Nature finance: is relying on subsidy reallocation realistic?

There is a nature financing gap. The precise numbers vary but plans to close the gap partially rely on the reallocation of harmful subsidies to nature-based solutions. This paper briefly examines whether such a strategy is realistic. We observe that a range of countries have successfully eliminated subsidies – so it can be done – but others failed. We need to learn how the former delivered subsidy reform, and why others were unsuccessful.

Mind the financing gap

It is widely recognised that there is a deficit of financing for nature-based solutions (NbS). The “State of Finance for Nature (2024)”,ⁱ, estimates that current finance flows to NbS of USD 200 billion are overwhelmed by flows of USD 6.7 trillion which have direct negative impacts on nature.

Note that not all analyses support these numbers. For example, BloombergNEF estimates that the biodiversity finance gap between current and future needs has widened to USD 942 billion. It estimates that current biodiversity financial flows amount to USD 208 billion per year, up from USD 166 billion in 2021.ⁱⁱ Over USD 1.2 trillion per year is needed by 2030 to restore and maintain biodiversity, based on a 2020 report by the Paulson Institute, Nature Conservancy, and Cornell Atkinson Center for Sustainability.ⁱⁱⁱ

Sticking with the UNEP data, current financial flows to NbS are approximately one-third of levels forecasted to reach climate, biodiversity and land degradation targets by 2030, which are estimated at USD 542 billion (by 2030). Sovereign states continue to provide most of the NbS funding (82 per cent) which has increased by 11 per cent since the 2022 edition.

On the other side of the equation, UNEP estimates that private finance flows that have a direct negative impact on nature are USD 5 trillion, which is 140 times larger than the private investments into NbS. From public sources, environmentally harmful subsidies have increased 55 per cent to USD 1.7 trillion since the last UNEP report.

It is this mismatch between nature-positive and nature-negative flows that has created some optimism that the financial markets could be used to protect nature by realigning public and private nature-negative financial flows. Fundamental to this optimism is the need to repurpose harmful subsidies. This was baked into the Kunming-Montreal Global Biodiversity Framework. Target 18 aims to “reduce harmful incentives by at least USD 500 billion per year, and scale up positive incentives for biodiversity”.^iv Target 19 calls for the mobilisation of USD 200 billion per year for biodiversity from all sources by 2030.

In 2022, the vast majority of tracked negative public flows were directed towards energy (USD 1.16 trillion or 69 per cent of the total) and agriculture (USD 0.35 trillion or 20 per cent of total harmful subsidies). See Figure 1.

So, is this reallocation of subsidies realistic?

Unwinding subsidies

Subsidies are incentives often given by governments to individuals or businesses, in the form of cash, grants, or tax breaks, that improve the supply of certain goods and services. This allows consumers and businesses to access cheaper products and commodities. They can take several forms such as production subsidies – to encourage the manufacture of a product – consumption ones – to offset the costs of products such as food – employment ones – to provide job opportunities – and export subsidies. And here lies the problem: once in receipt of these benefits, they are not easily removed without considerable resistance from the recipients.

According to UNDP and BIOFIN, there are mainly two types of subsidies which are important drivers of activities harmful to biodiversity, resulting in losses of ecosystem services: those aimed at under-pricing the use of natural resources leading to overconsumption beyond sustainable levels and those aimed at increasing production can lead to an increased usage of polluting inputs, damaging production methods, or an unsustainable transformation of ecosystems. in turn aggravating the risk of long-term environmental damage.^v

Figure 1: Environmentally harmful subsidies USD trillion Sources: FAO, UNDP and UNEP (2021), IEA (2023), OECD (2020, 2022e), Environmental Markets Lab (2018), Skerritt and Sumaila (2021), WB (2021), Koplow and Steenblik (2022). From The State of Finance (2023), UNEP

Subsidy removal – it is possible

Below we provide some global examples of where governments have successfully removed subsidies.

