TRADE, INVESTMENT AND COMPETITIVENESS TRADE, INVESTMENT AND COMPETITIVENESS EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Catalyzing Investment for Green Growth The Role of Business Environment and Investment Climate Policy in Environmentally Sustainable Private Sector Development Abhishek Saurav and Brody Viney Catalyzing Investment for Green Growth: The Role of Business Environment and Investment Climate Policy in Environmentally Sustainable Private Sector Development Global Investment Climate Unit, World Bank Group Prepared with support from the Improving Business Environment for Prosperity (IBEP) Global Influence Window, November 2020. © 2021 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. 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Cover design and layout: Diego Catto / www.diegocatto.com >>> Contents Executive Summary 5 1. Introduction 6 2. How Does the Investment Climate Support Green Growth? 9 2.1 Legal and regulatory transparency is essential 10 to promote investor confidence. 2.2 Ease of doing business for domestic investors 11 can support green entrepreneurship and innovation. 2.3 Openness to foreign direct investment (FDI) 12 is needed to attract and retain sustainable finance. 2.4 A sustainable investment climate system 13 can drive green growth. 3. How Can Regulatory Reform Account for the Environment? 14 3.1 Policymakers should heed the risk of 15 moving backwards on environmental protection. 3.2 Businesses can benefit from reforms that ease compliance 16 and administrative costs without reducing protections. 3.3 Reforms should leverage synergies between 17 sustainability and private sector growth where possible. 4. How Can Investment Attraction Policies Increase Sustainability? 19 4.1 Robust environmental protections can form a 21 key part of a country’s value proposition to investors. 4.2 Shifts in global FDI present an opportunity to reorient 22 attraction strategies towards sustainable investment. 4.3 A range of policy approaches are available to 24 accelerate the shift towards sustainable FDI. 5. Conclusion 26 References 27 Executive Summary Developing countries today confront an unprecedented com- ness regulation reform efforts must account for environmental bination of challenges: the need for inclusive growth, worsen- sustainability, including by: ing environmental degradation, and the impacts of the CO- • Avoiding regulatory exemptions and repeals that reduce the VID-19 pandemic. A successful response must be founded on overall strength of environmental protections and incentives. the principles of sustainable development, circular economic • Focusing on easing the compliance and administrative systems, and green growth. By transforming private sector ac- costs generated by environmental policies without com- tivity through sustainable investment, countries can acceler- promising environmental protection. ate recovery and stimulate growth. • Identifying synergies between sustainability and private sec- tor growth, and pursuing win-win reforms where possible. Achieving this transformation will require robust environmen- tal policies to address externalities and to drive sustainable Countries can further accelerate green growth by reorienting investment. However, the success of such policies depends FDI attraction policies toward sustainability-enhancing firms on having countries also maintain a supportive investment cli- and sectors, including by: mate, including: • Making protection of the environment part of a country’s • A transparent legal and regulatory environment to pro- value proposition to global investors. mote investor confidence. • Capitalizing on shifts in global FDI flows by including sus- • Ease of doing business to support green entrepreneur- tainability considerations as part of sector prioritization. ship and innovation. • Shifting incentives and other policy tools away from • Openness to foreign direct investment (FDI), which can more polluting industries and toward sustainability-en- provide finance for sustainable projects and access to hancing investments. new technologies. Together, environmental sustainability and investment climate Environmental policies and regulations should be efficiently priorities can become mutually reinforcing, creating a sustain- designed and implemented to minimize costs imposed on able investment climate system that can drive green growth businesses. However, a green growth approach means busi- (Figure 1). > > > F I G U R E 1 - Components of a Sustainable Investment Climate System SUSTAINABLE FDI NEW GREEN FIRMS • Facilitated by an open FDI regime • Product and business model and transparent legal environment innovation driven by robust • Robust protections for the environmental policies and environment part of country value consumer and financial proposition market demands for more • Strategic attraction and retention sustainability efforts in sustainable sectors • Entrepreneurship supported by transparent legal environment INVESTMENT A SUSTAINABLE and ease of doing business BY INCUMBENTS INVESTMENT • New market entrants CLIMATE SYSTEM supported by finance and technology transfer from • Transparent legal environment foreign investors providing confidence • Environmental policies, consumer and financial market demands for more sustainability, and competitive pressure all driving change Source: Authors’ representation. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 5 1. >>> Introduction As the global population has increased and developing and emerging economies have made large development gains, human activity has placed an increasingly severe strain on the natural envi- ronment. Pollution—of air, land, fresh water, and oceans—is a pervasive problem for developed and developing countries; ecosystem damage and habitat loss increasingly endanger biodiversity; and global greenhouse gas emissions continue to rise, threatening catastrophic climate change (UNEP 2019). The consequences are hard to overstate: air pollution contributes to 4.2 million premature deaths each year (WHO 2018); pollution-related diseases reduce gross domestic product (GDP) by 1.3–1.9 percent annually in low-income countries (UNEP 2018); and in the absence of mitigation, climate change threatens massive loss of life and may reduce global GDP by as much as seven percent by the end of the century (Kahn et al. 2019). In fact, recent research by the World Economic Forum (WEF 2020) suggests that more than half of global GDP is directly or indirectly exposed to risks from current environmental challenges.1 Private sector activity is responsible for generating many of these negative environmental ef- fects. Fossil fuel use in energy production and transport is the primary source of global green- house gas emissions, as well as air pollutants such as particulate matter and sulfur dioxide (UNEP 2018). Agricultural and industrial practices are leading contributors to soil and water pollution, and agriculture is the primary cause of deforestation across Africa and South America (FAO 2020). 1. The US$44 trillion of economic value generation is estimated by considering moderate or high dependence on nature and its services. The risks to businesses occur through direct dependency of business on nature, fallout of business impacts on nature, and impacts of nature loss on society. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 6 As low- and middle-income countries have followed the path A new approach is needed—one that transforms the private of industrialization taken by high-income countries, the result- sector across both developed and developing countries to mit- ing rise in energy use and in consumption of food and materi- igate environmental impacts and capitalize on green growth als has intensified these processes (Figure 2). This process opportunities. In fact, as set out in the World Bank’s Inclusive of industrialization has brought income gains and reductions Green Growth report, a green growth strategy is the only way in global poverty, but there is mounting evidence that continu- to reconcile the rapid growth required to bring developing ing this development approach will see the world exceed its countries to a greater level of prosperity with the imperative of ecological carrying capacity (OECD 2012). a better managed environment (World Bank 2012). > > > F I G U R E 2 - Key Environmental Indicators and Private Sector Drivers, 1990–2015 C L I M AT E C H A N G E ( W O R L D ) Greenhouse 55 20 Energy use gas emissions (kg oil eq., (kt CO2 eq., 45 15 trillions, RHS) millions, LHS) 35 10 25 5 1990 1995 2000 2005 2010 2015 D E F O R E S TAT I O N ( W O R L D ) Forest area 33 39 Agricultural (% total land land, LHS) 32 38 (% total land, RHS) 31 37 30 36 1990 1995 2000 2005 2010 2015 AIR POLLUTION (LOW INC.) Particulate 90 40 Industry matter value (% popn 80 30 added exposed, (% GDP, LHS) 70 20 RHS) 60 10 1990 1995 2000 2005 2010 2015 Source: World Bank World Development Indicators.2 2. Particulate matter calculated as the share of population exposed to levels of PM2.5 pollution (particulate matter 2.5 micrometers or smaller) exceeding the World Health Organization (WHO) Interim Target-1 value, aggregated across 20 low-income countries with available data. