Research and Reports

SESSION 6


GSSD Reports

Global Accords for Sustainable Development:
Enabling Technologies and Links to Finance and Legal Institutions

Session 6: Finance and New Institutional Mechanisms


Chair: Wallace R. Baker
Senior Partner, Baker & McKenzie, Paris

Good morning, Ladies and Gentlemen.

Baker & McKenzie is a firm with an environmental practice in many countries. The reason why Baker & McKenzie appreciates the honor of co-sponsoring this conference is that we believe it will be enormously important that the private sector businesses and their lawyers should make maximum efforts to solve the seemingly intractable problems of finding transitions to sustainability. We hope that we can make the rules more user-friendly, and cost effective.

Instability
I refer to the many problems as intractable because solutions often, but not always, cost money and run counter to the primary objectives of most businesses -- which is making profit, and often the objective is short-term profit. Building into our economic system financial incentives is one possible solution to this obstacle. Other obstacles include deeply held beliefs in absolute property rights, lifestyles, and consumption patterns that are not sustainable.

What I am talking about is illustrated in the very interesting graphic analysis of sustainable development called the Global System for Sustainable Development (GSSD), which you heard about in Session 5, which Professor Choucri and others at MIT are perfecting. The center portion describes the core problem, i.e., "Interactions of Population Dynamics, Technological Change, Resource Utilization Reinforced by Prevailing Values, and Production and Consumption Generate Pressures on Life Supports."

Two Quotes
On the subject of property rights (prevailing values), a 1993 case decided in Texas eloquently describes the problem. The defendant, Marinus Van Leuzen, knowingly violated environmental laws by building a house on wetlands in the Texas Gulf which he filled with earth and cement, claiming he could do what he wanted to his property. In an unusual opinion, Judge Kent, before ordering Mr. Van Leuzen to restore the land to its original state, started off by quoting two writers. The first wrote:

"Is there nothing about the United States of my youth aside from youth itself that I miss sorely now? There is one thing I miss so much that I can hardly stand it, which is freedom from the certain knowledge that human beings will very soon have made this moist, blue green planet uninhabitable by human beings. There is no stopping us. We will continue to breed like rabbits. We will continue to engage in technological nincompoopery with hideous side effects unforeseen. We will make only token repairs on our cities now collapsing. We will not clean up much of the poisonous mess that we ourselves have made. If flying saucer creatures or angels or whatever were to come in a hundred years, say, and find us gone like the dinosaurs, what might be a good message for humanity to leave for them, maybe carved in big letters on a Grand Canyon wall?

We probably could have saved ourselves, but were too damned lazy to try very hard. 

We might well add this:

And too damn cheap.

So it's curtains not just for me as I grow old. It's curtains for everyone ...."

That is Kurt Vonnegut.

The judge continued to explain the reasons for his opinion with another quote:

"To the earth, a hundred years is nothing. A million years is nothing. This planet lives and breathes on a much vaster scale. We cannot imagine its slow and powerful rhythms, and have not got the humility to try. We have been residents here for a blink of an eye. If we are gone tomorrow, the earth will not miss us ....
..... Let's be clear. The planet is not in jeopardy. We are in jeopardy. We haven't got the power to destroy the planet -- or to save it but we might have the power to save ourselves."

That was written by the author of Jurassic Park, Michael Crichton.

Beyond the Basics
With these two quotes I wanted to inject a little passion and emotion to our discussion, as some of the earlier speakers thought were necessary. I think we should mix reason and emotion. So in summary, we have economic obstacles as well as cultural, traditional, and outdated legal or lifestyle obstacles to overcome.

"Finance and New Institutional Mechanisms," the subject of this morning's session, can provide tools to help us try and overcome these obstacles in order to move closer to sustainable development. I am most anxious to hear what light our keynote speaker and our distinguished panel shed on this most important subject. Our keynote speaker is Glen L. Urban, who is Dean of the prestigious Sloan School of Management. After reading his resume, the only way I know how to describe Dean Urban is that he is a Renaissance man who seems to be able to do everything well. He is an educator, marketing expert, inventor of new methodology to simulate future sales of products, author, sculptor, sailor, and he has started up several successful businesses. His subject is "Management Challenges in the 21st Century: Implications for Sustainability." Dean Urban.


Keynote Address: Management Challenges in the 21st Century: Implications for Sustainability
Glen L. Urban
Dean, Sloan School of Management, MIT

Thanks very much. First thing I wanted to say is though I can do some things, I am not an expert on environmental technologies and I am not an expert on global warming, some of the topics that are here. But I think I can bring to this session, a little perspective about what top management is thinking about around the country.

In my job as Dean, I have a chance to meet with a lot of management audiences and many of the CEOs around the country, so I have a little bit of feeling of the challenges they are facing and their attitudes towards sustainability and environmental policy.

Business Environment
So what I would like to do in this brief 25 minutes this morning is give you a little perspective of what I see as the business environment as it has existed in the 1990s and what is likely to happen in the next ten to fifteen years. What are the conditions businesses will face? What changes will the 21st Century bring for them? I will maintain that in fact management, because of these changes, will have to develop a very new style and that we will see new success factors characterizing companies that we put at the top of the respect pile. After looking at that general management environment, then I would like to spend a few minutes thinking about implications of sustainability of that environment in which business will have to operate.

Retrospective Look
First let us do a little retrospective look at the 1990s and say what it is that has really characterized successful businesses, the businesses that have done the best on the stock market, that have been the most respected in the world. I can list six major driving factors. If a company really meets the top level of all six of these, they are probably very highly correlated with successful business practice in the 1990s.

TQM 
First is total quality management, building products that have no defects which started out as kind of a zero error policy, ISO 9000 standards, but moved quickly on to designing products that met consumer needs, a whole field called quality function deployment, linking engineering to customer needs. Now today, companies practice total quality management as a company philosophy, that every part of the company should run on a total quality principle. So that moves out from production to marketing, finance, public relations, and the environment.

Re-engineering
The second factor is the "leaning-down" of industry, popularly known as re-engineering, where companies have downsized to become more efficient. They have taken out the slack; on the average across companies probably ten percent to fifteen percent of the employees have been cut back, and that has been across all levels, management as well as workforce.

Core Competencies
A third factor has been a focus on their core competencies. Companies are not trying to do everything for everybody. They are saying, we do what we are best at in the world, what few things can we do better than anyone else, and let us concentrate on that, and then we will build partnerships to fill in the rest of the capabilities.

There is a tremendous effort on productivity, things like time-to-market or cycle-time in new products. So you see automobiles going from design to market in half the time they did five years ago; software coming to market in six months; tremendous pressure overlapping in new product development to get products out that meet customer demands.

Globalization
As well, companies have gone global. The world is a factory. The world is the market. No longer can a successful company think of itself as existing in a national boundary. It really sees itself as operating everywhere so it will produce where the costs are lowest. It will sell where the demand is highest and where they can make the highest margins.

Customer Satisfaction
Lastly is a trend to move in on customer satisfaction, which reminds companies that they are in business to serve customers, so they go directly to their customers to measure how well they are doing and they drive their whole business based on that. So Xerox, for example, collects customer satisfaction measures, and the bonuses of all their management are related to those measures, whether you are in production, finance, marketing, or distribution.

If you know a company and they are at the top level of all six parts, I think they would be very successful. One of the things that is perhaps relevant relative to this conference is that environment is not on that list. I do not think in the last five years a kind of positive view to the environment has been an attribute of the successful companies.

Environmental Constraints
Most of the companies in the last ten years have viewed environmental issues more as a constraint, had a more adversarial relationship where they say, well, we will meet those needs or we will try to change the laws. We will try to do the things we can to just get past the legal constraints. You will see I am going to argue that that is going to change in the future; but I think over the past ten years, basically, managements have been more in an adversarial relationship and a reactive view with the environment.

If you look at what is going to happen in the next ten years -- and many of you probably have as good a view of this as I do, and we may want to in the discussion share some views on what is going to happen in the future -- those first six factors are going to be even more important.

Ticket to the 21st Century
In fact, what were success factors in the 1990s are going to be the ticket to admission to the 21st Century -- that is, if you are not making the best quality product at the lowest cost with a focused business strategy concentrating on your customers, you will not even be in the game.

Overcapacity
Most business markets over the next ten years are facing overcapacity. There is more than one-third on average capacity excess in almost every industry, whether that is automobiles, computers. Even in the energy market, people will look at the next five years or so and say that we will have excess on the oil supply side.

Certainly in the long run it will look very different than that, but many of these companies are going to face in the next ten years markets where there is dramatic excess capacity in almost every industry worldwide. That means the competitive intensity will go up. There will be even more push to try to become efficient, to get quality products out, to be successful.

Volatility
As well, I think volatility will go up over the next ten years.

Economic
On the economic side, probably in the developing world, most companies predict that the growth will be very slow and quite flat and that markets will be very saturated. In the U.S. there are now 350 models of automobiles. What is the market for a 351st automobile? So most of these companies are looking at the developing world as a holding action, try to do better there. But the real growth is going to occur in the emerging markets, so if you look at India, China, Indonesia, Malaysia, those are the economies where we are likely to see the five to ten percent real growth rates over the next ten years. So companies are concentrating very heavily on those parts of the world in terms of asset allocation.

