCooperation on Environment and Development).2011. “Development Mechanism and PolicyInnovation of China’s Green Economy.”CCICED Task Force Report, CCICED AnnualGeneral Meeting, November 15–17.

HUMAN CAPITAL 103Copeland, B. R. 2012. “International Tradeand Green Growth.” Paper presented at theGreen Growth Knowledge Platform inauguralconference, Mexico City, January 12–13.Cosar, A. K. 2010. “Adjusting to TradeLiberalization: Reallocation and LaborMarket Policies.” University of Chicago,Booth School of Business, Chicago.Dix-Carneiro, R. 2010. “Trade Liberalizationand Labor Market Dynamics.” CEPS WorkingPaper 212, Princeton University, Departmentof Economics, Center for Economic PolicyStudies, Princeton, NJ.EBRD (European Bank for Reconstructionand Development). 2011. Special Report onClimate Change: The Low Carbon Transition.London: EBRD.Ellerman, A. D., F. Convery, and C. de Perthuis.2010. Pricing Carbon. Cambridge, UK:Cambridge University Press.European Commission. 2007. Facts andFigures: Links between EU’s Economyand Environment. Luxembourg: Officefor Official Publications of the EuropeanCommunities.Fankhauser, S., F. Sehlleier, and N. Stern. 2008.“Climate Change, Innovation and Jobs.”Climate Policy 8: 421–9.Fullerton, D., and G. Heutel. 2007. “Who Bearsthe Burden of a Tax on Carbon Emissionsin Japan?” Environmental Economics andPolicy Studies 8: 225–70.———. 2010. “Analytical General EquilibriumEffects of Energy Policy on Output andFactor Prices.” NBER Working Paper 15788,National Bureau of Economic Research,Cambridge, MA.Fullerton, D., and G. E. Metcalf. 1997.“Environmental Taxes and the Double-Dividend Hypothesis: Did You Really ExpectSomething for Nothing?” NBER WorkingPaper 6199, National Bureau of EconomicResearch, Cambridge, MA.GCN (Global Climate Network). 2010. “Low-Carbon Jobs in an Interconnected World.”Discussion Paper 3, GCN, London.GHK. 2009. “The Impacts of Climate Change onEuropean Employment and Skills in the Shortto Medium-Term: A Review of the Literature.”Final Report to the European CommissionDirectorate for Employment, vol. 2, SocialAffairs and Inclusion Restructuring Forum,London.Goettle, R. J., and A. A. Fawcett. 2009. “TheStructural Effects of Cap and Trade ClimatePolicy.” Energy Economics 31 (SpecialSupplement 2): 244–53.Guivarch, C., R. Crassous, O. Sassi, andS. Hallegatte. 2011. “The Costs of ClimatePolicies in a Second Best World with LabourMarket Imperfections.” Climate Policy11: 768–88.Harris, J. R., and M. P. Todaro. 1970. “Migration,Unemployment, and Development.” AmericanEconomic Review 60: 126–42.Ho, M. S., R. D. Morgenstern, and J-S Shih.2008. “Impact of Carbon Price Policies on U.S.Industry.” Discussion Paper 08-37, Resourcesfor the Future, Washington, DC.IEA (International Energy Agency). 2010.Comparative Study on Rural Electrifi cationPolicies in Emerging Economies: Keys toSuccessful Policies. Paris: IEA.ILO/CEDEFOP (International LabourOrganization and European Centre for theDevelopment of Vocational Training). 2011.Skills for Green Jobs: A Global View. Geneva:ILO.Kammen, D. M., K. Kapadia, and M. Fripp.2004. “Putting Renewables to Work: HowMany Jobs Can the Clean Energy IndustryGenerate?” Report of the Renewable andAppropriate Energy Laboratory, University ofCalifornia, Berkeley.Karp, L., and M. Stevenson. 2012. “GreenIndustrial Policy.” Paper presented atthe Green Growth Knowledge Platforminaugural conference, Mexico City, January12–13.Kojima, M., and T. Johnson. 2005. “Potentialfor Biofuels for Transport in DevelopingCountries.” Energy Sector ManagementAssistance Programme, World Bank,Washington, DC.Krueger, A., and L. Summers. 1989. “EfficiencyWages and the Inter-Industry WageStructure.” Econometrica 56: 259–93.Martin, R., U. J. Wagner, and L. B. de Preux.2011. “The Impacts of the Climate ChangeLevy on Manufacturing: Evidence fromMicrodata.” NBER Working Papers 17446,National Bureau of Economic Research,Cambridge, MA.Mazumdar, D. 1976. “The Rural-Urban WageGap, Migration, and the Shadow Wage.”Oxford Economic Papers 28 (3): 406–25.Michaels, R., and R. P. Murphy. 2009. “GreenJobs: Fact or Fiction? An Assessment of theLiterature.” Institute for Energy Research,Houston, TX.

104 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTMorgenstern, R. D., W. A. Pizer, and J.-S.Shih. 2002. “Jobs versus the Environment:An Industry-Level Perspective.” Journal ofEnvironmental Economics and Management43 (3): 412–36.Morriss, A. P., W. T. Bogart, A. Dorchak, andR. E. Meiners. 2009. “Green Jobs Myths.”Law & Economics Research Paper LE09-001,University of Illinois, Champaign, IL.Muendler, M. 2010. “Trade Reform, EmploymentAllocation and Worker Flows.” In TradeAdjustment Costs in Developing Countries:Impacts, Determinants and Policy Responses,ed. G. Porto and B. M. Hoekman, 103–42.Washington, DC: World Bank.OECD (Organisation for Economic Co-operationand Development). 1999. The EnvironmentalGoods and Services Industry: Manual forData Collection and Analysis. Paris: OECDPublishing.———. 2011a. “Labor Markets in the Transitionto Green Growth: Challenges and PolicyResponses.” OECD, Paris.———. 2011b. Towards Green Growth: ASummary for Policy Makers. Paris: OECDPublishing.Pollin, R., H. Garrett-Peltier, J. Heintz, andH. Scharber. 2008. “Green Recovery: AProgram to Create Good Jobs and StartBuilding a Low-Carbon Economy.” Universityof Massachusetts Political Economy ResearchInstitute and the Center for American Progress,Amherst, MA, and Washington, DC.Pollin, R, J. Heintz, and H. Garrett-Peltier. 2009.“The Economic Benefits of Investing in CleanEnergy.” University of Massachusetts PoliticalEconomy Research Institute and the Centerfor American Progress, Amherst, MA, andWashington, DC.Porter, M., and C. van der Linde. 1995. “Towardsa New Conception of the Environment-Competitiveness Relationship.” Journal ofEconomic Perspective 9 (4): 97–118.Porto, G. 2012. “The Cost of Adjustment toGreen Growth Policies: Lessons from TradeAdjustment Costs.” Paper prepared for theGreen Growth Knowledge Platform inauguralconference, Mexico City, January 12–13.Quirion, P. 2011. “Les quotas échangeablesd‘émission de gaz à effet de serre: élémentsd‘analyse économique.” Mémoire d’habilitationà diriger les recherches, École des HautesÉtudes en Sciences Sociales, Paris.Rutovitz, J. 2010. “South African Energy SectorJobs to 2030” Paper prepared for GreenpeaceAfrica by the Institute for SustainableFutures, University of Technology, Sydney,Australia.Sartor, O. 2012. “Carbon Leakage in the PrimaryAluminium Sector: What Evidence after6½ Years of the EU ETS?” CDC ClimateResearch Working Paper 2012-12, Caisse desDépôts et des Consignations, Paris.Sartzetakis, E. S., and P. D. Tsigaris. 2007.“Uncertainty and the Double DividendHypothesis.” Nota di Lavoro 99.2007,Fondazione Eni Enrico Mattei, November.Schwartz, J. Z., L. A. Andres, and G.Draboiu. 2009. “Crisis in Latin America.Infrastructure Investment, Employmentand the Expectations of Stimulus.” PolicyResearch Working Paper 5009, World Bank,Washington, DC.UNEP (United Nations EnvironmentProgramme). 2008. Green Jobs: TowardsDecent Work in a Sustainable, Low-CarbonWorld. Washington, DC: WorldwatchInstitute.———. 2011. Towards a Green Economy:Pathways to Sustainable Development andPoverty Eradication—A Synthesis for PolicyMakers. Geneva: UNEP. http://www.unep.org/greeneconomy.Wei, M., S. Patadia, and D. M. Kammen. 2010.“Putting Renewables and Energy Efficiency toWork: How Many Jobs Can the Clean EnergyIndustry Generate in the US?” Energy Policy38: 919–31.World Bank. 2011a. South Africa EconomicUpdate—Focus on Green Growth.Washington, DC: World Bank.———.2011b. World Development Indicators.Washington, DC: World Bank.World Bank and DRC (Development ResearchCenter of the State Council, China). 2012.“Seizing the Opportunity of Green Developmentin China.” Supporting Report 3 for China2030: Building a Modern Harmonious, andCreative High-Income Society. Washington,DC: World Bank.

Natural Capital: ManagingResources for Sustainable Growth5Key Messages• Sustainable management of natural capitalunderlies green growth in key sectors—suchas agriculture, manufacturing, and energy—and is vital for resilience and welfare gains.• Different resources require different typesof policies. For extractable but renewableresources, policy should center on definingproperty rights and helping firms move upthe value chain. For cultivated renewableresources, policy should focus on innovation,efficiency gains, sustainable intensification,and “integrated landscape” approaches.• The elements of natural capital cannot beregarded in isolation. Integrated landscapeapproaches can increase production of both“regulating” and “provisioning” services ofnatural capital.• In some cases, growth and green outcomes—such as cleaner air, cleaner water, less solidwaste, and more biodiversity—will involvetradeoffs. But not all of these tradeoffs areinevitable: innovation, which can be supportedthrough smart subsidies, can helpminimize or eliminate some of them.Meeting peoples’ needs for food,fuel, and fiber depends on soundmanagement of the naturalcapital—agricultural lands, forests, water,fisheries—on which production of thesegoods depends. Manufactured goods alsodepend on sustained production from naturalcapital, such as subsoil assets.But what exactly is natural capital? Theterm refers to the stock of natural resourcesthat provides flows of valuable goods andservices. Major types of natural capital includeagricultural lands; subsoil assets (oil, gas, coal,and minerals); forests; water; fisheries; and theatmosphere. 1 Goods and services provided bynatural capital underpin conventionally measuredeconomic growth by providing inputs toagriculture, manufacturing, and services andby increasing the productivity of agricultureand the reliability of infrastructure servicesthrough climate control.Complementing natural capital withhuman, physical, and social capital greatlyincreases its productive capacity. But the105

106 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTextent to which other forms of capital cansubstitute for natural capital is bounded,because people require water, food, and airto live, and demand for water and food willincrease as population and incomes rise.How can better management of naturalcapital lead to green growth? Sustainablemanagement of capture fisheries canincrease economic returns. Restoration andenhancement of watershed services canenhance agricultural productivity. Conservationof biodiversity can generate economicreturns through nature-based tourism andbioprospecting. Rents accrued from mineralextraction can be invested in infrastructureand human capital, thus generating economicreturns.But achieving these outcomes is not easy,given the myriad market and institutionalfailures at play. What is needed, therefore,is a package of measures encompassing bothprice and nonprice interventions to enhancethe management of natural capital. Reapinghigher economic returns from natural forests,for example, requires aligning policies,incentives, capacity, and governance. Reapinghigher returns from mineral extractionrequires policies that increase productionefficiency, fiscal policies that are fair to boththe government and investors, and publicexpenditure policies that encourage the reinvestmentof income for broader developmentgains.This chapter explores how better managingnatural capital can promote greengrowth. It looks at four broad categories:(1) extractable renewable resources (capturefisheries, natural forests, soil, and water);(2) cultivated renewable resources (crops,livestock, aquaculture, and forest plantations;(3) nonrenewable resources (oil, gas,coal, and minerals); and (4) ecosystemsthat provide regulating services (watershedmanagement, climate regulating services,and nature-based tourism). The fi rst threecategories provide “provisioning” services(those that directly produce goods and services,such as food and water); the fourthembraces “nonprovisioning” services (thosethat provide regulating services, supportingservices, and cultural services). 2The key fi nding is that sustainable managementof natural capital is essential forgreen growth in key sectors—such as agriculture,manufacturing, and energy—and is vitalfor resilience and welfare gains. The type ofmeasure (both price and nonprice) needed willvary with the type of resource being targeted:• For extractable but renewable resources,policy should center on defining propertyrights and helping firms move up thevalue chain.• For cultivated renewable resources, policyshould center on innovation, efficiencygains, sustainable intensification, and“integrated landscape” approaches thatcan lead to productivity gains withoutdamaging the environment. 3• For nonprovisioning services, effortsshould concentrate on increasing knowledgeof the economic value of these servicesand incorporating these values inpolicy decisions.• For nonrenewable resources, the focusshould be on minimizing environmentaldamage and recovering and reinvestingrent optimally for broader economicdevelopment.Second, the elements of natural capitalcannot be regarded in isolation. Integratedlandscape approaches can increase productionof both “regulating” and “provisioning”services of natural capital—for example, byintegrating the production of crops, trees, andlivestock on the same land area or by managinganimal waste to enhance soil fertility andproduce energy rather than contributing topollution. But solutions need to be adapted tolocal circumstances and need to include theright policy measures to provide incentivesfor innovation and adoption.Third, in some cases, growth and greenoutcomes—such as cleaner air, cleaner water,less solid waste, and more biodiversity—willinvolve tradeoffs. These tradeoffs are mostcommon in current cultivation practices inagriculture, livestock, aquaculture, and plantationforests. But not all of these tradeoffsare inevitable: innovation, which can be supportedthrough smart subsidies, can helpminimize or eliminate some of them.

NATURAL CAPITAL 107Extractable renewable resources:Defining property rights andmoving up the value chainExtractable renewable resources (capturefisheries, natural forests, soil, and water) areoften, though not always, common propertyresources—goods from which it is difficultto exclude potential users, whose consumptionprecludes consumption by others. Theinability to exclude users often leads theseresources to be managed under open accessproperty rights regimes, under which no economicreturns or rents accrue to the scarcenatural capital. Under such a scenario, morefactors of production are employed in theextraction of the resource than is efficient,and more of the resource is extracted, acceleratingits depletion.If property rights were established, totaloutput would increase (perhaps after a lagduring which the resource regenerates itself),and rents would accrue to the scarce naturalresource. Some factors of production, suchas labor, could, however, be worse off onceproperty rights were established, unlessthe rents were redistributed (Weitzman1974). The fact that establishment of propertyrights can reduce the returns to labormay explain the resistance to introducingsuch rights. These potential losses shouldbe weighed against enhanced productivity,which can improve overall economic welfareand, with a supportive policy environment,can enhance opportunities for moving upthe value chain (by shifting from extractionalone to downstream processing), providingnew job opportunities.Capture fisheriesGlobally, capture fisheries added $80 billionin gross value and provided direct and indirectemployment to more than 120 millionpeople in 2004 (World Bank and FAO 2009).But because fish are mobile, marine capturefisheries are very difficult to manage: only ahandful of fisheries are being managed reasonablyefficiently.The open access nature of capture fisherieshas led to overcapitalization, rent loss,and overexploitation. Because of a shrinkingresource base, the growing number of fishersand fishing overcapacity, the catch per fisherand per vessel has been declining globally—despite significant technological change andinvestments in vessel capacity (figure 5.1).The prevalence of subsidies has reduced thecost of fishing below its economic cost andhas contributed both to overfishing andresource depletion and to the economic wasteassociated with overcapacity (World Bankand FAO 2009).The good news is that well-managed fisheriescould accrue rents as high as $50 billion(World Bank and FAO 2009), whichcould be used to build wealth or increaseproductivity. Establishing property rightswould help unlock the potential economicvalue of fisheries. But defi ning and enforcingthese rights remains a challenge. Highseacapture fi sheries (beyond the exclusiveeconomic zone) are dominated by largecommercial vessels, which are often largelyunregulated, overcapitalized through subsidies,or both. 4For their part, inshore capture fisherieshave long been used as a safety netFIGURE 5.1 Current fishery practices are not sustainable(productivity of global fishing fleet, 1970–2005)number of decked vessels (millions);fleet capacity index (fishing power)3.53.02.52.01.51.00.50197019801985decked vessels (number)catch per vessel (tons)Source: World Bank and FAO 2009.Note: The fleet capacity index is the relationship between the capacity of a fishing fleet to catch aparticular quantity of fish and the quantity of fish it actually catches.199019952000200514012010080604020fleet capacity index (fishing power)catch per unit capacity (tons)catch per vessel (tons); catch per unit capacity (tons)

108 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTfor the rural unemployed; for this reason,policy makers resist altering the status quo.Success stories suggest that policy interventionsthat directly address the job lossassociated with defining property rightscan make green growth politically feasible(box 5.1). In addition, moving up thevalue chain can help create jobs that aremore productive. However, such “industrial”policies may not reflect the country’scomparative advantage and would need tobe justified on a case-by-case basis (Hausmannand others 2008).Natural (including managed) forestsNatural forests (including natural foreststhat are actively managed) provide a rangeof extractable commodities (from timberto wood fuel to various nontimber forestproducts) and a range of ecosystem services(from regulation of soil, water, and theclimate to sequestration of carbon and provisionof habitats). In Africa alone, forestsaccount for 65 percent of the total primaryenergy supply. Nontimber forest products(fruit, nuts, medicinal plants, and game) arean important source of rural livelihoods.Global demand for industrial wood wasabout 1.8 billion cubic meters in 2010, andit is projected to rise to 2.6 billion cubicmeters by 2030, with most of the increasecoming from Asia and Eastern Europe(FAO 2011). 5How will this growing demand be metgiven that natural forests are often notwell managed? The global rate of deforestationremains high, especially in tropicalregions, with deforestation averaging about1 percent a year in Latin America and Africaover the 1990–2010 period. The encouragingnews is that the rate of deforestation hasbeen declining since 2000 (FAO 2011), withimpressive declines in some key countries suchas Brazil. Moreover, some areas—such astemperate and boreal zones and some emergingeconomies—have witnessed increases inforest area through both natural forest recoveryand reforestation. Indeed, more than 80percent of traded timber is produced in temperatecountries.A problem for the world’s forests—80 percent of which are publicly owned—ispoorly defined property rights. In manydeveloping countries, forests are oftentreated as de facto open access areas. Significantprogress has been made in recent yearstoward devolving full or partial forest managementto local communities to deal withthe problems associated with open accessBOX 5.1Job creation and revenue generation from off-shore capture fisheries in NamibiaSoon after gaining independence from SouthAfrica in 1990, the new Namibian governmentdeclared an extended economic zone, established acoherent fisheries policy, and enacted comprehensivefisheries legislation based on long-term fishingrights (rights-based management) and paymentsfor these rights. At the same time, it focused onthe “Namibianization” of the processing sector.Before independence, all fish were exported (ortransshipped at sea) whole and frozen for laterprocessing into value-added products abroad. Byinvesting in local processing capacity, Namibiacreated many jobs and increased the industry’svalue added (although it also created considerableprocessing overcapacity).With an average catch of 500,000–800,000 tonsa year (in 2003 the total catch was about 636,000tons), the fisheries sector’s contribution to grossdomestic product rose from about 4 percent at independenceto 10.1 percent in 1998. About 95 percentof Namibia’s total fish production is exported, yieldingabout $375 million in foreign exchange in 2005.About 14,000 people were employed in the fisheriessector in Namibia in 2003, about half of them inonshore processing.Source: http://www.fao.org/fishery/countrysector/FI-CP_NA/en.