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 7 Importantly, this transformation need not come at the expense mate policy) can play in meeting these goals and transition- of private sector success. The potential upside of a green tran- ing to green private sector growth in developing countries.3 sition is enormous: the World Economic Federation estimates A country’s investment climate comprises the legal and reg- that shifting critical systems such as food, energy, and cities ulatory conditions under which firms and investors make in- toward greater sustainability could generate more than US$10 vestment decisions (Smith and Hallward-Driemeier 2005). It trillion in new business opportunities and 395 million jobs by includes the regulations that govern starting and operating a 2030 (WEF 2020). business (the business environment); the rules for domestic and foreign investors seeking to finance and operate firms and Although many developing-country governments and develop- projects; and the predictability provided to investors by wider ment organizations around the world have committed to such legal, political, and macroeconomic settings. The investment an approach, the investment task ahead is significant. Tar- climate helps to shape the direction of private sector develop- gets for 2030 set under the Sustainable Development Goals ment and, by extension, its impact on the natural environment. (SDGs) include: substantially reducing deaths from pollution This places investment climate policy at the center of efforts to (target 3.9); substantially increasing the share of renewable achieve green growth. energy in the global energy mix (7.2); substantially reducing waste (12.5); and protecting and restoring fresh-water, ocean, The paper is organized around three key questions. First, and forest ecosystems (6.6, 14.2, and 15.2). In addition, 189 how does a country’s investment climate help enable green countries are parties to the Paris Climate Agreement commit- economic growth? Second, how can efforts to improve the ment to limit global warming to 1.5 to 2.0 degrees C above domestic business environment through business regulation pre-industrial levels. Immense private sector investment will reform take account of the need for environmental protection be needed to transform resource consumption, energy pro- and sustainability? Third, how can policies related to FDI be duction, manufacturing processes, and other economic sys- adjusted to play a stronger role in promoting sustainable sec- tems to achieve these goals, and policy intervention will be tors and business practices? Together, the answers to these needed across many fronts to support this transition. questions establish key concepts and principles that can make investment climate reform an effective and integral component This paper considers the unique role that business environ- of a green growth strategy. ment and investment climate policy (hereafter investment cli- > > > B O X 1 - COVID-19 and the need for a green recovery The need to prioritize green growth is even more urgent as countries look to recover from the COVID-19 crisis. The pan- demic has exposed the fragility of many aspects of modern life in the face of threats from the natural world, including the disproportionate impact that such threats can impose on poor, marginalized, and vulnerable populations. Indeed, many of the pandemic’s impacts—such as illness, loss of life, and business and supply chain disruptions—mirror potential climate change impacts. Downturns in specific sectors, such as energy and materials, have also reinforced the need for countries dependent on specific sectors to diversify (Mukanjari and Sterner 2020). Importantly, the policy actions that governments take to drive their recovery from the crisis today will shape environmental outcomes for decades to come. There is significant scope to prioritize sustainability in stimulus and reform measures in order to increase resilience and accelerate decarbonization of economic activity (Hammer and Hallegatte 2020). In- vestments in green infrastructure, building efficiency improvements, natural capital, education and training, and clean technology research and development all have high potential stimulus and environmental benefits (Hepburn et al. 2020; Engstrom et al. 2020). More broadly, the effects of the crisis on private behavior, firm operations, and the role of govern- ment make the pandemic a critical juncture, with the potential to substantially reorient the path of economic development toward greater sustainability (Kuzemko et al. 2020). 3. Environmental sustainability will require robust policy in many areas, including pollution regulation, ecosystem protection, and climate change mitigation, as well as policies to enhance environmental sustainability in trade, finance, and other sectors. Although this paper touches on policies in these areas, they are not the focus of this paper. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 8 2. >>> How Does the Investment Climate Support Green Growth? Transforming private sector activity to achieve environmental goals and deliver a successful green growth strategy will require substantial capital investment. The United Nations Conference on Trade and Development (UNCTAD) estimates that global investment in developing countries of up to US$1.2 trillion annually is needed to achieve environmental aspects of the SDGs by 2030 (UNCTAD 2014). While there are many opportunities for firms to benefit from sustainable investments, there is a strong case for government action to drive change at the speed and scale required to address today’s environmental challenges (see Box 2). In response, governments have leveraged a range of environmental policies to push firms toward more sustainable investments. For environmental policies to be effective, they must exist within an investment climate that supports and enables such a transformation. As set out in the Policy Framework for Investment of the Organ- isation for Economic Co-operation and Development (OECD 2015), many policy factors that support business investment in general are, by extension, important for supporting sustainable investment and green growth. In addition, environmental policies are themselves part of the investment climate, and the interaction between the two can shape the success or failure of a green growth strategy. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 9 2.1 Legal and regulatory transparency is essential to promote investor confidence A transparent legal and regulatory environment that protects the megawatt (MW) wind-energy project currently costs more than property rights of investors is an essential foundation for a sup- US$250 million and takes three years to build (EIA 2020).4 With- portive investment climate. For example, transparency in law- out confidence that the investment climate will offer a predictable making and regulatory processes, protection from arbitrary or operating environment and protection from political risks, firms unpredictable government actions (including expropriation), and may be unwilling to commit to sustainability projects at scale. access to recourse mechanisms to resolve disputes are vital to give both domestic and foreign private sector actors the confi- The need for transparency and consistency also applies to dence to commit investments. In fact, in the most recent Global environmental policies and regulations themselves. Like other Investment Competitiveness survey, 42 percent of firms ranked areas of business regulation, environmental policies can gener- the legal and regulatory environment as critically important to ate regulatory risks for investors if these policies are unclear, investment decisions, behind only political and macroeconomic involve excessive bureaucratic discretion, or are changed regu- stability (World Bank 2020a). larly without warning or consultation with the private sector. Ro- bust, well-designed, and effectively implemented environmental This foundation is particularly important as firms consider mak- regulations are integral to achieving sustainability goals, but are ing transformative investments in sustainable technologies, likely to have little effect if firms cannot be reasonably