Environmental Feedback
I do think also we are going to see in the next ten years some real environmental feedback. I am sure many of you who have been in Bangkok (I was there recently, and I know from talking to GM and other auto companies that they are planning to build big plants there) know that you have a hard time taking a breath, and secondly you have a hard time getting across town to a meeting, which takes one to two hours. You wonder where you are going to put any more cars. A business has to be feeding that feedback. You cannot put a billion dollars into Thailand to produce autos for Southeast Asia and not come to grips with the fact that you are going to have to deal with clean air or you are going to have to deal with transportation systems. In the next ten years, many of the things that maybe in the last ten years businesses might have been able to put on the back side and say we can deal with that later are in fact going to be in our face, and that is going to put a big pressure on companies who are trying to be succe
ssful, as they clearly see the environmental feedback.

Continuing Technological Change
Another change for the 21st century will be the continuing technological change. We look at changes in the information system area, computer costs going down 25% per year, the World Wide Web and Internet, bioengineering, material science, some of the things I am sure you talked about yesterday. So these will be drivers of the change coming up in the next years.

With that it causes me to think a little bit about what management will be doing to be successful. First of all, they are going to be super good at those survival skills, the six factors that worked in the 1990s. But in addition, they are going to have to develop new techniques to manage risk. With the volatility, political, social, economic, companies are going to be scrambling to try to develop risk procedures that allow them to diagnose risks and take actions to overcome them. You can see some of this in the banking system, where today banks will, on a daily basis and sometimes even an hourly basis, review their exposure to fluctuations in foreign exchange and fluctuations in interest rate and readjust their portfolios. That kind of risk management will become common in all business.

Also as you look at the 21st Century, if you want to make profit, which companies do in return for their shareholders, the opportunities are not going to be very large in reducing costs any more and quality will be up at almost its highest level. The profits will come from innovation. They will come from new products, developing new products and services. So organizations will shift dramatically from the downsizing, short-run negative atmosphere of many organizations today to a technology and innovation-driven company if they are going to be successful. They will also become learning companies, companies that can move up the learning curve progressively with the rapid changes so that they are able to adapt effectively with the new opportunities.

Different Management
This means -- in my scenario anyway -- that companies who are successful in the 21st Century will be ones that have much different management. They will be managers that have a longer range view of where they are going, of where the next quarter comes from but then how they are going to succeed over a five- to ten-year period. So they will be the managers who have the vision of where the company fits in not only to the economic system but also to the social political system of the world.

Organizational Form
Finally, we predict that organizations in the future are going to have to reinvent themselves in terms of organizational form. As you go global, you cannot operate effectively with the old hierarchical organization that has characterized business for the last 75 years. I am from the Sloan School of Management, and Alfred P. Sloan invented that paradigm; and in fact I sit behind his desk in my office with some trepidation, but I think Alfred did a great job for 75 years, 1920 until now.

Ten years from now we will look back and we will say, wasn't that a cute form of organization. How did it ever work? Because we will have to be flat, agile, interconnected worldwide organizations to meet the changes and opportunities worldwide.

Worldwide Organizations
You can see some of that going on now where Ford Motor Company has 24-hour design teams building new cars. So they work in Detroit for eight to ten hours, then pass it over to Thailand; they work eight to ten hours, then back to London; and they will get back here having done 24 hours of work. So there is a tremendous interchange of strategy, ideas, and information with teams that will be very agile, very flat-based organizations where teams have responsibilities to carry out specific tasks for the long-run vision.

Two Scenarios
In the panel we may want to discuss other people's vision of this, but for this session, I wanted to say, if this is where we are going and that is what it looks like, then what are the implications for sustainability and environmental policy? I think you can construct two cases here: a pessimistic case and an optimistic case. Let me give you both of those and tell you where I net out and again we may want to have some discussion.

Pessimistic Case
The pessimistic case would say we thought the 1990s were tough and environment was not the top of the list and that was because of cost pressures and short-run pressures. Maybe in fact what will happen is because of this increased intensity of competition, that will get worse, so companies will get even more short-run and more likely to dump waste and do anything they can to cut costs because the only way they can survive is to minimize their cost. That means they would do anything they can get away with.

They will have clean factories maybe in the U.S., where the regulations are high but have dirty production abroad where they can get away with it, where the regulations are not so tough -- maybe just meet the constraints.

If you can get away with violating and it is not enforced, let it happen, and continue the 1990s adversarial government-customer relationships, where we say we cannot do that; we are going to produce a lot; we are going to make a lot of money; the rest of you people worry about the world.

This pessimistic scenario also has a continuing driver of the stock markets and the quarterly returns phenomenon. So if this case is true, business will do nothing and in fact probably do harm to the efforts for environmental policy and sustainability.

Optimistic Case
Now the optimistic case is the following. If in fact the successful company in the next ten years is innovative and has vision and is more long-run, then we may find that this new visionary management and its long-run perspective dramatically changes the kinds of things people did in the 1990s. So we would expect to see companies saying, well we are in the same boat as everybody else. If we are going to produce cars in Thailand, we are going to have to have a proactive policy on the environment. We are going to have to cut our emissions not only because we can become more efficient and save money but also because this is the right thing for the world in which we are going to compete in the long run.

They would be very sensitive to customers' preferences and looking for opportunities where customers are willing to substitute for products that are environmentally responsible or pay a little bit more for a green product. They will be putting a lot of their innovative effort into materials that are more friendly, into creating products that are recyclable, products that customers will view as positive.

They will also be setting up global standards so they will find that if you are an innovative organization, you cannot have a dirty plant in China and a clean plant in the U.S. If you are truly global in this flat, team-based organization, you have to have the same global standards on your ethics, your culture, and if it is high-quality products, you cannot maintain that culture of high quality worldwide if you allow certain parts of the world not to be at that global standard.

In this specific scenario now, we will also be responding to government incentives. In fact, probably you will find these companies trying to work with government to define the regulations and the incentive systems that cause them to take the actions that are best for the world.

So the basic argument here is one of quality of management. It says that correlating activities for high profit and share are also the culture and mentality that is going to cause business to be positive with respect to the environment.

It would suggest in this optimistic case that then we will see business as a dialogue partner with government and consumer groups and other groups working to bring about long range policies that make sense in balancing the very complex equation of economic, political environmental growth.

So the question to each of us is: are you an optimist or a pessimist?

We really did define the extremes here, didn't we? One of the things we may want to have in some of the discussion is some views about where this is. Let me just indicate a couple of precursors, though, that make me feel that we will be a little more toward the optimistic end than the pessimistic end.

Precursors of the Future
For example, look at companies like Monsanto: Monsanto has reinvented itself as a pro-environmental company. Pesticides are being replaced at Monsanto by biogenetic engineering of plant species that are resistant to pests. So they have basically taken their old core chemical technology and gone to a biotech technology and say, our business in the long run is to create new species that do not need pesticides. For the few pesticides they do need -- they have a product called Roundup, for example, which is a pesticide and after exposure to water and sun over time, breaks down into harmless chemicals -- there is no toxic pesticide residue to recycle or do anything. It breaks down completely into natural substances.

Now all these precursors are not the large companies, and I am sure you have heard other ones, 3M and others. Let me tell you a story of a little company called the Dexter Corporation in Connecticut. The Dexter Corporation makes specialty materials and paper products, paints airplanes, coats cans, and produces plastic and high-tech resins. In 1990, they were fined $20 million for polluting the Connecticut River by the release of toxic elements into the river from their paper non-woven fabric factory.

I would characterize them as typical of what was happening just around 1990s, adversarial, negative on the environment: if we get caught, the penalties are not going to be that high. Well, $20 million off the bottom line was quite a wake-up call for a small company with sales less than a billion dollars. What they did was instead of saying we are going to fight this and well, okay, we will improve this plant, they took on a complete proactive stance.

They hired a health safety environment officer, set up a committee of the board to indicate how they could become proactive rather than an enemy of the environment. As a result, they set up standards that led them to exceed all the requirements for emissions on all their waste products below the national standards. They also developed a new product development process which led to some new products, for example, a low-toxicity paint system for painting large jet airplanes, which was one core part of their business.

As a result of that innovation, they have been able to increase their market share substantially and increase their profitability. But it meant new technology and high density, new training procedures, new application procedures which had to be standardized and certified at Boeing and other companies. They developed the water-based coating for the inside of cans rather than an earlier, more toxic form. So they actually were making more money after the proactive environmental stance than before.

They are continuing to set goals to exceed the standards and are trying to position themselves as a positive environment firm. In fact, last year they were given an award by the Connecticut EPA as an outstanding firm in Connecticut with respect to the environment. So it really shows even for a little company that you are seeing tremendous transformation from adversarial to proactive.

DuPont, again, could be an example, and we could talk about for a long time. They define themselves as moving from compliance to trust and sustainability. Compliance is where they were in the old days. They got rid of the CFCs.

Trust is a step where not only the government but also the people trust DuPont as a positive participant in the process. Sustainability would be the complete clean technologies, reduction in consumption role of DuPont as a complete sustainability company. You may know DuPont was a pioneer of the Chemical Manufacturers' Association with the responsible care initiatives, and they would say that fits somewhere between compliance and trust. Their long-run view in this sustainability is a partnership with nature.

General Motors would be another example, with its electric vehicle program. Even though it is quite clear to most people in the industry that the California regulations on electric vehicles are going to erode and perhaps go away, GM has retained its commitment to the electric vehicle program, putting in upwards of a billion dollars, with no sales results yet, to produce a car that is 80% recyclable, electric-vehicle clean, and is now offering that car in California, the EV-1, and they were also a series signer.

These precursors are not restricted just to the U.S. In Thailand, for example, Siam Cement makes more than cement. They are one of large diversified companies that has defined themselves to a commitment to a greener, safer world, and they back that up by going to water recycling, air scrubbing, reforestation that vastly exceeds the requirements of the government.

