Investment Promotion Agencies (IPAs) must shift gears in attracting investors to help achieve the green transition
Earth is warming at an unprecedented rate, with the past decade being by far the warmest on record. The severe implications of this climate change have made sustainability one of the most important challenges facing humanity and its imperative clearer than ever.
Countries around the world have accordingly made new commitments and taken action to fight climate change, often setting more ambitious goals to achieve net zero emissions. By the end of 2021, net zero pledges were estimated to cover 65% of global emissions, according to the OECD. Countries have also increased the number of policies tackling climate change adaptation and mitigation goals, including through direct support to the private sector. For example, the US Inflation Reduction Act (IRA) of 2022 provides $369bn in subsidies and tax credits aimed at cutting carbon emissions in half by 2030. In February 2023 the European Commission unveiled its EU Green Deal Industrial Plan.
Many countries are also adjusting existing industrial policies to align with green transition goals. This is especially the case with one ubiquitous policy: investment promotion. However, while many investment promotion agencies (IPA) claim to promote their local market’s sustainability ambitions, evidence suggests that for this to be actually the case, they must design and implement consistent targeted strategies.
Allies or Enemies?
The primary goal of investment promotion policies is to attract FDI. Among the main metrics of these policies’ success have thus far been the number of firms attracted and the amount they invest. But by influencing the probability of multinational firms establishing foreign affiliates in the economy, these policies can directly (and indirectly) affect a country’s overall emission footprint. This naturally leads to the question of how different policy goals — and actions taken to reach them — interact with each other and, most importantly, whether there is a tension between their economic and environmental goals.
From a theoretical perspective, investment promotion could have positive or negative effects on domestic environmental performance. This depends on the characteristics of the foreign investor (whether they have high or low emission intensity) and the policy’s design. For example, IPAs can target sectors that develop new technologies facilitating net zero transition, or sectors in which countries have a comparative advantage but are relatively high polluters.
Latin America Under the Microscope
To establish how investment promotion policies contribute to, or detract from, countries’ environmental efforts, we examined the direct effects of investment promotion policies on emission intensities in an IDB Working Paper. We combined detailed data on the distribution of multinational firms and their foreign affiliates across sectors over time, sector-specific pollution levels, and assistance provided by IPAs across 12 of the region’s countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Honduras, Mexico, Nicaragua, Peru and Uruguay. The approach relies on widely available data and can be applied in other countries and regions.
The evidence suggests that IPAs’ portfolio of multinational clients is skewed towards heavier polluters, and that this is primarily driven by these agencies’ sector prioritisation strategies. In addition, our results indicate that while IPAs seem to be equally effective in attracting multinational firms with different levels of emission intensities, their promotion efforts appear to have stronger impacts on the location decisions of more polluting multinational firms within priority sectors.
Setting Priorities
This means that choosing priority sectors can be an important mechanism through which IPAs can redirect their interventions towards sectors or activities that more closely support national environmental goals. Adequate adjustments to IPAs’ priorities are crucial to ensure both effective investment promotion policies and better environmental outcomes. This could, for example, be the case if IPAs target new climate technologies.
Environmental sustainability has become imperative. IPAs need to explicitly factor into their strategies the environmental implications of their actions. They must develop and adopt solid policies to track and assess the environmental impact of their support to multinational firms to better inform their prioritisation strategies. Our study provides a first approach to doing so. It serves as a foundation for further, much-needed research and policy development to ensure investment promotion works hand in hand with environmental sustainability to achieve long-term, sustainable growth.
fDi
Monika Sztajerowska is a former senior trade consultant (currently an economist at the IMF) and Christian Volpe Martincus is a principal economic advisor at the Inter-American Development Bank