certain products, and markets. Such investments are often very large of the standards they will need to meet or of the price that will and can take several years to generate positive financial returns be imposed on any pollution they emit (Teeter and Sandberg from the associated cost savings, the benefits of expanded 2017). As such, transparency and consistency in environmental market share, or the success of new products. For example, policy are paramount to inspire investor confidence. the US Energy Information Administration estimates that a 200 > > > B O X 2 - Environmentally sustainable private sector investment and the role of government While no single definition of sustainable investment exists, the term can encompass any private sector investment that contributes to a more environmentally sustainable economy, including: • Investments in more sustainable and efficient production practices. • Investments in new firms and products that are more sustainable than competitors. • Investments in the research and development of sustainable technologies. Some of these investments may have direct benefits for businesses, such as the energy cost savings that arise from a more efficient plant or office building. Others may provide businesses with access to new market opportunities or repu- tational advantages over competitors that attract new customers. In fact, empirical studies suggest firms’ environmental performance is related to better financial performance (Albertini 2013; Earnhart 2018). However, sustainable investments also generate positive externalities (or reduce negative externalities), which are the wider benefits to society that arise from a better environment. As these benefits do not necessarily accrue to firms in the form of revenue or profits, the level of sustainable private investment will generally fall short of the optimal level for society overall. As such, some government intervention is needed to incentivize firms to account for environmental impacts and undertake the optimal level of investment. Common environmental policies used by governments include pollution and technology standards, permitting and ap- provals processes, pollution taxes, green subsidies, and information disclosure requirements. In general, market-based mechanisms such as taxes and tradeable permits are considered the most efficient approach, although uniform standards are less complex and often are seen as more equitable, which can make them easier to implement (Zhao 2019). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 10 2.2 Ease of doing business for domestic investors can support green entrepreneurship and innovation. A key factor in a country’s investment climate is the ease with tal and labor) from existing businesses with unsustainable which domestic investors can do business. This covers ev- products and practices to more sustainable businesses (Gast, erything from the business incorporation process to obtaining Gundolf, and Cesinger 2017; Johnson and Schaltegger 2019; construction permits, registering property, accessing finance, Haldar 2019). This is particularly true in developing countries and paying taxes, as well as covering legal issues such as where small- and medium-sized enterprises play an outsized enforcing contracts and resolving insolvency (World Bank role in the economy (UNCTAD 2017). In addition, if sustain- 2020b). It also includes the rules for employing workers, con- ability improvements provide new firms with a reputational tracting with the government, and engaging in international advantage among consumers, the competitive pressure from trade. Countries where the business environment is more these new market entrants can also drive incumbent firms to favorable for the private sector tend to have higher levels of become more sustainable, thus enhancing the impact of regu- entrepreneurship, which in turn supports employment growth, latory pressure. innovation, and overall economic development (Djankov et al. 2002; Nyström 2008; Chambers and Munemo 2019). A supportive regulatory environment that enables entrepre- neurs to efficiently start and grow more sustainable business- Innovation is widely recognized as essential for achieving green es is therefore an important mechanism for achieving environ- economic growth. Well-designed environmental policies create mental goals. Conversely, a regulatory system that maintains incentives for innovation as firms seek to meet higher standards excessive barriers to entry and burdensome red tape may see at the lowest possible cost, and in some cases this can serve the effectiveness of environmental policies stymied. In addi- to enhance the competitiveness of firms and countries overall tion, competition policy has an important role to play by ensur- (Porter and Linde 1995). Numerous studies have confirmed this ing that new businesses are on equal footing with incumbents. relationship between environmental regulation and innovation, Environmental regulations such as licensing and approval often focusing on the impact on innovation within existing firms processes also need to be designed and implemented effi- (Ambec et al. 2011; Cohen and Tubb 2018). ciently to facilitate compliance—a question explored further below. Working together in this way, environmental regulation However, the entry of new businesses is also a key mecha- and improved ease of doing business will help accelerate a nism for this innovation process, reallocating resources (capi- green economic transformation. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 11 2.3 Openness to foreign direct investment (FDI) is needed to attract and retain sustainable finance. The rules governing foreign direct investment (FDI) and as- approaches that have been researched and deployed success- sociated investment policies are an equally important element fully in advanced economies, which still make up more than of a country’s investment climate. Excessive screening and 70 percent of global research and development expenditure.5 restrictions (on ownership, products, technologies, and prices) Foreign parent firms can transfer specific technologies, such can deter FDI, whereas strategic and focused investment pro- as clean energy technology and pollution abatement systems, motion activities can help countries attract and retain FDI in to their affiliates and can also pass on business practices and key sectors. In turn, FDI can play a significant role as a source management approaches that may include greater prioritiza- of finance for new projects and businesses, and as a mecha- tion of sustainability concerns (Saurav and Kuo 2020). nism to accelerate productivity growth by transferring knowl- edge and technologies to host economies (Kusek, Saurav, and These effects can spread, particularly where standards im- Kuo 2020). These two roles—as a source of financing capital posed by FDI affiliates drive improvements in their domestic investments and as a conduit for technological change—make suppliers. In particular, where investment is aimed at produc- FDI an instrumental channel for achieving environmental sus- ing intermediate and final goods and services for export mar- tainability goals, particularly for developing countries. kets with higher environmental standards, foreign investors have strong incentives to expand the use of cleaner technolo- First, the investments needed in clean energy, sustainable indus- gies and practices in their affiliates and supplier networks. trial production, and green infrastructure in developing countries There may also be spillovers to domestic competitors, who are immense. UNCTAD estimates that between US$550 billion may be driven to improve environmental performance through and US$850 billion in capital investment in developing countries competitive pressure or may gain access to new knowledge is needed annually to meet SDGs related to climate mitigation. themselves from demonstrations or staff movements. Another US$80 billion to US$120 billion is needed for adaptation, and US$70 billion to US$210 billion is needed to preserve eco- Not all FDI flows finance sustainable firms and industries, but systems and biodiversity (Figure 3). FDI is the largest source of FDI will be crucial for green growth going forward. Historical- overseas finance to developing countries, and despite the signifi- ly, much of the FDI directed toward developing countries has cant impact of COVID-19 and the broader slowdown in global FDI sought to exploit the availability of natural resources, including flows, it will play a crucial role in financing these goals (Gestrin fossil fuels. Businesses with environmentally unsustainable 2019). Without a supportive FDI regime in place that allocates practices may also seek out locations with weaker environ- global capital efficiently, developing countries will find it far more mental protections, further contributing to local environmental difficult to attract the necessary volume of green investment. challenges. These issues are discussed further below. None- theless, significant FDI flows will be crucial for developing coun- Second, a green growth transformation requires more than tries to transform their private sector and rapidly improve the capital: it requires the deployment of new technologies and sustainability of major industries. For this reason, a legal and practices in almost every sector of the economy. FDI provides policy framework that effectively attracts and retains FDI is an an important avenue for developing countries to access new essential component of any country’s green growth strategy. > > > F I G U R E 2 - Annual Capital Investment Required to Achieve Environmental SDGs Climate change adaptation Other (US$100 billion) Climate change SDGs mitigation (US$2.96 (US$700 billion) trillion) Eco-systems and biodiversity (US$140 billion) Source: UNCTAD 2014 (midpoint of estimates). 