Transitions to Optimistic Results
So these kinds of precursors would kind of suggest that at least there are some examples that indicate business is making this transition towards the longer run, towards our more optimistic case. Of course there is one precursor on the partnership and natural dialoging between industry in Sweden. The Natural Step system had very heavy industry support: Electrolux, for example, is designing a cleaning apparatus that will be completely recyclable; and unbleached paper products; and new retailing and packaging methods. That case was based on a dialogue where the companies along with customers and farmers and national municipalities led to what I think could be a precursor on national dialogues about "how to cope" with the issues of sustainability.

So it is encouraging that we have some positive aspects here. If this in fact goes on, then what we could look for over the next ten to fifteen years is that business would be active participants in a potential partnership in that we would have our proactive companies going beyond the restraints, looking at incentives, looking for flexible regulations, perhaps output-based regulations, allowing the companies various ways to achieve those goals, agreed-upon consensus of goals to get to particular global levels, global standards, and basically a responsibility for the long run.

To back that up, we need high consumer demand. One of the things when we look at business and their role is that we have to realize that business is basically driven by the customer. It is critically important that the customer develop attitudes and preferences toward products that are sustainable.

As important as trying to push business to take actions, equally important in this system is to educate customers and make them active components, because business does listen to them. Total quality customer satisfaction are the key components of listening to your customer.

Universities of course have a big role to play, and I think you have had a chance over this conference to see some of the specifics of the MIT role. We have many initiatives in place here from global sustainability to climate change. This might be a good point to indicate that the Sloan School itself has a component program on global warming, particularly the economic effects and feedback of global warming policies. We have a Center for Energy and Environmental Policy, and our Learning Center has just begun a new program on sustainability. So it is important not only that we develop technology but also give people a leadership profile in all fields of how they can react to the environment and train people in policy interaction.

The government, for their part, needs to step up and move away from the kind of adversarial, regulatory constraint view and look more for constraints as minimums and try to participate with the community to develop incentives and flexible regulations that lead to the achievement of a consensus of shared goals. Most of the record on enforcement of strict government regulations is not very good. Without an attitude of cooperative agreement on where we are going, it is very difficult. So we see a lot more negotiated goals and a lot more incentives.

Well, you may ask, who is this guy Urban? What an optimist. I guess I am.

I tend to feel we have some good trends in place and I think we will see some more enlightened management. But I do not want to be too naive. I think there will still be a lot of stockholder dominance driving companies towards quarterly returns. Leadership companies are consistently going to have to sell the fact that their long-term vision is the long-term success for their stockholders, not the quarterly results.

Carrot and Stick
I am not so naive to think that all businesses are going to be like our precursors. There will be some who violate. We do need a carrot and a stick policy. We really have to have effective regulation, and I think you will see the leadership companies supporting that. The leadership companies want a level playing field where the sustainable product will give them a competitive advantage. They do not want someone out there low-cost polluting that destroys their attempts to create positive, sustainable products.

Consumer Pays? 
Another concern obviously is: Will the customers pay? In a lot of products, in fact a sustainable product can be less expensive by substitution of materials, better production. We may actually be able to lower costs, but that is not going to be true for all of them. If you look at the electric vehicle program, for example, the electric vehicle EV-1 being sold in California will probably be around $30,000. Except for the environmental impact, it will be functionally equivalent to a car you could buy for about $15,000. How many people will pay that premium? Then how do you bootstrap this so you can get to enough markets so the $30,000 comes down to the $15,000? Well the answer is to build market, to build new technologies in batteries, to build the systems to encourage customers to want to step up to the environmental side of the equation.

Beyond Management
Lastly, I think, although I have given kind of an upbeat view of what management would like to do, there are some problems that are much larger than management. Obviously a key one of those is population growth and the aspiration of people worldwide to consume.

When I was in India in 1970, I was at the Indian School of Management in Calcutta, and there were about 450 million people at that time. I was doing marketing in family planning. I was recently there last summer, and now there are 960 million people in India today. Now those people have aspirations and legitimate rights to a standard of living worldwide. How are we going to cope with the growth in consumption that is going to occur there?

At the same time, the developing world is consuming many resources. So with the equity issues, the political issues, obviously technology change is important, but will it happen fast enough to overcome the dramatic increase in the populations and the standards of living? Those areas are the ones with the eight to ten percent growth rates, and much of the eight to ten percent growth is coming in consumption that is not clean technologies and sustainable products.

I indicated that there may be a short-run surplus in oil, but it is hard for any of us in the long run to believe that we are not going to run out of these non-renewable resources.

Cautious Optimism
So I guess I would say that I am cautiously optimistic, and I would conclude that I definitely see a very strong trend among the leadership companies towards seeing business as proactive. I believe that business will be increasingly interested in being a partner in a dialog to achieve global sustainability.

Wallace R. Baker

Thank you very much, Dean Urban, for that comprehensive and focused speech. Now we turn to Hugh Faulkner who is Executive Chairman, Sustainable Project Management. Mr. Faulkner has had a distinguished career as a member of Parliament in Canada. He was also Executive Director of the Business Council for Sustainable Development, a business organization which has led the way in sustainable development in the private sector.


Action to Mobilize Investments via Public-Private Partnerships
J. Hugh Faulkner P.C. 
Executive Chairman, Sustainable Project Management

Yesterday there was an interesting discussion about whether or not we had made any progress since Rio. Reflecting on that last night, I remembered, and some of our guests outside the United States realized, that about 400 years ago this land came out of the jurisdiction of the Great Law of the Iroquois Confederacy. That was a confederacy of five indigenous tribes, and there was a provision in the Great Law. It reads like this:

"In our every deliberation, we must consider the impact of our decisions on the next seven generations."

When one thinks about that, one cannot be wildly optimistic about the degree of progress we have made in the last 400 years.

Background
Now what I have got to do today, what I have been asked to do, is touch on a specific initiative in the area of public-private partnerships. I represent here today the Sustainable Project Management, which we will call SPM. It was a spin-off of the Business Council for Sustainable Development, which was created in 1991 at the instigation of Maurice Strong to provide an industry business input into the Rio conference. We produced a report. It was called Changing CourseA copy is outside.

Two Concepts
It had, amongst other things, two important concepts. One was the new concept of eco-efficiency, which was a word that did not exist in the English language before, which basically means adding value to a product and service while minimizing resource input and eliminating pollution or minimizing pollution. The other concept was the concept of technology cooperation, as opposed to the concept that was being developed by the UN system at the time, called technology transfer.

In 1994, the SPM was formed by the Business Council post-Rio in conjunction with the UNDP. It was a collaboration, and in 1995 we were spun off to demonstrate how concepts like eco-efficiency and technology cooperation could be built into viable business projects.

Goals
The purpose of these public-private partnerships (let me just come back for a second) was to focus on public-private partnerships as a vehicle for transferring, developing movement of technology plus mobilizing private sector finance. We also decided to focus a bit on the urban environmental issues, urban environmental services in the developing world, basically water, waste, and energy.

Our objective was to try and turn some of these development problems in urban areas into viable businesses, joint ventures, but we were focused particularly on some of the small and medium-sized types of projects. The larger projects, $200-$300 million would generate their own commercial and political interests. It is the smaller projects that need attention, and there are a lot more of those than the larger ones.

Logic
Why public-private partnerships? Yesterday we heard the stronger argument that in fact in the world today, development assistance (i.e., ODA monies) is declining, and private sector capital flows are expanding.

It seems to me that therefore the challenge is trying to use diminishing ODA flows far more strategically than we have heretofore, and one of the strategic options appears to be to work with the private sector. That is the origin of the partnership concept.

Leveraging
In that process, leverage private sector investment to try to meet some of the broader development goals of governments. In other words, leverage them to try to achieve some of your development goals as opposed to trying to achieve it through traditional aid flows.

That is the first argument for these partnerships. It is a way of bringing together these two constituencies.

Alternative to Privatization
A second argument is that is an alternative from privatization. Privatization is an option. In some places it may not be the best option. There is a case to be made for encouraging public sector involvement in the project. It does reduce some of the political risk, particularly for smaller projects, and it maintains the public sector's involvement and concern for the broader questions of the public good. The public-private partnerships are also an alternative to the traditional delivery of municipal services through public-owned monopolies.

We know the problems of these in every developing country, indeed in some of the developed world: lack of technology, lack of finance, lack of management. Those are the precise skills that the private sector can bring to bear. But you have to get them in as investors, not just simply equipment of suppliers.

Building Bridges
The third argument for public-private partnerships in our view is that they are indeed not easy to make work. But when they do, they are very effective. Let us not minimize the difficulty of this innovation. But they do tend to build bridges. I happened to have spent part of my career in public life, as I think the Chairman pointed out, and the other part of my career in business. These are two separate cultures, and building bridges between these two cultures is not self-evident. But if you start off by trying to become partners, you have to come to grips with both some of the constraints and indeed some of the opportunities.

In our judgment, it facilitates negotiation and contractual arrangements, which are always part of any business deal. We think, in fact, it becomes an instrument of platform, if you like, for policy reform. If you are sitting around the table with your public-sector partner and you try to explain to them why you cannot proceed with this water recycling plant unless you have a user fee built into it to build your cash flow, so they begin to see policy reform in the light of something real and reasonable that will happen.

I think it improves risk management for smaller projects, and for the smaller projects it reduces project development cost because there is a high level of replication.

Methodology and Examples
Let me quickly touch on our methodology just to illustrate, and it is a bit complicated so I will not go over it in detail. There are four phases when we develop a project. I want to cite two or three key points here.

