Category Archives: Sustainable Finance

Sustainability, Finance, and a Proposal from China

During the Second Open Global Systems Science Conference in Brussels, June 10-12 2013, we are going to introduce and make available our paper entitled “Sustainability, Finance, and a Proposal from China”.

In this paper, we deal with one of the most interesting contributions to the debate about the global financial crisis. This contribution is a brief note by Zhou Xiaochuan, governor of the People’s Bank of China. It represents one of the very few attempts to place the present financial crisis within a long-term historical perspective. We highlight that striving for global financial governance is a paradigmatic example of a deeper underlying sustainability challenge.

You can download our paper here.

The Doomsday Machine

I am attaching a document


describing the idea I presented on Tuesday about the role of the financial system in decoupling saving from real economy.

Here is the slide


It is a short paper I wrote together with Paolo Tasca who at the time was doing his PhD with me.  We did not further develop the concept but I think it’s very relevant to GSS, because if we do not understand how this decoupling can be mitigated, it will be very difficult to address global issues effectively.

I think there are some objections to the approach used in the paper around the issue of internalizing externalities and I would be happy to hear them.

Energy transition, climate change and financial crisis: zooming in and zooming out

The Global Climate Forum (Berlin) has started a series of workshops, which link new economic thinking to practical challenges in economic and environmental policy. The series aims at providing a productive setting to share current research efforts, to provide comments to and inspiration for each other’s work, and to engage in dialogues with relevant stakeholders. By doing so, we strive to establish a community of researchers who set standards for new economic thinking.

A good starting point for these kinds of dialogs was our first workshop, held on June 19th, 2012. More information can be found here.

A second workshop, held on December 11th 2012, discussed the topic “Energy sector transition – German madness or an opportunity for growth?”. This workshop included many inspiring presentations and discussions zooming into the electricity sector (at the German, Dutch, European and international level) and zooming out by assessing cross-sectoral effects as well as macroeconomic impacts. The vast knowledge of the matter among speakers and participants was very impressive and turned this into a promising endeavor.

To summarize the general ideas on green growth and some elements of the workshop discussions:

Climate crisis

Zooming out by looking at the latest climate negotiations in Copenhagen, Rio and Doha, the results are quite disappointing. No game changing decisions have been taken. Despite the strong evidence about climate change leading to large costs of climate adaptation in the distant (and not so distant) future, there is persistent inaction at a global scale.

There are even voices in Germany arguing that the currently proactive German and European approach increases incentives for other countries to free ride and is therefore not the best strategy. Germany should rather invest in adaptation instead of mitigation to increase its power in international climate negotiations. The cost of climate change adaptation would be much lower for Germany and therefore the urgent need for mitigation is not as high. But where will such a strategy take us? If framed like that, it is an example of a Prisoners Dilemma, and would lead to actively and consciously choosing for the inferior equilibrium. We should know better than that.

Financial crisis

On the other hand there is a seemingly never ending debt crisis in the Euro zone, fears of a fiscal cliff in the US, to name the most pressing financial challenges. These short-term and urgent matters are used as an excuse not to take any proactive decisions regarding long-term issues such as climate change. This is nicely picked up by a cartoon in the economist. However, if we reframe the problem, can a green investment strategy especially in southern European countries be a source of new and more sustainable growth and bring Europe back into balance? Can the trend of ever increasing youth unemployment rates and resulting social problems within countries and between the surplus and deficit countries be reversed?

Energy transition

Workshop focus: Zooming into the electricity sector and investigating the macroeconomic effects in Germany and elsewhere.

Germany has decided to phase out nuclear energy and to transform its energy sector into one based on renewable energy. The goal to raise the share of renewables in the energy market to 20% has been achieved. This largely happened due to the feed-in-tariff (guaranteeing a fixed price for  renewable energy sold to the transmission system operators over 20 years) and without significant changes to the structure of the energy market. But striving towards an 80% share of renewables by 2050 will require massive changes in technology and infrastructure related to production, storage, grid and consumption, as well as associated transformations of governance structures and the market mechanisms themselves.

