Floods and Infrastructure Investments (II)

Floods and Infrastructure Investments (II)

The previous Infrastructure Ideas column looked at the rising incidence and costs of major flooding events across the world, and early adaptation strategies to this new reality. This follow-up column will look at some of the options for funding adaptation efforts.

In the two weeks since our first column on this topic, flooding made headlines two more times. In the Baltimore suburb of Ellicott City, flash floods carried away cars and ruined a substantial amount of the downtown of the city of 65,000. What made this “once in a thousand years” flood event so remarkable was that it was an almost instant replay of a devastating flood of 2016: as far as we can tell, twice in three years is a bit more frequent than once in a thousand years. This week, the New Orleans Times-Picayune reported, along with the NOAA prediction of a 75% chance that the hurricane season starting June 1 will have above-normal activity, that New Orleans’ rebuilt storm control infrastructure has been rebuilt only to withstand storms that are severe enough to occur once every 100 years – less severe than Hurricane Katrina which hit the city in 2005. Not terribly reassuring. Away from the headlines but also in the press is a drumbeat of complaints from Houston that promised federal funding to rebuild after last year’s Hurricane Harvey is slow to come and far short of expectations.

It’s clear that a great many cities worldwide will need to deal with sharply higher flooding-related infrastructure costs in the coming decade. Higher costs for infrastructure maintenance, transportation delays, electricity outages. Larger investment needs for flood control measures, transport system adaptation, power grid resiliency, and large investments in data to figure out what best to do. A broad range of estimates for developing countries would put needs at somewhere between $10 to $60 billion a year – or somewhere between ½ and twice the size of total Official Development Assistance today.

Where will the money come from? Let’s look at a few of the options:

1. Let’s start with the option of transfers of OECD tax dollars. The idea of a giant climate adaptation fund, financed by OECD countries for the benefit of poorer countries to help the latter deal with the various impacts of climate change, has been around for decades. It remains popular in some circle. From the perspective of Infrastructure Ideas, as a solution for developing countries, it looks about as probable as finding a magic wand.

2. Multilateral development banks. International Financial Institutions undoubtedly will play an important tole in helping lower-income countries adapt to a changing climate. The recent agreement to increase the capital of the World Bank Group institutions included a provision to raise the share of World Bank lending related to climate to 30%. This could mean $10 billion per annum in funding for government projects related to climate change. Though today some 80-90% of these funds target climate mitigation efforts, the share targeting support climate change adaptation is bound to grow. Adding regional Multilateral Development Banks, which will also support emerging market governments in this area, one could expect to see collectively $5 billion or more from the MDBs for climate adaptation. Important, but still only a piece of the larger puzzle.

3. Other public financing options.

A. Repurposing public funds for flood control. To date, this has been largely the default scenario for most countries and cities. If the magnitude of costs seen to date and being forecast are remotely reliable, it is going to become an increasingly untenable option for many.
B. Raising taxes. This is always an option for governments. However, the ability and/or willingness to raise taxes is questionable in many countries. One could expect that the costs related to climate adaptation, in particular flood-related, would be distributed quite differently across the parts of any large country, potentially making it difficult to raise taxes across an entire national population for what many may view as local effects. It may well be that site-specific taxes, such as city taxes, become politically easier to envision as part of the solution.
C. Flood levies. Levies raised on local properties or industries would be analogous to raising city or other location-specific taxes, as noted in the previous section. The specificity of use of proceeds associated with flood levies, linking funding to specific beneficiaries, may also make them politically easier to execute.

4. Capital Markets options

A. Green bonds. Green bonds can be a means for governments to access additional capital for climate change adaptation. In October 2017, Fiji became the first emerging market sovereign to issue a green bond, the IFC supporting the $100 million issue. One could expect this instrument to become popular going forward. Bonds, of course, require repayment, and so the capacity of governments to issue bonds is limited. And they require creditworthiness, which at a municipal level only 4% of cities in the developing world only have today.
B. Environmental impact bonds. A variant on green bonds, this new instrument has been pioneered in a number of US cities. The first issuer was Washington DC, in September 2016. The variant here is that the investors share some of the risk of achieving the impacts which the associated investment targets. In the model to date, that risk-sharing takes the form of a variable return, and not risk to the capital itself.
C. Climate insurance funds. Beyond the leverage which bonds may provide an issuing government, insurance products by pooling and diversifying risks can help countries and/or cities reduce large payouts related to climate events. What is clear from the experience of recent years, however, is that insurance premiums in climate event-prone zones are getting significantly more expensive. High-income areas are able to spend more to remain insured after post-flooding rebuilding, but a growing number of low-income areas are no longer able to access storm and/or flood insurance.

5. Private Capital. It is unlikely that either directly funding climate related infrastructure investments with public money, or doing so through government borrowing, will be enough to address all the increased costs and investment needs related to flooding and other climate change adaptation. The “crowding in” of private capital for infrastructure needs, already a high priority in the development finance community, will be made even more important by climate change. How best to do so remains a challenge for governments, with private sector infrastructure in emerging markets flat or declining in recent years. The best approach will also vary country-by-country, and across cities or states within countries. The following are some potential approaches which federal or local governments may use in coming years:

• Cross-sectoral funding shifts. Most governments have unused potential for integrating private capital in areas of infrastructure which have proven commercially fundable elsewhere – typically because they are or could be revenue generating through user fees. Increasing the use of Public-Private Partnerships in these areas will free up resources for adaptation funding which may be less able to generate user fees or other revenues.
• Using capacity payments. A central problem with flood prevention infrastructure is that it does not have regular users who can be expected to pay a fee each time they use it, unlike a metro system or a toll bridge. Many governments therefore assume that their only option for this type of work is direct public financing. However, the model of capacity payments could be applicable here. Capacity (or availability) payments are common in the electricity sector, and becoming more widely used for road public-private partnership. In this model, a government would tender the right to build large flood-control infrastructure, preferably through an auction mechanism, with the builder of the infrastructure being paid over time by the government for the costs – providing the infrastructure functions properly. As with borrowing, the contingent liabilities associated with this model need to be monitored, but this model has the advantage of sharing performance risk with the private sector builder of flood-control infrastructure.
• Data partnerships with local industry. Data costs are going to become more and more significant as climate evolves and extreme weather events cause more damage. Data on climate risk modeling, and assessing risk mitigation, will be of high value to commercial actors in a city – industrial plants, real estate managers, transportation companies and others. In some cases, private actors will be the ones with the data cities need to assess situations — as has proven the case in a number of cities with the information generated from GPS systems of ride-sharing services.  Well-structured partnerships with these actors may enable cities to reduce their own costs related to accessing and utilizing climate-related data.
• Resiliency partnerships with local players. Broad estimates project that the costs of extreme weather events are twice as high as they would be where resiliency has been built in. By promoting the value of resilient building and infrastructure, governments can help reduce their later disaster spending needs. Back-up systems for electricity grids, a clear problem with hurricanes Katrina and Sandy, are obvious needs. Elevating, or conversely burying, certain kinds of infrastructure also are clear paths for reducing flooding damage to infrastructure. But failure to do so in partnerships will be common: a good example is the rejection earlier this month by Miami Beach residents of a $500m plan to elevate infrastructure systems in flood-prone areas, with voters failing to absorb the need and value of making the city’s infrastructure more resilient.

This column has outlined a series of funding options related to the increased costs and investment needs related to flooding which we can expect to observe. The menu is today certainly not perfect, and probably not enough to deal with future needs, but at least it is broad. As climate continues to evolve, we can also hope for more innovation in these mechanisms.