Phase one, this phase here, is really where public sector money is involved. It is seed money. It is low cost. It is a small element of the total cost of the project. It is in there that we do the pre-feasibility.

We check out whether the political will is there within the municipality, for instance, etc. We create at this point in time, if all the elements are there and it appears to be a viable project, what is called a project development company (we have entity there). That really is to get the partners to the deal to sign on.

You will see in the two cases that I am going to give you how that is critical to the step forward.

One is East Europe, where the shareholding structure is creating this new, if you like, project development company, in which the city became a partner. That in turn becomes the vehicle for these other sorts of businesses which they were (jointly) going to get into.

What happened is that project development company brought in EDS, which is a subsidiary of Tractor Bel, a large Belgium company. They came with 55%. A French company came with 20%, they are an equipment supplier, creating a new company called EMCO BEL, and its first business is the district heating system.

EMCO has a five percent share; those are the employees I think or some of the employees of the old district heating company which has now been refigured, regenerated by this new EMCO BEL, so the old company shareholders are now shareholders in the new one. There are some of the features of it. The new company will manage the district heating. They have a 25-year cost plus contract, and if you want to hear an interesting story: How did you negotiate a 25-year cost plus contract, but that is the condition precedent of getting the company going and getting the investors in. The municipality retains the ownership of the assets, etc., etc. But that is another model of a public-private partnership.

Those are two examples of the public-private partnership in the urban environmental service area. We are also doing other things. There is a very interesting new business we are developing, and that is capacity-building centers. I do not have time to do that apparently, but if any of you are interested in it, there is a very interesting approach to capacity-building. It is making the people whose capacity is being built shareholders in the training process itself. I can explain to those of you who are interested how it works. We have two projects developing, one in Vietnam and one in Colombia. I think it is one of the really new and radically interesting approaches to capacity-building.

The new thing we do is the Indian Microenterprise Development Fund in New Delhi. We have discovered that if you are really talking about sustainability in the developing world, unless you can find an instrument for help financing the small and microscale and a system financing that encourages them to move sustainably, it is not going to happen.

So that is what SPM does. We do it in partnership with the UNDP, and let us give them marks. They have got a lot of flak, but they have been great partners of ours and they have been very helpful and I would like to acknowledge it publicly. That is what we do.

May I just say as a last word: Thank Nazli very much because she has been an important bridge between some of us in the private sector and institutions like MIT and others, and I think that is going to be critical to the future. Thanks very much.

Wallace R. Baker

Our next speaker is Norio Yamamoto. He has a Ph.D. in Communications Engineering. He is Research Director for Mitsubishi Research Institute, and perhaps more importantly he is Managing Director and Secretary General of the Global Infrastructure Fund, GIF, a research foundation in Japan. This organization and he have been active in promoting global infrastructure projects such as environmental rehabilitation of the Ural Sea and water resource development in the eastern Himalayan region.


Meeting the Demand for Global Infrastructure Requirements
Norio Yamamoto
Managing Director and Secretary General, Global Infrastructure Fund (GIF) Research Foundation, Japan

Professor Nazli Choucri gave me an assignment to make a presentation of "Meeting the Demand for Global Infrastructure Requirements." My remarks are from a private sector perspective.

Background
About 20 years ago in 1977, the late Mr. Nakashima, Chairman of Mitsubishi Research Institute of that time, a good friend of Mr. Maurice Strong, launched the proposition named Global Infrastructure Fund for sustainable development of the global community by making use of the peace dividend based on the idea of the globalism and of the expectation of the termination of the East and West confrontation. Say, if we could have $500 billion in cash now, what do we do for the future of all humankind? This was the question.

The idea resulted in an investment into infrastructure as a confidence-building project for a global committee to stimulate the mind of entrepreneurs to think about the future of mankind for sustainable development aiming at the coming 21st Century. This was the idea. In 1992, we gathered at Rio with the expectation of a peace dividend in our minds, but of course the situation was somewhat different. Rio, though various efforts have been made, unfortunately has not generated as much in the way of results as previously expected.

Demand for Infrastructure
I would like to talk about the factors that shape the demand for infrastructure in relation to sustainable development.

Economic Growth
The first one is of course rapid economic growth. For example, we have seen a rapid increase of population in Asia and also in the rest of the world, and we have seen rapid growth in the economy in Asia, particularly China and the Indian sub-continent.

Population Growth
Rapid expansion of population leads to food shortage as well as energy and water resources -- as predicted recently by Dr. Lester Brown. But this trend is apparent not only in Asia but also the rest of the developing countries of the world, as all of you know. The demand for large-scale investment infrastructure -- for instance, in Asia, say, from now until the end of the year of 2010 and in the rest of the developing countries -- should be fulfilled as soon as possible. Otherwise we are going to go beyond the point of no return.

GIF Case
I would like to describe our typical effort to devise an effective strategy in the area of infrastructure development for sustainable development, especially related to activity with GIF from now.

Ural Sea
The fourth largest inland sea has dried up and is going to disappear in central Asia due to the failure of management of water resources at the cost of environment and human resources. The former Soviet Union jumped up to the second largest cotton producer in the world, especially for the production of military uniforms. Inhabitants are suffering from one of the lowest life averages in the world. As a typically infrastructure-related failure of design and planning and operation, we have been studying and supporting the possibility of the rehabilitation of the dried-up sea since 1990.

We encouraged the local government and facilitated the establishment of the local organization interstate council of the Ural Sea, and also an interstate fund for the Ural Sea. We had expected this institution and organization to become counterparts to communicate with each other and receiving this support from the rest of the international committee for rehabilitation. But what resulted was somewhat different from our expectation. We have not reached even yet a definition and a consensus for what rehabilitation of the Ural Sea is and what action is needed.

There are three countries upstream of the two rivers pouring into the Ural Sea; people use more water for their own welfare, and so there is less water for the sea. We will have to find the way how to pay the cost of the negative heritage or legacy of the command economy as we make a transition to the global community. So the question is: Do we need the Ural Sea from the global point of view or not? Yes or no? But one thing is very clear, the Ural Sea is still dying.

Euro-Asian Continental Bridge
On another subject, we at GIF, in cooperation with our German friends, started the Euro-Asian Continental Bridge Initiative in Berlin in 1993. The idea is the design of a transportation system for efficient management of the united continent called Euro-Asia.

One of the most expensive transportation systems from the point of systemic development is the Euro-Asian Continental Bridge Railway System, which will link the fast-growing East with the West through deep, untapped central Asia.

For example, in April of this year, 1996, in China, the agreement signed by leaders of the neighboring countries tells us to withdraw our military force from the sensitive area, away from the border, and suggests a joint effort to develop infrastructure for mutual interest such as a gas pipeline for natural gas. The Chinese government and the Worldbridge Foundation of Hong Kong and Taiwan have an idea to construct a new artificial city called Cities of Hope in the so-called new demilitarized area along the border.

Greater Basin Development
So this kind of initiative is going on and also the next one related to the new development which we are promoting. It is the Greater Basin Development among the so-called Asian Ten Countries with the support of the United States, Korea, and Japan. The new railway of this region will be also linked to the track line of the Euro-Asian Continental Bridge. The Asian Ten includes Thailand, Vietnam, Cambodia, Laos, Indonesia, Malaysia, the Philippines, Burma, Singapore, and others. Our friend, Mr. Chuck Lankester of UNDP, who was with us yesterday, made a tremendous effort for this program in the past.

South American River Basin
The next one is the South American River Basin System. We also are studying ways of promoting the development of the river basin in South America such as for original sustainable development. This concept was integrated and elaborated into the South American River Basin System by our friend at MIT, Professor Moavenzadeh, and also Professor David Marks.

Next Fall, in Bogota, our Colombian and Brazilian friends, with support from MIT and GIF, Japan, will organize the inaugural meeting for the long-standing institution. Also yesterday we had the Minister Lorenzo from Colombia with us. He is one of the organizers of the Bogota conference. We are doing other experimental projects which will be accelerated if our Euro-Asia Continental Bridge is completed.

Nepal Water Resource Development
The last, most important, project which we are promoting is, as the Chairman of this Session noted with my introduction, the Nepal Water Resource Development. We have come to a successful consensus-building among our friends of India, Bangladesh, and Nepal since 1985. Of course, this was with support from our friend Professor Moavenzadeh and also Professor Oldman of Harvard.

One of the successful outcomes was the river basin development agreement for hydroelectricity integration and water management between Nepal and India in 1996 (this year in February). Also it was appreciated from this concept that hydroelectricity development is essential for the economic sustainable growth of such a country as Nepal with untapped, huge resources. Today we have our friend from Nepal, Dr. Vaidya, with us and he is one of the supporters of this project.

Finance and Support
So, finally I would like to turn to new trends of financing and support. ODA budget is reduced in almost every donor country, and the condition of environmental ODA approval makes the decision-making process more complex and costly for recipient countries. Better capacity-building efforts between recipient and donors are more frequently and intensively needed.

We at GIF are doing capacity-building in relation to infrastructure policy development. So, again we have been collaborating with our colleagues at MIT and Harvard, in Katmandu and Dacca, and in New Delhi. Also, so many members of international organizations, as global citizens, participate in our activities. Mrs. Elizabeth Dowdeswell kindly contributed to our gatherings in the Indian subcontinent several times in the past and has encouraged us lately.

At present private investment into the infrastructure of developing countries are getting popular especially in Asia.