NATURAL CAPITAL 109BOX 5.2Reform of forest tenure in Albania and ChinaIn Albania serious degradation of the forests andpastures was observed in the early transition years.To address the problem, the government reformedand decentralized national institutions andincreased support to pasture and forest managementat the local level. Reforms transferred managementrights of forests and pastures to local communities.To deal with fi re management and control illegallogging, the government adopted a cross-sectoralapproach. It provided local investment support forthe restoration of watersheds, forests, and pastureland using participatory planning approaches. Thissupport included small-scale investments in theplanting of forests and orchards in degraded lands,the thinning and cleaning of degraded forests andpastures, and measures to control erosion and grazing.This mix of policy, social, and natural capitalinvestments enhanced resilience (erosion controland soil restoration), yielded environmental benefits(carbon sequestration), increased efficiency (greaterpasture and forest productivity), created jobs, andreduced poverty.In China, the government has made substantialinvestments in tree planting across the country overthe past 25 years to restore environmental balanceand secure supplies of raw materials. It hasalso reformed forest user rights to collective forests(forests under the control of provinces and othersubnational authorities). Like reforms to propertyrights of agricultural lands, these reforms soughtto harness the productive energies of rural householdsand communities. They amount to the largesttransfer of forest wealth ever recorded. Mostreforms involve provisions that offer individualhouseholds a large degree of economic autonomyand independence to manage the forests, withhouseholds and farmers’ groups receiving certifi -cates of use rights.Source: World Bank 2010b, 2010c.regimes (box 5.2). But there have been fewassessments of the impact of changes inforests management regimes on the rate ofdeforestation or the productivity of forests.A review of 42 studies on community forestmanagement concludes that little is knownabout the effect of community forest managementon improving the productivity offorests or reducing poverty (Bowler and others2010).Another problem is that assessmentsof the economic value of forests are rare,especially in developing countries, particularlywhen it comes to valuing the economiccontribution of nontimber forest products.These products are undervalued because,in many countries, they are not reflected innational accounts systems, in part becausethey are produced informally. For example,in Europe, where these products are economicallymarginal, they were valued at $7billion in 2010. In contrast, in Africa, wherethey are much more important economically,they totaled only an estimated $0.5billion (FAO 2011).Where these assessments do exist, they suggestthat a number of factors limit the valueadded from these resources. A meta-study of61 case studies of production of and trade innontimber forest products in Africa, Asia,and Latin America finds that, by and large,commercialization has not helped reducepoverty, for four reasons:• Resources are often collected under openaccess regimes, where overexploitation iscommon, leading to rent dissipation.• Access to markets tends to be poor, limitingeconomic returns.• Fluctuations in quantity and quality makecommercialization of nontimber forestproducts difficult.• Middlemen often capture the bulk ofadded value (Belcher and others 2005).As with capture fisheries, increasing theeconomic returns from natural forests sustainablyrequires a package of measures thatincludes strengthening property rights; assessingthe economic value of forests; and adoptingmeasures, such as better market access

110 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTTABLE 5.1growthCountryand improved product quality, that increaseeconomic returns and reflect the full value ofthe service.SoilSoil quality reflects how well a soil performsthe functions of maintaining biodiversityand productivity, supporting plantsand other structures, and providing a slewof other nonprovisioning ecosystem services.Land degradation includes deteriorationof soil quality, vegetation, and waterresources (Nkonya and others 2011). It isa process that affects all agroecologicalzones, potentially reducing GDP (table 5.1).A quarter of the world’s agricultural land isestimated to be seriously degraded (Bai andothers 2008).Factors leading to land degradationinclude poor agricultural and grazing practicesand forest degradation as well as factorsoutside the renewable natural resourcesector, including poorly designed infrastructureand mining activities. Land degradationcan, in turn, affect the operationof infrastructure installations by silting upkey facilities such as ports and hydroelectricpower generation facilities.Land users need to be given the right economicincentives to invest in preventing ormitigating land degradation. The strengthof these incentives depends on the nature ofland tenure regimes (Deininger and FederPoor soil quality and land degradation hurt economicType of degradationPercentage ofGDP lostCentral African Republic Cropland and soil 1.0Colombia Land 0.8Egypt, Arab Rep. Soil 1.2GhanaAgricultural soils, forests, and 5.3savanna woodlandsPakistan Soil salinity and erosion 1.2TajikistanLand, including soil erosionand salinity3.7Source: Country Environmental Analyses conducted by the World Bank (World Bank 2005a, 2006a,2006b, 2007c, 2008b, 2010a).2001; López 2002) and on the way costsand benefits are shared. Costs, for example,are often borne only by the farmer, whereasenvironmental benefits accrue to society asa whole.Well-defined, transparent, and secureland tenure systems are essential if farmersare to undertake the long-term conservationthat underpins agricultural productionand investments to improve natural capitaland productivity. In Rwanda, for example,land tenure reform led to a rapid doublingof investment in soil conservation, witheven larger increases for plots managedby female farmers (Ali and others 2011).Secure land tenure also leads to the developmentof land markets, which improvesoverall allocative efficiency and the possibilityof using land as collateral in formalcredit markets. That said, land registrationand tenure systems must be adaptedto local conditions and customs (Deiningerand Feder 2001). In Africa, approaches toland use rights increasingly recognize thatcustomary and modern systems may existside by side.On-site approaches, such as conservationagriculture, can be tapped to fosternatural ecological processes to increaseagricultural yields and sustainability. Thisapproach, which dates back to the 1930s,is based on three main principles: continuousminimum mechanical soil disturbance;permanent organic soil cover; and diversificationof crop species grown in sequences,associations, or both (FAO 2001). Its useyields environmental benefits (decreasednutrient pollution of waterways, increasedcarbon sequestration in soils), increases theefficiency of production (through the use oflower levels of energy inputs), increases resilience(through frequent crop rotation), andincreases long-run agricultural productivity(through decreased erosion and enhancedsoil structure). Local conditions should dictatethe technology (box 5.3).Conservation agriculture tends to involveup-front costs (for new machinery necessaryfor direct seeding or for tree seedlings in

NATURAL CAPITAL 111BOX 5.3Conservation agriculture in Brazil and ZambiaConservation agriculture first emerged in the 1930sduring the severe dust storms in the United States.It has been gaining momentum worldwide since the1990s, when it was employed to deal with soil erosioncrises in southern Brazil. Its use is now widespreadglobally. By 2007, for example, zero-tillagepractices were in use on about 43 percent of arableland in Latin America (World Bank 2007a).In Brazil, conservation agriculture relies on avariety of technologies, depending on the region.One approach supports a mixed livestock and cropsystem, rotating pastures with crops. The zerotillagesystem supplies residual nutrients for cheappasture, thereby reducing pests, weeds, and diseases.The most common rotations are soybeans, cotton,and maize, followed by 1–3 years of pasture. Thesepractices have increased pasture stocking rates andhave reduced soil degradation and water runoff.In Zambia, five basic conservation farmingtechnologies are being used: retaining crop residues,concentrating tillage and fertilizer applicationin a permanent grid of planting basins or seriesof planting rows, completing land preparation inthe dry season, weeding aggressively to reduceplant competition, and intercropping or rotatingnitrogen-fixing legumes on up to 30 percent of cultivatedarea.Many farmers also incorporate nitrogen-fi xingtrees, which provide fodder and fuelwood. As of2010, Zambia had restored 300,000 hectares in aneffort that involved more than 160,000 households.Conservation agriculture practices doubled maizeyields over those achieved with conventional plowingsystems, and increased cotton yields 60 percent.A recent study finds returns of $104 per hectarefor plots under conservation agriculture in Zambia—5.5times the $19 per hectare of plots underconventional tillage (FAO 2010a).Source: Landers 2005; FAO 2010a; Scherr and others 2011.agroforestry systems) and short-term yieldreductions as farm systems are changed.Benefits may materialize only in the mediumto long run. Smart subsidies and access tolong-term fi nancial markets can help covershort-run costs and increase adoption.Focusing public support measures onsoil fertility can yield impressive results.In Brazil—where state support of agricultureis just 5 percent of aggregated grossfarm receipts compared with an average of18 percent in Organisation for EconomicCo-operation and Development (OECD)countries in 2010 (OECD 2011)—the governmenthas concentrated on investmentsin soil fertility enhancement, land andwater management systems, and crop andlivestock breeding for varieties adapted toBrazil’s climate and ecosystems. Brazil’spublic support of research and soil fertilityhas paid off handsomely, helping transformthe country from a net food importer into aglobal food exporter.WaterThe sustainable management of waterresources is becoming more urgent thanever as several global trends collide. 6 Indeveloping countries, growing populationsare increasing demand for water to produceessential commodities like food andenergy. Higher rates of urbanization fueldemand for water for domestic and industrialuses, putting stress on existing rawwater sources. Exacerbating matters, climatechange increases the risks of greaterwater variability.One big worry is water scarcity. Developingcountries account for 71 percent of globalwater withdrawals, and their demand isexpected to increase by 27 percent by 2025(from 2010). In 2010, about 44 percent ofthe world population lived in areas of highwater stress, and projections indicate thatan additional 1 billion people will be livingin areas with severe water stress by 2030(OECD 2008). And many countries in Asia

112 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTand North Africa are exhibiting moderateor extreme scarcity, which is expected toincrease in the future.Another worry is poor water quality,which sets back growth because it degradesecosystems; causes health-related diseases;constrains economic activities (such as agriculture,industrial production, and tourism);reduces the value of property and assets; andboosts wastewater treatment costs. For example,the annual costs of poor water qualitystand at 0.6 percent of GDP in Tunisia and2.8 percent of GDP in the Islamic Republic ofIran (World Bank 2007b).Yet another worry is natural hazards—thevast majority of which involve water—whichaffect almost everyone and retard growth.Kenya, for example, was hit by several disastersover a 3-year period that undid yearsof economic growth (an extreme flood costits economy 16 percent of GDP, and extremedrought 11 percent of GDP) (World Bank2004). And when these natural hazardsstrike, it is the poor who suffer most, becauseof their locations, low incomes, insufficientinfrastructure, and greater reliance on climate-sensitivesectors like agriculture.What can policy makers do to better managewater resources? Four green growthwater policies—none of them easy to designor implement—can be adopted:• Correct distortions in water allocationdecisions. New mechanisms for allocatingwater resources should embraceeconomic principles of allocative efficiencyto correct for market failuresand imperfections. These failures arecompounded by the sector’s politicaleconomy and the fact that more efficientwater pricing boosts costs for some elementsof society more than others. Decisionmakers need to devise efficient andflexible ways to allocate water amongcompeting quantity and quality demandsfor human use (energy, agriculture, fisheries,and urban consumption) and ecosystemshealth (forests and wetlands)(World Bank 2010d). A study of Chinafinds that improving water allocationcould increase per capita income by1.5 percent a year between 2000 and2060 (Fang and others 2006).• Expand the use of water pricing mechanismsto manage demand. The price ofmost water services does not include investment,operation, and maintenance costs orthe scarcity value of the resources. Pricingcould be used as an effective instrument toensure the resource’s optimal allocation.Most countries fail to use it because of thepolitical and social sensitivities of watermanagement, particularly the need toensure affordability for the poorest communities.Most countries allocate surfaceand groundwater by assigning fixed quotasto major sectors and activities. Althoughfar from effective, these quotas have beenpolitically and socially acceptable. In theshort term, they seem to be a more realisticoption than full cost pricing.• Create new markets. Tradable waterrights are an effective water managementinstrument in the long term but haveproven difficult to implement in the shortterm in most developing countries—partly because success depends greatly onsound design and partly because it takes along time to establish the necessary institutions(World Bank 2010d). Thus, in theshort term, it is imperative to ensure thatthe proper institutional arrangements andcapacities are in place.• Strengthen the framework for analyzingthe relationship between growth andwater. There have been few attempts toanalyze and quantify the relationshipbetween water and economic growthand development because of the complexspatial and temporal dimensionsof water and its management. There is aneed to strengthen this analytical frameworkby examining regional differencesin growth within a country or group ofcountries. This information would allowmore informed decision-making processesby providing a clear understanding of theeconomic tradeoffs of policies in differentsectors (such as energy, agriculture, urban,land use, environment, and health).

NATURAL CAPITAL 113Cultivated renewable resources:Innovation, sustainableintensification, and integratedlandscape approachesFood production will need to increase by75 percent between 2010 and 2050 to copewith rising demand caused by populationand income growth and changes in thestructure of demand. As incomes increase,demand for higher-value horticultural andlivestock products is likely to increase bymore than direct demand for staples; demandfor livestock products will likely increase85 percent between 2010 and 2030 (Foresight2011). Yet hunger remains a challenge:800 million people in the world remain foodinsecure. Improving agricultural productivityand access to food remain core elementsof an inclusive growth agenda.For cultivated renewable resources,the main policy challenges are to supportsustainable increases in productivity andresource-efficient production by focusingon innovation, increasing efficiency in inputuse, regulating pollution, and ensuring thatsmallholder farming more fully realizes itspotential, especially in lower-income developingcountries. In the future, a larger shareof fish and wood products is likely to comefrom aquaculture and plantation forestrythan from natural forests or wild fisheries,further increasing the importance of sustainablemanagement of cultivated renewableresources in meeting green growthobjectives.Agriculture, including livestockAgricultural production is strongly affectedby how natural capital—especially energy,land, water, forest, marine, and coastalsystems—is managed. Agriculture, includinglivestock, accounts for 70 percent of freshwater consumption and 40 percent of landarea. Many agricultural systems dependheavily on fossil fuels for nitrogen fertilizer,crop husbandry, harvesting, transport, andpumping water for irrigation. Thus, foodand fossil fuel energy prices are closelylinked. There are synergies and tradeoffsbetween maximizing production of food atlow cost and conserving the environment.These synergies need to be maximized andthe tradeoffs managed.Strategies in support of a green growthagenda for agriculture need to differentiatebetween agriculture-dependent, transitioning,and urbanized economies and betweenland and water–dependent and land andwater–abundant ecosystems and countries.In agriculture-dependent countries, agriculturalproductivity and inclusive growth areclosely related: GDP growth in these sectorsis estimated to benefit the poor two to fourtimes as much as GDP growth in other sectors(World Bank 2007a). Four elements maybe considered in a green growth strategy foragriculture.Increasing productivity while improvingland and water management.Intensification—producing more with less—has been responsible for the dramatic rise inglobal cereal yields in recent decades. From1960 to 2010, rice yields rose 250 percent(from 1.8 to nearly 4.5 tons per hectare[Dobermann and others 2008; InternationalRice Research Institute data]), whilebetween 1965 and 2000 cultivated landarea increased by just 20 percent (from 125million to 150 million hectares [Khush andVirk 2005]). Attaining the same productionincrease with no growth in yields wouldhave required increasing the area plantedwith rice to 300 million hectares, reducingfurther land availability for wetland orwatershed protection functions. Extensive,poorly managed agricultural and grazingsystems, often related to poverty and lack ofaccess to fi nance or knowledge, contributeto the land degradation and loss of soil fertilitydescribed above. Sustainable intensificationcan protect biodiversity, reduce deforestation,save water, and reduce greenhousegas emissions. By integrating improved land,soil, and water management measures intoproduction systems, such intensive systemscan also increase productivity while maintainingand even enhancing the value ofnatural capital.

114 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTIn a number of agricultural systems intensificationhas been accompanied by negativeenvironmental consequences. Excessive andpoorly managed fertilizer and agrochemicaluse has polluted water bodies and soils; runoffhas created “dead zones” in coastal areasthat cover about 245,000 square kilometersworldwide, mostly in OECD countries. 7 Agriculturalrun-off from intensive farming is thesingle greatest water polluter in China andother intensively farmed countries, includingDenmark, the Netherlands, and the UnitedStates (Chinese National Census of Pollution2010; Scheierling 1996).Similar tradeoffs are linked to livestockproduction. In the United States, forexample, production efficiency in the dairyindustry soared over the past 60 years. In2007, producing 1 billion kilograms ofmilk required just 10 percent of the land,21 percent of the animals, 23 percent of thefeed, and 35 percent of the water used to doso in 1944. But there were plenty of negatives,including the geographical concentrationof livestock waste, increased water andair pollution, and reduced animal welfare.These problems could be avoided with theright mix of incentives and regulation toprotect water bodies and manage waste.Productivity increases, innovation, andgenetic improvements are a “low-hangingfruit”: in India, average milk yields are only3.4 kilograms per day compared with theworld average of 6.3 kilograms, and only20 percent of animals are cross-bred; doublingproductivity would halve greenhouseemissions per cow.But in Colombia, a mix of policies hassupported sustainable productivity increasesfor livestock by encouraging landscapebased,mixed agro-sylvi-pastoral systems.The aim is to introduce trees and betterpasture in grazing lands, provide improvedfodder and shade, and reduce heat stress foranimals and soil degradation. The results areimpressive—including increased meat andmilk yields as well as improved water infi l-tration, increased bird populations, reducedmethane generation, and improved carboncapture (López 2012). This livestock policy ispart of a broader land use policy intended tosupport sustainable intensification togetherwith forest and landscape restoration. Theseapproaches have helped achieve “triple wins”of increased productivity, enhanced resilienceto climate variability, and reduced carbonemissions (“climate-smart agriculture”).Some agricultural subsidies exacerbate thenegative effects of intensification. In landscarce,intensely farmed agricultural systemswith already high levels of inputs, subsidizationof inorganic fertilizer encourages overuse,with deleterious effects on the environment(box 5.4). However, in countries withlow-input/low-output systems, a fertilizersubsidy may initially be justified to increaseyields and enhance vegetative growth andsoil carbon.BOX 5.4The use and misuse of agricultural input subsidies in IndiaIn India, fertilizer and other input subsidiescontributed to rapid development of irrigationand more intensive farming methods, resultingin increases in yields and food security: by 2010,irrigated wheat yields in some provinces averaged4.5 tons per hectare, up from 1.5 tons per hectarein 1975. However, subsidized energy is nowcontributing to excess groundwater withdrawals(about 75 percent of groundwater used in Punjaband Harayana originates from overexploited aquifers),requiring pumping water from ever-deeperaquifers and salinization of aquifers in some areas.In addition, the fertilizer subsidy—which costthe government $30 billion (2 percent of GDP) in2008—is contributing to excessive use of nitrogencompared with phosphorus and potassium, exacerbatingnitrate pollution of rivers and aquifers.Source: Prince’s Charities’ International Sustainability Unit 2011.

NATURAL CAPITAL 115Increasing efficiency and reducing waste.Reducing food waste involves some of thesame issues encountered in increasing energyefficiency: even where the saving potential ishuge, many barriers, including transactionscosts, prevent efficiency-increasing investmentsfrom being made. The problem has been recognizedfor decades, but limited progress hasbeen made. In both agriculture-dependent andOECD countries, up to one-third of food islost or wasted. The reasons for this waste—and the solutions to the problem—vary withthe settings (Foresight 2011).In agriculture-dependent countries, wherefood accounts for a large share of householdexpenditure (46 percent in Pakistan), there islittle household waste, despite lack of refrigerationat home. But 15–30 percent of foodproduced is lost before it reaches markets,because of postharvest losses caused by poorstorage and inefficient transport systems. Theproblem is compounded by food quality andfood safety issues, which may preclude poorfarmers from participating in value chains(Gómez and others 2011). For low-incomecountries, the following strategies couldreduce food waste:• Diffusing existing knowledge and technologyin storage and investing in transportinfrastructure.• Investing in new technologies to reducepostharvest waste.• Using information and communicationtechnology to improve market information,helping match supply and demandin local markets.• Investing in capacity building, infrastructure,and regulatory improvements infood quality and food safety.OECD countries have developed efficientsupply chains from farm to market, with lowspoilage rates and effective transport systems.But about one-third of food supplied isnevertheless wasted through losses in supermarkets(food thrown away because it isnot sold by the sell-by date), losses in homes(food discarded before it is used), and platewaste (food that is served but not consumed).Because food accounts for a relatively smallproportion of household expenditure inOECD countries (11 percent in Germany,7 percent in the United States), there is littleprice incentive to avoid waste. However,new technologies, such as enhanced sensortechnologies to monitor the edibility of food,could help reduce wastage. The main challengeis changing consumer behavior.Harnessing technology. Technologicalinnovation plays a key role in green growthstrategies for agriculture. It can be used toincrease input efficiency, as is the case inirrigation water management, where advancesin the use of remote sensing technologies permitestimation of crop evapo-transpiration(the sum of evaporation and plant transpirationto the atmosphere) on farmers’ fields andfacilitate improvement of water accountingat the regional and basin-wide levels. Chinais adopting this approach with its XinjiangTurpan Water Conservation Program, inan arid part of the country (World Bank2010c). This program monitors basin-wideevapo-transpiration with remote sensingand supports a combination of engineering,agronomic, and irrigation managementmeasures to increase agricultural productivitymeasured in terms of evapo-transpiration.Innovation includes developing agriculturalproducts that feature improved characteristics,such as being drought resistant, requiringless fertilizer, and being resistant to commonpests and diseases (which reduces the needfor pesticides)—as India is doing with betterbackyard chickens (box 5.5).Innovation can also be used to increaseaccess to weather and climate informationservices for farmers, which improves resilience,increases efficiency, and raises income.In Florida, a timing tool helps farmers reducethe quantity of fungicide they use, reducingthe harmful effects on the ecosystem and savingthem money (Pavan and others 2010). Butin many developing countries and transitioneconomies, investment and expenditure inthe classic public goods of weather and climateinformation generation and servicesis far too low (World Bank 2008a). A 2010study by NetHope in Kenya indicates thatfarmers gain access to information through a

116 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 5.5Producing a better backyard chicken in IndiaKegg Farms in India has bred a robust and improveddual-purpose backyard chicken. The “Kuroiler”lays 100–150 eggs a year (many more than the40 eggs a year the Desi chicken lays) and grows to2.5 kilograms in about half the time a Desi chickenreaches 1 kilogram. The chickens typically commanda premium of about Rs 60 per kilogram overother broiler chickens, because the meat is darkerand more flavorsome.Kegg Farms produces about 16 million day-oldchicks a year, which it sells to 1,500 small enterprisesthat raise the chicks for about two weeks before inoculatingthem and selling them to about 6,500 bicyclesalespeople, who sell them to some 800,000 farmers,most of them women, many located in some of theremotest parts of the country. The turnover in salesof chicks is about $5 million a year, with another$5 million turnover by the thousands of small, rurallybased businesses that grow and sell the chicks.An independent assessment indicates that theaverage gross revenue generated per Kuroiler chick(as eggs and meat) is $3.10. With some 16 millionchicks distributed annually, total output is about$50 million, with a net profit of about $10 million.Profits from the Kuroiler are significantly higherthan profits from the Desi bird. The Kuroiler birdscontribute significantly to household cash flow.Women have maintained control over their chickengrowingenterprises as the business has become morecommercial.The success of Kegg Farms reflects several factors.Its chickens are more robust than other chickens, arebetter able to scavenge food, and have higher foodconversion ratios. The company’s business modelfeatures a devolved, rural-based distribution systemwith in-built incentives.Source: Isenberg 2006.range of methods, including SMS (cell phonemessaging), radio, newspapers, and extensionofficers. 8Changing the structure of support policies.Changes in the structure of support policiescan also help manage potential tradeoffs. Inthe European Union (EU)—and to a lesserextent the United States—the past 20 yearshave been characterized by a shift away fromhighly distortive price and quantity instruments(target prices, export subsidies, andquotas) toward lump-sum payments. Thepolicy change has weakened the incentivesfor farmers to use polluting inputs, such asfertilizers and pesticides. Between 1991 and2006 fertilizer use decreased in most EUmember countries, though it increased in newmember countries (Eurostat 2011). Moreover,as agricultural transfers became decoupledfrom production, they became increasinglysubject to environmental provisions. 9AquacultureIn 2009, humans consumed 117 million tonsof fish—almost half of which was producedon farms (FAO 2010b). By 2030, this figureis expected to rise to 140 million tons. Capturefisheries are not expected to support thehigher demand, leaving aquaculture to meetshortfalls in supply.As in the livestock industry, competition,economies of scale, and economies of agglomerationhave increased productivity but havepushed some systems into potentially damagingenvironmental practices. Farms tend toconcentrate where there is expertise, goodland, water resources, and marketing infrastructure.This crowding has sometimes ledto overuse of ecosystems services, pollution,and massive fish kills. Agglomeration in theNorwegian salmon farming industry, forexample, has reportedly improved the transferof knowledge and increased the supplyof specialized production factors, but it hasalso helped spread fish disease (Tveteras andBattese 2006).There are two approaches to greeningaquaculture. The first is zoning—that is,leaving adequate space between farms andinterspersing a variety of aquaculture systems(including a mixture of species at the farm

