A Hot Topic: The Role of US Development Assistance in Addressing the Climate Crisis

With COP26 only weeks away, policymakers around the world are focusing renewed attention on the climate crisis—and the US Congress is no exception. An upcoming House Foreign Affairs hearing, convened jointly by the Subcommittee on International Development, International Organizations, and Global Corporate Social Impact and the Subcommittee on Europe, Energy, the Environment and Cyber, will profile US plans to combat climate change through development assistance.  

Over the summer, we examined US bilateral development tools for climate and identified key questions facing USAID and MCC as they look to support emerging economies’ climate and development goals in a sustainable way. Since the publication of that paper, President Biden committed to doubling his previous $5.7 billion climate finance pledge, which itself was double the amount provided under the Obama administration. If the president’s commitment is realized, US international climate finance would total approximately $11.4 billion annually by 2024.

This new ambition on the part of the administration is sure to generate both opportunities and challenges for US development agencies, and the upcoming hearing is an important opportunity for lawmakers to learn more about how officials plan to follow through on this international climate agenda. Drawing from our earlier work, this blog outlines key agency-level climate commitments and highlights issues we hope receive attention during Thursday’s hearing.

An overview of agency-level climate commitments

As the largest US aid agency, USAID will be responsible for managing the bulk of any new bilateral climate finance (see the figure below), but both MCC and DFC have also promised to increase climate spending.

US climate change adaptation and mitigation spending by agency, 2015-2019

Note: data are from the OECD Development Assistance Committee (DAC) Creditor Reporting System (CRS) database on aid activities targeting global environmental objectives. Because a single activity can target—and be recorded as contributing to—multiple objectives (e.g., both climate change mitigation and adaptation), the graph doesn’t represent (and will exceed) total climate spending. The data excludes payments made by the US Treasury to multilateral organizations as well as loan and other financing commitments from the Overseas Private Investment Corporation (OPIC, which is now DFC). DFC’s spending is discussed separately below.

USAID

From 2012 to 2018, USAID’s Climate Change and Development Strategy steered the agency’s climate programming. The strategy had three main pillars: one focused on adaptation, (reducing vulnerability to the effects of climate change) and two—clean energy and sustainable landscapes—focused on mitigation (reducing greenhouse gas emissions and enhancing greenhouse gas reservoirs).

USAID dialed back publicity around its climate-related programming during the Trump administration. Even so, Congress largely sustained the funding channels USAID had typically drawn from to support its climate programs—and the agency continued much of its work in this area.

USAID plans to release a new climate strategy in November 2021. Both USAID and the White House have suggested the strategy will emphasize that climate change considerations will factor into all agency programming. The strategy is also likely to include a renewed focus on renewable energy and supporting countries to transition away from fossil fuels—and it could highlight opportunities for USAID to mobilize private sector climate-related investment.

MCC

MCC has never had a specific climate mandate, but climate considerations have long been part of its due diligence and assessment processes. The agency estimates that between 2015 and 2020, nearly 40 percent of its portfolio was invested in climate adaptation and mitigation activities, particularly in the energy, water, transportation, and agriculture sectors. MCC has committed to improving the analytical processes it uses to inform project selection to better account for climate-related needs and risks, and the agency plans to grow its climate-related investments to reach at least 50 percent of the portfolio over the next five years.

DFC

Between 2015 and 2019, DFC’s predecessor agency, the Overseas Private Investment Corporation (OPIC), channeled around 45 percent overall investment volume into infrastructure projects—about half of which was investments in renewable energy. DFC, which opened its doors in 2020, has continued to pursue investments in clean energy on a more modest scale.

While DFC’s original development strategy made no mention of climate change, that strategy is now under revision. And earlier this year, the agency announced bold new climate commitments—which include achieving net zero greenhouse gas emissions by 2040 and directing one third of its annual spending to climate-related investments.

Questions for agencies as they refine and implement their new climate strategies

How will agencies manage potential trade-offs between development objectives and climate objectives?

Development and climate goals often overlap—but not always. Within some adaptation efforts, tradeoffs might exist between climate resilience and other development objectives. More stark tradeoffs can emerge in the context of spending on mitigation objectives. Globally, mitigation programs—especially those focused on emissions reduction—rarely target the poorest countries since they’re low emitters. If aid spending remains relatively flat, an increase in mitigation efforts in middle income countries (the benefits of which materialize diffusely and over a longer time horizon) can displace targeted assistance to poorer countries and peoples. While our limited analysis of USAID’s climate funding found that the agency’s mitigation activities were more concentrated in lower income countries—and more focused on conservation programming than clean energy—a shift in focus toward renewable energy and emissions reduction could concentrate a greater share of development spending in middle income countries.

Looking at DFC, it’s already facing pressure to expand its mandate beyond the poorest countries. This mission creep is largely driven by geopolitical concerns rather than climate goals, but even within the agency’s climate-related activities DFC will need to operate deliberately to ensure it is maximizing opportunities for development impact. While DFC’s current climate portfolio is heavily invested in renewable energy, including in solar projects in lower middle-income countries—some of which was inherited from OPIC—there is unexplored scope to align the agency’s ambitious climate commitments with sectors known for impact in poverty reduction, such as agriculture.