As the Chinese government says they will welcome foreign investment into their infrastructure project, we hope this trend will facilitate and accelerate the development of infrastructure for sustainability.

The type of financing, of course, is co-financing, joining with financing from various funding sources and including, we hope, the peace dividend as a funding source.

Funding Mechanism
If we look at the future from the long-term point of view, we may now need a global infrastructure funding mechanism for sustainable development.

Further integrated approach is needed to promote infrastructure for sustainable development. This must be done under the framework of global cooperation.

Thank you very much.

Wallace R. Baker

Our next speaker is Heinrich Siegmann, who is Vice President of the Union Bank of Switzerland (UBS). He is the Chief Political Analyst and Head of Economic Research Emerging Markets. He is no stranger to MIT, since he got his Ph.D. here, and he has also studied computer science.


How Financial Signals Reflect Political and Economic Conditions and Crises
Heinrich Siegmann
Chief Political Analyst and Head of Economic Research Emerging Markets, Union Bank of Switzerland (UBS)

Thank you very much, Mr. Chairman. Let me, just for the record, preface that what I am saying here is basically my point of view and not necessarily that of UBS.

Four Key Points
I want to make four points in this talk:

First, the financial signals exist; and in the long run we believe that they fairly accurately reflect economic and political conditions in the country we are talking about.

Second, we do have a trend towards more markets. It has been commented upon repeatedly yesterday and today and we believe that the fact that there are more market factors in force actually makes for better, for more continuous, for more empirically based signals to look after.

Third, the financial community has been observing these signals and is probably more and more observing and heeding these signals.

Fourth, and this might not come as a surprise, as far as sustainable development is concerned, these signals do not yet really reflect what in terms of sustainable development would probably be valued highly. So there still is something to do in terms of, for one thing, education, but also in terms of having markets internalize the concerns of sustainable development.

Long Records
These are the four main points. Let me try in the short time available to substantiate them. Unfortunately, it is a bit more anecdotal than really direct scientific evidence.

Let me go back 2000 years. We have been back 400 years an hour ago or so showing that yes, there have for quite some time been financial signals indicating the perception at least of economic and of political conditions. About 160 years ago, a James Rothschild made a statement to his brother that in times of peace there is a higher value to government bonds than in times of war. We have a risk premium, or we have had a risk premium, based on international conditions early in the last century already.

Financial Indices
There are a variety of signals one can look at, obviously. Coming to mind, first, are stock markets, bond prices, commodity prices, interest rates, things like that. Here, for example, is a 25-year track record of the U.S. stock market index based on Standard & Poor's 500. We did put in a couple of political events occurring during that period.

You can see in the longer run shown here, these political events -- like the Kuwaiti crisis, not the one this week but the one five years ago -- sometimes show up it seems, but over a while if one looks at this general trend, it does not make all that much difference. If markets are perceiving that economic fundamentals are right and that the management practices overall are successful, then you will have sort of a very clear trend which might be intermittently interrupted but not all that much.

If one looks sort of at percentage changes of a monthly basis -- taking account of the fact that for the grand picture that we have seen in the previous light, there is a tendency to neglect percentage changes in the lower parts of the chart -- again, you can see the ups and the downs not so much driven apparently by political events. Federal reserve interest rate decisions, for example, will certainly have a stronger impact many times. But again, this Kuwaiti crisis of five years ago certainly does show a bit.

Emerging Economies
There is a whole literature -- and I will skip through that indicating what findings are -- how the Vietnam and Korean Wars and so forth have been reflected in American stock prices. Let me come to the part that deals more with the emerging countries, which are at the center of interest of this conference. Again, something which I think is a signal is a chart like this one, showing that in the 50-year time frame, it is much, much longer than we usually look at from a bank's perspective.

We see a very clear signal here.

The share of world output is more and more moving in the direction of the developing countries. It just happens to be a coincidence that we seem to be fairly, fairly close to this point here where we had a 50-50 percent situation. But a generation from now we will have two-thirds of world production coming from the developing countries.

This is too obviously the considerably higher growth rates developing countries have been showing for quite some time and will be showing in the foreseeable future. Just a couple of aggregate growth rates according to geographic regions. Here the heavy red line of industrialized countries, and of course what comes to attention is the considerably higher rates in Southeast Asia. Here in Latin America you see more volatility, but overall clearly higher rates than in the industrialized countries on the average. The same is true for the Middle East, for example. So this is the underpinning at least in data terms.

Future to LDCs
Now another signal that has also been repeatedly referred to has a dramatically increasing flow of funds into developing countries. Here we are talking about net flows in the last six years; the absolute flows have about tripled from $80 billion to about $230 billion or so. What is striking here is that the official flows have more or less remained at level here, official grants, official loans. They made up more than half in 1989 and now they are down to perhaps 15-20% today.

So we do see this massive increase of private flows, and within that we do see especially the massive increase of foreign direct investment, which of course makes for much more of a commitment in these countries than if we just look at portfolio flows, which can go in just a few minutes but also come out within a few minutes or maybe days.

Recipients of the flows have been mostly Southeast Asia, to a lesser extent Latin America, and that is the focus of attention.

Interruption from the Floor: Carlos Suarez
Executive Vice President, Ingeniero Qu’mico, Funda■ion Bariloche

But this is not real investment. It is money going to buy an already existing investment ,and this is not the productivity effort made by generations of people in Latin America. I think that you have to cite the real world. These investments are not real. All of these examples are going for these purposes.

Heinrich Siegmann

No, this is not so. There is clearly foreign direct investment occurring in these countries which is bringing, producing something new in these countries. If General Motors built a new plant in a Latin American country, then this is a new investment going into this country, and there are many other instances.

We talk about a complex world, and we talk about investment flows going into many targets and into many different purposes. Some of them might be going along the lines you are suggesting. Certainly many others are bringing something new into these countries. We were talking here about net flows.

I am not here to make any value judgments. I was asked to describe how flows are, at least how my perception or the perception of others in the financial industry indicate and how they respond to such signals. So I think that the answer is that there are signals emanating from these countries which are utilized as main contributors to investment decisions and business decisions. Some of these decisions might be less favorable than others from the point of view of where the investments are happening.

Impacts of Markets
Here is a signal indicating how a variety of developing countries has been treated by the markets in a roughly ten-year time period since the mid- to late seventies and we can see a clear slump of market pricing from something of 70% of nominal value approaching the 30% level, but then in the early 1990s up to today more or less moving upwards, with some interruptions, I grant you that.

Here is part of that, just to exemplify the situation: We have Argentinean bond prices since mid-1994 indicating in particular the effects of the Mexico peso crisis in late 1994, showing that the bond markets in Argentina were reacting fairly significantly to this event. It has recovered since, but this does indicate the reaction of one particular indicator to one particular event.

Just to visualize the amounts of the Mexico peso change in late 1994, and again here in terms of comparison to some of the other currencies in Latin America, we have this major drop of the Mexican peso. Due to the currency pact, we have remained at a constant level for the Argentinean peso and there has also not been too much of a change in Brazil and Chilean currency values, indicating that there is a discriminate few of the markets, two individual country conditions. But it does matter how the economics -- how the politics in these individual countries -- are being perceived by the markets.

Again, the stock market reaction in Argentina following the currency crisis in Mexico. Again, these reactions do matter. Just to show sort of the opposite picture here is a 25-year trend of Hong Kong stock market. Just look at the red line here. We are seeing roughly a twelve-fold, thirteen-fold rise of this market in a nominal scale, again reflecting a perception of great performance of the Hong Kong economy, not really being bothered by the fact that in 1997 Hong Kong will be changing over to Chinese government.

International Rating
Much of what I can refer to is anecdotal material. What banks are looking for (what banks are doing) are ratings by the international community and, more importantly, by organizations like Standard & Poor's and Moody's. Just here, a signal, different kind of signals. This is the rating of various countries by Institutional Investor, which is an outfit that gathers the ratings of various countries from a variety of institutions and averages them out. You can tell here, for example, that the Chinese rating did drop markedly after the event of 1989.

Then moving up again, many other countries are being rated that way just here. The Kuwait crisis bringing Kuwait down markedly after 1990. So Moody's, Standard & Poor's, they have been rating these countries, for quite some time increasing the number of countries being rated dramatically the last ten, fifteen years, showing the need for having these ratings and again the ratings do matter.

Need for New Indices
If I tried to be a lobby for sustainable development, which has to focus its resources, I would try to go to Moody's and Standard & Poor's and educate them that in the long run it certainly does matter how a country is performing, how stable it is politically, economically, and also ecologically.

Internal Rankings
In our ratings which we do internally, this is still marginal but in countries where we think there is a major environmental risk, it is being incorporated. So I think it is picking up, but it certainly is not where it probably should be in the minds of most of the people here.

Wallace R. Baker

Thank you, Mr. Siegmann, for that valuable contribution. Our next panel member is Michael Walsh, who is Senior Vice President, Center for Financial Products Limited. Mr. Walsh has a Ph.D. in Economics and was Senior Economist with the Chicago Board of Trade, where he directed efforts to develop exchange-based environmental markets and directed auctions of sulfur dioxide emissions conducted on behalf of the U.S. Environmental Agency.


Financing Market Mechanisms for Sustainability
Michael J. Walsh 
Senior Vice President, Centre Financial Products Limited

Thank you, Mr. Chairman. Thank you, Professor Choucri, for the kind invitation to participate in this symposium. I am with a small company based in Chicago and New York that has a history of involving itself in the design, implementation, and participating in numerous new exchange-based and over-the-counter markets.

