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EMISSIONS GAP REPORT 2018 – BRIDGING THE GAP: THE ROLE OF INNOVATION POLICY AND MARKET CREATION


Mazzucato, 2018). Staying abreast of how innovation is changing markets also requires these institutions to deliberately engage with a wider set of actors and to track and quickly learn from wider innovation progress (Shakya and Byrnes, 2017). Emboldening agencies and institutions is easier when they are kept apart from political decision makers and thus independent of the short-term political process (Haley, 2016).


Setting strong policy mandates also helps strengthen an institution’s capabilities. For instance, for SIBs to effectively address the low-carbon finance gap, their mandate needs to define their sectoral and geographical focus areas, specify the instruments to be used, define ‘green’ safeguards for project selection, and determine the SIB’s own financing. Given the high importance of in-house technological capabilities and the resources needed to build them, the sectoral focus areas must be aligned with the government’s mission-oriented low-carbon policy (Mazzucato and Penna, 2016). It is also important that the instruments that a SIB provides are appropriate for their target sectors and project types. For instance, projects with very long loan tenors require long-running loan guarantees. Importantly, these instruments should also be designed in a way that reflects the financial sector’s existing structures. One example is household rooftop solar projects in Germany: the KfW channelled loans through Germany’s local banks, utilizing Germany’s decentralized financial sector (Hall et al., 2016). Depending on the sectors and the scale, governments must also decide whether SIBs can refinance themselves in capital markets, as KfW has done (Mazzucato and Penna, 2015b) and, if so, whether they can utilize a state guarantee.


7.4.2 Funding


Many countries have significant barriers to financing innovative technologies because, on top of the technology being unproven, the countries themselves are considered high-risk places to invest, with high political risk, policy uncertainty and currency fluctuation (Schmidt 2014; BNEF et al., 2016), now exacerbated by an increased exposure of these countries to climate change risks (Buhr et al., 2018). This situation makes both international and domestic investors averse to exposing themselves to additional risk by investing in new technologies and business models without a solid track record (Mehta et al., 2017; Kidney et al., 2017). Most of the poorest countries are also small markets with a large proportion of low-income consumers who lack credit history, which limits potential investors’ interest in engaging with the government to improve investment conditions (GOGLA et al., 2017). In addition to these challenges, matching the right type and scale of finance to the opportunities in innovative small-scale distributed technologies has significant transaction costs, as well as the risk of the business models around these technologies having a limited track record (Hystra, 2013; Lewis et al., 2017).


To stimulate innovation in low-carbon sectors, such as distributed energy, several developing countries have set up platforms that aggregate finance for small-scale renewable energy projects, thereby reducing transaction


costs to public and private investors and managing risk (Shakya and Byrnes, 2017). Various types of aggregation platforms have successfully reduced the cost of capital to the energy enterprises by bundling the enterprises’ small ticket deals or their assets into portfolios that diversify risk across several projects, and standardizing project data to build investors’ confidence. This bundling has also allowed the platforms to meet the deal size preferred by larger-scale investors offering cheaper finance (Wilson et al., 2014). In addition, the platforms create a space for dialogue among public policymakers, entrepreneurs and private investors to resolve market challenges (Bertha Centre and WWF, 2016; Simanis, 2012). Once again, it is important to recognize that as not all sources of finance are the same, those with an appetite for risk should be sought out (Mazzucato and Semieniuk, 2018). Financing constraints are also prevalent in developed countries, especially at the municipal level, and the online appendix A.3 explores innovative financing mechanisms to overcome these constraints for low-carbon lighting.


Large amounts of funding are by themselves insufficient, as funding needs to be stable over time. Cyclical spending is problematic on both the supply and demand sides. On the supply side, fluctuations in spending due to political decisions (or the expectation that spending will not be stable) can hinder investments in long-term projects (Chan et al., 2017), whereas on the demand side, the business cycle is an important consideration. While the financial crisis of 2008 led to various ‘green stimuli’, this increased spending was often soon replaced by austerity measures. Perhaps the most dramatic casualty of tightened fiscal belts was the Spanish support for renewable energy. Until 2008, Spain’s feed-in tariff supported one of the fastest expansions of not-yet- commercialized renewable energy. However, the feed-in tariff was paid by the central government and added to its fiscal deficit, so when Spain was hard-pressed to tighten the budget, it was reduced retroactively. Spanish renewable energy investment dropped after 2008 and collapsed completely after 2012 (Mir- Artigues et al., 2018), contributing to a crisis in Spanish PV manufacturing companies (Ibarloza et al., 2018). Ringfencing support policies across the business cycle is therefore crucial for long-lead-time innovation processes.


7.4.3 International competition


Countries’ domestic policies are also affected by the industrial policy aspect of innovations. Developed countries fear that their expensive R&D efforts will be appropriated by other, poorer countries that take a large market share due to lower production costs. The most prominent case is perhaps the migration of the PV manufacturing industry to China, reviewed above. ‘Free-riding’ on others’ efforts, whether perceived or real, is prevalent in the literature analysing how countries contribute to global climate change mitigation efforts (Barrett, 2007). The flipside of this fear is the concern of developing countries — which are almost completely excluded from the current corporate R&D activities (Nolan, 2018) — that they will remain excluded from a new, green technological revolution. They see themselves at risk of having to buy the new technology from


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