NATURAL CAPITAL 117or watershed level) and water uses betweenmajor centers of production. This approachwould hinder disease transmission, moderatenegative impacts on wild fish populations,and reduce the contribution of aquaculture towater eutrophication.The second approach is creating synergieswith other economic activities in the watershed.The farming of aquatic plants (suchas seaweed) and the filter feeding of detritivorousorganisms (such as mussels, clams,and sea cucumbers, which together representabout 40 percent of total global aquaculture)reduce nutrient loading from livestock, agriculture,and other sources. Fish production incages or culture-based fisheries can be conductedin reservoirs and irrigation systems toamortize costs, improve water quality, reduceweeds, and replace wild catch where damshave destroyed indigenous fish stocks. Mixedfish and rice production systems are widespreadin low-lying areas and flood plains,taking advantage of synergies between thewater and land management approaches.Although dispersing fish farms is good forthe environment, it does raise costs, in partbecause of the losses from agglomeration.Thus, green growth strategies will requirepractical financial and market incentives tosupport spatial dispersing, technical guidelineson green technology, and governmentpolicies that encourage investors to avoid thetraditional practice of copying successful production/market models and instead explorenew partnerships at the watershed level.Plantation forestsAfforestation—the planting of forestsin areas that were not forested in recenttimes—is expected to meet an increasingshare of the demand for wood and fiber, possiblyreducing pressure on primary and naturalforests. In 2010, the global area underplantation forests (forested areas artificiallycreated by planting or seeding) accounted for7 percent of total forest area and 40 percentof industrial timber production (FAO 2011).Plantation forests provide a growing shareof industrial timber, both because the areaunder plantation forests has increased andbecause productivity has risen. Areas underbamboo and rubber plantation are alsoincreasingly being used to provide timberproducts, providing an important source ofincome for rural households. Reforestationand restoration of degraded woodlands alsoplay a role in plantation forestry.Whether plantation forests help or hurt theenvironment depends on the land use systemsthey replace. In China, for example, bambooplantations have helped control soil erosionby replacing agriculture on steep slopes. Butin some provinces, where plantations havereplaced natural forests in areas not wellsuited to bamboo, soil erosion has increased.The Chinese government has tried to addressthese negative environmental effects by establishingenvironmental regulations, but theseregulations have been resisted in some cases(Ruiz-Perez and others 2001). More recently,China has supported programs with speciesbetter adapted to local ecosystems (WorldBank 2010c).Agroforestry systems, in which trees areincorporated into the broader productionlandscape, are widespread in some areas.They can yield the “triple wins” of climatesmartagriculture by enhancing productivity,resilience, and carbon sequestration, as theyhave in Kenya and the Sahel (Liniger andothers 2011).Nonprovisioning services:Creating knowledge and marketsfor economic valuationIn addition to ecosystems that provide foodand water (“provisioning services”) are ecosystemsthat regulate, support, and offercultural services (“nonprovisioning” services).This group includes nature-based tourismsupported by biodiversity, watershedservices, and climate-regulating services.The main challenge in this area is to createmarkets for these services so that theybecome part of the visible economy and areefficiently provided.Another challenge is coping with the timingof benefits. Although efforts to reduce the

118 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTloss of ecosystem services are likely to boostgrowth in the near term, efforts to restorethese services take a long time and are unlikelyto do so in the near term (Vincent 2012).BiodiversityBiodiversity refers to the degree of variationof life forms, including all animals,plants, habitats, and genes. It mattersbecause genetic diversity provides the basisfor new breeding programs, improvedcrops, enhanced agricultural production,and food security. When species becomeextinct or habitats are threatened, biodiversityis reduced; according to the InternationalUnion for Conservation of Nature,875 species went extinct (or extinct in thewild) in 2008. Ecosystem fragmentationcan contribute to species loss, especially forlarge predators, leading to a cycle of habitatdegradation.Tropical, temperate, and boreal forests(forests in northerly latitudes) are home tothe vast majority of the world’s terrestrialspecies. They play a major role in biodiversityand provide cultural, recreational, andother supporting services, such as soil andwater conservation. For this reason, 12 percentof the world’s forests are designatedfor the conservation of biodiversity—anincrease of more than 20 percent since the1990s (FAO 2010a).A key reason why the world has experiencedsuch a dramatic loss in biodiversity isthe difficulty of valuing it, given knowledge,time, and spatial asymmetries. Building aroad around, rather than through, a fragileecosystem increases its cost by a knownamount, payable immediately; the benefitof protecting the ecosystem and its inherentbiodiversity is much more difficult to valueand accrues only over time. At the globallevel, many efforts are under way to protectbiodiversity, dating back to the 1992 Conventionon Biological Diversity. At the locallevel, the incentive could come in part fromthe economic returns that biodiversity cangenerate through nature-based tourism andbioprospecting.Nature-based tourism. Nature-basedtourism (or ecotourism) is defined by theInternational Ecotourism Society as “responsibletravel to natural areas that conservesthe environment and sustains the well-beingof local people.” It is one of the fastestgrowingsectors in the tourism industry,with annual growth rates of 10–12 percent(TIES 2006). Nature-based tourism aims tocombine stringent environmental provisionswith the generation of local economic revenues,thus concurrently triggering positivedevelopment impacts and incentives to conservenatural capital.Nature-based tourism can be a significant source of employment, economicgrowth, and revenue (including foreignexchange) (Aylward and others 1996;Wunder 2000). A study of nature-basedtourism in Zambia estimates that ecotourismgenerated 3.1 percent of GDP in2005 (agriculture contributed 6.5 percent,mining 8.6 percent, and manufacturing10.6 percent) (World Bank 2007d). Potentialtradeoffs between rural livelihoods andnature-based tourism need to be managedby involving local communities. Indeed, thesuccess of a nature-based tourism initiativeis often linked to such involvement, whichrequires establishing incentives for local peopleto effectively protect their community’snatural capital (box 5.6). Tourism revenuesare only a partial solution, however, as manyimportant ecosystems have only limitedappeal for tourists.Bioprospecting. Bioprospecting is thesearch for genetic material from plants oranimal species that can be used to developvaluable pharmaceutical (or other) products.It represents a second example of how thecreation of a market can provide incentivesto protect biodiversity, although in practice itis hard to achieve (Polasky and others 2005).Returns to bioprospecting are often too lowto provide sufficient incentives to conservebiodiversity, and disputes arise over the distributionof rents resulting from discoveries.The Access and Benefit Sharing provisions ofthe Convention on Biological Diversity mayhelp alleviate this problem. 10

NATURAL CAPITAL 119BOX 5.6Involving local communities in nature-based tourism in IndonesiaThe Komodo National Park is a protected marinearea in the Lesser Sunda Islands of Indonesia. ThisWorld Heritage Site was established in 1980 to protectthe habitat of the Komodo dragon. Since then,its goals have expanded to include protection ofthe area’s many coral species and nearly 1,000 fishspecies.In 2005, a nonprofit joint venture, Putri NagaKomodo (PNK)—comprising The Nature Conservancy,a local tourism company, and the InternationalFinance Corporation—was set up to runthe area. The aim is to protect biodiversity andenable local communities to benefit from the parkin a sustainable way—through carefully managednature-based tourism, alternative livelihoods forlocal people, and collaborative protection strategies,such as antipoaching patrols. All proceedsgo toward stewarding biodiversity and developingalternative and sustainable livelihoods for the localcommunities.PNK, which is the exclusive manager of the venture,has invested $1 million in helping people in thepark develop new activities, such as woodcarvingand textile weaving. It has also provided them withtechnical assistance to develop sustainable seaweedfarms, as well as facilitate the breeding of high-valuereef fish to substitute for threatened wild fish. Theseefforts notwithstanding, a recent evaluation report(Agardy and others 2011), while acknowledging theproject’s positive impacts, raises concerns about thesustainability of the results, given the difficultiesencountered in making this public-private partnershipwork.Source: The Nature Conservancy website (http://www.nature.org/); CatherineCruveillier-Cassagne (personal communication).Watershed servicesWatersheds—that is, the area of land whereall of the water that is under it or drains off itgoes into the same place—provide a range ofecosystem services, supplying water and hydroelectricpower, regulating water flows andfloods, 11 controlling soil erosion, and creatinghabitats for wildlife. Because of spatial tradeoffs—andin some cases open access regimes—the market often underprovides these services,creating the need for public intervention. Tocorrect this market failure, governments havebeen investing directly in the restoration andenhancement of watershed services throughinitiatives such as watershed developmentprograms. Payments for such environmentalservices are a recent policy innovation to createmarkets and provide incentives to conserveor generate these services.Support for investments in soil and waterconservation. Investments in soil and waterconservation normally include support fora mix of measures adapted to local conditions,including landscape restoration, erosioncontrol, grazing management, waterharvesting, and agricultural productivitysupport measures. At lower altitudes in irrigatedlandscapes, they often include supportfor improved irrigation water management,drainage, and salinity control. Such integratedprograms have been supported to scalein a number of countries and include a mix ofprivate and public investment measures.In Turkey, better land managementpractices—promoted through investmentsin watershed rehabilitation and landscaperestoration and reforestation programs, aswell as profound changes in agriculturalpolicy—have led to greening in the interiorof the country, despite declining rainfall andincreased temperatures in these areas. However,it is unclear whether this “regreening”also led to increases in rural incomes andemployment.In India, where several watershed developmentprograms have been tried in semiaridrain-fed regions of the country, the verdictis still out. These programs seek to increaseagricultural productivity by controllingsoil erosion, preventing siltation of water

120 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTbodies, and improving the reliability of waterresources. They also hope to provide employmentopportunities and improve the availabilityof drinking water, particularly during thesummer. Between 1996 and 2004, the governmentof India spent more than $6 billionon watershed development (WRI 2005), butno systematic, large-scale assessment of theimpact of these programs has been conducted(Joshi and others 2004).There are nevertheless some positiveresults for integrated landscape approaches.In Kazakhstan, the Syr Darya/Northern AralSea Control program in the lower Syr Daryawatershed supported innovations in watermanagement, combining “soft” and “hard”infrastructure solutions and flood management,which helped restore river functionsand the Northern Aral Sea, leading to recoveryof grazing lands, ecosystems, and fisheries(World Bank 2011b). In Rwanda, the landhusbandry, water harvesting, and hillsideirrigation programs have already increasedyields and incomes and have reduced soillosses (World Bank 2011a).Payments for ecosystem services. ThePago por Servicios Ambientales (PSA) program,implemented in Costa Rica in 1997,was one of the first schemes to pay peopleto provide ecosystem services. Under thisprogram, private landowners and communitiesreceive payments for conserving the forestand helping protect water quality downstream.Financing for the scheme comes fromdonor grants, earmarked taxes, and buyersof ecosystem services, including municipalutilities. Other examples of payments forecosystem services include schemes establishedto eliminate or reduce animal wasteand agricultural chemical residues to protectwater reservoirs, payments to landownersto encourage conservation, and REDD+schemes, under which payments will be madefor carbon sequestration services and to providean incentive to reduce deforestation andforest degradation. 12In some developing countries, policy makershave tried to design payment for ecosystemservices programs to benefit the poor, butthe evidence on both the environmental andthe poverty reduction effects of payment programsis thin (Pattanayak and others 2010).In China’s Sloping Land Conversion Program,average household incomes remainedunchanged, although incomes increased forsome households and decreased for others. Inaddition, increased availability of fodder toimprove income from livestock rearing, andextension services to improve agriculturalproductivity have helped compensate householdsfor the loss of agricultural incomesfrom the conversion to forests. In Ecuador,Costa Rica, and Mexico, large-scale paymentfor ecosystem services schemes (table 5.2)may have benefited the poor, although assessmentsremain to be done.Whether the poor are helped will nodoubt depend on the scheme’s design. Thosebased on land diversion (from current useto a use that is more oriented toward theprovision of environmental services) arelikely to benefit the landed, some of whomare poor— although they could also hurtpoor households, especially the landless, byreducing access to key natural resources.Those based on working lands are likelyto increase the demand for labor and maythereby benefit the poor. However, schemesexpected to meet poverty reduction goalsmay be less effective in meeting environmentalgoals (Jack and others 2008). Where thepoverty reduction impacts are likely to besmall, it may be better to design schemes tobe as effective as possible in achieving environmentalgoals and draw on other instrumentsto reduce poverty (Bond and Mayers2009; Wunder 2008).Climate-regulating servicesNatural capital—including the oceans, land,and their living organisms—plays a key rolein climate regulation. 13 However, the valueof these key regulating services is not adequatelycaptured through markets, and valuingthem is difficult.One of the most important services that forests,soils, and water provide is storing carbon.Indeed, out of the 9 gigatons (Gt), or billiontons, of CO 2emissions released in 2007, the

NATURAL CAPITAL 121TABLE 5.2Impacts of payment for ecosystem services schemes on poverty reductionCountry/study Scheme Seller characteristics/results Payment Impact on incomeChina/Bennett(2008)Costa Rica/Pagiola (2008)Ecuador/Wunderand Albán (2008)Sloping landconversionprogramPayments forenvironmentalservicesPROFAFORTens of millions of ruralhouseholds; 9 million ha ofmarginal sloping lands convertedfrom agriculture to forests,4.92 million ha of degradedlands reforestedPrivate landowners, indigenouscommunities; 270,000 haenrolled in 2005109 private landowners (50- haminimum contract size),43 communities.Annual in-kind payment of grain(1,500–2,250 kg per ha), cashsubsidy ($36 per ha), and freeseedlings. Length of subsidydepends on type of forests.Income from forests andgrasslands tax free$64 per ha per year for forestconservation and $816 per ha for10 years for timber plantation(15% of which goes towardtransactions fees)$100–$200 per ha to coverplantation costs; 70–100% valueof harvested wood, 100% ofnontimber forest productsMixed results: in Gansu, 50%of participants lost 8% of 1999household net income; inSichuan, 30% lost 11% of netincome; in Shaanxi, 7% lost33% of net income; estimatesdo not include net presentvalue of future income fromtrees and grassesBulk of benefits goes to largerand better off farmers, butno assessment of impact onpoverty reductionUpfront payment of $60–$635per household (6–50% ofhousehold expenditure);income of $7–$2,481 perhousehold from harvestingoceans absorbed about 2Gt and terrestrialecosystems about 2.7Gt. The remaining halfremained in the atmosphere, increasing theconcentration of CO 2and contributing to globalwarming (World Bank 2010d). Maintainingand, where possible, increasing the sequestrationcapacity of terrestrial, coastal, andmarine ecosystems thus plays an importantrole in mitigating climate change.Healthy ecosystems that sequestercarbon also function better in flood anderosion management, increasing the adaptivecapacity of ecosystem services such asagriculture, forestry, and fisheries in thefollowing ways:• Coastal ecosystems (including mangrovesand wetlands) reduce erosion and floodingand provide spawning grounds formarine species.• Freshwater wetlands and floodplainsmaintain water flow and quality, actingas floodwater reservoirs and water storagefacilities in times of drought; theyalso provide grazing land for livestockand aquatic habitats.• Forests and vegetation stabilize slopes,control erosion and flash floods, and conservesoil fertility for agriculture.• Integration of trees into agricultural productionsystems builds climate resilience.However, ecosystem losses reduce theireffectiveness as carbon sinks and their rolein adaptation. Under current managementregimes, land-based ecosystems in some countriescontribute significantly to greenhousegas emissions: emissions from agriculture,land use change, and forestry (deforestation,degradation, and fires) account for more than30 percent of greenhouse gas emissions (forestsaccount for about 17 percent and agricultureanother 14 percent) (UNFCCC 2007).Overall, more progress has been madein recognizing the importance of terrestrialecosystems in climate regulation than inmarine ecosystems, and more progress hasbeen made in recognizing the role of forestsin climate mitigation than of soils (UNEPand others 2009). Total carbon stocks invegetation and in the top meter of soils areestimated at 466Gt (vegetation) and 2,011Gt(soil) ( Ravindrah and Ostwald 2008; Watsonand others 2000). The top meter of soil isimportant because annual crops depend onits quality and organic content for growth.For tropical forests, nearly half of the 428Gtof carbon stocks is from above-ground

122 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTvegetation; in tropical savannahs, 80 percentof the 330Gt of carbon stocks is from soil.Much work remains to be done to incorporateagricultural and grazing land andsoils into climate change regimes. Only onepilot program in Africa, the Agricultural SoilCarbon Project, has benefited from financialsupport from carbon finance throughthe BioCarbon Fund. 14 The project supportsincreased agricultural productivity, agroforestry,and sustainable land managementpractices on more than 65,000 hectares inwestern Kenya; farmers benefit from sellingcarbon sequestered both in and above thesoil as a result of improved farming practices(World Bank 2011a). The Clean DevelopmentMechanism recognizes emissions fromlivestock and paddy rice as major sources ofemission, especially in more intensive farmingsystems in East Asia and OECD countries. 15Lessons can be learned from the progressmade on forests, including the work onREDD+. As countries prepare REDD+ strategies,they must address carbon monitoring,reporting, and verification as well as challengesregarding tenure rights to carbon storedor sequestered, potential tradeoffs betweenconservation and development, the rights ofindigenous people and forest-dependent communities,and the tradeoffs between carbonsequestration and other ecosystem services,such as biodiversity.Increasingly, countries are weighingco-benefits from adaptation and local incomegeneration as they develop REDD+ strategies(box 5.7). However, given the modest developmentof international carbon markets, it isimportant to manage expectations regardingpotential revenues from these sources overthe next few years (FAO 2010a).The role of marine ecosystems in adaptationand mitigation has received relativelylittle attention, partly because of their complexity,their status as an international commonproperty resource, and the absence ofrobust mitigation metrics. Focusing firston coastal ecosystems in relatively shallowwaters, where restoration approaches are wellknown, would be a low-risk, shorter-termstrategy that could restore their capacity inoxygenating coastal waters, provide nurseriesfor fish stocks, and shelter coastal settlementsBOX 5.7Scoring a triple win in Ethiopia by restoring the landscapeThe overexploitation of forest resources in Ethiopiahas left less than 3 percent of the country’s nativeforests untouched. In Humbo, near Ethiopia’s GreatRift Valley, deforestation threatens groundwaterreserves that provide 65,000 people with potablewater. It has caused severe erosion, resultingin floods and mudslides. With a population thatdepends heavily on agriculture, exacerbation ofdroughts and floods creates poverty traps for manyhouseholds, thwarting efforts to build up their assetsand invest in a better future.Under the Humbo Assisted Natural RegenerationProject (implemented with the help of World Vision),farmer-managed regeneration of the natural forestencourages new growth from felled tree stumps thatare still living. The regeneration of nearly 3,000 hectareshas resulted in increased production of woodand tree products, such as honey and fruit, whichhas increased household revenues. Improved landmanagement has also stimulated grass growth, providingfodder for livestock that can be sold as anadditional source of income. Regeneration of thenative forest is expected to provide an importanthabitat for many local species and reduce soil erosionand flooding.The forest now acts as a carbon sink, absorbingand storing nearly 0.9 million tons of CO 2overthe project life. The project is the fi rst large-scalereforestation project in Africa to be registeredwith the United Nations Framework Conventionon Climate Change. The operation is regardedas a model for scaling up under a broader greengrowth and landscape restoration strategy forEthiopia.Source: Brown and others 2011.