Historically this has ranged from futures contracts on financial instruments, option contracts on energy products, to more recently a shift towards introduction of market mechanisms as a tool for addressing social problems. For example, we have participated in the introduction of insurance futures contracts designed to allow for additional transfer of risk in the property and casualty area as well as the agriculture area.

Re-Insurance
As a primarily re-insurance company, we have a particular interest in the issues associated with climate change. Intersecting with that interest has been our more recent involvement in the introduction of environmental markets that were just mentioned. Those include the recyclable materials exchange that we helped introduce at the Chicago Board of Trade, and most pertinent to this discussion is the trading in the emission entitlements that has gone on here in the United States, which we feel is an outstanding model from which we can base a greenhouse gas emission entitlement trading program. So that is the essence of my presentation.

Context
Let me provide some perspective. As you all know, the Rio Conference helped highlight the need to introduce effective policies to prevent climate change. There was also reference made, particularly in the closing remarks by Mr. Maurice Strong, of the attractions, the benefits of market-based policies for protecting the environment. Throughout the discussions, there was a tone that there needs to be improved, expanded mechanisms for transferring clean, economic development technologies to developing countries.

Emission Trading
It is our feeling that an emission trading program helps solve several of these problems at the same time and is therefore politically more acceptable than all of the alternatives and socially more powerful in achieving many of those objectives. To that end, we intend to help move this issue forward and help introduce a pilot program for trading in greenhouse gas emission reductions.

We believe that the model has been proven and a strong success here in the U.S. both at the national level and at the local and regional level.

One of the primary appeals of an emission credit trading program relative to other market instruments -- which we do feel should be explored, developed, and tested wherever they can -- is,we feel, that you get certainty in reducing the emissions that are believed to contribute to the greenhouse gas problem.

The economic benefit is clearly a lower cost in achieving those reductions in emissions, and there is substantial potential for major side benefits to facilitate clean technology transfers to developing countries. So we think these are strong foundations from which to pursue this issue.

The Model
Now let me address the model. You probably heard a little about emissions trading. I have placed out on the table some studies related to this topic that were prepared by the UN Conference on Trade and Development. We have contributed to some of those reports.

There are many misconceptions as to what an emission trading program means, so let me try to just spell out the elements and clear up some of those misconceptions.

Problem
In the U.S., the problem of sulfur dioxide emissions, primarily from the burning of coal and electric power plants, is thought to contribute to numerous problems throughout the eastern third of the country and Canada. Primarily these problems consist of higher acid levels in streams, lakes, and forest soils; reduced visibility in important scenic areas such as our national parks; direct physical damage to structures; and accelerated corrosion as well as some direct human health concerns.

Property Rights
So to address this problem, a ten-year debate ensued here in the United States and we gravitated to a solution that will require a 50% reduction in overall emissions. So there was some form of consensus that the carrying capacity of the environment would be able to tolerate half of what we had previously been emitting from our power plants which are the dominant source of these emissions. A property rights mechanism was adopted.

Markets
Ronald Coase won his Nobel Prize largely because he said that if you let the market work, society will figure out the most cost effective means to get to the solution that is desired. So allowances, credits, certificates, if you will, were given to each of the power plants that are operating in this country. But they were only given half the certificates compared to their prior emission levels. There were very strict monitoring standards required from each of the power plants. So calibration devices to quantify the amount of pollution that was going into the air are mandated.

This is not the market deciding how much pollution there will be, the free enterprise deciding how to do this -- not at all. This is command-and-control regulation. A 50% emission cut is required. Monitoring is required.

There is no latitude there. The latitude comes in how we get the job done and allowing a flexibility in the market to achieve this at lower costs.

Buying Credits
So at the end of every year, each of the affected power plants has to hold enough of these credits to cover the amount of emissions that have come out of their power plant during that year. Now, if you have higher emissions than the standard, you can buy credits from somebody else. But the only way somebody has credits to sell is if they made an extraordinary emission cut, if they cut their emissions 60% or 70%.

Basic Responsibility
So there is no way out. There is no way to buy your way out of the problem. You are responsible for your emissions, and if you cannot solve the problem within your own company, hire somebody else to do it. That is the essence of this program.

Now, I should emphasize, though, that there is a whole additional layer of environmental regulations that require compliance with local air quality standards. So you cannot get away with it and just buy all the certificates that you want and pollute the air in your local area.

The problem that we are addressing here with the sulfur dioxide program is really a long-distance transport problem where emissions come out of the Midwest and land in the East for the most part. So the local environmental rules remain in force, but the essence, the purpose of this program is to provide for economic savings, and it is documented now that the program costs far less than it would have under traditional regulations.

Market Guiding Choices
What we have instead of the government deciding who and how emission reductions will occur is the market guiding affected firms to the best choice. For example, if the market value of these tradable credits is $100 and your alternatives to reduce emissions would cost you $200/ton then you are better off buying credits, that is, hiring somebody else to do the job. If your cost of controlling emissions is $50/ton and the credits that you can free up sell for $100/ton then you are encouraged to make extra emission cuts and sell those credits, to hire yourself out to another party.

So this is the same way we produce most goods and services in a market economy. Those who can produce it cheapest are encouraged to do more of it. Those who can find a cheaper way to control pollution to protect the environment are rewarded. There is a profit if you can find a better way to protect the environment. That is just the opposite of what we have got now.

There is no reward. There is no financial incentive to reduce carbon dioxide emissions. I say: Let us pay people to do the right thing, and that is what this program does.

Least Cost
So now we have a program where those who can cut emissions cheapest make more of the emission cuts. We have a program that allows for flexibility and innovation. So it is not the government telling people how they must comply with this. It is the private enterprise figuring out what is the cheapest way.

If you want to turn off certain power plants that you used to run more frequently, turn those down and run the cleaner plants more often. If you can come up with a better way to control emissions at lower costs, the market gives you a financial reward. Innovation is a very important concept that we should incentivize.

Now what we have seen is that the cost is far less, perhaps one or two billion dollars per year, to get the emissions down by half, as opposed to four or five billion dollars per year, had a traditional regulatory scheme been applied. First we saw there is the notion that there needs to be a fine if somebody does not hold enough of these certificates at the end of the year. We have to make this fine high enough to make sure that people comply, so that we do not have confrontation. We have people avoiding regulatory conflict. So they set the fine at $2000 figuring that would be high enough, and the government sells some of these allowances at $1500 to make sure there is a ready supply and there is not a problem with monopoly power. In 1990, the industry asked everybody what they thought these credits would go for. How much is it going to cost per ton to clean up the air, and they said $600. The first trades that we saw come out in 1992 and 1993 saw these credits going for $300 per ton, and in the first auction
that we administered at the Chicago Board of Trade, the prices were about $130/ton, and more recently they are in the $60-$80/ton range. So the prices are something like 20% of what honest and engineering studies concluded they would be. The program cost far less. The market worked far better than anybody ever expected.

Added Benefits
There have been additional benefits. Power plants that are affected in the first and biggest part of the program, which is ongoing now, were allowed in 1995 (this is a phased-in program; I have made the story a bit simpler than it really is) in the phased-in program to emit almost 9 million tons per year, but in the first year of the program we see that they have only emitted 5 million tons per year. Now this is not out of the goodness of their hearts.

The credits can be retained and used in later years, but by slowly phasing the program in and allowing for carry forward of these credits, we have actually got earlier action. Incentives for early action I think are something that has been referenced many times in the dialog on greenhouse gas emission reductions. How do we get people to take early action? This program seems to be encouraging that.

Earth Council
So based on the model, Center Financial Products has been working closely with Mr. Strong's organization called the Earth Council, and we are preparing at this time what we have called the Global Environmental Trading System, which has as its purpose the introduction of a program, a pilot program, that tests the concept out and work out the bugs for trading in greenhouse gas emission allowances.

We are working with the Earth Council as the chief sponsor of this program and working extensively with UNCTAD as well. This will be a shareholder organization.

We are trying to leverage private capital and to attract public funding as well and we are just about to formally initiate the fund-raising effort. We are optimistic there based on preliminary responses.

We intend to make this program fully consistent with the parameters and the participation requirements that will arise from the Framework Convention on Climate Change. So we hope that the Framework Convention includes flexibility for groups of countries to work together to find better ways to solve this problem.

What we expect to do in the next two to three years is formalize all the parameters of the program, that is, fund a variety of studies and development initiatives that will identify the rules of the market, the participation guidelines, establish a clearinghouse for trading in these credits, and at the same time work with the Framework Convention on Climate Change to make sure that the parameters of the program comply with the Framework's mandates as may be arising next year out of Kyoto.

One Type of Market Solution
So the point is emissions trading can be one of the various market-based solutions that can fulfill the mandates and goals stated at Rio. Effective programs for preventing climate change and reducing greenhouse gas emissions, utilization of lower-cost tools to get the job done, and provision of secondary and tertiary benefits such as transfer of clear energy technologies to developing countries which have it is thought a comparative advantage at cleaning up the environment and helping the entire globe limit greenhouse gas emissions at lower costs.

GETS
The Global Environment Trading System (GETS) being developed with the Earth Council can, we think, help demonstrate (this is not the final solution) the viability of this approach on a limited scale, five to ten countries perhaps, trading among the countries, the industry participants in those countries, across sectors.

There is no reason to feel that it cannot work for both stationary sources as well as other fuel-consuming processes.

So with that I thank you for your time.


Question from the Floor

I have one question directed to Mr. Walsh. Who fixes the $2000/ton?