5. Based on World Bank World Development Indicators data. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 12 2.4 A sustainable investment climate system can drive green growth. In summary, a supportive investment climate is a crucial com- innovation needed for new green businesses to flourish, while panion to strong environmental regulations in achieving a green FDI can provide finance and technologies to accelerate this private sector transformation in developing countries. Strong en- transformation. In turn, new businesses put competitive pressure vironmental standards and incentives, when implemented in a on incumbents while also opening new markets and new sectors. competitive and transparently regulated market, can incentivize Together, as shown in Figure 1 above, these elements can re- firms to invest in more sustainable practices and to shift activity inforce one another to create an investment climate system that toward greener sectors and products. Effective business regula- drives green growth. tions support this process by facilitating the entrepreneurship and EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 13 3. >>> How Can Regulatory Reform Account for the Environment? Policy makers often face difficult trade-offs between regulatory reforms that support private sec- tor growth and environmental sustainability goals. Business regulation reforms are changes to laws, regulations, and government processes that aim to make it easier to do business and reduce risks—for example, by eliminating unnecessary restrictions on sectors and industries or by increasing regulatory transparency (Ploeg, Hinojosa, and Miedzinski 2017). Environmental policies can become a target of such reform efforts because these policies gener- ally restrict some types of business activity. For example, environmental standards and licensing requirements prevent businesses from operating in ways that do not meet minimum require- ments. Similarly, pollution taxes and permits discourage or cap certain activities to incentivize abatement. Environmental regulations also create compliance costs that can weigh on firms’ productivity and serve as a barrier to entry. While reducing the bureaucratic burden on businesses is important, encouraging private sector de- velopment at the expense of environmental protections is incompatible with the goal of achieving sustainable development. As outlined above, the consequences of environmental degradation and climate change threaten not only public health and well-being, but the overall viability of the economic system. Furthermore, analyses of regulations in advanced economies such as the United States have found that the business costs imposed by environmental regulations tend to be outweighed by the welfare benefits achieved for the community overall (Gray 2015; Ferris et al. 2017). Importantly, the outcomes of such analyses depend on the efficient design and implementation of regulations. This means that policy makers in developing countries must engage in regulatory reform in ways that account for and enhance the imperatives of environmental sustainability and green growth, while also ensuring that environmental regulations are as efficient and effective as possible. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 14 3.1 Policymakers should heed the risk of moving backwards on environmental protection. There may be good reasons for policy makers to be concerned formed and benevolent regulator (Earnhart et al. 2019). In policy about the effects of environmental regulation on the cost of do- environments where exemptions are proposed without careful ing business—particularly business entry and entrepreneurship. assessment of environmental costs or where decision makers As set out above, extensive research documents that more re- are under undue pressure from interest groups, such exemptions strictive business regulations can reduce the entry of new firms. are likely to undermine the effectiveness of sustainability policies Numerous studies have confirmed that this is true of environ- (Huetel and Kelly 2016). mental regulations, with stricter requirements related to reduced business formation and particularly reduced entry of small firms In some cases, governments have gone further and scaled back (Dean, Brown, and Stango 2000; Helland and Matsuno 2003; or entirely repealed environmental policies in the name of private Heyes 2009). As a result, incumbent firms may benefit from re- sector advancement. For example, the Australian government duced competition—but they may also face environmental regu- repealed carbon pricing legislation in 2014 after several years latory barriers themselves when considering new projects and of operation, citing its impact on rising energy costs for indus- expansions. As such, easing environmental restrictions may pro- try (Irigoyen 2017). More recently, observers have identified as vide a tempting opportunity for governments to improve the ease many as 74 deregulatory actions taken by the US government of doing business. between 2016 and 2020 that weaken environmental protections (Gross 2020). Recent reforms to environmental laws in countries One approach that governments have taken is to introduce ex- such as Brazil, India, and Indonesia have also raised concerns emptions to environmental regulations for particular firms or in- about the weakening of protections (Aggarwal 2018; Gonzalez dustries. For example, a high-profile clause in the US Energy 2020; Jong 2020). Policy Act of 2005 sought to bolster the expansion of the oil and gas industry by exempting the chemicals used in hydraulic frac- Exemptions and repeals may be necessary in some cases, but turing from regulatory oversight under the Safe Drinking Water such changes risk permanently reducing the stringency of policy Act (CRS 2005). In China, research suggests that higher pol- settings or the strength of sustainability incentives. New environ- lution from state-owned enterprises may have arisen because mental policies can be extremely politically difficult to legislate their bargaining power with regulators results in fewer inspec- due to their concentrated effects on some sectors and workers tions (Dasgupta et al. 2001). and diffuse benefits for the community overall (Vona 2019). As such, existing progress toward greater sustainability should be Such de jure and de facto exemptions can be beneficial in some carefully protected. Policy makers should approach reforms to circumstances, such as when firms have different abatement environmental regulation with caution, should undertake com- costs or levels of environmental impact. However, these benefits prehensive analysis of sustainability impacts, and should avoid are possible only when exemptions are overseen by a fully in- options that reduce the overall level of environmental protection. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 15 3.2 Businesses can benefit from reforms that ease compliance and administrative costs without reducing protections. While preserving the stringency of environmental protections is firms; and risk-based prioritization of regulatory supervision. vital, there may be opportunities to make progress on compliance costs. An important distinction can be made between, on the one Recent reforms to environmental licensing processes in the hand, the costs and restrictions that regulations intentionally Brazilian state of Ceára, which were implemented with the impose to achieve policy aims, and on the other hand, the support of the World Bank and the Improving Business Envi- compliance and administrative costs that regulations inadvertently ronment for Prosperity (IBEP) program, demonstrate this ap- generate. The latter encompass costs created by environmental proach (see Box 3). These reforms bolstered transparency impact assessment processes, licensing applications and and simplified the licensing process for low-risk firms, and while approvals, and ongoing compliance activities. opportunities remain for further improvement, progress to date demonstrates that ease of doing business need not come at Prior research suggests that these regulatory costs are not the expense of the environment. By focusing on reducing inef- systematically related to the actual stringency of environmental ficiencies and costs in the licensing process, officials in Ceára policies themselves, which suggests there is scope to reform have found a way to meaningfully reduce the regulatory bur- compliance processes and requirements while maintaining or den placed on the private sector without reducing protections even enhancing the overall level of environmental protections in place for the natural world. Furthermore, such reforms can that are in place (Koźluk 2014; Berestycki and Dechezlepêtre free up scarce resources within the environmental agency, 2020). Reducing the compliance cost burden of regulation can enabling staff to focus on more impactful oversight activities be done in many ways, including: creating integrated, digital rather than excessively bureaucratic processes. systems; simplifying processes; enhancing transparency for EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 16 3.3 Reforms should leverage synergies between sustainability and private sector growth where possible. Finding ways to reduce the compliance costs associated with An example of this kind of win-win reform is provided by efforts environmental policies is important, but there may also be to improve the management of ship waste in Indonesia (see reform opportunities that are beneficial for both businesses Box 4). With the support of the World Bank and IBEP, a new and the environment. Such synergies can be realized in system was developed to track and manage waste collection a number of ways: removal of some sectoral restrictions and treatment, not only helping to reduce pollution, but also may allow companies to better manage their environmental facilitating the expansion of the waste management services impacts; new mechanisms for natural resource governance subsector. Work remains to be done for the new system to may create business opportunities in ecosystem management; deliver its full potential. However, the success of the reforms to and integrated licensing and permitting processes may ensure date shows how stakeholders across government and the pri- better overall enforcement of important standards (Ploeg, vate sector can work together to find effective solutions to en- Hinojosa, and Miedzinski 2017). Identifying and capitalizing vironmental challenges that enhance private sector efficiency on these reform opportunities can be challenging and depends and provide growth opportunities for new businesses. on local conditions and institutions as well as implementation arrangements. However, such reforms have the potential to unlock and accelerate a transition to more environmentally sustainable private sector. > > > B O X 3 - Environmental licensing in Ceára, Brazil In 2018, the World Bank and IBEP worked with the Brazilian state of Ceára to complete a technical study of environmental licensing processes and gather feedback about issues experienced by firms using the system. The study identified that the process generated costs and uncertainty for applicants while leaving gaps in the assessment of impacts, and in the monitoring and enforcement of license conditions. For example, licenses took an average of 142 days to be approved and involved extensive paperwork, and applicants reported concerns about a lack of information on their application’s progress. Licensing laws left considerable room for discretion by officials, and a lack of standardization in the requirements for environmental impact assessments exacer- bated uncertainty. At the same time, assessments focused narrowly on individual aspects of applications rather than on integrated and cumulative environmental impacts. A lack of ongoing monitoring and enforcement of license conditions risked leaving licensing as a bureaucratic process with little connection to outcomes. In response, the Ceára environmental agency (SEMACE) introduced a case-tracking tool, systematic user feedback sur- veys, and an artificial intelligence–supported chatbot to improve transparency, information access, and predictability for firms applying for licenses. In April 2019, the state environmental council (COEMA) made further progress through a new resolution that changed licensing rules. The period of license validity was extended, easing the renewal burden on both businesses and administrators and freeing resources to assess new applications more quickly. In addition, a streamlined process was introduced for low-risk applications, simplifying licensing for more than 100 sectors where pollution potential is relatively low, while maintaining intensive requirements for higher-risk projects. There is scope for further improvement, such as standardization of the requirements and methods used in environmental impact assessments in order to further improve certainty for businesses while minimizing opportunities for lenience or error by the regulator. Licensing data could also be leveraged to assess cumulative risks to particular ecosystems, while resources that were once required for application processing could be used to bolster monitoring of compliance and ef- fectiveness of licensing conditions. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 17 > > > B O X 4 - Ship waste management in Indonesia Across several years, engagement between Indonesian government agencies, port operators, and shipowners high- lighted shared concerns about the poor management of ship waste—particularly oil—in Indonesia’s ports. For example, in 2016 only 5 to 10 collections of oil waste occurred on average each month at the Port of Tanjung Priok in Jakarta, despite more than 13,000 ships calling at the port each year. This low collection rate reflected the lack of a functioning waste management system, with inefficient reporting and cumbersome rules for collection and delivery. In addition, the number of firms providing waste management services was limited at port locations. With the support of the World Bank and IBEP, the Indonesian Port Corporation (IPC) and government agencies (including the Port Authority and Harbor Master) collaborated to develop a new waste management system with the potential to sig- nificantly improve environmental outcomes and while also bolstering the port services subsector. Over the course of 2018, a new online system for ship waste notification was developed and integrated into Inaportnet, the existing shipping data portal used across 17 business ports. The new system requires all ships to report the type and volume of waste planned for disposal ahead of arrival, with the online approach providing a simple and efficient process for ships and improved data collection for port operators and officials. In 2019, IPC built on this progress at Tanjung Priok by developing an online application to connect shipping agents to waste management operators. Importantly, the new system was expected to increase the demand for waste management services, which led IPC to expand the number of waste management firms operating at Tanjung Priok. This change has increased competition in this subsector and created opportunities for new firms develop. Once fully implemented, the new system could improve both pollution outcomes and business development across In- donesia’s growing port sector. Now in place across 17 ports, use of the online notification system remains imperfect and greater enforcement may be needed to ensure full compliance with requirements. Work also remains to be done to ex- pand use of the business-to-business application, to resolve questions of fee design, and to continue expanding competi- tion among service providers. Importantly, the key actors are committed to addressing these issues to fully implement the waste management system and advance the plan for greening Indonesian ports. