Making investment work for green growth

Foreign direct investment (FDI) that fosters green growth and development while preserving natural assets will make a key contribution to efforts to curb climate change and achieve the SDGs. In the run-up to COP26, the OECD’s Iris Mantovani explores the contribution of FDI to lowering carbon emissions and advancing green growth.

The UN estimates that between USD 3.3-4.5 trillion per year needs to be mobilised between now and 2030 to achieve the SDGs. This will entail a significant scaling-up of investments that advance sustainable development and achieve economic, social and environmental policy goals. Green growth means fostering growth and development while preserving natural assets, and ensuring that they continue to provide the resources and environmental services on which our well-being relies. Beyond mainstreaming environmental considerations into investments in general – to minimise their environmental footprint – green growth requires investments in innovative technologies, services and infrastructure that use natural resources more sustainably.

Foreign direct investment (FDI) can contribute the financial and technological resources needed to deliver green growth. The premise behind FDI spillovers is that multinational enterprises have access to innovative technologies and operating procedures which, if applied, could help raise environmental performance overall and induce the broader uptake of low-carbon technologies. In some cases foreign investors are greener than their domestic counterparts as a result of the more stringent international environmental standards that they are measured against. But foreign investors can also worsen environmental outcomes by, for example, offshoring highly polluting activities to countries with less stringent regulations or inducing a race to the bottom with respect to environmental standards as countries compete to attract FDI.

Polluting sectors attract substantial FDI

Creating an enabling environment for foreign investors that use cleaner technologies, consume less energy, and support green knowledge and technology transfers to domestic firms can make an important contribution to greening domestic industry. The energy sector is the largest contributor to greenhouse gas (GHG) emissions in OECD countries (37%) and the second largest in non-OECD countries (46%). Accelerating investments in renewable energy generation is essential to reducing the carbon footprint of all economic sectors.

But green growth requires greening of investments beyond the energy sector. Non-energy industries that account for over 70% of global FDI flows are responsible for the bulk of CO2 emissions generated in both OECD and developing countries (Figure 1). Over the last two decades, manufacturing and construction attracted almost 60% of the total value of greenfield FDI in developing countries, and almost 50% in OECD countries. In 2018, these activities produced close to half of all the emissions generated by developing countries, and a quarter of emissions generated in advanced countries.

Figure 1. The most polluting sectors attract the most FDI

Source: OECD based on IEA World Energy Statistics (2021) and Financial Times fDi Markets (2021)

The role of FDI in the energy transition

To date, FDI has been key to expanding renewable energy generation capacity, accounting for 30% of global investment in renewables in 2020 (Figure 2, Panel A). Global installed capacity of renewable energy has almost quadrupled over the past decade and production from all renewable technologies more than doubled since 2000; costs for most technologies have decreased significantly; and supporting policies have continued to spread throughout the world. FDI in the energy sector has also shifted considerably away from fossil fuels and into renewables, particularly in advanced countries where renewables account for 90% of energy FDI, but increasingly also in developing countries (Figure 2, Panel B). At the same time, global energy demand is outpacing the deployment of renewable energy, resulting in a still limited contribution of renewables to the global energy mix, which reached almost 20% in 2021. According to the International Energy Agency, investment in renewable energy must triple by 2030 to curb climate change.

Figure 2. FDI can make a large contribution to decarbonising the energy sector

Source: Author calculations based on IEA World Energy Statistics (2021) and Financial Times fDi Markets (2021)

Foreign firms tend to have greener business practices

Survey data suggest that foreign companies make an important contribution to greening business practices in manufacturing sectors, and that this contribution may be especially large in developing countries. The OECD FDI Qualities Indicators, developed using the green economy module of the EBRD-EIB-World Bank Enterprise Surveys, help shed light on how FDI contributes to green growth. According to the surveys, a minority of manufacturing firms incorporate environmental issues into their strategic objectives (5-18%), and even fewer employ a manager responsible for environmental issues (4-12%). More substantial shares of companies monitor energy consumption and introduce measures to save energy (20-40%), and over 50% of companies seek measures to control pollution, while still few companies specifically monitor or seek to reduce carbon emissions (0-5%).

In general, companies in OECD countries tend to outperform companies in non-OECD countries across environmental dimensions (Figure 3, Panel A), and foreign firms perform at least as well as domestic firms (Figure 3, Panel B). The gap between foreign and domestic firms is often wider in non-OECD countries than in OECD countries, particularly when it comes to addressing carbon emissions.

Figure 3. Foreign investors outperform domestic peers in terms of green business practices

Note: Panel A captures all surveyed firms, while Panel B compares foreign and domestic firms. The OECD and non-OECD averages are not representative of the entire economic groups. They are based on a subset of countries from Europe, Middle East, North Africa and Central Asia.
Source: Author calculations based on EBRD-EIB-World Bank Enterprise Surveys (2020)

Can policy reforms improve FDI impacts on green growth?

Green investors are no different than any other in requiring a stable, predictable, and transparent investment environment in which to identify bankable projects. Too often the reason countries fail to attract green investment is due to the lack of an enabling climate for investment. Thus, efforts to mobilise green investment will fail to meet their intended target unless governments ensure a regulatory climate that provides investors with fair treatment and confidence in the rule of law.

The OECD Policy Framework for Investment (PFI) and its chapter on Green Growth provide insights on global good practices to create a regulatory framework conducive to green investment. At the same time, openness, stability and fair treatment are not enough to channel private investment towards green growth and decarbonisation objectives, and targeted policy interventions may be necessary. Building on the PFI, the forthcoming FDI Qualities Policy Toolkit seeks to link investment and environmental policies and support policy makers in designing policy and institutional reforms to improve the contribution FDI makes to decreasing carbon emissions and advancing sustainable development, more generally.

On 2 November 2021, at the virtual OECD Roundtable on Investment and Sustainable Development, policy makers, private sector representatives, and experts from the investment and health communities will discuss the key challenges and opportunities associated with creating an investment framework that is conducive to green growth and helps advance decarbonisation efforts.

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