NATURAL CAPITAL 123from storms while additional scientific workis undertaken on assessing technical strategiesfor using oceans as potential carbonsinks (UNEP and others 2009).Nonrenewable resources:Promoting rent recovery andreinvestmentEconomic growth in countries with nonrenewableresources is a process of extractingresources efficiently and investingrevenues from these resources in other formsof productive capital that can continue toproduce income after the nonrenewableresources are depleted. Only in this way canthese resources be used to promote sustainabledevelopment.Some nonrenewable resources are essentialfor green growth. The generation of solarpower uses silicon; devices that control vehicleexhaust and refining processes for cleaningfuels require precious metals to act ascatalysts; wind turbines, semiconductors usedin smart grids and other computer applications,and batteries for hybrid vehicles requirerare earths; and almost all processes requiresteel, which is made from iron, carbon, andalloying elements. Natural gas is a relativelyclean fuel; because it can readily generatepower on demand, it complements solar andwind power well.Avoiding the natural resource curseOne major problem for countries withabundant natural resources is what isknown as the natural resource curse. Thisphenomenon refers to the economic observationthat countries rich in natural assets—particularly oil, gas, and minerals—oftenfail to use these resources as a platform forsustainable growth and actually grow lessrapidly than similar countries without suchassets. These countries—such as the DemocraticRepublic of Congo, Guinea, Nigeria,and República Bolivariana de Venezuela—fail to transform natural capital into othertypes of capital, such as human capital andinfrastructure.Early explanations of the resource cursefocused on economic factors, such as the difficultyof managing revenue volatility or thenegative impact of exchange rate appreciationon the more technologically sophisticatedmanufacturing sector (Dutch disease). Suchanalysis left open the question of why somecountries were able to overcome these economichurdles.The current consensus is that the resourcecurse is the result of weak governance (institutionalcapital) and human capital (Gelb andGrasmann 2010). Concentrated resources,coupled with very large investments, are easilysubject to capture. Instead of directing theirenergies toward productive activities and thedevelopment of the institutions needed in amarket-oriented economy, political and economicelites engage in “rent seeking,” usingtheir proceeds to reward their supporters andstifle dissent by potential reformers. Duringdownturns, the government finds it difficultto adjust to lower levels of spending, becausethe survival of the regime may depend onrent allocation. In short, resource rents areused not to develop other forms of productivecapital but to perpetuate the political regimeand its inefficient economic policies. Oncetrapped in the resource curse, it is difficult toescape, because the elite have little incentiveto do so. In the extreme case, the resourcecurse can lead to armed conflicts as a way todetermine access to the rents.Not all resource-rich countries gettrapped by the resource curse. Some (likeAustralia, Botswana, Canada, Chile, andKazakhstan) have managed to avoid italtogether. Others (like Ghana, Peru, andZambia) suffered the resource curse earlierin their development but went on to enjoysteady growth in the past 10–15 years.Moreover, many of the fastest-growingcountries in the world in the past decadehave been mineral-rich countries, some ofwhich were once victims of resource curse,although the sustainability of such growthhas not been tested by a significant drop inresource prices or production.Given that most of the fastest-growingcountries in Africa since 2000 have large

124 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTextractive industries—with major investmentsongoing or planned—it is particularlyimportant that these countries act now toavoid the resource curse. History showsthat countries that have successfully managedconcentrated natural resources foreconomic development have tended to havea cadre of strong technocrats, pointing tothe importance of developing human capital.Countries that have recently becomeresource abundant, such as Mongolia andMozambique, need to be as transparentwith their rents as possible (through theExtractive Industries Transparency Initiativeand other means); set up a means ofsmoothing volatile revenue, such as a fi s-cal stabilization fund; and focus on policiesand programs to build human capital andcompetitive industries.Even where growth has been rapid, thepresence of nonrenewable resources canskew income distribution in undesirableways. In Equatorial Guinea, for example,one of the richest and most resourcedependentcountries in Africa, 77 percentof the population lives on less than $2 perday (Goldman 2011). Institutional innovationscan help countries avoid this outcome.Botswana and Norway, which have stronginstitutional capacity, have managed theirresource rents well. That even countrieswith a history of political instability—suchas Chile, Indonesia, and Malaysia—haveused resource rents effectively for economicdevelopment suggests what can be achieved(Gelb and Grasmann 2010). 16Managing resource revenuesHow can policy makers promote effi cientproduction, rent recovery, and rent reinvestmentin ways that support broadereconomic growth? First, they can adoptsaving mechanisms, such as fiscal stabilizationfunds and saving funds, whichhelp smooth expenditure and ensure thatfunds are used only when the country hasthe capacity to absorb the new investment.Second, they can use the nonrenewableresource rents to help overcome marketfailures or deficiencies—such as inadequateskills, poor health and social protection,lack of infrastructure (especially electricity),and high business transactions costs.Third, they can avoid using these rents topromote industries in which their countryhas no or little comparative advantage.The World Bank’s comprehensive wealthaccounts—notably, its adjusted net savings(ANS) indicator—assess whethercountries rich in subsoil assets are usingtheir natural capital to support sustainabledevelopment through rent capture andreinvestment (World Bank 2005b, 2010b).These accounts can help countries assesswhether they are on a sustainable developmentpath. Unlike national accounts, whichmeasure gross savings and depreciation ofproduced capital but do not record changesin the stocks of human and natural capital,ANS measures the change in a country’snational wealth. Since 2000, many lowincome,resource-rich countries have failedto leverage their nonrenewable resourcesfor broader development. In fact, theirANS indicators were negative for severalyears and were relatively low when positive,suggesting that they may be runningdown their total wealth (figure 5.2). Highincomenon-OECD countries are alsoexhausting their natural resource wealth.The Wealth and Valuation of EcosystemServices Initiative is being used to pilotincorporation of natural resource depletionor restoration, including renewablenatural resources, into national accountsin a number of OECD and developingcountries.Practicing sustainability in miningThe largest source of employment in nonrenewableindustries comes from artisanaland small-scale mining. This sector contributesto livelihood development, creatingtens of thousands of jobs in many countriesand hundreds of thousands in several countries(including the Democratic Republic of

NATURAL CAPITAL 125FIGURE 5.2 Not enough wealth creation from natural capital(adjusted net savings of resource-rich countries, by income group, 2000–08)15% gross national income1050–5–10–15200020012002200320042005200620072008low incomeupper middle incomelower middle incomehigh income: non-OECDhigh income: OECDSource: World Bank 2010b.Note: Adjusted net savings (ANS) measures the change in a country’s national wealth. A positive ANS indicates that the country is adding to its wealth; anegative ANS indicates that the country is running down its capital stocks.Congo and Ghana). But for the sector to besustainable, there needs to be a long-termcommitment by the government and stronglocal institutions.Artisanal and small-scale mining is oftena highly destructive industry that causes significantenvironmental damage, includingmercury pollution and extensive riverbeddestruction. The struggle to obtain controlof the resources in remote, largely lawlessareas also creates social tensions. Althoughcontinuation of the current mode of artisanaland small-scale mining is damaging,prohibiting it would immediately throwmany miners and their families into poverty.For this reason, there is a consensus that theway forward is to recognize the role of thistype of mining in development and to supportimproved management and livelihooddevelopment through formalization of thesector, registration of both miners and traders,adoption of technological good practice,strengthened health and safety standardsand their enforcement, economic diversification,and adequate protection for female andchild labor.For medium- and large-scale miningprojects, foundations and financialsureties are increasingly being used todeliver sustainable benefits to communities.These two instruments help miningcontribute to broader economic developmentwhile providing environmental protection(box 5.8).Sustainable management of natural capitalunderlies green growth in other sectors,including agriculture and manufacturing.It is also key to resilience and welfaregains. Well-managed, nonrenewable naturalcapital can provide both jobs and revenuesfor investment in human capitaland infrastructure. Well-managed, renewablenatural capital protects people and keyinfrastructure from floods and drought,provides key productive and culturalservices, and is the basis for important tourism-basedactivities. Innovation, efficiencygains, and enhanced human and physicalcapital all play roles in achieving naturalcapital outcomes that are consistent withgreen growth. In turn, as the next chapterillustrates, the infrastructure agenda andinvestments in physical capital can supportor undermine green growth, dependingon management, policy, and investmentchoices.

126 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 5.8How the mining sector is investing in communitiesMedium- and large-scale mining projects typicallyleave a large environmental footprint, resulting inthe destruction of land, loss of natural habitats,damage to ecosystems, and the reduction of waterand air quality. To reduce these negative externalitiesand produce sustainable benefits for the community,mining companies are increasingly establishingfoundations—there are now more than 60worldwide—and financial sureties (a sum of moneyor a guarantee by a third party that a financial liabilitywill be met).FoundationsMining companies often set up foundations forlarger mining operations; a few countries, includingCanada and South Africa, require that they beestablished. These entities increase the benefits ofmining by developing skills (for mining-related jobsand alternative livelihoods) and providing funds thatcan provide a benefit stream once a mine is closed.They are usually funded by one or more miningoperations, which contribute 0.25–1.0 percent oftheir gross revenues. The funds are used to delivercommunity investment programs for companies,facilitate the use of government payments to localareas, and manage compensation funds. A criticalcondition for success is adaptation to the localcontext, which should be subject to extensive socialassessment to defi ne the foundation’s vision, beneficiaries,and project types. The foundation’s complexityshould be proportionate to the funding andcapacity of the operating environment, and its operationsshould be integrated with local and regionaldevelopment plans.Financial suretiesOver the past 20 years, it has become the norm formining companies to be legally obligated to set upfinancial sureties. These instruments reduce the negativeexternalities associated with mining by ensuringthat there will be sufficient funds to pay for siterehabilitation and postclosure monitoring and maintenanceat any stage of a mining project, includingearly or temporary closure. Funding should be basedon a cash accrual system or a fi nancial guaranteeprovided by a reputable fi nancial institution. Mineclosure requirements should be reviewed annuallyand the closure funding arrangements adjusted toreflect any changes. Financial sureties should notbe regarded as a surrogate for a company’s legalliability for clean-up but rather as a buffer againstthe public having to shoulder costs for which theoperator is liable. Closure costs vary enormously buttend to range from $5–$15 million for medium-sizeopen pit mines to more than $50 million for largeoperations. Some sureties include socioeconomicobligations, making their goals similar to those offoundations.Source: Sassoon 2009; Wall and Pelon 2011.Notes1. By and large, natural capital is the formof capital that is not created by deliberateinvestment, although investments may beneeded to restore it (by removing pollutantsor reversing soil erosion, for example) orenhance it (by building water storage structuresto enhance the water retention servicesof watersheds, for example). This chapterconsiders the role of natural capital as a factorof production. Its role as a sink and therelationship to growth is covered in otherchapters.2. Following the Millenium Ecosystem Assessment(2003), ecosystem services can be classifiedinto “provisioning services” (services thatproduce goods and services, such as water,food, fuel, fiber, and fodder) and “nonprovisioningservices.” Nonprovisioning servicesinclude services that provide regulating services(such as watershed management and climateregulation), supporting services (such asnutrient cycling and soil formation), and culturalservices (including services that embodyrecreational and spiritual values). The reportstates that biodiversity and ecosystems areclosely related concepts. Biodiversity is the

NATURAL CAPITAL 127variability of living organisms from all typesof ecosystems.3. Landscape approaches integrate managementof land, agriculture, forests, fisheries andwater at local, watershed and regional scalesto ensure that synergies are captured.4. Exclusive economic zones—referred to in thepreamble to the United Nations Conventionon the Law of the Sea Treaty (1982)—aredefined as waters that are 200 nautical milesor less from the coastline of a sovereign state.Within these areas, the state has exclusiveeconomic rights concerning management ofall natural resources.5. Projections vary widely, depending onassumptions about recycling and the movefrom paper to electronic communicationformats.6. In the case of aquifers, in which the actualrecharge rate is negligible, water can be consideredas a nonrenewable resource. A studyof China estimates the annual environmentalcost of the depletion of nonrechargeablegroundwater in deep freshwater aquifers tobe on the order of 50 billion yuan (WorldBank 2007b).7. Dead zones are areas in which oxygen concentrationsare less than 0.5 millimeters per literof water. These conditions usually lead tomass mortality of sea organisms.8. Nethope is a Kenya-based organization thatbrings together 33 nongovernmental organizations,with the mission of improving connectivityand access to information.9. EU farmers receiving direct payments mustrespect mandatory cross-compliance provisions,which require them to fulfill therequirements of 19 European legislativeacts related to the environment, public andanimal health, pesticides, and animal welfare.Farmers who do not comply face partialor total withdrawal of their Single FarmPayment. Beneficiaries of direct paymentsmust also keep their land in good agriculturaland environmental condition.10. The Nagoya Protocol on Access and Benefit-Sharing is an international treaty that aimsto develop greater legal certainty as wellas transparency for providers and users ofgenetic resources. The protocol covers theuse of genetic resources (covered by theConvention on Biological Diversity) andthe traditional knowledge that is associatedwith it. Its objective is for both parties toacknowledge and respect their reciprocalobligations.11. The evidence on the role of forests in regulatingwater flows and floods is mixed, asVincent (2012) notes. The evidence thatforests mitigate large floods is scant, and itappears that their effect on low flows can goin either direction, depending on the balancebetween infiltration and evapo-transpiration.12. REDD stands for “reducing emissions fromdeforestation and forest degradation.” Tothis, REDD+ adds conservation, sustainablemanagement of forests, and enhancement offorest carbon stocks.13. This section does not address nonrenewablenatural capital from subsoil assets (fossil fuels),which are dealt with in other chapters.14. The BioCarbon Fund, housed within theWorld Bank’s Carbon Finance Unit, is a public-privateinitiative mobilizing resources forpioneering projects that sequester or conservecarbon in forest and agro-ecosystems, mitigatingclimate change and improving rurallivelihoods.15. The mechanism, defined in Article 12 of theKyoto Protocol on Climate Change, allows acountry with an emission-reduction or emission-limitationcommitment under the 1997Kyoto Protocol (mostly high-income countries)to implement an emission-reductionproject in developing countries. Such projectscan earn saleable certified emission reductioncredits, each equivalent to one tonne of CO 2,which can be counted toward meeting Kyototargets.16. Chile had the highest human developmentindex of all South American countries in2010 (UNDP 2010).ReferencesAgardy, T., Hicks, F., and A. Hooten. 2011.“Komodo Collaborative ManagementInitiative.” Evaluation Report, InternationalFinance Corporation, Washington, DC.Ali, D. A., K. Deiniger, and M. Goldstein. 2011.“Environmental and Gender Impacts ofLand Tenure Regularization in Africa: PilotEvidence from Rwanda.” Policy ResearchWorking Paper, World Bank, Washington,DC.Aylward, B., K. Allen, J. Echeverria, and J. Tosi.1996. “Sustainable Nature-Based Tourism in

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NATURAL CAPITAL 131Economic Justification for Fisheries Reform.Washington, DC: World Bank; Rome: Foodand Agricultural Organization.WRI (World Resources Institute). 2005.Millennium Ecosystem Assessment:Ecosystems and Human Well-BeingBiodiversity Synthesis. Washington, DC:WRI.Wunder, S. 2000. “Nature-Based Tourism andEconomic Incentives: An Empirical Approach.”Ecological Economics 32: 465–79.Wunder, S., and M. Albán. 2008. “DecentralizedPayments for Environmental Services: TheCases of Pimampiro and PROFAFOR inEcuador.” Ecological Economics 65 (4):685–98.

Physical Capital: The Role ofInfrastructure in Green GrowthStrategies6Key Messages• Infrastructure policies are central to greengrowth strategies, because of the huge potentialfor regret (given the massive infrastructureinvestments required and the inertiathey create) and substantial potential forco-benefits (given the current gap in infrastructureservice provision).• The infrastructure gap offers opportunities to“build right” and leapfrog; but huge unmetneeds also can imply difficult trade-offs between“building right” and “building more,” particularlygiven financing and fiscal constraints.• A framework for green infrastructure mustbuild on efforts to address overall constraintson infrastructure finance (includingcost recovery issues) and must developstrategies to both minimize the potential forregrets and maximize short-term co-benefitsto address social and political acceptabilityconstraints.Getting infrastructure “right” is at theheart of green growth. It is criticalbecause infrastructure choices havelong-lived and difficult-to-reverse impactson the carbon, land, and water intensityof future patterns of development. Infrastructurealso offers substantial co-benefits:many investments needed for growth andimproved living conditions are also good forthe environment.The challenges and opportunities ofgreening infrastructure in developing countriesmust be understood in the context ofthe huge unsatisfied needs that remain: thefact that much remains to be built createsan opportunity to build right; the fact thatneeds are so large implies important tradeoffsbetween “building right” and “buildingmore.” While the additional costs ofbuilding green are relatively modest, theyoccur in a context of frequently bindingfi nancing and fi scal constraints. Complicatingmatters is the dramatic rise in populationand growing urbanization. As such,a framework for green infrastructure needsto offer strategies to minimize the potentialfor regrets and maximize short-term localbenefits; and it must build on efforts to133

134 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTaddress overall constraints on infrastructurefinance.This chapter focuses on long-lived infrastructuresystems such as energy, water, sanitationand transport infrastructure, althoughit recognizes other infrastructure—for example,buildings—also play a key role in drivingthe demand for infrastructure services (irrigationis covered in chapter 5).Infrastructure as the heart ofgreen growthInfrastructure policies are central to greengrowth strategies because of their uniquecharacteristics, namely the large potentialfor regret (linked with the large inertiaembodied in infrastructure investments)and the substantial potential for co-benefits(linked to the current gap in infrastructureservice provision).A massive potential for regretInfrastructure decisions are long-lived (table6.1). They influence the purchase of consumerdurables and the location choices ofhouseholds and fi rms. As such, they createsubstantial inertia in socioeconomic systems.Because the economic system reorganizesitself around infrastructure, this inertiacan even exceed the physical lifetime of specificinfrastructure investments. A delay ingreening investments may therefore proveTABLE 6.1 Sectors in which inertia and sensitivity to climateconditions are greatSectorExampleTime scale(years)Water Dams, reservoirs 30–200Land-use planningNew development in flood plain >100or coastal areasCoastal and flood defenses Dikes, sea walls >50Building and housing Insulation, windows 30–150TransportationPort infrastructure, bridge, roads, 30–200railwaysUrbanism Urban density, parks >100Energy production Coal-fire plants 20–70Source: Hallegatte 2009.extremely costly if it results in a lock-in intotechnologies that turn out to no longer beappropriate (because of their excessive carbon,land, or water intensity) or settlementpatterns that prove vulnerable to changingclimatic conditions. The infrastructurealready in place now will raise global temperaturesby 1.3°C–1.7°C unless it is retrofittedor retired before the end of its usefullife (Davis and others 2010; Guivarch andHallegatte 2011).Inertia is particularly evident in urbanpolicies and the transport-related decisionsthat shape cities. The consequences of thesedecisions are illustrated by the contrastbetween Atlanta and Barcelona, two citieswith roughly the same population andincome but dramatically different densitiesand, hence, dramatically different optionsin terms of urban transportation and housing(figure 6.1). Once a city is developed, itis difficult to change its form. This irreversibilitymakes the idea of “growing dirty andcleaning up later” inapplicable in this domain(box 6.1).The consequence of the inertia in infrastructuredevelopment is an enormouspotential for regret if decisions are madewithout adequate consideration of howconditions—socioeconomic, environmental,and technological—will change over time.The potential for regret has always been achallenge for infrastructure policy; it is mademuch more complex by climate change,which introduces deep uncertainty aboutfuture climatic conditions, technologies, andenvironmental standards and prices.Uncertainty about future climatic conditions.This complicates decision making,given the importance of weather and climateconditions for infrastructure designand performance (Hallegatte 2009). Inthe energy sector, weather directly affectsdemand (which varies with temperature)and supply. Water availability affects electricityproduction from hydropower andthermal plants (because of cooling needs),and wind and nebulosity determine windand solar power. Electricity networks arealso highly vulnerable to extreme events

PHYSICAL CAPITAL 135FIGURE 6.1 Urban densities determine cities’ options for greening(built-up areas of Atlanta and Barcelona, represented at the same scale)Source: Bertaud 2003.(such as strong winds and snowstorms, asillustrated by the January 2008 snowstormthat left millions of people stranded acrossChina or the repeated power outages causedby heavy snow in the United States). Transportinfrastructure, which affects urbandevelopment and land use, including inflood-prone areas, must also account forlong-term climate changes.Uncertainty about how technologiesevolve. This has a particularly importanteffect on cities. With current technologies,low-density single-home suburban developmentslead to high carbon emissions. But theymay become sustainable in terms of emissions(albeit maybe not in terms of water and landconsumption) with efficient electric vehicles,decarbonized electricity production and lowenergy-consumptionhouses (box 6.2). Uncertaintyabout the evolution of energy technologycosts complicates the design of energypolicy (Kalkuhl and others 2011). Anecdotalevidence suggests that uncertainty is alsoleading investors to postpone investments forfear of being stuck with an older and uncompetitivetechnology.Uncertainty about environmental policiesand prices for energy, oil, or carbon.Energy-intensive development may createdeep vulnerabilities and loss of competitivenessin a future with high carbon or energyprices (Rozenberg and others 2010; WorldBank 2010). Dense cities are less vulnerableto shocks in energy—hence transportation—prices (Gusdorf and Hallegatte 2007).The combination of sensitivity to uncertainparameters and the high level of inertiacreates a high risk of lock-ins into situationsthat will be undesirable in the future. Avoidingthese lock-ins—and the correspondingregret or retrofitting costs—should be a priorityfor decision making on infrastructure(see chapter 7).The vast potential for co-benefitsThe second reason why infrastructure willplay a key role in green growth strategy is that

136 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 6.1The case for immediate action in the transport sectorTransport is a major contributor to CO 2emissions.It is also one of the fastest-growing sources ofemissions. Not surprisingly given the 1 billion carsalready on the road, road transport accounts forabout two-thirds of total transport emissions.Developing countries, which still face a hugetransport infrastructure gap, have the opportunityto choose their transport development path: lowemissiontransport or car-dependent transport (boxfigure B6.1.1). Experience suggests that demandfor car ownership increases dramatically at annualhousehold incomes of $6,000–$8,000. If historyrepeats itself, an additional 2.3 billion cars willbe added by 2050, mostly in developing countries,given expected economic growth and past patternsof motorization (Chamon and others 2008). Withoutpolicies to encourage high-density urbanizationand public transport, high reliance on individual cartransport will ensue.If public transport is included as a major partof modal structure in urban transport, there is noconflict between a low emission transport sectorand rapid growth or high income. In fact, economieswith some of the lowest ratios of energy consumptionto gross domestic product (GDP) in the world—including Japan, Singapore, and Hong Kong SAR,China—have experienced extraordinary developmentover the past few decades.FIGURE B6.1.1 As income rises, will countries choose low energy consumption in road transport?(relationship between per capita income and energy consumption from the road sector)2.22.0Qatar1.81.6United Stateskiloton of oil equivalent1.41.21.00.80.60.4Iran, IslamicRep.Saudi ArabiaKorea,Rep.United Arab EmiratesCanadaIsraelSingaporeIcelandSwitzerlandNorwayJapan0.2Hong Kong SAR, ChinaCuba00 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000GDP per capita ($2000)Source: World Bank 2011d.