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 18 4. >>> How Can Investment Attraction Policies Increase Sustainability? FDI has an important role to play in supporting developing countries’ economic growth, and govern- ments can use a range of policies and tools to attract and retain FDI and maximize its impact on the local economy. This starts with the entry rules and operational processes that apply to FDI, but also includes policies and incentives that are designed to attract new investors, as well as the way that domestic laws and policies apply to foreign-owned companies. As with the domestic business environment, the restrictions imposed by environmental policies can appear on the surface to put them at odds with the goal of FDI attraction. Mixed evidence suggests that multinational enterprises may relocate pollution-intensive activity to avoid the costs imposed by environmental regulations, and this could incentivize countries to maintain weak or unenforced poli- cies as they compete for FDI (see Box 5). However, trends in sustainable investment such as the growth of environmental reporting require- ments and green bonds, as well as shifts in global FDI flows toward clean sectors, indicate that many investors may now be drawn to countries with robust environmental protections. In fact, as many countries have recognized, reorienting investment promotion to target sectors such as clean energy has the potential to generate both economic and environmental benefits. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 19 > > > B O X 5 - The ‘pollution haven’ vs. ‘pollution halo’ debate Research on the effects of FDI on the environment has focused on two competing theories. The ‘pollution haven’ hy- pothesis posits that the costs imposed by environmental policies can drive firms to relocate economic activity, causing industries with a significant environmental footprint to shift production from well-regulated developed economies to less- restrictive developing economies (Copeland and Taylor 1994; Cole 2004). By contrast, the ‘pollution halo’ hypothesis posits that foreign firms bring cleaner and more efficient technology and management practices, thereby reducing overall pollution levels (Zarsky 1999). Consistent with the haven theory, many empirical studies have linked historical FDI inflows to greater pollution and green- house gas emissions in developing countries, with extensive evidence of causal link from FDI inflows to industrialization and increased energy consumption, which in turn generate both pollution and economic growth.a However, it is not clear that FDI location decisions themselves are driven by environmental policy differences between countries. While some studies have found that environmental policies do matter for multinational firms’ decisions about investment location, es- pecially in pollution-intensive industries, research suggests that other factors are the primary drivers of these decisions.b At the same time, a number of empirical studies find that FDI inflows can lead to reduced pollution, in line with the theory of a halo effect (Tamazian and Rao 2010; Zhu et al. 2016). Supporting this finding, studies have shown that foreign firms tend to be more energy efficient and use cleaner technology than domestically owned firms, and that FDI contributes to the uptake of clean energy in developing countries (Eskeland and Harrison 2003; Paramati, Ummalla, and Apergis 2016; OECD 2019). Such contradictory results may reflect heterogeneity in effects across sectors, between firms with different investment motivations, across different levels of development, or in the mix of FDI over time.c a. The historical relationship between FDI and pollution has been documented in South and Southeast Asia (Merican et al. 2007; Baek 2016; Behera and Dash 2017; Guzel and Okumus 2020), in Africa (Kivyiro and Arminen 2014; Solarin et al. 2017), in the Middle East (Al-mulali 2012), in Latin America (Blanco, Gonzalez, and Ruiz 2012; Sapkota and Bastola 2017), in the BRICS (Brazil, Russia, India, China, and South Africa) and MINT (Mexico, Indonesia, Nigeria, and Turkey) countries (Pao and Tsai 2011; Zakarya et al. 2015; Balsalobre-Lorente et al. 2019), and across developing countries overall (Omri, Nguyen, and Rault 2014; Shahbaz et al. 2015). b. Commonly identified drivers of FDI location decisions include trade and FDI openness, resource availability, cost and availability of labor, agglomeration, geographic and cultural proximity, and broader political and economic conditions (Manderson and Kneller 2012; Rezza 2014; Koźluk and Timiliotis 2016; Neilsen, Asmussen, and Weatherall 2017). c. For example, Doytch and Uctum (2016) find that although manufacturing FDI is generally linked to worsening pollution, FDI in services sectors can reduce pollution in high- and middle-income countries. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 20 4.1 Robust environmental protections can form a key part of a country’s value proposition to investors. Contrary to perceptions, there is little evidence that maintaining ability as one of the megatrends that will shape international weak environmental protections is an effective overall strategy production over coming years. The number of stock markets for FDI attraction. As noted in Box 5, environmental policies with mandatory requirements for sustainability reporting has are unlikely to be a key driver of investment location decisions risen from two to 24 in the past decade, securities regulators for most firms. Similarly, a recent study by Jobert, Karanfil, and are increasingly requiring disclosure of climate-related risks, Tykhonenko (2019) finds that even pollution intensive FDI in- and the value of sustainable investment products such as flows increase only at very low levels of regulatory stringency. green bonds and green equity funds has risen to an estimated Several studies emphasize that responsiveness to environmen- US$1.2 trillion to US$1.3 trillion. tal regulations depends on firm characteristics, such as whether the firm already operates in countries with stringent regulations Higher environmental standards expected by consumers and or has capabilities that allow it to adapt to requirements (Dean, product regulators in final export markets are also a factor, and Lovely, and Wang 2009; Bu and Wagner 2016). As such, an the ability for countries to participate in global value chains may FDI attraction strategy centered on weak overall environmental be limited if domestic firms are unable to produce intermediate protections would not only be damaging to well-being through or final export goods that meet these standards. As this pres- its effect on environmental outcomes, but would also be unlikely sure from investors and consumers grows, investment location to attract FDI beyond a narrow set of investors. decisions will increasingly need to account for the strength of local environmental regulations and weigh factors such as host In fact, emerging evidence suggests that robust and stable country compliance with global climate change goals.6 In this environmental regulations can actually contribute to attract- context, robust environmental policies may become a prerequi- ing and retaining FDI flows. For example, Omri, Nguyen, and site for attracting FDI and a core part of a country’s value propo- Rault (2014) find that while FDI inflows tend to contribute to sition to investors. greater CO2 emissions in developing countries, higher CO2 emissions actually reduce subsequent FDI inflows, suggesting Embedding sustainability priorities in international investment that elevated pollution can send negative signals to prospec- agreements (IIAs) and broader trade policies may help to re- tive foreign investors. Other studies have taken this analysis inforce these dynamics. IIAs complement domestic rules and further to show a positive effect of environmental regulation on processes for foreign investors by providing additional pro- FDI flows (Rivera and Oh 2013; Kim and Rhee 2019). tections against expropriation and regulatory risk, as well as recourse mechanisms such as investor-state dispute settle- While at first this finding seems counterintuitive, it may be that ment. As set out by UNCTAD (2015), in some cases IIAs can firms increasingly see environmental protection as a neces- constrain domestic policy making related to sustainable de- sary or even desirable feature of an investment location due velopment, and countries may benefit from ensuring that IIAs to the related benefits for the health of workers and the sus- preserve space for domestic environmental policies and limit tainability of projects, or due to the reputational benefits for the scope to challenge legitimate public-interest regulations. firms with sustainability-conscious consumers. As highlighted above, having transparent and effective environmental poli- In addition, there may be ways to strengthen obligations on inves- cies in place may also provide investors with confidence about tors and even governments in FDI source countries to promote the long-term regulatory conditions that they will face. Firms responsible and sustainable investment, which would strength- may even view robust environmental regulations as a signal en the positive feedback loop between FDI inflows, sustainable about the effectiveness and stability of the wider political and technologies and practices, and environmental outcomes. regulatory environment. Ensuring that trade policies and tariffs align with sustainable investment goals, and coordinating such policies at the re- Trends in sustainable investment indicate that robust environ- gional level, may have further benefits by supporting domestic mental protections may be increasingly important to attract firms to export sustainable goods and services, and capitaliz- FDI going forward. The most recent UNCTAD World Invest- ing on economies of scale to develop regional ecosystems of ment Report (2020) highlighted a growing focus on sustain- green trade and investment. 