Finally, some of our colleagues have pointed to the potential trade-offs that may arise from wholesale restrictions on fossil fuel investment—arguing that even ambitious climate policies should permit exemptions for low income, low emitting countries. In other words, US policies should factor in growth and energy access goals for the countries who bear the least responsibility for the climate crisis and will be forced to reckon with its worst effects.

With enormous development needs that will persist beyond a global recovery from the pandemic, how will agency officials weigh these potential tradeoffs? What processes will officials across USAID, MCC and DFC use to assess the merits and drawbacks of different approaches? And who will decide which priorities prevail?

How will agencies ensure local actors help define and shape US-funded climate investments?

The climate hearing comes on the heels of an important discussion the international development subcommittee recently convened on locally led development. That hearing explored what it means for development to be locally led and what USAID and other donors might accomplish through these approaches. To date, much of USAID’s focus on locally led development has centered around partner diversification and expanding use of local implementers. However, as the agency recognizes, this is a partial approach. Instead, locally led development must entail the meaningful inclusion of local voices in the decision-making processes around what gets prioritized, what gets funded, and, to our point above, how tradeoffs are identified, and which tradeoffs are acceptable.

Incorporating a range of local leaders (including indigenous groups and women) into these decision-making processes will need to be a central principle of US climate assistance and agencies should be held to account for doing so. MCC already works closely with partner countries to identify investment priorities but ensuring the climate-related components of its compacts reflect local goals will continue to be critical. And DFC’s investments necessitate active private sector demand but can likewise benefit from coordinating with leaders in country—whether civil society representatives or government officials.

What does it mean to mainstream climate sensitivity?

In an early executive order, the Biden-Harris administration committed to mainstreaming climate across the federal government and placing climate at the center of foreign policy. While this may not require a major pivot for USAID, MCC, or DFC—all of which are already working to integrate climate considerations into their practices—it does suggest scope for strengthening and prioritizing these processes.

For several years, USAID has applied a climate risk management process across its portfolio. A recent study found that though this process has been widely employed and successfully raised awareness of climate considerations, its implementation has often been incomplete. Climate risk management processes often petered out after a program’s design phase, potentially limiting their successful mitigation of climate risk. USAID’s recently published 2021 Climate Readiness Plan pledges to strengthen these processes, and we hope to hear more from USAID’s witnesses on how this will look. A key ingredient for successful climate mainstreaming will undoubtedly be its prioritization by high-level and bureau leadership, especially the big bureaus like health and resilience and food security.

For MCC, there are questions about whether some of its analytical and decision-making processes need to be retooled to better integrate climate sensitivity. For example, MCC relies heavily on cost-benefit analysis—and the associated summary economic rate of return (ERR) metric—to inform project selection (projects must have an ERR over 10 percent to be considered for funding). In some cases, modifications to make activities more climate sensitive may increase costs while complicating estimates of the associated benefits. The nature of risks, including climate risk, is that they’re uncertain, so the long-term benefits of adaptation interventions are similarly difficult to model and predict. And for some important interventions related to policy reform, benefits are hard to quantify and attribute to a particular program. As a result, MCC is likely grappling with some big questions. How can the agency better model the short- and long-term benefits of climate sensitive programming and avoid rejecting potentially good projects due to artificially low estimated returns? What level of uncertainty is it willing to tolerate?

When reviewing projects for approval, MCC management evaluates, in addition to ERRs, things like compliance with environmental guidelines and the agency’s gender policy, among other things. Climate-related criteria may be considered but are not part of the core decisional criteria. With the new focus on climate, will MCC amend its investment criteria to include a specific analysis of climate sensitivity?

Meanwhile, DFC is aiming to direct a third of its total annual investments (potentially more than $2 billion a year) to climate finance. But—so far—there’s limited information on how DFC plans to incorporate climate sensitivity principles into project approvals. DFC’s ex-ante scoring mechanism awards bonus points for voluntary sustainability operations and makes score adjustments based on environmental risk assessments, but climate isn’t a major pillar of whether an investment gets the go ahead. Will this need to change to meet—and measure progress toward—the agency’s climate goals?

Are agencies adequately staffed to meet new climate ambitions?

Increasing and mainstreaming climate-sensitive programming will require staff with the skills to forecast climate threats, understand potential options for mitigation, and establish effective monitoring and evaluation systems that track climate risks and the effectiveness of interventions intended to reduce them. At USAID, climate integration leads have managed much of climate mainstreaming efforts at the bureau and mission levels, but they are often stretched thin. Similarly, at DFC, as our colleagues have pointed out, DFC has a small administrative budget and is relatively understaffed for the size of its portfolio.

More comprehensive integration of climate issues will require the engagement of (and buy in from) a broader set of expert staff, especially those overseeing individual programs or sector portfolios. It could be helpful to hear about what agencies see as staffing or skills gaps they might need to address as they embrace a more ambitious climate agenda.

Is the US development toolkit optimized to play the long game that climate-related investment requires?

While some communities are experiencing acute impacts of climate change now, many of the goals of climate adaptation programming are longer term and require long-term investment (e.g., transitioning crops and farming methods over a 10-20-year horizon). There can be a disconnect between this long-term framing and the timeline of US development assistance tools—USAID’s typically three- to five-year program cycles and MCC’s discrete, five-year compacts. DFC also faces pressure to get money out the door and investments with near-term financial returns may be particularly attractive. This hearing could be an opportunity for agencies to outline the structural barriers to longer-term approaches and what could help accommodate a shift in longer-term thinking.