PHYSICAL CAPITAL 137BOX 6.2The impact of technologies on transport policies—not enough?Given the significance of emissions from road transport,the green growth path of transport depends onhow rapidly vehicle technologies develop. If low- orzero-emission vehicles become available in the nearfuture, relatively small changes in existing transportinfrastructure stock would be required. People couldcontinue relying on individual cars without harmingthe climate. But this may not be realistic.Technical standards in transport can also helpreduce emissions in the sector. Emissions per kilometerof new cars have historically been reducedthrough better gasoline and diesel internal combustionengines, better lighting and air conditioning,and better tires. The aviation fleet has also reducedemissions in accord with international efficiencyagreements. There is also an opportunity to reduceemissions levels through Intelligent TransportSystems—for instance, by allowing drivers to accesstimely traffic reports, identify available parkingspots, and optimize routing.But technical standards are unlikely to leadto massive reductions in emissions, so barring therapid emergence and global adoption of low-carbonengine technologies, modal shifts will be needed. Anaverage bus emits only half as much CO 2equivalentper passenger kilometer as a small car. For travelbetween distant cities, railways are even more ecofriendlythan buses: emissions from light-rail transitcan be as much as half of average bus emissions. Butthe efficiency and feasibility of modal shifts dependon urban forms, with mass transit requiring minimumlevels of density, and on tackling market structureand coordination failures.Modal shifts will also imply addressing consumerpreferences, and here the “nudging” andsocial marketing campaigns discussed in chapter2 are an important complement to price incentivesand supply-side interventions. In a world in whichmajor automobile companies spent some $21 billionworldwide on advertising in 2009—an increasingpercentage of which is aimed at emerging markets—public transport agencies across Africa, Europe,and North and South America are beginning toapply to public transportation the same marketingapproaches used by the auto industry to bolster salesto shift demand for public transportation (Weberand others 2011).infrastructure is a domain in which substantialsynergies exist between economic growth andthe environment. Infrastructure systems areindeed designed to provide welfare- improvingand productivity-enhancing services, whichare critical for development, but they alsooften provide environmental benefits.Providing service to the unserved—who usually pay a higher price for waterand energy than connected households—provides both social and environmental benefits(box 6.3). Universal access to water andsanitation is good not only for welfare andeconomic growth—with impacts on healthand human capital, especially for the poor—but also for the environment. (For instance,providing sanitation services to the slumssurrounding the Guarapiranga Lake helpedslum dwellers but also preserved the watersource of 25 percent of São Paulo’s 18 millioninhabitants in the early 1990s.) This is alsotrue for energy. When reliable network electricityis available, pollution is reduced andcompetitiveness increases, as firms no longerneed to rely on expensive back-up diesel generators.Photovoltaic (PV) solar systems areoptimal solutions for isolated, low-densityareas; hydroelectricity is the cheapest andmost reliable energy source for some countries(box 6.4). Better public urban transportreduces congestion and air pollution, withlarge economic and health impacts. 1An additional source of co-benefits islinked to distributional effects. Infrastructureconsumption subsidies are both regressive andbad for the environment (Komives and others2005). Subsidies not only distort demand,with financial and environmental consequences,they also often fail to reach the verypoor they are supposed to help (see chapter 2).The poor do not own cars and often are notserved by utilities; if they do, they consume

138 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 6.3Benefits from using photovoltaic electricity in rural areasPower grids in Africa are available only in cities andhigh-density areas. In most rural areas, keroseneand candles are the main source of lighting, whiledry cell batteries are used to power radios. All areexpensive (1 liter of kerosene can cost more than$0.80 and provides about 20 hours of light). PVsystems are superior solutions. For example, a solarhome system may be sized to power a refrigeratorand television (costing $1,000); a large televisionand three lamps (for $250); a small television, threelamps, and a radio (for $100); or a lamp, radio, andcell phone charger (for as low as $50—about thesame cost as a cell phone).Africa offers a huge market for modern, energyefficientlighting products. Although the markethas a low profit margin, its strength is in the highnumber of clients (if the right product for the rightprice can be offered). The GTZ-sponsored pico-PVprogram and the World Bank Group’s LightingAfrica are examples of two initiatives that aim totransform the lighting market from fuel-based productsto clean, safe, and efficient modern lightingappliances.Source: ESMAP 2009.BOX 6.4Hydropower as a green choice for lower-income countriesFor lower-income countries, sustainable hydropowerrepresents an important clean energy source—andone that will assume a larger share of the world’senergy production as these countries develop further.Africa is exploiting only 7 percent of its hydropowerpotential; if the region developed it to thesame extent that Canada has, its electricity supplywould be multiplied by a factor of 8.The reality, however, is that hydropower projectsare complex—with impacts on agriculture, watermanagement, irrigation, food production, climatechange, and the sustainability of communities. Theyrequire detailed planning and studies before a shovelbreaks the ground. Social and environmental impactshave to be assessed and addressed, consultationsmust be held, and regulations need to be developed.In some cases, new institutions have to be createdand made viable. None of this is easy or cheap, but itis essential, because well-managed hydro projects cangenerate an array of benefits, including flood control,drought management, provision of water supply, andenvironmental benefits.Storage facilities for hydropower are essential toadapt to changes in the hydrological cycle that areexpected to occur as a result of climate change. Withincreasing water scarcity in some regions, there is aneed to develop multiyear storage that is economically,environmentally, and socially feasible. Wherethe intensity and frequency of floods increases,storage is required to manage flows. Multipurposestorage facilities can also provide water services toagriculture, water supply, and environmental flows.Box text contributed by Diego Rodriguez.small quantities of water and electricity ortransport fuel. The lion’s share of consumptionsubsidies benefits wealthier segments ofthe population (Arze del Granado and others2010). The urban poor may enjoy some spillovers,but the rural poor seldom do.There are also trade-offs between infrastructuredevelopment and the environment.A first trade-off is related to infrastructure’sdirect environmental footprint. Building theinfrastructure that is needed for developmentwill have detrimental impacts on naturalareas, biodiversity, and the environment(Geneletti 2003). Another trade-off is linkedto the fact that building better (cleaner, moreresilient, or both) can be more expensive.This trade-off raises the fear that countriesfaced with severe financing constraints may

PHYSICAL CAPITAL 139need to choose between “building right”(which may make both economic and environmentalsense) and “building more” (whichmay be what is required socially).But the additional cost of building greenerinfrastructure should not be overstated. Insome sectors, green infrastructure is moreexpensive—where electricity grids are present,solar or wind energy is more expensive thanelectricity produced from coal, for example.But thanks to innovation and economies ofscale, the difference in cost is narrowing rapidly,and green energies are now competitive insome contexts (where the hydropower endowmentis large, where electricity is producedoff-grid, or where carbon is priced). In thetransport sector, providing public transport ismore expensive than building roads, but publicand individual transports are imperfectsubstitutes: in highly congested cities, publictransportation becomes necessary for economicreasons, and the environmental benefitscan be reaped with no or little additionalcost. In the construction sector, the additionalcost to build lower-energy buildings—thanksto better insulation and more efficient heatingsystems—may not exceed 5 percent, and thisadditional investment cost is rapidly recoupedby reduced energy bills.One case in which additional costs maycreate trade-offs is the retrofit of existing buildings.Indeed, retrofitting the lowest-efficiencybuildings into average-efficiency buildingscosts €500 per square meter in France(Giraudet and others 2011). However, energysavings can pay back upfront costs in manyinstances. The main constraint is thus one ofaccess to capital rather than financial or economicviability, as many green investments payfor themselves over the medium to long term.Recognizing the need forefficiency: Meeting largeunsatisfied infrastructure needswithin tight fiscal constraintsDeveloping countries are characterized bylarge unsatisfied needs, including needs metby infrastructure such as drinking waterand reliable electricity (table 6.2). The scaleTABLE 6.2 Gaps in access to infrastructure in developing countriesremain large, particularly in Africaof unmet needs is particularly great in Sub-Saharan Africa, where less than a third ofhouseholds have access to electricity. Connectivityalso remains low in the developingworld, particularly in rural areas, where only70 percent of the population has access toan all-weather road (33 percent in Africa).Access to water has increased, but 780 millionpeople still lack access to an improvedwater source (WHO-UNICEF 2012).Globally, the challenge is greater for sanitationthan for water supply. The percentageof the population with adequate access topotable water increased from 74 percent in1990 to 89 percent in 2010. Sanitation figuresare much lower, having increased from44 percent in 1990 to just 63 percent in 2010(WHO-UNICEF 2012). The difference partlyreflects the greater “public good” and “externality”element of sanitation and sewerage—that is, individuals feel the welfare impactsof inadequate access to water, whereas othersectors and members of society feel the effectsof inadequate sanitation (through impactson water quality and corresponding healthand productivity impacts). Estimates of thecosts of inadequate water and sanitation inthe Middle East and North Africa are about1 percent of GDP in the Arab Republic ofEgypt and 2.8 percent in the Islamic Republicof Iran (Hussein 2007). With 2.5 billionpeople lacking access to improved sanitation,the achievement of the Millennium DevelopmentGoal (MDG) on sanitation is unlikely. 2All developingcountriesAfricaPercentage of households with access to electricity 75 31Improved water source 89 61Improved sanitation facilities 63 31Percentage of rural population with access to anall-weather road 70 33Telecom: mobile and fixed lines per 100 inhabitants 85 46Source: Roberts and others 2006 for roads; World Bank 2011d for telecom; IEA 2011 for electricity;and WHO-UNICEF 2012.Note: Road access data are for 2005 or the latest year available up to that date; telecoms, for 2010;water and sanitation data are for 2010. Averages are weighted by country population. The roadaccess indicator measures the share of the rural population that lives within 2 kilometers of anall-season road.

140 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFilling the infrastructure gaps in developingcountries—to address household needsand expanding infrastructure so that fi rmshave access to the kind of energy and transportservices they need to compete—willcost an estimated $1.0–$1.5 trillion a year,or 7 percent of developing-country GDP (Fayand others 2010). 3 Developing countries arecurrently investing about half that amount,although the amount varies dramatically byregion and income level. In Africa, infrastructureneeds were projected to reach 15 percentof the region’s GDP in 2008, about twicethe level actually spent (Foster and Briceño-Garmendia2010). Moreover, given theconstraints on poor households’ budgets,increases in infrastructure services need to beprovided in a way that is affordable.In the energy sector, the challenge is toprovide all people with modern energy tomeet their basic needs at affordable costswhile ensuring the sustainable growth pathof energy consumption (through conservationand greater energy efficiency) and makingenergy sources more environmentallysustainable (box 6.5). Thus, the goals of theBOX 6.5 The energy challenge: Expanding access and increasing supply in an efficient,clean, and cost-effective mannerHow will countries meet the goal of the UnitedNations Sustainable Energy for All initiative of providinguniversal energy access at affordable costswhile ensuring environmental sustainability throughimproved efficiency and an increased role for renewables?The answer is through a portfolio of technologies(World Bank 2010).To achieve universal access to electricity by 2030,countries need to develop not only grid systemsbut also off- and mini-grid power systems, at leastas a transition solution. The International EnergyAgency estimates that about 45 percent of electricitywill come from national grids, 36 percent frommini-grid solutions, and the remaining 20 percentfrom isolated off-grid solutions serving remote andlow-density areas. Off- and mini-grid technologiescan be complemented by other solutions at the enduserlevel. For instance, the Lighting Africa initiativelowers entry barriers to the off-grid lighting marketby establishing quality standards, developing agood investment climate, and supporting productdevelopment while educating consumers on the benefitsof solar lighting products. In 2010, more than134,000 solar portable lamps that had passed LightingAfrica quality tests were sold in Africa, providingmore than 672,000 people with cleaner, safer,better lighting and improved energy access.Energy-efficiency policies could potentially contributea quarter to a third of averted greenhouse gasemissions by 2050 (World Bank 2010). Technologiesthat increase energy efficiency are typically not costlyor innovative: existing technologies alone couldreduce energy consumption 30–40 percent acrossmany sectors and countries. For instance, 70 percentof lighting (which consumes 20 percent of total globalelectricity consumption) can save 50 percent of energyuse just by using current technologies alone. A problemis that the transaction costs for energy- efficiencyprojects tend to be high, compared with their relativelysmall amount of investment. Relatively longpay-back periods may still be a considerable barrier tofinancing these projects (World Bank forthcoming).Among renewable sources of energy, large-scalehydropower tends to be the least expensive. It canbe competitive with conventional thermal generation.Geothermal energy can also be cost competitive,making it another suitable candidate. Both types ofenergy involve large upfront costs and long lead-timesfor development, however. At the opposite end of thespectrum, solar energy is more expensive, but it maystill be the least-cost option in remote, isolated areas.One challenge in developing renewables is thetemporal variation in the availability of electricity.Demand for electricity varies continuously, withlarge fluctuations during the day and even largervariation from season to season. Rapid variability ofsome renewables can add to the challenge of maintaininga balance between supply and demand at alltimes. A proper mix of generation technologies withvaried output control characteristics (for example,hydropower with storage and fast-responding gasunits), well-developed transmission systems, andimproved forecast and grid operations capacity willhelp cushion the effects of variability.

PHYSICAL CAPITAL 141United Nations Sustainable Energy for All(UN SE4ALL) initiative are to achieve universalaccess to modern energy, doublingthe global rate of improvement of energyefficiency, and doubling the global share ofrenewable energy.And providing modern energy services toall does not need to be done at the expense ofthe environment—in fact, the environmentalimpacts are likely to be modest to positive,even when using brown technologies. This isbecause the poor consume little even whenthey are connected to modern infrastructureservices, particularly in comparison to therich. For instance, the additional emissionsproduced by providing electricity using standardtechnologies to the 1.3 billion peoplewho currently lack service could be offsetby a switch of the U.S. vehicle fleet to Europeanstandards (World Bank 2010). Greening,infrastructure does not need to comeat the expense of universal access—in fact,universal access is likely to be good for theenvironment.In the water sector, developing countrieswill need to invest an estimated $72 billion ayear to reach the MDG targets on improvedwater supply and sanitation, 75 percent ofwhich is needed just to maintain existingfacilities (Hutton and Bartram 2008).Meeting infrastructure needs,protecting the environmentEven with significant synergies betweeninfrastructure service development andenvironmental consideration, greeninggrowth will increase investment needs inthe infrastructure sector. As an illustration,an analysis of mitigation scenarios fromfour models suggests that the global energyinvestment needed to achieve a greenhousegas concentration of 450 ppm CO 2-eq (partsper million CO 2equivalent) could amountto $350 billion–$1.1 trillion a year by 2030(figure 6.2). A 550 ppm target appears mucheasier to achieve, requiring $50–$200 billionof additional annual investments. (These figuresare gross investment costs; they do nottake into account the benefits from higherenergy efficiency and reduced operatingcosts.) These additional investment needsare significant, but they remain a smallshare of total world investments, at least forthe 550 ppm target. They do not include thecost of adapting infrastructure to a changedclimate, which could cost developing countriesan additional $15–$30 billion a year by2050 (World Bank 2010).Financing infrastructure:Efficiency and cost recovery toimprove access and sustainabilityInvestment in infrastructure in the developingworld is inadequate partly becauseinfrastructure is expensive and “lumpy”—capacity can be increased only in large increments,not through a continuous process. Inaddition, when investments require publicfunding, the financing gap is linked to limitsto the borrowing capacity. Even when a projectis economically beneficial and will generatesufficient tax revenues to pay back theupfront cost, it is difficult to mobilize privatefinance because of information asymmetry,long return on investments, and politicalrisks. Doing so would require shifting therisk- adjusted return upward, by increasingreturns or reducing risks, so that proposedprojects can compete with other categoriesof investment.Another reason for the insufficiency ofinvestment in infrastructure is that economicand fiscal sustainability has long been amajor challenge in the infrastructure sector.Full-cost pricing continues to be an elusivegoal, and infrastructure often involves significanttechnical and nontechnical inefficiency.Colombia grappled with both issues successfully(box 6.6). In Africa, quasi-fiscal deficitscaused by underpricing, technical losses, andnonpayment amount to about 2 percent ofGDP. Eliminating these problems could offsetabout a third of the financing gap (Briceño-Garmendia and others 2008). In South Asia,more than 20 percent of electricity producedis lost because of technical and nontechnicalreasons, including illegal connections(World Bank 2011d); 30–45 percent of water

142 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTFIGURE 6.2 Upfront investment costs for energy supply andgreater energy efficiency could be substantial(additional investment needs in the energy sector projected by fourglobal models and for two climate objectives)additional annual investment in 2030 ($billion)1,2001,0008006004002000 550 ppm 450 ppm 550 ppm 450 ppm 550 ppm 450 ppm 450 ppmMESSAGE TIAM-WORLD REMIND IEASource: Authors’ compilation based on following sources: MESSAGE: van Vliet and others 2012;REMIND: Luderer and others forthcoming; TIAM-World: Loulou and Labriet 2008; IEA: IEA 2011.Note: The targets 450 ppm and 550 ppm are in CO 2-eq (parts per million CO 2equivalent) whichmeasures the concentration of all greenhouse gases using the functionally equivalent amount orconcentration of CO 2as the reference; 450 ppm CO 2-eq is the concentration is needed to maintain a50 percent chance of not exceeding global warming of more than 2°C above preindustrial temperatures.IEA 2011 does not provide estimates for a 550 ppm scenario.is leaked from the network or not accountedfor (IBNET 2011).What can be done? Addressing theseinefficiencies would help improve bothinfrastructure coverage and the greening ofinfrastructure. Strengthening cost recoverywould not only contribute to the fi nancialsustainability of energy sector development,it would also encourage consumersto use energy wisely. Efficient managementof metering, billing, and collection wouldimprove the financial performance of serviceproviders. New metering technologies basedon information and communications technologyare facilitating this activity in manyplaces, including small, off-grid private serviceproviders and large publicly owned distributionutilities. And more efficient managementof utilities would eliminate wasteand reduce environmental impacts.In addition, incentive mechanisms shouldbe tightened at the utility and end-user levels.The biggest hurdles to doing so are accountabilityand enforceability in implementingtariff setting and collection. The cost ofenergy imports and power generation canbe volatile; it needs to be passed on to consumerprices, although smoothing mechanismsmay be required. Adjusting tariffs willgreatly improve the fi nancial sustainabilityof utilities. But utilities will also have to takemeasures against illegal connections andnonpayers.Chapter 2 discusses the difficulties ineliminating subsidies to infrastructure services.It suggests complementary actions tomitigate undesirable distributive impacts ofthese measures (such as connection subsidiesor targeted cash transfers).Another measure in the arsenal maybe cross-country collaboration. Becauseinfrastructure exhibits significant economiesof scale and scope, cross-countrycollaboration—for instance, through regionalpower pools—is generally helpful, particularlyfor small countries.In Africa, where many countries are toosmall to build national power plants at anefficient scale, $2 billion of energy investmentcould be saved if trade in power tradewas fully exploited (Foster and Briceño-Garmendia 2010). Regional power pools(for example, in West and East Africa) canhelp capture benefits from economies of scaleand smooth the intermittency of solar andwind energy. Trade and cross-country coordinationalso help countries manage naturalresources (such as shared water resources)and improve reliability.Hydro-meteorological services also benefitfrom cross-country collaboration. An analysisof South Eastern Europe estimates thatthe financing needed to strengthen nationalhydro-meteorological services in seven countrieswithout regional cooperation and coordinationwould be about €90 million (ISDRand others 2011). With deeper cooperation,the cost would be 30 percent lower.Managing demandImproving the delivery of infrastructureservices is critical. But in infrastructure,increased supply often translates into

PHYSICAL CAPITAL 143BOX 6.6Pairing cost recovery with deregulation in ColombiaIn 1964, only 50 percent of people in Bogotaand other large cities had access to electricity,water, and sanitation. And coveragerates were even worse in smaller cities (about40 percent for water and electricity and20 percent for sanitation). Today, Colombiahas almost universal access to basic servicesin cities of all sizes. But achieving convergencetook more than 40 years (box figure B6.6.1).How did Colombia achieve near universalcoverage? The key was a series ofpolicy reforms in the 1990s that broughttariffs toward cost recovery levels. In thewater sector, average residential tariffs percubic meter were increased from $0.33 in1990 to $0.78 in 2001 (World Bank 2004).With almost 90 percent of households havingmetered connections, the price increasetriggered a decrease in household waterconsumption from 34 to 19 cubic metersper month over the same period—in theprocess reducing the need for major newinfrastructure. But even with higher prices,water remains relatively affordable for theaverage household. The tariff structureallows the Colombian government to crosssubsidizethe poorest consumers from richerhouseholds and industrial users. As a result,the average poor household spends less than5 percent of its income on utility services.In the electricity sector, in the 1990s therules on who gets to generate and sell electricitywere changed. After two major blackoutperiods (1983 and 1992/93), the governmentgrappled with increasing capacity orincreasing efficiency. Given severe financialconstraints, increasing capacity was not anoption. Deregulation was therefore undertakento improve the efficiency of existingcapacity (Larsen and others 2004). As partof the reforms, electricity was unbundledinto generation, transmission, distribution,and commercialization. In the 1990s,the electricity sector represented a third ofColombia’s public debt stock. By 2004,this had fallen to less than 5 percent andColombia had become a net exporter ofelectricity.Box text contributed by Somik Lall.FIGURE B6.6.1 Access to basic infrastructure services hasrisen dramatically in Colombia(access to services, by city size, 1964–2005)percentpercentpercent100755025010075502501007550250BogotalargestBogotalargestBogotalargesta. Access to electricitycity sizeb. Access to watercity sizec. Access to sanitationcity size1964 1993 2005Source: Based on data from the Colombia’s National AdministrativeDepartment of Statistics (DANE) census 1964, 1993, and 2005.smallestsmallestsmallest

144 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTincreased demand, making a supply-side-onlyapproach both costly and ineffective. Forinstance, building new roads is often ineffectivein reducing congestion because it incentivizesthe use of individual vehicles, leavingcongestion unchanged. For this reason,action is also needed to manage demand.Policy makers can chose from an array oftools that includes price instruments, regulation,and integrated planning of supply anddemand.Prices: Important but hamperedby low elasticityPrice elasticity—that is, the percentage changein quantity demanded in response to a changein price—is relatively low in the transportationsector, at least in the short term. Thisis, in part, because consumers may be slowin responding to price signals. But it is alsobecause the real cost of transport (sometimesreferred to as the generalized cost) includesboth the monetary cost of transport and thecost of the time spent in transportation. Andsometimes the cost of time is larger than themonetary cost of transportation. Elasticity isgreater in the long run, because individualscan adjust their choice of where to live, meansof transportation, or lifestyle. For instance,the price elasticity of automobile fuel demandranges from –0.1 to –0.4 in the short run and–0.6 to –1.1 in the long run (Chamon andothers 2008).This low elasticity explains why therebound effect (whereby people may increasetheir driving when the cost of car usedecreases as a result of improved efficiency)is relatively limited, even though it may begreater at lower income levels. Sorrel (2007)finds that this effect should remain below 30percent (that is, less than 30 percent of thegain in efficiency will be “taken back” bythe increase in demand). Greene and others(1999) find that the rebound effect for individualtransport in the United States is about20 percent.Various price instruments have proven efficient.Singapore’s Area Licensing Scheme—the first-ever comprehensive road pricingscheme in the world—required drivers topay an area license fee of S$3 ($1.25) a dayto enter the central business district duringpeak hours. The number of vehicles enteringthe restricted zone declined by 73 percent,and average speeds increased by an estimated10–20 percent (Federal Highway Administration2008). Modal shift can improve the efficiencyof such price-based transport policiesand help mitigate their negative consequences(such as the significant spatial inequality theycan create) (see Gusdorf and others 2008).But it requires investments in public transportmultimodal coordination (such as creatingparking lots next to train stations), and urbanplanning (to maximize access to public transitand ensure that passenger density is highenough to justify the required investments).In the water sector, different uses havedifferent elasticities. Residential use has alow price elasticity, estimated at about –0.1to –0.3 (Nauges and van den Berg 2009;Nieswiadomy and Molina 1989). Agriculturaluse has a higher elasticity, and subsidies(whether to water or to the electricity neededfor pumping) in this sector can thus createdistorted incentives, favoring activities withhigh water consumption. And disincentivesto water conservation are greatest where theresource is scarcest (Frederick and Schwarz2000). Removing subsidies and raising pricescan thus be efficient in this sector.Demand-side actions, standards,and regulations: Criticalcomplements to pricesPrice-based instruments can be made moreefficient if complemented with appropriatedemand-management actions. Large quantitiesof water can be saved in India throughbetter irrigation technologies, obviatingthe need to exploit new raw water sources.In China, industrial water reuse systemscan save water, reducing the need to buildexpensive water conveyance systems. Manyof the technologies that can make a differencealready exist and are in use in developedcountries. Further application needs tobe supported by institutions and promotedby sector leaders. India’s Total Sanitationcampaign is a successful example of using