The transition is more complex than often thought. As an example, even if the costs for renewable energies reach grid parity (when the cost per kwh of solar power reaches the level of retail prices) this will not be enough to change the entire energy system. A household owning a photovoltaic panel will not use the power at the same time it is produced. Hence, this involves external costs in the form of storage costs, transport costs, additional capacity for flexible production or for demand side control. The supply and demand of electricity needs to be balanced, centralized or decentralized, and this will not come at zero cost.

Other countries are watching Germany with a skeptical eye. But why is nobody talking about the positive external effects of such a strategy? It will reduce CO2 emissions and in terms of climate change mitigation everyone will benefit from it.

Instead, the negative effects on neighboring countries are emphasized a lot lately, for example by the French Centre d’Analyse Strategique saying that the Energiewende comes at a high cost for the consumer and is endangering the equilibrium of the European energy systemHowever, this would assume that the system is in some kind of equilibrium, which is questionable.

The European energy system as a whole is characterized by opportunistic national decisions, not aimed at finding efficient solutions for the European system as a whole. Hence, all countries need to concentrate on how we can better cooperate on a European level with respect to energy production and consumption.

Can Germany show that the energy transition will become an economic opportunity by 2020? 

Can the energy transition be regarded as a potential source of economic growth, where innovation and technological advances increase energy efficiency and general productivity? And more importantly, can it help overcome the reluctance in international climate negotiations on the one hand and serve as a viable and sustainable exit strategy from the negative feedback loop of austerity policies, low investment, low employment and low growth in the Euro zone, on the other?

How can these seemingly unconnected discussions on climate change, the financial crisis and the energy transition be combined? Success of the global climate negotiations are a necessary, but not sufficient condition for a more sustainable future. The discussions need to become broader and include the interrelatedness of the problems. This requires new ideas and new concepts. Can green growth be such a new concept?

Green Growth

Zooming out again, there is much talk about green growth, no growth, de-growth and so forth. Which opportunities lie within a green growth strategy?

The general goal is to reach a superior equilibrium resulting in win-win situations in a social, environmental and economic dimension. We can reach this with a national (or international) commitment combined with proactive policies triggering a (public and private) green investment surge into renewable energies, renewing the built environment and energy efficiency measures in industry and transport at a large scale. A transition to a new growth path entails more than an energy sector transition alone.

Therefore, the German energy transition needs to be put into perspective. It will not succeed by 2020 if carried out without additional measures. Especially important are the effects on other sectors and the resulting impacts on the economy as a whole.

As an example, the increasing price for electricity associated with the energy transition is subject to much criticism within Germany and abroad. But is this the whole story? If the price of one unit of electricity (kWh) rises but if we can use this much more efficiently then the overall energy bill doesn’t necessarily have to rise. Additionally, if a country were to pursue a green growth strategy and largely invest in a transformation process, including renewable energy and energy efficiency in buildings, industry and transportation, this would increase the national income and reduce energy usage and CO2 emissions at the same time. A higher national income will translate into increased turnover of firms and wages of workers, and can more than compensate for increased energy bills.

Lack of attention to this broader picture is a barrier currently suspending any movement towards pursuing a green growth strategy. We cannot zoom into a specific sector and neglect the interactions on cross-sector and on macroeconomic level.

New Economic Thinking

Generally speaking we need to look at the problems at hand in a more holistic way.

There is an urgent need for a professional dialogue about the tools that economists can develop to help design and assess suitable policies. What is needed is more than the standard neoclassical approach. Assessments need to go beyond single equilibrium models and include the possibility of multiple equilibria. Furthermore, we need to investigate the relevant agents, their interactions and the networks they engage in, the set of choices they have and the governance arrangements hindering or promoting a transition. This can be done with agent based models for example.

Furthermore, there is a need to discuss these models with policy makers, to whom they should provide more insight into the dynamics of the problem at hand.

Further information

For a summary of the workshop as well as the workshop presentations click here.

For further interesting contributions, also read Klaus Hasselmann’s latest post.

Report from a break-out group

When our break-out group met, we started by individually putting down three kind of issues on colour-coded cards. We used green ones for putting down advantages and opportunities, red ones for risks and dangers, and yellow ones for questions that need further research. Moreover, we separately dealt with the short term dimension and the long term dimension of Governor Zhou’s proposal, respectively. When everyone had finished, we displayed the cards on two black boards, one for the short term, and one for the long term, and started a discussion. For your convenience, here you can find the documentation of what we gathered on the black board.