6. Although empirical evidence is limited, some studies show that multinational enterprises with stronger corporate social responsibility mandates avoid investing in coun- tries with weak environmental regulations (Dam and Scholtens 2008; Poelhekke and van der Ploeg 2015). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 21 4.2 Shifts in global FDI present an opportunity to reorient attraction strategies towards sustainable investment. Global FDI flows are rapidly shifting away from environmental- Developing countries have an opportunity to capitalize on ly damaging industries, such as fossil fuels, and toward clean these trends by reorienting investment promotion policies to- sectors such as renewable energy. The number of new green- ward attracting and retaining investment in sustainable indus- field FDI projects in renewable energy in developing countries tries. Strategic planning and prioritization of target sectors is has risen rapidly in recent years and has now surpassed the key to the effectiveness of investment promotion efforts and number in fossil fuel industries (Figure 4). This shift is ap- can result in higher overall FDI flows (Harding and Javorcik parent across projects in upper middle-income, lower middle- 2011). By targeting sustainability-enhancing sectors such as income, and low-income country groups, as well as across renewable energy, as well as other green industries such as all regions including traditionally fossil-fuel dependent regions the production of recycled materials, electric vehicle produc- such as the Middle East and Africa. tion, and sustainable agriculture,7 governments can unlock a double benefit. The same trend is apparent, though less pronounced, in the value of cross-border merger and acquisition (M&A) transac- Greater foreign investment in these sectors will provide ac- tions that target developing countries. Fossil fuel M&A values cess to green technologies as well as a source of finance have fallen by 3 percent on average each year since 2009. for sustainable projects, accelerating improvements in envi- Although they still total less, M&A values in renewables have ronmental outcomes, reducing pollution, limiting biodiversity risen by almost 40 percent on average each year over the loss, and enhancing well-being. At the same time, developing same period, reaching US$1.8 billion in 2019. There has also economies stand to gain from diversification away from fossil been a steady rise in project finance (domestic and foreign) fuel extraction and pollution-intensive manufacturing as global for renewable energy in developing countries, which has risen investment shifts away from these sectors. Instead, by attract- from 20 percent of all project finance in 2010 to 44 percent in ing investment in sustainable sectors, countries can benefit 2019 (UNCTAD 2020). from job growth and productivity improvements that typically accompany expansion. 7. Sustainable agriculture includes the use of particular farming techniques and technologies, crop and livestock selection and management, and market structures that improve productivity while conserving habitat, water resources, and soil quality, and supporting reductions in poverty (World Bank 2014). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 22 Reorientation of investment promotion will require countries vestment promotion agencies (IPAs), conducted jointly by the to adjust their approach to analysis and prioritization of tar- World Bank and the World Association of IPAs, found that the get sectors. Traditionally, the selection of priority sectors has SDGs play a significant role in influencing the identification of focused narrowly on the economic benefits that a sector can priority sectors, and renewable energy was the most common bring, as well as on its feasibility. As shown by a World Bank priority sector across IPAs (Sanchiz Vicente and Omic 2020). investment sector scan undertaken for Paraguay (Box 6), in- The next step is for countries to formally embed sustainabil- troducing a sustainability lens requires consideration of new ity objectives in their IPA’s mandate, strategy, and processes. factors in this analysis. With momentum on targeting sustainable sectors, developing countries can capitalize on global trends in sustainable foreign Importantly, many countries have already begun to pursue investment. such approaches. Evidence from the most recent survey of in- > > > F I G U R E 4 - Renewables vs. Fossil Fuel FDI in Developing Countries, 2003–2019 NUMBER OF GREENFIELD FDI PROJECTS 400 350 300 250 200 150 100 50 0 2003 2007 2011 2015 2019 Fossil Fuels Renewables VA L U E O F C R O S S - B O R D E R M & A S ( U S $ M I L L I O N S ) 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 2003 2007 2011 2015 2019 Fossil Fuels Renewables Source: fDi Markets (greenfield) and Thompson Reuters (M&A) data. Note: Data are for projects and deals in low- and middle-income countries. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 23 4.3 A range of policy approaches are available to accelerate the shift towards sustainable FDI. An important starting point for governments as they re-direct Successfully attracting sustainable foreign investment will re- investment promotion toward sustainability is to phase out, quire governments to draw on a wide range of policy tools. As where possible, any existing support for unsustainable indus- set out in UNCTAD’s Investment Policy Framework for Sus- tries. As noted above, such support could exist in the form of tainable Development (UNCTAD 2015), this begins with IPAs lenient environmental protections that have been introduced developing in-house expertise in sustainable sectors, building or maintained in the interests of a sector with significant pol- partnerships with relevant trade and business organizations lution or ecosystem impacts, or involve regulatory exemptions and research centers, and engaging in promotion activities provided to specific investors and projects. with a broad set of target investors and businesses. Some countries also have financial incentives targeted at at- Additionally, governments can consider introducing measures tracting investment in sectors such as fossil fuel extraction. that incentivize sustainability-enhancing investment. Such Recent research estimated that the global cost of direct fos- measures can target firms in new, more sustainable sectors, sil fuel subsidies was US$269 billion in 2015, or as much as or firms within an established sector that meet higher stan- US$4.7 trillion after accounting for environmental costs (Co- dards for environmental performance. In fact, a recent review ady et al. 2019). Such measures draw on scarce government found that 97 countries have some form of investment pro- resources and may be a barrier to economic diversification. gram in place relevant to the SDGs, including 40 with invest- As set out by the OECD (2015), phasing out such measures ment incentives related to climate change mitigation (UNCTAD is essential to ensure that the overall system of investment 2020). These include special economic zones with facilities for incentives is coherent with green growth goals. sustainable industries, financial incentives conditional on envi- ronmental performance, and risk-sharing approaches such as public-private partnerships and investment guarantees. > > > B O X 6 - Target sector prioritization in Paraguay As a result of its economic, social, and environmental characteristics, Paraguay is significantly vulnerable to the effects of climate change. Paraguay’s economy is highly dependent on the primary sector, with production dominated by livestock and agriculture. At the same time, it is currently among the 10 countries most exposed to risks of loss of agricultural pro- ductivity from climate change worldwide. In 2018, the World Bank conducted an