PHYSICAL CAPITAL 145noneconomic incentives to promote greeneroptions (box 6.7).Standards and regulations may also beuseful where price elasticity is limited or thepolitical economy of price reform is complex.Examples of such instruments include renewableportfolio standards, in which regulatorsrequire utilities to include a given percentageor an absolute quantity of renewable energycapacity in their energy mix.In transport, fuel economy standards arecommon for new vehicles (see chapter 2). In1995, Japan introduced fuel economy standardsto reduce new car fuel consumptionby 19 percent, achieving the target by 2004.A new target, set in 2006, aims for another23.5 percent reduction (An and others 2007).In Europe, improvements in fuel economyoccurred largely as a side effect of air pollutantregulations, although automobilemanufacturers agreed with the EuropeanCommission on a voluntary fleet averageemission target of 140 grams of CO 2per kilometerfor new passenger cars. Governmentscan also create automobile restricted zonesto limit passenger car traffic in urban areas,as Denmark did in the city of Aalborg.Promoting clean cooking and heatingsolutions is another case in which standardsand public investments are likely to be morehelpful than pricing instruments. Replacingtraditional three-stone cooking fireswith advanced stoves could significantlyreduce emissions and health risks (WorldBank 2011b). Without drastic interventions,2.7 billion people may still lack clean cookingfacilities in 2030 (IEA 2011).Integrated market development, includingtechnology standards, is needed to promotethe use of clean and efficient solutionsat the household level. The Global Alliancefor Clean Cookstoves, launched in September2010, aims to enable 100 million householdsto adopt clean and efficient stoves and fuelsby 2020. The alliance works with public, private,and nonprofit partners to help overcomethe market barriers that impede the production,deployment, and use of clean cookstovesin the developing world.Green infrastructure requiresplanning and strong institutionsBecause infrastructure is lumpy, infrastructuresystems cannot be grown incrementallyand continuously, and they need to beplanned in a holistic manner. A road or trainline cannot be designed without consideringother parts of the transport system, land useregulations, and urban planning.Moreover, different infrastructure systemsinteract across sectors and cannot be designedin isolation. Water availability affects electricitygeneration, and electricity is critical inwater management (for groundwater pumping,for example). Transportation and energyinteract closely: energy production oftenrequires transport infrastructure, and differenttransport modes have different energyneeds (from liquid fuel transport to electricitygrids for electrified cars). Smart use of informationand communication technologies cangreen the urban environment and improvethe efficiency of other infrastructure systems(box 6.8). Thus, much can be gained fromBOX 6.7Using noneconomic incentives to reduce the demand for water and sanitationIndia’s Total Sanitation Campaign, launched in1999, focused on communication, education, communitymobilization, and the provision of toilets ingovernment schools, mother/child centers, and lowincomehouseholds (World Bank 2011c). There waslittle government contribution to the capital cost ofsanitation facilities. Instead, the focus was on privateinvestment and private behavior change.Part of the effort involved the Clean VillageAward Program—awards to local councils thatachieved the status of “Open-Defecation Free andFully Sanitized Uni.” The awards—inspired by a programinitially introduced in Maharastra (the “SantGadge Baba”)—helped increase reported sanitationcoverage from 21 percent in 2001 to 57 percentin 2008.

146 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 6.8 Harnessing smart information and communication technologies to shape agreen futureThe smart application of information and communicationtechnologies can facilitate green growth,both by reducing emissions of greenhouse gasesand by creating new market opportunities, such assmart grids and Intelligent Transport Systems (ITS).To date, most of these mitigation opportunities havebeen applied in high- and middle-income countries.But it is arguably in the megacities of the developingworld where the impact could be greatest. Applicationof ITS in Bangkok or Manila, where there arefew substitution opportunities for private road trafficin the form of mass-transit system, would have amuch more beneficial impact than in, say Hong KongSAR, China, or Singapore. Asian countries committedto introducing ITS—such as electronic fare androad-user charging systems, transport control centers,and real-time user information—in Goal 11 ofthe Bangkok Declaration on Sustainable TransportGoals for 2010–20.a planning system that can integrate variousobjectives and infrastructure systems at boththe country and regional level to significantlyreduce infrastructure costs.Developing cities: Managing rapidexpansion to tap the potential forefficiency gainsRapid urbanization is both a driver and afeature of economic development, with seriousconsequences for infrastructure design(World Bank 2009). In many developingcountries—particularly countries transitioningfrom low- to middle-income status—thenext few decades will see a dramatic increasein the share of people living in cities. Infact, the number of people living in urbanareas in developing countries is expected todouble, from 2 billion to 4 billion, between2000 and 2030. And this massive increase isexpected to triple the physical footprint ofurbanized areas from 200,000 to 600,000square kilometers. The public policy andinvestment challenges of managing thesocial and environmental implications whilepromoting cities that are economic driversof the economy are substantial. Fortunately,practical options exist to efficiently greenthe urbanization process.The first priority is designing policies andinstitutions that can help anticipate futureurbanization. These policies should enableexisting urban areas to be redeveloped andshould prepare the peri-urban fringe toaccommodate new settlements. For this towork, land markets need to be functional.Urban land markets mediate demand andsupply and enable the efficient use of landand optimal development of constructedfloor area, both of which shape a city’s spatialstructure. Developed countries typicallyrely on market data from transactions andproperty attributes to reveal land and propertyprices. In contrast, most developingcountries lack the basic institutional machineryto value and price land.Higher land prices routinely lead tohigher density—which enhances productivityspillovers, potentially increases the supplyof affordable housing, and helps manage thedemand for transport. But this mechanism issometimes impaired by land regulations—inmany Indian cities the floor-space index islimited to 1 (as opposed to 5–15 in otherAsian cities). As a result, high land pricescoexist with low density and sprawl, creatingboth housing affordability and transportationissues.Also, when “official” land prices do notreflect demand and are depressed at the urbanperiphery, it is likely that sprawl or suburbanizationwill be excessive. How the periurbanexpansion is managed will be a criticaldeterminant of whether cities can harnessagglomeration economies and induce efficient

PHYSICAL CAPITAL 147resource allocation. The absence of a functioningland market creates a major urbangovernance challenge, as the scale at whichurban and metropolitan economies now operateoften does not coincide with their physicaland administrative boundaries. The institutionalarrangements that can enhance coordinationacross these entities is likely to be contextspecific, but significant efforts are neededto make them emerge.The second priority is redeveloping older,obsolescent areas to promote more efficientdevelopment and achieve higher densities.Older areas typically share several commontraits. Their network of streets and alleys isoften irregular and highly granular—limitingthe ability of developers to build modernhigh-rise buildings. An alternative is to redesignthese areas to accommodate higher densities.Doing so typically requires assemblingsmall plots into larger and more efficient parcelsand ensuring that the redeveloped areahas adequate infrastructure (particularlytransport, water, electricity, broadband Internet,and public services) to support higherpopulation densities. These actions shouldbe designed using consultations with thelocal population, to make sure they benefit.For instance, rehabilitation projects need toaccount for the fact that slum dwellers oftengain more from slum upgrading than fromrelocation (World Bank 2006).The third priority is integrating landpolicy with urban mobility and transportation(Viguié and Hallegatte 2012). Optionsfor urban transportation are closely tied tourban land development and can create bothpositive and negative externalities as citiesgrow. Problems arise when there are inconsistenciesbetween new developments and masstransit investment—as in Hanoi, where newdense urban development projects are notbeing located near the planned transit network.This kind of planning creates a doublerisk of having too few users of a publictransit system, threatening the financial andsocial return on investment, and increasingthe number of cars on the roads, with consequenceson congestion and air pollution.Urban transport is best addressed aspart of integrated urban strategies that canaddress the interests of multiple user groupsand anticipate long-term needs for which noone is yet advocating but that will becomecritical in the future. Although public transporttends to be more sustainable than personalmotor vehicles, it is often unviable inlow-density agglomerations (table 6.3).Although planning and developing publictransit is likely to generate co-benefits for economicintegration and manage demand forprivate modes of motorized transport, thesestrategies should not come at the expense ofallowing a wider range of transport optionsthat can enhance the poor’s mobility. Surveysshow that many people cannot affordpublic transport. In Sub-Saharan Africancities, walking represents between 5 percent(in Kigali) and 80 percent (in Conakry) of allurban trips, with public transportation rangingfrom 10 percent to 90 percent (WorldBank 2008). A significant share of householdsTABLE 6.3Effect of land use and density on use of public transportPopulation densityLow (25 people per ha)Medium (50–100people per ha)High (more than250 people per ha)Typical regionMotorizedprivateModal model split (%)PublictransportNonmotorizedAutomobile use(km/person/yr)Publictransportuse (trips/person/yr)Petrol consumptionfor transport(MJ/person/yr)North America 80 10 10 >10,000 55,000and AustraliaEurope 50 25 25 — — —Asia 25 50 25 250

148 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTreports no public transport expenditure, butthe average share of income spent in publictransport ranges from 3 percent (in AddisAbaba) to 14 percent (in Lagos), reachingabout $12–$16 a month in most cities. Thisimplies that at low-income levels, the wideravailability of different service levels andmodes at different prices is a necessary strategyfor providing urban transport serv ices. Inparticular, improving sidewalks, streetlights,and other measures to protect pedestrianusers should be parts of an urban transportstrategy.Urban transport also plays a key role inspatially integrating urban labor markets. Ascities around the world expand their spatialfootprints, the limited reach of walking tripsmay exacerbate slum formation, as manypeople trade off housing quality to be closeto jobs. It can also severely limit labor marketopportunities for people who live fartheraway from economic centers. Bovenberg andGoulder (1996) suggest that higher commutingcosts can decrease labor supply. Graham(2005) finds that productive firms are locatedin accessible and densely populated places.A fourth priority is integrating urbanplanning with natural risk management—still rare, especially in low-income countries.In 2005, the global community adopted theHyogo Framework for Action, a 10-yearplan to make the world safe from naturaldisasters. To date, 70 percent of high-incomecountries are carrying out urban and landuseplanning under the framework, but onlyabout 15 percent of low-income countries aredoing so (figure 6.3). This low participationmatters because cities are increasingly vulnerableto natural hazards, including floodsthat are becoming more destructive in manyparts of the world. And considering thelimited protection offered by dikes and seawalls, only risk-sensitive land-use planningcan mitigate flood losses over the long term(Hallegatte 2011).Given the role of urbanization in development,a green policy able to develop citieswithout increasing risks and negative environmentaloutcomes would help maintainor increase cities’ attractiveness and produceeconomic benefits (World Bank 2009).It is an open question as to how cities canFIGURE 6.3 Too few countries are implementing plans to mitigate against natural disasters(percentage of countries that implemented risk management policies under the 2005UN Hyogo Framework for Action)80706050percent403020100drainage infrastructureslope stabilizationin landslideprone areasmasons training onsafe constructionprovision of safeland for low-incomehouseholdsurban and land-useplanninghigh incomeupper-middlelower-middlelow incomeSource: UN 2011.

PHYSICAL CAPITAL 149accommodate the huge increase in urbanpopulation that is expected in many regionswithout experiencing a hike in disaster losses(World Bank 2010). That said, a recent WorldBank study uses Alexandria, Casablanca,Rabat, and Tunis to illustrate how floodrisks and climate change can be integrated inurban planning (World Bank 2011a). Transportationinfrastructure has a key role to playto make it possible for the population to livein safe locations while retaining access to jobsand services (Hallegatte 2011).Infrastructure robustness and redundancyare critical to maintaining the functions ofthe economic system after disasters, especiallyin urban environments, where the failure ofone component (such as electricity, transport,water, or sanitation) can paralyze activity.In many cases, indirect disaster impactscaused by the loss of lifeline and essentialinfrastructure services are of similar magnitudeto direct disaster losses (Hallegatte2008; Tierney 1997). However, increasingrobustness and redundancy is costly, creatingtrade-offs between the resilience of theeconomic system and its efficiency in normalconditions (Henriet and others 2012).Minimizing the potential forregrets and maximizingshort-term benefitsSome infrastructure investments that arerequired from a development and economicperspective and useful from an environmentalpoint of view cannot be implementedbecause of fi nancial, institutional, or planningconstraints. Given these constraints,a green growth policy should seek to minimizethe risk from regret and maximizeshort-term benefits.To do so, one needs first to identifywhat investments made today can leadto irreversibility that will cause regret inthe future. An example is urban planningand urban form, which are being decidedon now in many countries and cannot beeasily reversed in the future. Next, oneneeds to identify what policies (such asremoving subsidies or imposing an environmentaltax) or additional investmentsin infrastructure (such as sanitation systems)can yield large co-benefits and synergiesbetween economic and environmentalobjectives. An example is the provision ofurban public transport in crowded citieswith high congestion and air pollutionlevels, where public transport can increaseeconomic efficiency and improve environmentalconditions. Sometimes the synergyis between the environment and welfare,without being uniquely mediated by economicefficiency (an example is sanitationinfrastructure, which improves water qualityand thus population health).Previous chapters have shown that manyactions and policies can green growth andcapture synergies between environmentalprotection and development. Designing agreen growth strategy requires policy makersto choose among these options, based onwhat is most important and urgent. The nextchapter proposes a methodology to identifypriority actions, as a function of the inertiaand irreversibility they imply and of thetrade-offs and synergies they create.Notes1. Transport externalities in the United States areestimated at $0.11 per mile (Parry and others2007). Traffic congestion not only increasesemissions, it also increases local pollutantsand noise.2. WHO-UNICEF (2012) projects that by 2015the share of people without improved waterwill have fallen to 8 percent, exceeding the targetof 12 percent. In contrast, about 33 percentof the world’s population is projected tolack access to improved sanitation, far fromthe 23 percent target.3. Investment needs is a relative concept, asit depends on what the target level of coverageand quality is. No firm data exist onhow much countries invest in infrastructure,although efforts have been made to collectinformation for Africa and for private investmentsin infrastructure (see Fay and others2010; MDB Working Group on Infrastructure2011).

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Crafting a Green GrowthStrategy7Key Messages• The design of green growth policies mustbalance predictability against flexibility andrelevance against enforceability.• Step-by-step guidelines, including a checklist,can help analysts and decision makers structurethe process of crafting green growth strategies.• The suggested approach identifies prioritiesalong two dimensions: synergy (the existenceof local and immediate co-benefits) andurgency (inertia and the risk of irreversibilityand lock-in).• A green growth strategy needs to be designedbefore individual projects are assessed andselected. Project assessments need to accountfor uncertainty and diverging world views.Agood green growth strategy canincrease welfare by providing bothenvironmental and economic benefits.It is not a panacea to a country’s economicills: if economic growth is insufficientbecause of institutional or policy problems,green growth will not boost it in the absenceof other structural changes.Many green policies impose economiccosts in the short term, such as higher investmentor operational costs. But over the longerterm, they are designed to yield economicbenefits and contribute to long-term sustainablegrowth. Even so, short-term costs cancreate trade-offs between environmental protectionand short-term economic growth.For this reason, political and social acceptabilityrequire that green growth policies bedesigned with the specific goals of mitigatingtrade-offs across both space and time andoffsetting costs by maximizing synergies andshort-term economic benefits (such as jobcreation, poverty alleviation, and increasedefficiency).Traditional economic analysis of policiesand projects can be complemented with ascreening exercise that helps design policiesthat provide short-term economic benefits153

154 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTand are thus easier to implement. Not allgreen growth policies can yield such synergies,and trade-offs will be unavoidable. Itis nevertheless useful to scrutinize policydesigns for opportunities to achieve more cobenefits,if necessary by combining severalpolicy interventions.This chapter does not provide a one- sizefits-allgreen strategy, because the appropriatemeasures and policies are highly dependenton the context, especially on the mostpressing environmental and economic issues.Countries at different income levels will necessarilyhave different priorities; the lowestincomecountries are more likely to delay theimplementation of environmental policiesthat imply trade-offs with short-term productivity.Instead, this chapter provides a stepby-stepapproach to designing a strategy thatis appropriate in a given context.The challenges of developinga green growth strategyMuch can be gained from framing environmentalpolicies as national strategies withpositive long-term goals. Doing so increasesthe acceptability of immediate costs by thepopulation and the private sector. It alsoimproves consistency among policies andfosters policy certainty—which creates afriendlier climate for investments, makingit more likely that private resources will beinvested in long-term projects. But buildinga national strategy creates some challengesof its own, including the need forinteragency coordination, private sectorengagement, and the defi nition of relevantlong-term goals and indicators.Balancing predictability and flexibilityPromoting a transition toward a moreenvironment-friendly growth pathwayrequires balancing the credibility and predictabilityof long-term objectives on the onehand and the flexibility of the selected strategyon the other. Credible and predictablelong-term objectives are necessary to helpcoordinate economic actors and promoteinvestments: businesses will not invest heavilyin research on low-energy or water-savingtechnologies if they cannot be sure thata market will exist over the long term forinnovations in these domains. Their willingnessto invest in green technologies andinfrastructure depends on their trust in andprojections of future environmental goals.But environmental policies themselvesneed to evolve over time, in response to newinformation (such as technology or scientificfacts) and to the actions undertaken byother countries or regions. Thus, the abilityto adjust course is essential—even if it canoccur only at the expense of predictability.Getting around the commitment problem.What factors might reduce predictability?Certainly, changes in the politicallandscape, scientific uncertainty, and differencesin interpretations of scientific results orfuture technological potentials will arise—aswill questions about the government’s abilityto commit (Dixit and Lambertini 2003;Kydland and Prescott 1977). The fact thatgovernments lack the ability (or credibility)to make long-term commitments has led tothe transfer of monetary policy to independentcentral banks in many countries. Onthe fiscal front, independent fiscal councils(such as the Office of Management and Budgetin the United States) have been createdto monitor government policies and informpolicy makers from a technical and nonpartisanperspective.This commitment problem exists in theenvironmental domain as well. Innovativesolutions will have to be found to combinepolitical legitimacy with the ability to commit.A process needs to be established thatallows long-term objectives to be monitoredby a body other than the government inplace at a given point in time. There may bea role for an “independent environmentalcouncil” that monitors environmental policiesfor consistency with agreed-upon longtermobjectives.Building consensus. How a national strategyis developed and implemented stronglyinfluences its sustainability, credibility, andpredictability. National strategies help bring

CRAFTING A GREEN GROWTH STRATEGY 155together diverse groups of stakeholders (businesses,worker unions, and civil society) tobuild connections, exchange viewpoints, raiseawareness, and build a sustained politicalcommitment. This approach signals to societythat significant and durable efforts will bededicated to environmental protection.Local authorities play a vital role, giventhat it is at the local level that citizens experiencethe destructive impact of environmentaldegradation (such as atmospheric pollution)and government is often empowered to takecorrective action (through land-use planningor the regulation of economic activity). Localauthorities have proved to be willing innovators,offering opportunities to test policiesand build consensus before scaling up.Some countries, such as Brazil and France,have tried to build consensus through openand participatory approaches involving politicalparties and civil society. Ahead of thepreparation of its National Plan on ClimateChange, Brazil created the Brazilian Forumon Climate Change, which brought togetherrepresentatives from government, civil society,business, universities, and nongovernmentalorganizations to mobilize society around aclimate plan of action. Public participationtook the form of a national conference on theenvironment and sector dialogues.Approaches that feature iterative, multistakeholderinvolvement and extensive consultationwith the private sector and civilsociety create the transparency and politicalbuy-in to make commitments to greengrowth sustainable. Extensive consultationcan also help address some of the governancerisks inherent in climate change—which ischaracterized by complexity, uncertainty,and asymmetries in information. It is particularlyimportant to ensure opportunitiesfor the indigenous and poor communities tovoice their concerns and priorities (TransparencyInternational 2011).Jointly setting economic and environmentalgoals. At the strategic level, integratingenvironmental concerns with broadergovernment activity involves systematicallyevaluating government policies throughan environmental lens and creating newcoordinating mechanisms to ensure thatenvironmental concerns are mainstreamedin government activity. Poverty reductionstrategies, economic development plans,disaster risk reduction strategies, and climatestrategies provide opportunities forthis to happen.Consider the case of climate strategies.One way for countries to balance climatepolicy and development objectives is throughnational climate plans and low-emissiondevelopment strategies. Already, more than47 countries have low-emission developmentstrategies supported by bilateral or multilateralbodies; many more have issued climatechange–related strategies on their own(World Bank 2011b).For instance, India’s National Action Planon Climate Change defines eight national“missions,” including policy programs forenergy efficiency, a sustainable habitat, andsustainable agriculture. Bangladesh’s 2009Climate Change Strategy and Action Planrequires reviewing and revising existing governmentpolicies to ensure that they take climatechange impacts into account. Climatechange “focal points” within all line ministriesare to work in coordination with a climatechange unit housed within the Ministryof Environment and Forests (Governmentof Bangladesh 2009). Other country strategiesoutline a central interministerial body tocoordinate climate activities, including withkey economic ministries (table 7.1).Another way to integrate economic andenvironmental goals is to require that theenvironment be brought into core governmentoperations. A logical place for this tooccur is through the budget, as the budgetprocess is the central means of ensuring thatexpenditures are aligned with policy goalsand that proper consideration is given to thetrade-offs involved when climate-related concernsand growth objectives clash. For example,carbon pricing schemes, subsidy reform,and energy and infrastructure investmentdecisions all affect the fiscal balance (as discussedin chapter 2). As a result, finance ministriesand other core government and developmentplanning actors must be key players