The number of yellow cards was biggest, followed by the green ones, with the red ones being in smallest number. The discussion was even more pronounced as we mostly discussed the questions that need further research. It was a lively and complex discussion. For this post, I do not aim at delivering a comprehensive overview of our discussion. Instead, I just want to highlight some of the issues that I found most remarkable:

  1. Their was wide agreement that current account imbalances and the relation of the financial system to the real economy are important issues.
  2. The issue was raised that it is not clear what caused the financial crisis. If one starts from this presumption, it is not clear whether Governor Zhou’s proposal could be a remedy for the financial crisis.
  3. If we found a mechanism other than using a supra-national reserve currency for keeping current account imbalances in check, there would be no need for large currency reserves. It is neither clear whether in such a situation there is a need for a supra-national reserve currency at all, nor whether the fact that a supra-national reserve currency would not be that important would make it much easier to establish it.
  4. If it is worthwhile to establish a supra-national reserve currency, it is not clear whether it is a good idea to link it to commodities.
  5. Today, there is the principle: one goal, one instrument. One thing is whether this principle is a good idea in itself. This notwithstanding, the group discussed whether it is a good idea to invent a complex instrument for simultaneously addressing several goals.
  6. Eventually, I asked the group members the following question: When Governor Zhou’s talks about the long term, how many years do you think we speak about? The response to my questions was: Four group members answered 10 years,  two answered 20 years, another two answered 50 years.

Sustainable SRDs? – Report from a group discussion

“Sustaining the biosphere is not an ecological problem, nor a social problem, nor an economic problem. It is an integrated combination of all three.” (Holling, 1994)

“Sustainable SRDs? – Pros and Cons” was the theme of discussion in parallel working groups. This post reports from one of the group discussions that took place on the first day of our workshop. Instead of giving a complete report of the discussions, I would like to highlight some aspects that were of importance and interest to me. It intends stimulating debates and discussions on the blog by inviting the other participants of the working group to comment and amend the post.

The discussion in our breakout group continued the vivid exchange that took place during the plenaries. In a first step, each of the participants’ of this working group had the task to fill out cards and put them on the board. Already while presenting their cards and while hanging them on the wall, we started to discuss further details. In a second step, we rearranged the cards as to group them thematically. The discussion about sustainable SDRs centered on several topics:

To my view, a very interesting debate occurred about the tension between a possible funding for sustainable development transformations on the one hand and the risk of stimulating economic growth with negative externalities on the other. In a positive reading, one could argue that increasing SDRs would help raising money for the societal transformations towards sustainable development. One could imagine, for example, to issue with this newly create money the Green Climate Fund, which shall receive $100bn annually by 2020. Thereby, the creation of SDRs could help to finance sustainable development projects, to construct global central bank and pave ways for a global central regulation of financial markets.

However, as another participant objected, the raise of money has in the past rather stimulated economic growth instead of sustainable development. So far, economics growth has been closely related to increases in CO2 emissions, resource extraction and material consumption. In short, economics growth has shifted costs to both the ecological and social sphere (see also Kapp 1950).

Since many positive arguments for SDRs were found, one participant raised the very important question to analyze why its implementation did not take place yet. Via historical analysis of processes, institutions and influential people one could learn more about barriers and bridges towards implementing SDRs. Following this reasoning, another question raised concerns the geopolitics of SDRs, which are worth studying.

A call for more transdisciplinarity was clearly put forward as to involve the broader public in the often technical and complex discussions about a sustainable global financial system.

Given my background in ecological economic, I found the questions concerning ecological macroeconomics very interesting. Amongst this topic, not only the question of human development and well-being within planetary boundaries is of interest. How to create mechanisms to recycle the surplus? How to install fiat currencies that limit financial speculation? – These are only two examples of further research paths.

The question of sustainable SDRs remains still open. Some answers and many questions have been raised during the breakout group as documented here in a first step. I hope that the participants of our working group will pick up the topics and add further information from our lively debate.