Michael J. Walsh

The $2000/ton criteria was put in by the legislation, that is, the U.S. Congress devised this law and required the U.S. Environmental Protection Agency to enforce that law. That was largely put there as a deterrent, and in fact there have been no violations. Nobody wants to pay $2000 (it is actually higher than $2000 -- they scaled it up for inflation) when one can turn around down the street and buy credits for $100. So that fine was put there to encourage the correct behavior, and certainly we have seen the correct behavior arise from the program.

Question from the Floor

This is a question for Dean Urban. It has to do with the leadership of the proactive companies that you described. I make the assumption that the decisions in the interest of sustainability were taken at very high levels, which then leads to the question as to whether you are able to observe any common characteristics of these leaderships beyond the courage and the vision that would be required for these kinds of decision.

Were they all educated at the Sloan School, for example? Were there particular political pressures in the areas where they are located? Was it the nature of their products that made it possible for them to institute these programs, or was it random? Do you find any common characteristics of the leaders?

Glen L. Urban

That is a good question because the people we see doing this are the ones that we would recognize as leaders in all areas of business, so in fact they are the leading edge at Shapiro, at Monsanto, and so forth. I do not think there is any single demographic one. The people who have risen to this level, moving out of this re-engineering world we are in now, are trying to look at their companies and say, how are we going to be successful in the future?

So I think it really is that the people who are rising up are the ones who have the vision, capture the long run, and within that view they have the perspective to see where this is going to fit. I would like to claim we did it, but we are not.

Question from the Floor

This is a question for Mr. Faulkner but was fired by the keynote address. Dean Urban's talk made me think that perhaps the specter that is haunting the market economies is in fact demand deficiency more than anything else. But we know this is not a deficiency in need.

There are billions of people needing clean water, better food, and so forth. It is in fact deficiency in effective demand, which is demand that can be backed up by purchasing power.

I am wondering whether the kind of public-private partnership that you were talking about is perhaps the way to break through that tension in market societies where you have deficient effective demand and yet real needs that are not being met.

J. Hugh Faulkner

Probably -- I am not quite sure. One of the ironies of effective demand is in fact that we deal with smaller projects in big places in poorer areas. The reality of life is that the poorer you are, the more certain you are to pay the bills. That is the credit rating of Gruman Bank. That rural extraordinary success in Bangladesh. Their losses on the boards are marginal, much better than you think in the United States. So in a way, we do not have a problem with effective demand. Even with the poor people, if you really deliver a service, and it is a predictable service and it is costed out reasonably well.

One of the important things about the public-private partnership is that really it is a vehicle for negotiating some of those other elements of cash flow, such as the user fee. There has got to be a cash flow associated with that.

It is too early to say (we have only been in business for a year-and-a-half), but in all the projects we have got started now, that idea has not been the roadblock. So many institutions, including the World Bank, have always been worried about it.

Question from the Floor

I have a question for Mr. Walsh and that is could you tell us a little bit more about the GETS, Global Environmental Trading System? Is it very much parallel to the system within the United States or is it something different?

Because when I think of that kind of profile, I do not know if anyone here has seen it, but he talks about a much larger scale program where countries like the U.S. or Canada that produce lots of greenhouse gas emissions actually do a technology transfer to the poor countries, so that the result is that each country has a certain so-called "win-win" position where you get the technology transferred and help the poor countries develop and yet you also get the environment cleaned up.

Michael J. Walsh

That logic is the spirit of our long-run goals, and while we think this is a profound concept, we have to be rather limited in our initial scope because as is obvious from the ongoing negotiations, consensus is literally impossible to achieve. So our objective is to demonstrate the viability of the concept on a manageable scale, and it is hoped that the concept will be proven and found the most attractive for an ideally universal application.

But that is a concept: to set a specific limit on the missions and allow for flexibility and achievement of those limits, but to absolutely be able to enforce those limits. The heart of the program is to develop answers to the questions you helped illuminate. Who will participate? What are the limits? How does one monitor and enforce these rules? How do we tabulate compliance with the program?

So while we think it has all been done before now, we are not recreating the wheel. It is nevertheless a significantly broad concept, and for that reason a limited participation base which ideally expands to a comprehensive base is our objective.

It took us two or three hundred years to get to this point of carbon concentrations. We think to take one hundred years to get back is not an unreasonable prospect and probably far less costly to society as a whole.

Now I have to throw in one little line that I always use.

Some people say, well this is a way for the North to pay the way out of the problems or something like that, which is absolutely wrong. There will be responsibility to everybody who is responsible for the current problem. In terms of the importance of cost efficiency, some say, well does that protect somebody's profit margin. Does that mean that folks in the North can drive bigger cars? That is not what we are talking about.

Any resources dedicated to protecting the environment are resources that cannot be dedicated towards other pressing needs like nutrition and housing and health. So it all comes from the same pool of money.

So we are strongly spirited and emotional about this concept of doing it more cost effectively because the environment is not the only topic on the agenda.

Question from the Floor

I guess a question also for Mr. Walsh. It seemed that in the U.S. there was a clear authority, a clear consensus about a need, an agreement, and a willingness to bear the cost, and I just wonder how you would foresee, for instance, the allocation of permits in a global scheme; on what basis that might occur?

How it would affect issues, such as transport, which occur in just billions of individual users? What are the challenges of going from a single authority base to a global one, and how does your pilot program begin to help illuminate this?

Michael J. Walsh

Well, you have just illuminated the questions. Those are the topics that we have to face head on. The allocation scheme, I do not know. We do not have the answer. We know what some of the proposed answers are per capita relative to efficiency, relative to economy. It is impossible to say what the right one is.

That design will critically affect the attractiveness of transferring technologies, I should note, but this is the heart of our development program to try to come up with workable answers. They are not going to be the best. They may be the ones that can work.

Now in terms of addressing, say, emissions from the transport sector, billions of automobiles, there are many points in the "pipeline" where one can impose a requirement to hold credits. It does not have to be at the retail gasoline station. It can be farther up the processing curve. It can be at the big pipeline. Perhaps an oil company has to have the credits each year, and I would hope that they would pass that cost on to their consumers so consumers better recognize the cost that they are imposing on the climate.

So I do not have the answers. We think the model is there. We are sure markets work. Now all the other answers we have to put together over the next few years.

Question from the Floor

I just wanted to say I enjoyed very much all of the presentations, and I have a comment which I would like for Dean Urban maybe to add to. That is, a number of us who work in international organizations are faced with the concern that people express that many of these worthy efforts are probably not enough to deal with what many perceive as a livelihood problem. They say it is like building a house on a second set of assumptions.

Once you thought the ground was firm, you thought it was sandy, you thought it would not get eroded; and then you found out there was a problem, and you start by fixing the roof, and you fix some walls, and you add something to the sewage system, and so on.

Some are saying basically the kinds of problems we are facing in terms of sustainability, given that the business systems that we have were built on a different set of production and consumption patterns that it almost calls for tearing the whole thing down (I do not know how one does that) and starting afresh. How does one counter this and still accept the fact that because of the magnitude of the problem, you feel like it goes beyond just responding to what might be consumer demands for green goods or the effectiveness of government regulations?

Glen L. Urban

That may be tough to respond to. Certainly the problems of the world are complex and big. Look at the interaction of population with resources and economic development and business can make a positive impact, but there are a lot of other things that have to fall in place to get a sustainable environment.

I do not think that tearing down the business system is likely to be a good next step. If anything, the world has moved to a market-based economy, and probably that market-based economy has shifted resources dramatically to the emerging nations.

I do not think voters in the developed world have really realized how much they have given up in terms of real wages and economic benefits as the system has actually worked to transfer substantial resources to the developing, emerging world. So I think there are some positive trends there, but it is only a small piece in the total puzzle of controlling the emissions and sustainable products and population growth.

Comment from the Floor

I wonder if I could make a comment about where we started in this meeting when we were thinking about next year's post-Rio review.

It picks up on a number of points that have been made this morning and yesterday. I was very struck by Jonathan Lash's indication that we are still going downhill fast on every sort of indicator of sustainable development. I ask myself how one might turn that around.

One thing that was extremely interesting this morning was the description of the emissions trading thing. One point in it strikes me as perhaps important for the review next year. That was that it worked because there was certainty. We are in a market economy. There is no point, it seems to me, in pretending we are not or trying to go back, and the other model did not work any better either.

The challenge, it seems to me, is to find ways of enabling the market economy to make the right choices from the point of view of sustainable development. This is where the trading regime is a very interesting though small example. It does seem to me that one of the challenges for the review conference next is in what ways could the world community or individual nations (because some nations can just go ahead and do it) create conditions, create economic frameworks in which the market would choose what is sustainable rather than what is unsustainable.

The trading regime could be extended, obviously, very complicated, to greenhouse gases, but there are many other things that if the review conference were minded to could give certainties to economic operators which would enable them to work out a solution. Suppose, for example, that next year's conference said, right, let us decide as a community of nations that by, let us say, 2025, 50% of energy requirements in all countries -- there would be exceptions obviously -- should be met from renewable sources. The goal is to phase out fossil and phase out nuclear. That is a suppose. That would provide some target. It would be goals.

This is what is interesting, to me, about the trading scheme. There is a goal. There is a clearly mandated goal. It is, as Mr. Walsh said, command and control, but without some guidance from public authorities which cannot escape it, it seems to me their responsibility, without some clear guidance as to where they think the world ought to be going in terms of targets for achievement of sustainability, I do not see how the market can use its skills to respond to them. If it has those guidelines, perhaps it can use its skills, and perhaps, coming back to Mr. Urban's very interesting analysis, we should no longer be relying upon the public-spiritedness of certain major corporations, but they would be able to operate in a condition which facilitates their commitment to sustainability and at the same time profits.