156 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTTABLE 7.1CountryBangladeshBrazilIndiaIndonesiaMexicoSouth AfricaVietnamInter-ministerial arrangements for coordinating on climate change strategy in selected countriesArrangementNational Steering Committee on Climate Change headed by the Minister of Environment and Forestsoversees the work of the Ministry of Environment and Forests’ climate change unit, which works with climatechange focal points in each line ministry.Inter-ministerial Commission on Climate Change is chaired by Ministry of Science and Technology andincludes the Ministry of Planning, Budget, and Management, and the Ministry of Finance, among others.Advisory Council on Climate Change, led by the prime minister, oversees climate policy. Coordinating unitwithin the Ministry of Environment and Forests implements the National Action Plan on Climate Change. Adhoc inter-ministerial commissions will address the eight national “missions” identified in the National ActionPlan.National Committee for Climate Change includes representatives of all departments with responsibilitiesrelated to mitigation or adaptation.Inter-secretarial Commission on Climate Change, led by the Secretary of Environment and Natural Resourcesand including the Secretary of the Economy as well as other line ministries and agencies, is charged withpromoting and coordinating the national plan and associated activities.Inter-ministerial Committee on Climate Change coordinates government climate change actions and alignsclimate policy with existing legislation and policy.National Steering Committee headed by the prime minister and representing all major line ministriesoversees the work of a unit within the Ministry of Natural Resources and Environment that is to coordinateimplementation of the National Target Program to Respond to Climate Change.Source: Governments of Bangladesh 2009; Brazil 2010; India 2008; Indonesia 2009; Mexico 2009; South Africa 2010; and Vietnam 2008.in developing and implementing green policies.The Republic of Korea’s national greengrowth strategy (box 7.1) and many nationalclimate strategies have already begun toreflect this reality.• The Indonesian Ministry of Finance hastaken a leading role in national climatepolicy. In 2009, it issued a green paperoutlining actions to support the country’sagenda on climate change (Government ofIndonesia 2009). It was the lead nationalpartner for a World Bank country studyon low-carbon growth.• Ministries of finance in Morocco and thePhilippines, among others, are undertakingclimate change public expenditurereviews to help align spending with climatechange and development objectives.• As part of Niger’s participation in thePilot Program for Climate Resilience—which provides assistance for integratingclimate resilience into national developmentplanning—the Ministry of Economyand Finance will house a strategicunit to coordinate actions taken underthe country’s climate resilience program(PPCR 2010).Balancing relevance and enforceabilityKey dimensions of the needed balancingact between relevance and enforceability ofenvironmental objectives include the choiceof indicators with which to measure progresstoward objectives; the time horizon overwhich environmental objectives should beselected; and the scale (national, local, orsectoral) at which environmental objectivesare set. 1The choice of indicators. Potentiallyaccurate indicators may be difficult to set orenforce, and easier-to-implement indicatorsmay be less relevant. For climate change, anatural indicator for measuring mitigationis a “long-term carbon budget,” which measuresglobal carbon emissions over the courseof a given period of time, say, a century(Matthews and others 2009; Meinshausenand others 2009). But carbon budget commitmentsare difficult to introduce and enforce.Indeed, there is an incentive for decision makersto delay investments and efforts beyondtheir mandate.Another possibility is to defi ne emissiontargets at one or several points in time—such as the European objective of reducing

CRAFTING A GREEN GROWTH STRATEGY 157BOX 7.1Implementing a green growth strategy in the Republic of KoreaKorea has moved assertively to become a leader inimplementing green growth policies and defininga global green growth agenda. Its two-tier strategyfocuses on a short-term response to the currentglobal economic crisis and a long-term transitiontoward green growth through export-focused greentechresearch and development. In acting as a resolutefi rst mover, Korea has exposed itself to bothrisks and potentially high payoffs.Policy makers in Korea are seeking transformation,not marginal adjustment, of the economy,seeking to move it away from its current heavy relianceon energy-intensive industries (which doubledits greenhouse gas emissions during the 1990s) andmassive energy imports (which account for twothirdsof imports). In pursuing green growth, theyare combining three complementary and mutuallyreinforcing objectives: responding to the economiccrisis, reducing the country’s energy dependency,and rebalancing the economy toward green sectorsover the long term.Korea’s $30.7 billion stimulus package, adopted in2009, was the greenest of any country, with 80 percentof all funds going toward environment-friendlyprojects (World Bank 2010). Investments initiallytargeted infrastructure as a short-term response tothe crisis. Projects funded included the developmentof renewable energy sources, energy-efficient buildings,and low-carbon vehicles; the expansion of railways;and the management of water and waste. Mostof the green investment funded three initiatives: riverrestoration, expansion of mass transit and railroads,and energy conservation in villages and schools.Together, the three projects were projected to create500,000 jobs (World Bank 2010).Source: http://www.greengrowth.go.kr.greenhouse gas emissions by 20 percentby 2020. This type of objective is easier toenforce, but setting an objective for a particularpoint in time removes some flexibilityas to when and how to act, leading tohigher costs.The time horizon over which environmentalobjectives are set. Relevance wouldfavor setting very long-term objectives, butdoing so risks encouraging policy makersand economic actors to delay action.Shorter-term goals are needed to ensure thataction is taken. Shorter-term milestones arealso useful because there is less uncertaintysurrounding technologies and economic conditionsover the short term, making it easierto define relevant targets. It thus makes senseto combine a long-term objective (such aslimiting global warming to less than 2°C)with shorter-term objectives (such as reducingemissions by 20 percent by 2020).Short-term goals complement rather thanreplace long-term goals. If a short-termgoal is an end in itself, it may make sense toimplement the least expensive solution. Butin this case, there is a risk that the solutionsselected to meet the short-term goal may lockin technology and infrastructure, making itimpossible to reach longer-term objectives(Vogt-Shilb and Hallegatte 2011). To meet anambitious long-term objective, a short-termtarget may need to be achieved by implementingoptions that have greater potential(or suffer from greater risks of lock-in orirreversibility). Urban policies such as landuse planning or mass transportation may notbe required to reach short-term targets (forinstance, in terms of emissions by 2020). Butconsidering the timescale of such policies,they need to be implemented without delayif longer-term (2050), more ambitious targetsare to be met.The scale (national, local, or sectoral)at which environmental objectives are set.Where objectives are economy wide (such asa carbon tax), the economic system has fullflexibility to reach the objective by takingaction where it is least expensive to do so.Given the information asymmetry betweengovernments and economic agents, it makessense to let market-based mechanisms determinewhere it is most cost-effective to act

158 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENT(Laffont 1999). But the government cannotset credible and predictable signals over thevery long term, and economic agents do notanticipate changes that occur over decades.As a result, there is underinvestment inland-use planning, resilient infrastructure,research, and other interventions critical togreening growth but whose benefits taketime to materialize.Given these constraints, action at the sectorlevel may make sense in sectors with significantpotential for both lock-in and greenimpacts (Vogt-Schilb and Hallegatte 2011;chapter 3). Overlapping sectoral objectives—such as the 20 percent renewable energy targetin Europe, fuel-economy standards in theautomobile industry, and changes in urbanplanning, building norms, and infrastructuredesign—may thus be part of an efficient mitigationpolicy.However, sectoral policies are vulnerableto regulation capture, rent seeking, and inefficientmicromanagement (Laffont 1996;Rodrik 2005). Rent-seeking behavior islikely to affect policies even in countries withstrong institutional capacity and appropriatechecks and balances (Anthoff and Hahn2010; Helm 2010). Systematic appraisal ofpolicies, using cost-benefit analysis wherefeasible, can mitigate these risks (see a discussionon such analysis below). It is alsoimportant for national authorities to ensurethat sector policies are developed through atransparent process that provides opportunitiesfor all stakeholders to contribute.A step-by-step processfor crafting a green growthstrategyHow should policy makers design a greengrowth strategy that fits the country’s requirements?This section proposes a series of stepsto follow. A key principle is that individualprojects need to be assessed with respectto a strategy rather than in an abstract andisolated way. For instance, building coalpoweredelectricity plants can be a usefulshort-term component of a strategy to greenelectricity over the long term, if doing so helpsreduce reliance on diesel generators and iscombined with demand-side action and measuresto transition to cleaner sources of energy.Similarly, building coastal dikes can be partof a long-term land-use strategy to managerisks—although if it is not combined withappropriate maintenance and land use regulations,it can increase vulnerability. Giventhese kinds of consequences, a green growthstrategy needs to be designed before individualprojects are evaluated and selected.Step 1: Identify economic and socialobjectives and key obstaclesStep 1 is to identify the key economic andsocial objectives in terms of the growth andwelfare channels noted in the green growthframework presented in chapter 1 (the firstthree bullets relate to growth; the last two,to welfare):• Increase production factors (human,natural, and physical capital).• Enhance efficiency, by correcting marketfailures to move closer to the productionfunction (the maximum production levelpossible with the available technology,physical capital, labor, and environment,assuming maximum efficiency).• Push out the production frontier, by correctinginnovation and disseminationmarket failures in order to be able to producemore with less.• Increase economic resilience and reducevulnerability to natural hazards and commodityprice volatility.• Increase the job content and povertyreduction of growth (that is, move toward“inclusive growth”).In addition, policy makers need to takeother important policy goals—such as maintaininga balance in regional and local development,which may also offer a potentialsource of synergy—into account.Once the objectives have been identified,the next step is to identify the market orinstitutional failures that retard growth andlimit well-being (table 7.2). Hausmann andothers (2008) claim that different countries

CRAFTING A GREEN GROWTH STRATEGY 159TABLE 7.2Channels through which green policies could contribute to growthChannel Questions Possible prioritiesIncrease in production factors(human, natural, and physical capital)Enhanced efficiency (correctingmarket failures to move closer to theproduction frontier)Outward movement in theproduction frontier (correctinginnovation and dissemination marketfailures to be able to produce morewith less)Increases in economic resilienceIncreases in the job content andpoverty reduction of growth(moving toward “inclusive growth”)Which categories of capital (physical, natural,human) are important in limiting economicgrowth or in reducing population welfare?What are the greatest inefficiencies in theeconomic systems?What are the obstacles to innovation and toinnovation adaptation and dissemination?Is the economy particularly vulnerable toexogenous shocks such as commodityprice volatility, natural disasters,or competitor innovations?What are the major problems in the labormarket and poverty reduction, andwhy have they persisted up to now?Increasing transportation (and export)capacity, improving secondary educationand population healthReducing urban congestion and energycosts, increasing energy supply reliability,increasing employment of young qualifiedworkersImproving worker skills and propertyright protection, reducing entry costs forinnovative firms, improving access to capitalDiversifying the economy, reducing energyintensity and dependency on importedenergy, reducing vulnerability to large-scaledisasters, improving food securityReducing rural or urban poverty, mitigatingethnic segregation, fighting poverty traps,improving access to capital for the poorface different obstacles to growth and thatgrowth-enhancing policies need to be targetedto address the specific obstacles. A study bythe Organisation for Economic Co-operationand Development (OECD 2011a) proposesthat green growth strategies be developed byfirst identifying specific obstacles to growth.Step 2: Identify environmentalobjectives and lock-in risksStep 2 is to identify (1) the environmentalimprovements that are most likely toincrease welfare and (2) the risks of irreversibilityin both the environmental andeconomic domains. The idea is to focus onwelfare-improving environmental objectivesthat preclude a “grow dirty, clean up later”pathway. Examples include improving waterquality, reducing air pollution and floodlosses, protecting soils, and avoiding irreversibledestruction of coral reefs. Here (asin Step 1), the analysis should combine scientificand economic information from reports,local knowledge, and widely agreed priorities.It should rely on broad consultations toensure consistency with population goals,objectives, and preferences and to avoid conflictsbetween the green growth strategy andother planning initiatives.Step 3: Consider six types ofinterventions and identifysynergiesStep 3 is to determine which types of policyinterventions would help a country reach itsenvironmental goals while also improvingeconomic growth and social welfare. Thisreport singles out six types of interventions.Pricing and fi scal policies: taxes, subsidies,or subsidy removal (chapter 2). Fiscalpolicies can be used to guide economicbehavior and create environmental and economicbenefits. Governments need to assessfiscal policies as a whole, taking accountof the trade-offs between alternative waysto source and apply funds. Reallocatingresources from fuel subsidies to spending oneducation, health, and infrastructure willhelp reach environmental objectives andincrease economic growth. Reallocatingthese funds to services that are accessible tothe poor will also help reduce poverty. Oil

160 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTdependency, and thus vulnerability to oilprice volatility, can be mitigated by imposingan energy tax, to favor energy-efficienttechnologies and equipments. Such policieswould provide environmental benefits andenhance economic resilience.Political economy considerations will playan important part in determining the feasibilityof a realignment of fiscal policies withgreen growth objectives. Interest groups willresist the withdrawal of subsidies and taxincentives. Nonetheless, as recent efforts bythe Islamic Republic of Iran to reduce fuelsubsidies illustrate, progress can be made. Aphased approach supported by communicationand complementary policies that reallocateresources to the poor can help buildconstituencies for reforms. In some cases,resources may need to be allocated temporarilyto compensate losers, even if they are notthe poor or needy. Building in sunset clausesto such compensatory programs may helpprevent temporary relief becoming anotherpermanent subsidy.Institutions, norms and regulations, andbehavior-based policies (chapter 2). Economicincentives can be usefully complementedwith other types of instruments. Forinstance, where low building energy efficiencycontributes to high energy imports, introducingregulations or creating new mechanismsto make dwelling owners invest in insulationand efficient appliances could yield a doubledividend, strengthening the economy andprotecting the environment.Policy makers must consider how environmentalpolicies affect businesses and individuals,taking into account their decision- makingbiases and the noneconomic incentives thataffect behaviors. A strategy that takes theseaspects into account—by, for instance, framingpolicy changes within a positive collectiveproject and providing individuals withfeedback on how they behave with respectto the project—will be more efficient thanone based on an economic argument alone.Information disclosure programs that requirefirms to publish their level of pollutant emissionscan be as efficient as and less costlythan a norm.Innovation and industrial policies(chapter 3). The greening of the economyrequires growing new industries, along withdeveloping and disseminating new technologies.This process can be eased with specificpolicies that target (1) the development anddissemination of technologies and innovations,by correcting the effect of a knowledgespillover, and (2) the development of newindustries and sectors, by correcting the effectof nonenvironmental market failures (suchas coordination failures and capital marketimperfections).Green industrial policies can help disseminatenew technologies (especially when theyhave been tested and demonstrated in developedcountries) and develop new competitivesectors. Examples of green industrial policiesthat have been used include feed-in tariffs forsolar electricity, or subsidies to research anddevelopment (R&D) in renewable energy.Countries with a latent competitive advantagein renewable energy (such as North Africa withsolar energy) may want to pursue this advantagewith the hope of creating a viable andcompetitive industry. However, support mustcarefully balance market failures and governmentfailures given the risks of policy captureand rent-seeking, especially where institutionsand civil society are weak (chapter 3).Education and labor markets policies(chapter 4). Green transitions are likely toinvolve structural change away from someindustries and toward new ones. Experiencewith trade liberalization offers valuable lessonsas to how to reduce the cost and lengthof such structural changes. In particular,policies that facilitate the movement of workersfrom one sector to another can acceleratethe transition and reduce adjustment costs.Where such movement is impeded by skillissues, training programs can help—forexample by training construction employeesto efficiently retrofit buildings.Natural capital, agriculture, and ecosystemservices management (chapter 5). Anexcellent way of greening agricultural productionis through conservation agriculture,which simultaneously yields environmentalbenefits (by reducing pollution of waterways

CRAFTING A GREEN GROWTH STRATEGY 161from nutrients and increasing carbon sequestrationin soils); increases the efficiency ofproduction (by reducing the use of energyinputs); increases resilience (by frequentlyrotating crops); and increases agriculturalproductivity in the long run (by reducing erosionand enhancing soil structure).But for this to work, there needs to be betterinformation underlying decision makingand better access to this information. Forexample, greater access to weather and climateinformation services for farmers canimprove resilience in the agricultural systemand the overall value chain, including production,post-harvesting, storage, and marketaccess. It can also help innovations to succeed(such as in weather-based risk products).Infrastructure, building, urbanism, transport,and energy (chapter 6). Green sectoralinterventions can help increase factors ofproduction, push out the production frontier,enhance efficiency, improve resilience,create jobs, and reduce poverty. In somecountries, urban congestion and the lack ofefficient transportation reduce well-beingand hold back economic growth, on topof causing negative environmental effects.Investments in public transit and changesin land-use plans to favor a more compacturban area could reduce air pollution andspur growth (thanks to the benefits fromurbanization and concentration). Multiplebenefits can also be reaped from multipurposeinfrastructure such as water reservoirsthat produce hydroelectricity, mitigatefloods, and ensure minimum river flow duringdrought. And regional integration ininfrastructure design and investments canimprove the efficiency of the system, forinstance by increasing the reliability of electricitygeneration and allowing for a greaterpenetration of renewable energy.Step 4: Define prioritiesPolicy makers face limitations in terms of thecapacity and resources to design and implementreforms and the political and socialcapital to launch several reforms simultaneously.They therefore need to define prioritiesbased on urgency (to avoid lock-in andirreversibility) and synergies (the existence oflocal and immediate benefits that will helpdiminish political and social resistance).Priorities can be defined by examining thepolicy options identified in step 3 through thelens of political and social acceptability andlock-in risk, as done in table 7.3. ColumnsTABLE 7.3Some guiding principles for establishing green growth strategiesInertia and/or risk of lock-inand irreversibilityLOWER(action is less urgent)HIGHER(action is urgent)LOWER(Trade-offs exist between short-andlong-term or local and global benefits)• Lower-carbon, higher-cost energysupply• Carbon pricing• Stricter wastewater regulation• Reduced deforestation• Coastal zone and natural areaprotection• Fisheries catch managementLocal and immediate benefitsHIGHER(Policies provide localand immediate benefits)• Drinking water and sanitation, solid wastemanagement• Lower-carbon, lower-cost energy supply• Loss reduction in electricity supply• Energy demand management• Small-scale multipurpose water reservoirs• Land use planning• Public urban transport• Family planning• Sustainable intensification in agriculture• Large-scale multipurpose water reservoirs

162 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTorganize policies for the extent of local andimmediate benefits they offer. Some policiesprovide immediate synergies between theeconomy and the environment (such as reducingleaks in water networks), whereas othersinvolve trade-offs, at least in the short term(restricting development in coastal areas, forexample). Rows classify interventions for theextent to which they prevent irreversibilityand lock-in. Policies may need to be implementedmore urgently even where they implytrade-offs, simply because acting later wouldbe more costly or even impossible. Other policiescan be postponed because they do notinvolve significant inertia.In designing a green growth strategy, priorityshould go to policies that are high interms of local and immediate benefits andmore urgent (such as public urban transportand sustainable intensification in agriculture).Policies that provide local and immediatebenefits, even if they are not urgent, can beimplemented at any level of income.It is more difficult to implement policiesthat are urgent but involve significanttrade-offs (such as reduced deforestation).But these policies would be more costly—oreven impossible—to implement later. For thisreason, these policies require internationalcooperation, especially when they affectglobal challenges, such as climate change.Developing countries (especially lowincomecountries) should focus on environmentalpolicies that have a negative or zeroeconomic cost thanks to synergies withdevelopment (such as developing hydropowerwhere appropriate, or implementing specificurban plans); have a positive economic costbut large direct welfare impacts, that is, whenthey target local environment goods such aslocal air pollution or natural risks; and whosecost can be offset with external resources(such as carbon trading).Step 5: Conduct a systematic analysis ofthe policies and projects included in thegreen growth strategyStep 5 is to thoroughly review each policyand project as a function of the selectedpriorities and strategic choices. Such a reviewshould rely on a multicriteria analysis, giventhe limitations of cost-benefit analysis.The limitations of cost-benefit analysis.The standard cost-benefit analysis—which iscommonly used to evaluate public policies orinvestment projects—is necessary but needsto be supplemented by other approaches forgreen growth policies. The reason is thatcost-benefit analysis encounters three majordifficulties when applied to environmental orgreen growth policies.First, some of the benefits (or costs) aredifficult to assess and measure. Environmentalbenefits are often problematic to quantifyand value, beyond the assessment of healthimpacts. But some economic benefits, likeinnovation-related or resilience-related ones,are also difficult to assess and are thus oftenleft out of the analysis. For instance, theinnovation benefit of a demonstration projectcannot usually be quantified. More generally,benefit-cost ratios consider only one projectat a time and often cannot take into accountthe integration within a broader, longer-termstrategy and the consistency with prioritiesand strategic choices.Second, different stakeholders often assignvery different weights to different types ofconsequences, and differences in world viewsand priorities translate into different preferencesfor design and targets of policies.Cost-benefit analysis requires agreeing onvalues—something that can be very difficultto achieve.Third, many of the tools and policies thatcan be part of a green growth strategy involvesignificant uncertainties. For instance, reducingvulnerability to oil shocks is a clear economicbenefit, but is difficult to quantify inthe absence of reliable probabilistic estimatesof future oil volatility. This uncertainty arisesfrom many sources, including technologicalchange, climate change, and policy efficiencyand enforcement. Cost-benefit analysis cancapture uncertainty when it can be translatedinto probabilities for different outcomes.Where policies and projects involve deepuncertainty, however—as green growth policiesoften do—it is very difficult to estimate