investment sector scan in Paraguay, with the objective of identifying sectors with the potential to contribute to a ‘green’ diversification of the Paraguayan economy in the short and medium term. Sectors were evaluated on two dimensions: their attractiveness to potential investors (feasibility) and the expected economic benefits to the country from increased investment (desirability). Importantly, this study introduced environmental sustainability as one of the five factors used to determine desirability. The potential contribution of each sector to sustainability was assessed based on available evidence and consultations with the public and private sector in Paraguay. This assessment helped to identify ‘ready-to-go’ sectors and ‘aspirational’ sectors that, although underdeveloped, had the potential to contribute to growth and diversification while enhancing sus- tainability if certain policy reforms were applied. These included tourism, medical devices, and textiles. Although such analyses are commonly used to identify target sectors for investment and export promotion efforts, envi- ronmental sustainability is rarely a consideration. As this example shows, integrating sustainability into prioritization and targeting processes can lead to new insights and can help align sectoral policy with wider sustainable development goals. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 24 These policy tools require careful assessment and design to fields. It also includes enhancing the capacity of local firms ensure they are tailored to local conditions, meet the needs of to act as suppliers to foreign-owned businesses that demand a particular sector, and most importantly deliver on environ- higher environmental standards in order to meet the expec- mental goals. A focus on sustainability may also mean that tations of sustainability-conscious investors and consumers traditional investment promotion tools must be implemented in final export markets, or that operate in sustainable sectors in a new way to achieve results. For example, designing per- such as renewable energy. formance-based incentives may be particularly important to ensure that foreign-owned firms use more sustainable produc- As demonstrated by the Supplier Development Program un- tion practices than incumbents. Public-private partnerships or der development in Turkey and supported by the World Bank other oversight mechanisms may also be crucial where invest- and IBEP (see Box 7), supporting the development of local ment is directed toward essential services such as electricity green supply chains can not only help to attract sustainable and water, which can often involve natural monopolies. investors by providing a supplier network that can meet these higher standards, but also has the potential to bolster produc- Finally, beyond promotion activities and the design of incen- tivity by facilitating the transfer of more advanced technologies tives, there is a wider role for government in facilitating the and management practices from multinationals to local firms. growth of sustainable industries. This role includes providing By developing these core supporting factors, countries can be enabling infrastructure, developing a pipeline of appropriate well placed as an attractive host for sustainable investment. projects, and supporting education and training in relevant > > > B O X 7 - Developing local suppliers for electric and hybrid vehicle production in Turkey In recent years, economic growth in Turkey has been hampered not only by political and economic instability, but also by a lack of productivity growth as domestic firms have struggled to increase production competencies and production of sophisticated goods and services. Given the potential productivity benefits of FDI inflows and integration with global value chains, the government has identified greater localization of the supplier base for automotive manufacturing as a policy priority. FDI firms and original equipment manufacturers (OEMs) in the automotive industry also stand to benefit from enhanced reliability and reduced costs if the local supply of high-value inputs could be increased. In response, the Ministry of Industry and Technology, with the support of the World Bank and IBEP, has developed a Sup- plier Development Program pilot that aims to boost the competitiveness and capacity of both existing and potential new local suppliers. Under the program, OEMs will nominate domestic firms to participate, and participating firms will receive technical assistance and coaching focused on performance competitiveness improvement over 24 months. An important feature of the program is a focus on suppliers to electric and hybrid vehicle production. This focus reflects both the high level of technological sophistication in this sector and the significant global shift towards greener models in the automotive manufacturing industry. In nominating potential participants, OEMs must reflect on their potential link- ages with electric and hybrid vehicle production, and a key goal of the support provided by the program is to positioning participants to benefit from the long-term growth of this sector. In this way, the program will help position Turkey as an attractive host country for future investment in this significant sustainable sector, while also enhancing competitiveness and productivity growth. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT | CATALYZING INVESTMENT FOR GREEN GROWTH <<< 25 5. >>> Conclusion As countries witness unparalleled economic contraction as a result of the COVID-19 pandemic, policymakers are grappling with questions about the future of growth. The human and economic toll of this pandemic has made clear the close interconnection of health, environmental, and economic systems, reinforcing that the private sector must reorient and transform to attain environmental sus- tainability. As governments consider how to respond to the crisis, a green growth model should be at the heart of recovery plans. Developing country policymakers should turn to this paper to understand how environmental sus- tainability can be integrated with investment climate policy during COVID-19 recovery. Policies to promote greater environmental sustainability will be needed in many areas, including directly ad- dressing emissions, pollution, and ecosystem impacts, as well as promoting sustainability in trade, finance, research and development, and consumer behavior. This paper outlines the role that a country’s investment climate plays in the success of these wider environmental policies, including by supporting investor confidence, providing access to finance and advanced technology for green projects, and facilitating green entrepreneurship. It further presents specific policy approaches that can advance regulatory reforms and attract productive investment to attain environmental sustain- ability goals, including: • Enhancing the efficiency and effectiveness of environmental regulations through integrated, digital systems; simplification; transparency; and risk-based approaches. • Finding synergies between private sector growth and sustainability by enhancing competition and removing barriers to entry in environmental service sectors such as waste management. • Strengthening sustainability obligations on investors through domestic environmental regula- tions and reporting, FDI rules, and IIAs. • Targeting investment promotion activities toward investors in clean energy and other environ- mentally sustainable sectors. • Introducing or reorienting investment incentives, special economic zones, and investment guar- antees toward sustainable sectors and achievement of environmental goals. • Preparing the domestic economy to transition and support green sectors through infrastructure, skills development, supplier development, and trade policy. Many opportunities remain to advance research and learning on these topics to inform policy solu- tions. Limited business-economics literature has investigated the role of the investment climate in transforming business practices to minimize the footprint and adverse effects on the environment. Relatedly, another area for research with evident gaps exists in understanding emerging environ- mental priorities of businesses and how they intersect with the needs of production, competitive positioning, and financial returns. A fuller understanding of the technological and financial barriers faced by businesses is key to develop public policy solutions that can shape market outcomes. A responsive research agenda could comprise illustrative case studies based on private sector consul- tations and new data insights as part of existing firm-level surveys. 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