Seven research questions on SDRs as a reserve currency

First of all I would like to express my personal thanks to speakers and participants in the workshop on a sustainable financial system and developed SDRs. The presentations and the discussions were thought-provoking and they showed the need for more reflections and research, which most certainly will be taken on board in the white paper that is the planned outcome of the conference.

We clearly need to be more precise about the objectives the developed SDRs would meet. One goal for the developed SDRs seems to be to offer an alternative  currency for cross-border exchange, the volume of which  whould be  mainly driven by the needs of the “real” economy and investments in “real” assets. However, already this seemingly uncontroversial goal raises immediate questions. What is the”real” economy and what is the value of “real” assets?  If other goals are added, such as the balancing of current accounts and the stabilization of exchange  rates the  complexity increases further.  In addition, if we among the goals want to include the role that SDRs could play in the necessary transition to a more sustainable economy and in the support of the development of the living conditions for the billions living in poverty we may reach a complexity level that is outside the reach of what now is possible.  A “big-bang” solution may be attractive in the case of a new financial crisis, but as, for the time being, the “muddling through” scenario is slightly more likely,  a more gradual approach could be favoured.

I have taken with me seven research questions from the workshop. They are in no way the only questions that can be raised and other participants may have other questions they have brought with them home, but I would like to share my seven questions with you for the purpose of promoting a common understanding of the challenges ahead.

1. What are the realistic alternatives to the USD as a reserve currency?

 It is clear that China does not wish the RMB to take over the role as global reserve currency as they are – and probably rightly so – afraid to be caught in the Triffin dilemma and become unable to tackle the domestic interest problem. They may end up having no choice in the matter as history has shown that the switch from one reserve currency to another can be surprisingly fast.

Many see the development of three regional reserve currencies – the USD, the Euro and the RMB. But would this be a stable sloution? It is unlikely, as Carlo Jaeger discusses in his blog input. We need to look more into it and may add some insights from research in other areas to the subject.

The third alternative is a new global reserve currency and given that the other solutions have some drawbacks, this is a solution worth looking into.

2.Who creates the SDRs for commercial use?

Base money are created by central banks, but the overwhelming creation of commercial money is done by banks. Who would create the SDRs, which Governor Zhou is proposing to be used for commercial purposes? If banks would be allowed to create them,  what would be the requests for reserves? There is a big difference between banking systems today as the UK is demanding 0 % in reserves, the US in principle 10 % and China above 20 %.  What would be the optimal liquidity reserves in SDRs if banks are allowed to create them?

3. How could a smooth and gradual transition look like?

Governor Zhou’s proposal is sketchy on this point. He just recognizes the attractiveness of a gradual approach.

4. Would we need capital controls?

The truth is that financial markets with private creation of money have been inherently unstable sinch the 17th century with the exception of the decades after Bretton-Woods. Perhaps we need to reintroduce some controls to reduce speculation and focus the system on the main objectives.

5. Stabilize exchange rates

The status of the USD as rressrve currency is automatically pressing the USD upwards. The introduction of SDRs would relieve the USD from that pressure and rebalance the the exchange rates.  A question: Would even a reintroduction of Bretton Woods in some form or the other be a possibility?

6. Do we need to balance the current accounts?

Keynes saw a rebalancing of current accounts as a major objective of his clearance union. As the exchange rates can be expected to be adjusted at the introduction of SDRs this problem can be expected to be reduced, and especially if a new “Bretton Woods” is introduced.

7. How about the store of value?

The Chinese are expressing concerns about the risk that the US is going to solve its debt problem by printing money. Given the gridlock in the US Congress it is a worry that seems reasonable. The USD was a reserve currency  when Roosevelt unilaterally disconnected the USD from the gold standard and it was a reserve currency when Nixon decided to print money to pay for the Vietnam war. The USD as a store of value is a shaky proposition given the present debt levels. The SDRs could perhaps if connected to the real economy (in a wise way) offer a better store of value. A concern is that commodity markets are highly volatile and manipulated due to speculation and cartels.

Once again -thank you all for your contributions to the workshop and we are looking forward to your input to the white paper!

Best regards

Ulf (Dahlsten)