1. New Zealand – agriculture. In 1984, the Fourth Labour Government abruptly ended many agricultural subsidies for production, processing and exports because of high national debt. These economic reforms were known as “Rogernomics”, named after the then Finance Minister Roger Douglas. Farmers were forced to transition to market-based pricing while some also diversified into other activities.
2. India – gasoline & diesel. In 2010, the Indian Government, led by the Indian National Congress under Prime Minister Singh, deregulated gasoline (petrol) prices as part of a plan to reduce the fiscal deficit. It also phased out diesel subsidies, but over a longer period, from January 2013 to October 2014.
3. Germany – solar installations. Initially, the German Federal Government provided substantial subsidies to encourage the building of solar installations. This was implemented in 1991 under the Electricity Feed-In Law, which required utilities to purchase renewable energy at a fixed percentage of the retail tariff. In 2000, the Renewable Energy Sources Act required utilities to buy solar power at a higher rate than the market price, for 20 years. Subsequently, the solar market boomed so in between 2010 and 2012, feed-in tariffs were gradually decreased. More aggressive subsidy cuts were implemented in the next two years as solar technology costs fell. Further adjustments were made, so by 2017, the country had transitioned to a competitive auction system for large solar projects. Nowadays, solar subsidies are low and are focused on smaller installations only.
4. Norway – electric vehicles. Norway’s electric vehicle (EV) subsidy programme has been altered several times. Initial incentives began in the early 1990s with tax incentives and toll-free access. By 2001, EVs were fully exempt from the 25% value-added tax (VAT) and registration fees. In 2009, additional benefits included free parking spaces, road toll exemptions and the use of bus lanes. Between 2010 and 2017, infrastructure such as public charging stations supported further EV growth. At the end of this period, some of these benefits were scaled back. By 2021, registration fees were reintroduced and in 2022 the VAT benefits was also reduced. Further subsidy reductions are expected as the ban on new fossil fuel car sales commences in 2025. In 2023, about 90 percent of all cars sold in Norway were electric cars, including battery-electric vehicles (BEV) and plug-in hybrid electric vehicles (PHEV).^vi
5. Australia – water. The removal of water subsidies in Australia started under the Liberal-National Coalition of Prime Minister Howard, with the introduction of the National Water Initiative in 2004. It aimed to create a more market-driven and sustainable approach to water use. Water trading, better pricing and efficiency improvements for agriculture were all promoted. In 2007, a Water Act oversaw the water allocation in the Murray-Darling water basin. Since 2010, Australia reduced direct agricultural water subsidies but did offer assistance for farmers to invest in water efficient infrastructure. With water subsidies largely removed, farmers were encouraged to participate water trading or invest in efficiency measures.

Common themes in these cases include a gradual phase-out, with the exception of the New Zealand agricultural subsides. Their removal was aimed at promoting more sustainable practices although India could be argued as an outlier. The reduction of national fiscal burdens was sometimes the priority, but improved market efficiency and/or improved competitiveness was highly important.

For the sake of balance, we should point out that not all subsidy withdrawals survive. In 2012, the Nigerian Government removed fuel subsidies overnight, causing a near doubling of the price. Despite the need to reduce the national fiscal burden, protest and widespread riots caused a (partial) subsidy reinstatement within two weeks. Ecuador attempted a similar strategy with fuel subsidies, resulting in a 120% increase in fuel prices. Widespread protests led to a reversal of this policy within weeks. Mexico’s Government started phasing out corn subsidies in the 1990s. But by 1994, the Government had introduced income support for farmers, effectively replacing one subsidy with another.

Common themes among the failures to drop a subsidy include widespread public protests, the effect of international pressure, notably the IMF or World Bank which promote subsidy reform, and the abruptness of some of these reforms.

The subsidy challenge

To close the nature financing gap, it is entirely reasonable to examine both flows into nature-based solutions and the harmful subsidies damaging biodiversity. The latter overwhelms the former. With a few case studies, we highlight that subsidies can be unwound. This is promising for nature finance. But, we can also demonstrate failures especially with regards to how those decisions have been rolled out, where widespread protests have caused a reversal of the original plan. Those facilitating greater capital flows into nature protection and recovery, need to be aware of successful subsidy withdrawals, but also learn the lessons from those that failed.