benefits from FDI are achieved mainly (or from some studies, only) as a result of investments in the manufacturing sector (which, presumably, includes the energy sector). Two further important requirements from the literature for positive growth effects to result are 1) that the labor force must be sufficiently skilled at the outset so as to effectively utilize any new technology transferred by the FDI; and 2) that the host economy must be at a “high level” of financial development.

# **8. Conclusions**

This paper has addressed a number of issues related to how an economy is likely to respond to an increased financial inflow that is somehow related to climate policy, or to other types of responses by the world community to climate-related distress. A basic danger, that we here seek to evaluate, is that such inflows may “overwhelm” or in other ways damage the receiving country, given a limited ability to absorb such inflows. Such damage could be of a general macroeconomic character (such as leading to currency appreciation or inflation), to making the economy overly dependent on imports, and to unwanted consequences such as increased rent-seeking and corruption.

Our overall assessment is that for most countries where this problem may be relevant, it is not grave over the short or medium term (up to, say, 10 years), as the size of flows is expected to be modest. Over the longer term, when flows related to climate policy could in principle be scaled up substantially (as might be the case under comprehensive global cap-and-trade or carbon tax schemes; but conditional on higher-income countries willingness to scale up overall aid outflows), this danger could conceivably be greater. But, one may argue at least in principle, if the additional financial inflows can be allocated largely to additional investment instead of to additional consumption, such flows could serve as a blessing by further enhancing the countries’ economic growth. One will then also, arguably, have plenty of time to facilitate and implement these flows in benign ways, so as to avoid adverse consequences. Another benign factor, pointed out in section 4 of this paper, is that such additional financial inflows can to some extent substitute for taxes in the receiving countries, thus reducing the deadweight loss and disincentive effects of these taxes, and in that way spurring economic growth and development.

The final section of the paper deals with potential implications of increased financial inflows on economic growth in low-income countries. The common thread from the studies on additional LIC financing, through ODA or FDI, on receiving countries’ growth, is that such effects can be found; but that positive growth effects are not universal. Almost unanimously, positive growth effects are found if financing is concentrated to the manufacturing or infrastructure sectors; and when the countries in question are already at a relatively advanced stage of development (in terms of their labor force and financial sector). Governance issues are also important. At least when considering the effects of ODA, growth effects in many studies appear to be significant only for “good governance” countries (as in the seminal Burnside-Dollar (2000) study). For FDI the evidence is here perhaps less convincing, but at least mildly supportive of a similar relationship. Moreover, ODA in most cases should have a greater effect than FDI on host country growth, which also seems to be the case. After all, the basic motivation of ODA is just such development; while the basic motivation of FDI is investor profits.

Considering specific climate-related finance items, growth effects are most likely when the external finance is fully concessional, and spent on investment, infrastructure and industrial development. Such finance items are likely to become most heavy for foreign-financed mitigation-related investments, and for adaptation finance in infrastructure that also has a substantial industrial component.

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