CRAFTING A GREEN GROWTH STRATEGY 163probabilities or reconcile different stakeholders’world views.Differing world views, diverging priorities,and the use of multicriteria analysis.A green/wealth accounting system wouldallow the consequences of green policiesto be aggregated and policies compared.However, as noted in chapter 2, aggregationis diffi cult, because many prices aremissing; aggregation also raises ethicaland philosophical issues on which thereis little consensus. In the absence of suchan accounting system, many policieswill involve difficult trade-offs betweenimproving the environment and traditionallymeasured growth. 2 Thus, it is usefulto complement the cost-benefit analysiswith decision-making methods that facilitatecapturing—if only qualitatively—thefull costs and benefits and the correspondinguncertainty.For these reasons, multicriteria analysiscan be useful, at least as a first screening tool.It does not provide an objective ranking of allpossible actions, but it allows decision makersto include a full range of social, environmental,technical, and economic criteria andpolicy goals in a balanced manner—mainlyby quantifying and highlighting trade-offsbetween conflicting objectives that are difficultto compare directly and agree on.Multicriteria analysis is widely appliedto environmental issues, including disasterrisk reduction and climate change adaptationassessments. In the past several years,it has been applied to urban flood riskin France (Viguie and Hallegatte 2012)and Germany (Kubal and others 2009);to adaptation options for climate changein the Netherlands (Brouwer and van Ek2004; De Bruin and others 2009); to climatechange–related health risks (Ebi andBurton 2008); and to adaptation planningin Canada (Qin and others 2008). Olderexamples include identifying vulnerabilityin the agricultural sector and assessingalternative crop options (Julius andScheraga 2000), and prioritizing climatechange adaptation options in Africa (Smithand Lenhart 1996).In 2002, the United Nations FrameworkConvention on Climate Change developedguidelines for using the adaptation assessmentprocess in low-income countries.The guidelines suggest using multicriteriaanalysis to prioritize adaptation measures(UNFCCC 2002). 3 In 2011, the UnitedNations Environment Programme proposeda multicriteria decision-making tool for climatepolicies in its Multi-Criteria Analysisfor Climate (MCA4Climate) project(box 7.2). The project lists the various benefits,co-benefits, costs, and co-costs of aset of environmental policies to ensure thatcoeffects are included.This multicriteria approach is particularlyappropriate for green growth, becauseit allows analysts to identify trade-offs andsynergies and present decision makers withthe information they need to capture thepotential for co-benefits from green policies.A variety of indicators can be used tomeasure the potential benefits from greengrowth policies. Each of the channels shownin table 7.4 could be further broken down(for example, improved environment couldbe split into biodiversity, air pollution, andclimate). Many institutions—including theOECD (2011b), World Bank (2011a), andthe United Nations Statistical Division thatcreated the System of Environmental andEconomic Accounting—have proposed indicatorsfor this purpose.Applying such a process would ensurethat the real motives for implementing aproject are taken into account. For example,a demonstration of new technologythat depends on economies of scale to beeffi cient would not be expected to pass acost-benefit analysis (or to reach the classicallyrequired return on investment) thatdoes not take this demonstrator statusinto account. These benefits can be madeexplicit by simply identifying the projects’contribution to a set of policy objectives,as Morocco did for a solar power project(box 7.3).Of course, no methodology providesa purely objective way of making decisions;it can communicate only trade-offs

164 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 7.2policiesMCA4Climate: A practical framework for planning pro-development climateClimate change is a pervasive and complex problem,with uncertainty surrounding its multifacetedimpacts. Setting priorities is hampered by the lackof a systematic and comprehensive description ofthe issues concerned, the links among them, and thetrade-offs involved. Structured guidance is neededto underpin long-term policy planning in this area—guidance that systematically considers the direct andindirect economic, social, environmental, and institutionalcosts and impacts.The goal of the MCA4Climate initiative is to helpfi ll this gap by developing practical guidance thatenables governments to identify low-cost, environmentallyeffective, and pro-poor climate mitigationand adaptation policy choices. The multicriteriaframework offers a useful planning tool for prioritizingand populating with concrete measures, includingNationally Appropriate Mitigation Actions,National Adaptation Programs of Action, and otherbroad, economy-wide climate strategies.MCA4Climate rests on three main principles:• Climate change policy has multidimensionalimplications for human societies and the environment,affecting multiple interests and a wide rangeof values and priorities.• If formulated appropriately, policy responses toclimate change can help meet country-specificdevelopment objectives.• Nonmonetary values, uncertainty, and the longtermdynamics of environmental, socioeconomic,and technological systems are inherent to climatechange. They should be considered in the developmentof any policy response to it.Source: UNEP 2011.TABLE 7.4Framework for measuring potential benefits from green growth policiesType of benefit Channels Examples of indicatorsEnvironmental Improved environment Indicators specifically developed for the domain inquestion (for example, reduction in greenhouse gasemissions, natural area protected from development,air or water quality)EconomicSocialIncrease in factors of production (physical capital,human capital, and natural capital)Accelerated innovation, through correction ofmarket failures in knowledgeEnhanced efficiency, through correction of nonenvironmentalmarket failuresIncreased resilience to natural disasters,commodity price volatility, and economic crisesJob creation and poverty reductionMeasured by the additional production fromincreased capital (potentially measured by the valueof ecosystems or renewable resources), or by thevalue of additional capitalMeasured by productivity indicators (for example,efficiency of photovoltaic panels used to produceelectricity) or dissemination indicators (for example,the fraction of the population with access tophotovoltaic electricity)Measured by indicators for resource efficiency(for example, the material or energy intensity ofproduction, reduction in the value of time lost fromcongestion), or by additional productionMeasured by metrics related to the project, fromavoided disaster losses (in monetary terms) ornumber of people at risk from floods to a measure ofthe vulnerability to oil price volatilityMeasured by the number of jobs created or anindicator of the impact on the poor (for example,reduction in the number of people without access todrinking water and sanitation)

CRAFTING A GREEN GROWTH STRATEGY 165BOX 7.3 Using a policy framework to analyze the benefits of Morocco’s Ouarzazateconcentrated solar power projectThrough a public-private partnership, the WorldBank is helping finance the first phase of a 500 megawattOuarzazate solar power plant in Morocco.The project’s goal is to increase power generationfrom solar power, along with mitigating greenhousegas emissions and the deleterious effects of powerproduction on the local environment.The project illustrates the limits of a cost-benefitanalysis when a project has nonmonetary objectivesand is part of a broader national strategy. Bothcost-effectiveness analysis and cost-benefit analysisindicate that the project is not economically justifiedunder prevailing economic conditions. However, asimple listing of policy objectives and the project’scontributions to these goals can help identify cobenefitsthat would otherwise be ignored.• The project seeks to help develop a globally availablenoncarbon power generation technology andto reduce the cost of concentrated solar powerworldwide (a global public goods benefit).• It will contribute to Morocco’s energy and climatechange objectives of security of supply,energy diversification, and reductions in CO 2emissions, as well as other economic and socialobjectives, such as helping start a new greenindustry, developing interior regions of the country,and creating jobs.• It will test the use of storage technology in concentratedsolar plants, create a precedent for theuse of the public-private partnership businessmodel to develop concentrated solar power plantsin Morocco and elsewhere, and contribute toregional integration of the electricity market in theMediterranean.These co-benefits can be identified using the sixrubrics shown in table B7.3.1. The multicriteria analysisis thus useful for decision makers, even thoughit should not replace the cost-benefit analysis, whichprovides invaluable information.TABLE B7.3.1Co-benefits of the Ouarzazate concentrated solar power projectType of benefit Channels Examples of indicatorsEnvironmental Climate change mitigation Reduced greenhouse gas emissionsEconomic Increase in factors of production (physical capital, Added electricity production capacityhuman capital, and natural capital)Local learning on solar technologiesSocialAccelerated innovation, through correction ofmarket failures in knowledgeEnhanced efficiency, through correction of nonenvironmentalmarket failuresIncreased resilience to natural disasters,commodity price volatility, and economic crisesJob creation and poverty reductionDemonstrate technology that has market potential in region,given likely latent competitive advantage and capacity toexport solar resources to EuropeInstitutional innovation through the development of PPPReduce cost of concentrated solar power globallyNoneDiversifying energy in MoroccoCreating jobs and new industriesSpurring economic activity in interior regions of the countrySource: Based on the “Ouarzazate Concentrated Solar Power Project for Morocco” Project Appraisal Document.to decision makers. For instance, acost- benefit analysis will provide differentanswers if different aggregation methodsare used (how to aggregate losers and winners)or if different valuation methods areused (how to measure ecosystem losses inmonetary terms).Uncertainty and the need forrobust decision makingAssessing the costs and benefits of a greengrowth strategy is extremely difficult, especiallywhen the future is difficult to projector even describe using probabilities. 4

166 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTUncertainty surrounding green growthstrategies stems from at least three sources:• Many factors of success are not controlledby national decision makers. Such factorsinclude the availability of technologiesfrom abroad; the price of internationallytraded goods such as oil, minerals, andfood; economic growth and imports andexports from other countries; and greenor trade policies in other countries.• There are many implementation obstacles,and it is difficult to predict how efficientinnovation policies will be or how quicklyproduction costs will fall when productionvolumes increase.• Scientific uncertainty is high. No one canproject future changes in local climateswith certainty, complicating decisionsabout land-use planning, water management,and electricity production.Green growth strategies need to be robustwith respect to these uncertainties. Kalkulhand others (2012) highlight how the optimalpolicy in the presence of perfect knowledgeon technology potentials and market failuresdiffers from the optimal policy in the presenceof deep uncertainty. Disregarding uncertaintyand basing actions on the most likelyscenario is dangerous and may lead to undesirableoutcomes (box 7.4).Cost-benefit analyses can be extended toconsider multiple states, each with a probabilityof occurrence. These probabilities aresometimes determined by a frequency-basedmethod (How often did the event occur inthe past?) or by belief-based analysis, such asBOX 7.4Incorporating uncertainty in protecting Ho Chi Minh CityHo Chi Minh City already experiences extensiveroutine flooding; increased precipitation and risingsea levels in the coming decades could permanentlyinundate a large portion of the city, placing the poorat particular risk and threatening new economicdevelopment in low-lying areas.In response to these challenges, Ho Chi MinhCity has developed plans for, and started implementingnumerous infrastructure projects to mitigateflood risks. Over the years, its multibillion dollarinvestment plans in sewerage and drainage infrastructurehave included 6,000 kilometers of canalsand pipes covering 650 square kilometers in thecity to upgrade the discharge capacity of the stormsewer system and address land up-fi lling; roughly172 kilometers of dikes and river barriers, mainlyto control tides; and a tide control plan that uses atleast 12 gates and 170 kilometers of dikes to createa polder system.These plans were based on the best predictionsof future climate and development available at thetime they were made. Recent analysis suggests, however,that climate change and urbanization will begreater than expected. In fact, some variables alreadyexceed the maximum values considered in the designphase. These surprises require significant revisionsto the plans. The canals and pipes built principallyto upgrade the discharge capacity of the storm sewersystem and address land up-fi lling may not be ableto handle increased flows. Increases in precipitationand tide levels observed over the past decade alreadyexceed those projected and may top dikes and barriers.Future saline intrusion and rainfall intensity may bemore severe than anticipated, potentially rendering thepoldering plans obsolete before they are approved.In addition, unforeseen effects may cause significantharm and increase risk in Ho Chi Minh City.Since the plan was created, the city has experiencedunprojected urbanization in low-density areas, perhapsbecause of the illusion of safety associated withthe presence of flood prevention infrastructure there.The city’s Steering Committee for Flood Control isconcerned that the insufficiency of the planned infrastructuremay exacerbate flooding in some areas. Ifit does, the legacy of the intervention will have beento increase vulnerability.The Steering Committee is now preparing anintegrated flood management strategy to harmonize(continued next page)

CRAFTING A GREEN GROWTH STRATEGY 167BOX 7.4(continued)the master plans for the storm sewer system, floodcontrol system, and urban development. Aware ofthe consequences of underestimating uncertainty,they have chosen a robust approach to address concernsthat their earlier approaches to planning consistentlyunder- or misestimated uncertainties; thatplans proved brittle to assumptions that provedinaccurate, leading to costly realignment; and that itwas often difficult to reach consensus among diverseactors and agendas. Through an integrated, robustapproach, the Steering Committee is accepting therole of persistent, deep uncertainties as a new componentin its planning process.Maximizing the robustness of strategies mayrequire changes in decision-making approaches. Traditionaldecision-making processes address quantifiableuncertainty (risk) by predicting a future state anddesigning a plan or project for the conditions of thatstate. This approach produces optimal results for theintended future, but its application may be increasinglylimited when faced with larger uncertainties.Source: Hallegatte and others 2012.Bayesian analysis (What are the odds of theevent? How much do I trust my model?).But as uncertainty grows, it becomes moredifficult to characterize the probability of anevent’s occurrence, particularly when multiplestakeholders with differing values andexpectations are involved. In such a situation,the optimal solution may be designed for aworld whose existence is uncertain; that solutionmay perform poorly in other plausible,yet unanalyzed, worlds. In such a context,solutions should be adopted that are morerobust—often achieved by making them flexibleand allowing for adjustment over time, asnew information becomes available. Learningand action are thus conducted in parallel,in an iterative process that includes learningand monitoring as a major component(figure 7.1). “Waiting for more information”is never an option: information has to be created,through experimentation, monitoring,and analysis. If information is not sufficientto make an investment decision, a learningplan is required.The robust decision-making approachhelps design strategies able to cope with deepuncertainty (Lempert and others 2003). Itstarts with analyzing a candidate strategyto determine its vulnerability to surpriseand uncertainty. It then tries to reduce thisvulnerability, thereby increasing the overallresilience of the strategy. In practice, thisFIGURE 7.1 Schematic for crafting solutions in the presence ofdeep uncertaintylearn act learnSource: Hallegatte and others 2012.reviseis done through a stakeholder consultationprocess that identifies the available strategiesor “policy levers,” then determines thecriteria for appraising these strategies andthe range of uncertainties to consider. Next,decision makers proceed through an iterativeprocess, identifying the vulnerabilitiesthat different scenarios expose and howthese can be addressed until the vulnerabilitiesare reduced to an appropriate level.This robust decision-making approach canbe managed through a consultative processor supported by sophisticated modeling(box 7.5).This approach is particularly relevantwhen multiple policy goals and world viewscoexist, because it allows for a flexible definitionof success and failure. A cost-benefitanalysis requires a consensual objectivefunction that is able to rank all potentialoutcomes. In contrast, the robust decision-

168 INCLUSIVE GREEN GROWTH: THE PATHWAY TO SUSTAINABLE DEVELOPMENTBOX 7.5Using robust decision making in water planning in southern California waterPlanners have traditionally used historical streamflow data and weather patterns to develop seasonalwater forecasts. But because climate change isexpected to change weather patterns, air temperature,and precipitation patterns in an as yet unpredictablefashion at the local scale, planners are nowseeking methods to incorporate the impacts of climatechange into their planning processes.In 2006, the RAND Corporation worked with theInland Empire Utility Agency (IEUA), in Chino Hills,California, to test its robust decision-making framework.In 2005, IEUA released its Regional UrbanWater Management Plan (UWMP), in response toa projected population increase of 800,000 to 1.2million people by 2030. The document outlined aplan to meet future water demands by improvingwater use efficiency and developing local resources.The robust decision-making analysis took theUWMP as its initial strategy, used climate informationfrom the National Center for AtmosphericResearch, and employed a planning system from theStockholm Environment Institute to assess how differentpolicy levers would perform under a variety ofpossible futures.The first run of the model evaluated the proposedmanagement plan under four climate scenarios. Itsfindings generally indicated that if the impacts of climatechange were minimal, the UWMP would meetits supply goals for 2030. However, if climate changewere to cause significant warming and drying, theUWMP could perform poorly and miss many of itsgoals, causing economic losses.Additional runs of the model, using more than200 scenarios and 8 additional management strategies,were then performed. In 120 of the scenarios,cost was 20 percent higher than expected. Theanalysis revealed that UWMP was particularly vulnerablewhen future conditions were drier, accessto imported water more limited, and natural percolationof the groundwater basin lower. Strategiesranged from increasing water use effi ciency, recyclingstorm water to replenish groundwater, anddeveloping the region’s water recycling program. Inall cases, augmenting the UWMP with additionalmanagement strategies reduced both costs andvulnerability.The analysis concluded that local solutions shouldnot be overlooked when developing ways to mitigatethe impacts of climate change. Local policies andmanagement opportunities may be more cost effective,reliable, and feasible than other options.Under the robust decision-making analysis, thebest management plan was found to be adaptiveand to include near-term implementation of morewater use efficiency techniques. Presented with theseresults, water managers expressed increased confi -dence that they could plan for the effects of climatechange despite the uncertainty of forecasts.Source: For more information, see http://www.cakex.org/case-studies/1029.making approach makes it possible to combinedifferent performance criteria. It is thususeful for the design of green growth policies,which are based largely on the identificationof synergies across policy goals.Both robust and optimal techniques arenecessary elements in a decision-making processinvolving significant uncertainties. Analysesfocused on optimality are vulnerable tooverconfidence bias. Robust approaches dwellon consequences and eschew risky behavior.Managed risk-taking, however, is an essentialpart of development and inseparable frominnovation.One critique of robust approaches is theirsensitivity to the worst-case scenario. Thistendency is not an artifact of the methodology;rather, it reflects the reality of somechoices; in other cases, decision makerscan judge that hedging about a worst-casescenario is too expensive and not worthit. Robust processes deal with this issuethrough stakeholder participation andexchanges with experts. The choice of theworst-case scenario is thus a negotiated,participatory process that plays a key role indetermining which policy options will eventuallybe implemented.

CRAFTING A GREEN GROWTH STRATEGY 169This type of approach is particularlyappropriate in the context of green growth,because it allows analysts to identify thepolicies and measures that are necessary toavoid getting locked into patterns that willbe extremely difficult to change in the future.Robust decision making thus helps identifymeasures that are needed over both the shortand medium terms.Moreover, the deep uncertainty surroundingenvironmental issues affects the type ofsolutions that need to be implemented. Asany good solution must be context specific,the application of “best practices” is difficult.Two general rules can be proffered, however.First, solutions that allow greater flexibilityshould be favored over those that createlock-in; and where choices that could leadto irreversible consequences must be considered,they should be evaluated very carefully(Hallegatte 2009). Second, given the difficultyin projecting the consequences of allpolicies, implementation should be based onexperimentation, monitoring, and generalizationof successful methods.Developing green growth strategiesand responding to climate change entailan investment in planning. One option isfor governments to develop specifi c greengrowth strategies alongside their core planninginstruments. An alternative—possiblymore in line with the goals of integrating climatechange, growth, and poverty reductionpolicy objectives—is to incorporate greengrowth strategies in core planning instruments(such as national development plans).This approach highlights the trade-offs thatgovernments will have to weigh: betweenpredictability and flexibility, between relevanceand enforceability, and among thevarious policy objectives. The step-by-stepprocess proposed here helps them resolvethese trade-offs, identify synergies and cobenefits,and formulate a comprehensivegreen growth strategy that incorporatesthe range of policies available, while takinginto account the deep uncertainty thatcharacterizes climate change. The processis equally applicable at the national, local,and sectoral levels.Notes1. This section draws heavily on Vogt-Schilband Hallegatte (2011).2. With widely accepted prices (and an agreedupon discount rate), all the components offuture welfare can be summarized in a singlenumber (which can be referred to as “wealth”).In this case, a policy is “good” (it increaseswealth) or “bad” (it decreases wealth).3. For an example of standardized multicriteriaanalysis scoring for a variety of adaptationactions, see Republic of Burundi (2007).4. This section relies extensively on Hallegatteand others (2012).ReferencesAnthoff, D., and R. W. Hahn. 2010. “GovernmentFailure and Market Failure: On the Inefficiencyof Environmental and Energy Policy.” OxfordReview of Economic Policy 26 (2): 197–224.Brouwer, R., and R. van Ek. 2004. “IntegratedEcological, Economic and Social ImpactAssessment of Alternative Flood ProtectionMeasures in the Netherlands.” EcologicalEconomics 50 (1–2): 1–21.De Bruin, K., R. Dellink, A. Ruijs, L. Bolwidt,A. Van Buuren, J. Graveland, R. De Groot,P. Kuikman, S. Reinhard, R. Roetter,V. C. Tassone, A. Verhagen, and E. C.van Ierland. 2009. “Adapting to ClimateChange in the Netherlands: An Inventory ofClimate Adaptation Options and Ranking ofAlternatives.” Climatic Change 95: 23–45.Dixit, A., and L. Lambertini. 2003. “Interactionsof Commitment and Discretion in Monetaryand Fiscal Policies.” American EconomicReview 93 (5): 1522–42.Ebi, K., and I. Burton. 2008. “IdentifyingPractical Adaptation Options: An Approachto Address Climate Change–Related HealthRisks.” Environmental Science & Policy11(4): 359–69.Government of Bangladesh. 2009. BangladeshClimate Change Strategy and Action Plan.Dhaka.Government of Brazil. 2010. Second NationalCommunication to the UNFCCC. Brasilia.Government of India. 2008. National ActionPlan on Climate Change. Delhi.Government of Indonesia. 2009. Ministryof Finance Green Paper: Economic andFiscal Policy Strategies for Climate Change

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As the global population heads toward 9 billion by 2050,decisions made today will lock countries into growth patternsthat may or may not be sustainable in the future. Care must betaken to ensure that cities and roads, factories and farms aredesigned, managed, and regulated as efficiently as possibleto wisely use natural resources while supporting the robustgrowth developing countries still need. Economic developmentduring the next two decades cannot mirror the previous two:poverty reduction remains urgent but growth and equity canbe pursued without relying on policies and practices that foulthe air, water, and land.Inclusive Green Growth: The Pathway to SustainableDevelopment makes the case that greening growth isnecessary, efficient, and affordable. Yet spurring growthwithout ensuring equity will thwart efforts to reduce povertyand improve access to health, education, and infrastructureservices. Countries must make strategic investments andfarsighted policy changes that acknowledge natural resourceconstraints and enable the world’s poorest and most vulnerableto benefit from efficient, clean, and resilient growth. Likeother forms of capital, natural assets are limited and requireaccounting, investment, and maintenance in order to beproperly harnessed and deployed. By maximizing co-benefitsand avoiding lock-in, by promoting smarter decisions inindustry and society, and by developing innovative financingtools for green investment, we can afford to do the thingswe must.ISBN 978-0-8213-9551-6THE WORLD BANKSKU 19551