Because after all, in a market economy we cannot expect, we should not expect, private business to do things for love. It does it for profit.

I would hope that out of this meeting could come some sort of challenge to the Review Conference to provide some guidance as to what the goals should be for sustainability that the market could respond to. Thank you.

Comment from the Floor

You kind of took my question in some respect, but I will try to state it a little bit more generally. That is, often when one is studying the environment, people say the market will handle it, and after you look at the way the market is supposed to handle it for a long time, one normally sees environmentally that it does not.

What I hear you saying, Mr. Walsh, is that a properly constructed market can generate environmentally beneficial outcomes.

My question is, would you see yourself being set up for the criticism that you are introducing market imperfections and in some sense you are trying to not let the market handle it in a general laissez-faire sense.

What you are trying to do is set up some middle ground between command and control and a laissez-faire system.

Michael J. Walsh

I think my economics professors would remind us that what we are addressing here is the "missing market." That is, nobody is responsible for protecting the environment in this particular domain. We have been giving away the air. There is no price on it. There is no limit, no budget. Take all that you wish.

So the existing market economies are incomplete, so to speak.

This is not one of these organically arising markets like the wheat market. People wanted wheat and people wanted to grow wheat. This is one that has to be in some sense mandated to internalize the costs that are now external to the market economy, and must be organized. It will not just pop up on its own.

We have to agree on rules, and that is what our mission is here. We view ourselves as helping to more fully complete the existing market economy by providing a market that has been missing.

Question from the Floor

This is a short one but a big one.

I have heard a lot of interesting ideas on doing things to affect greenhouse gas emissions, but the other major problem is the problem of poverty, and some of these things will, as Jonathan Lash said at the beginning, increase social inequity.

Are there some market mechanisms that can be coordinated with these other initiatives that might push us in the direction of better equity instead of going in the direction we are now going?

Glen L. Urban

May I take a quick stab at an answer?

Equity is served if efficiency is present. That is, I would rather have us all pay less to protect the environment so we have more money available for every other issue that needs to be addressed, and conceivably one could propose an emission entitlement scheme where entitlements are given out on a per capita basis. So if you are not emitting any emissions and you have the right to some, suddenly your portfolio is more valuable that it used to be. But I have to confess that this is not primarily an "equity-driven" concept.

It is an efficiency-driven concept. Now I have to leave the challenging equity questions and poverty questions to others, but we think this is not a harmful program. It could be helpful.

Question from the Floor

I have the last one: It is again to Mr. Walsh, and I think the number of questions asked to you show how high on the agenda the question of emission trading is for the time being. It definitely is in the climate change negotiations.

I think the concept has a lot of benefit and attraction and it seems to work in the SO2 area in the United States. But we are all aware -- and it has become clear with some of the questions -- that it will become much more difficult and complex for the greenhouse gases. If you include the other greenhouse gases, it gets even more complicated.

At the same time, the ideas that we heard so far are always that we should establish these systems between countries. I wonder if the concept is so good, and I think it has a lot of potential. Why doesn't one start to think about establishing it in one country, for example in the U.S.?

The U.S. is a huge market. Why not establish such a system first to implement the international commitment that a country like the U.S. and any other industrialized country, for example, has under or will have under the Climate Convention.

I am aware that the cost benefit or the situation might be better if you include developing countries, but it will be very difficult to get their agreement and that should not prevent us from testing the concept maybe at home.

Michael J. Walsh

There are discussions here in the US to try to initiate such a domestic program, but ultimately this is an international, global issue. Since we cannot solve the negotiation problem comprehensively to start off, let us try it on a limited basis. So issues of trade problems, border problems, different accounting, tax, legal and regulatory schemes, currency problems. The list is a very long one.

We have to start somewhere ,and limiting to a domestic program would not touch on those difficult issues. We have to start to address those difficult issues because if we are ever going to get this to work on a broad basis, it has to be a global one.

The reason we want it to be broad as opposed to a bunch of internal domestic programs is for the opportunity for cost savings and technology transfer. That is the whole idea that there are cost advantages in certain locations and clean, new generation technologies can be shifted to those developing economies that have the needs and the opportunities. So it has got to be an international program. We cannot do a comprehensive one to start, so we will start on a limited basis.

Wallace R. Baker

Thank you very much to our keynote speaker and panel members for their most interesting contribution to this program and to Professor Choucri and MIT for having brought us all together.

 

GSSD Reports

Global Accords for Sustainable Development:
Enabling Technologies and Links to Finance and Legal Institutions

Session 6: Finance and New Institutional Mechanisms


Chair: Wallace R. Baker
Senior Partner, Baker & McKenzie, Paris

Good morning, Ladies and Gentlemen.

Baker & McKenzie is a firm with an environmental practice in many countries. The reason why Baker & McKenzie appreciates the honor of co-sponsoring this conference is that we believe it will be enormously important that the private sector businesses and their lawyers should make maximum efforts to solve the seemingly intractable problems of finding transitions to sustainability. We hope that we can make the rules more user-friendly, and cost effective.

Instability
I refer to the many problems as intractable because solutions often, but not always, cost money and run counter to the primary objectives of most businesses -- which is making profit, and often the objective is short-term profit. Building into our economic system financial incentives is one possible solution to this obstacle. Other obstacles include deeply held beliefs in absolute property rights, lifestyles, and consumption patterns that are not sustainable.

What I am talking about is illustrated in the very interesting graphic analysis of sustainable development called the Global System for Sustainable Development (GSSD), which you heard about in Session 5, which Professor Choucri and others at MIT are perfecting. The center portion describes the core problem, i.e., "Interactions of Population Dynamics, Technological Change, Resource Utilization Reinforced by Prevailing Values, and Production and Consumption Generate Pressures on Life Supports."

Two Quotes
On the subject of property rights (prevailing values), a 1993 case decided in Texas eloquently describes the problem. The defendant, Marinus Van Leuzen, knowingly violated environmental laws by building a house on wetlands in the Texas Gulf which he filled with earth and cement, claiming he could do what he wanted to his property. In an unusual opinion, Judge Kent, before ordering Mr. Van Leuzen to restore the land to its original state, started off by quoting two writers. The first wrote:

"Is there nothing about the United States of my youth aside from youth itself that I miss sorely now? There is one thing I miss so much that I can hardly stand it, which is freedom from the certain knowledge that human beings will very soon have made this moist, blue green planet uninhabitable by human beings. There is no stopping us. We will continue to breed like rabbits. We will continue to engage in technological nincompoopery with hideous side effects unforeseen. We will make only token repairs on our cities now collapsing. We will not clean up much of the poisonous mess that we ourselves have made. If flying saucer creatures or angels or whatever were to come in a hundred years, say, and find us gone like the dinosaurs, what might be a good message for humanity to leave for them, maybe carved in big letters on a Grand Canyon wall?

We probably could have saved ourselves, but were too damned lazy to try very hard. 

We might well add this:

And too damn cheap.

So it's curtains not just for me as I grow old. It's curtains for everyone ...."

That is Kurt Vonnegut.

The judge continued to explain the reasons for his opinion with another quote:

"To the earth, a hundred years is nothing. A million years is nothing. This planet lives and breathes on a much vaster scale. We cannot imagine its slow and powerful rhythms, and have not got the humility to try. We have been residents here for a blink of an eye. If we are gone tomorrow, the earth will not miss us ....
..... Let's be clear. The planet is not in jeopardy. We are in jeopardy. We haven't got the power to destroy the planet -- or to save it but we might have the power to save ourselves."

That was written by the author of Jurassic Park, Michael Crichton.

Beyond the Basics
With these two quotes I wanted to inject a little passion and emotion to our discussion, as some of the earlier speakers thought were necessary. I think we should mix reason and emotion. So in summary, we have economic obstacles as well as cultural, traditional, and outdated legal or lifestyle obstacles to overcome.

"Finance and New Institutional Mechanisms," the subject of this morning's session, can provide tools to help us try and overcome these obstacles in order to move closer to sustainable development. I am most anxious to hear what light our keynote speaker and our distinguished panel shed on this most important subject. Our keynote speaker is Glen L. Urban, who is Dean of the prestigious Sloan School of Management. After reading his resume, the only way I know how to describe Dean Urban is that he is a Renaissance man who seems to be able to do everything well. He is an educator, marketing expert, inventor of new methodology to simulate future sales of products, author, sculptor, sailor, and he has started up several successful businesses. His subject is "Management Challenges in the 21st Century: Implications for Sustainability." Dean Urban.


Keynote Address: Management Challenges in the 21st Century: Implications for Sustainability
Glen L. Urban
Dean, Sloan School of Management, MIT

Thanks very much. First thing I wanted to say is though I can do some things, I am not an expert on environmental technologies and I am not an expert on global warming, some of the topics that are here. But I think I can bring to this session, a little perspective about what top management is thinking about around the country.

In my job as Dean, I have a chance to meet with a lot of management audiences and many of the CEOs around the country, so I have a little bit of feeling of the challenges they are facing and their attitudes towards sustainability and environmental policy.

Business Environment
So what I would like to do in this brief 25 minutes this morning is give you a little perspective of what I see as the business environment as it has existed in the 1990s and what is likely to happen in the next ten to fifteen years. What are the conditions businesses will face? What changes will the 21st Century bring for them? I will maintain that in fact management, because of these changes, will have to develop a very new style and that we will see new success factors characterizing companies that we put at the top of the respect pile. After looking at that general management environment, then I would like to spend a few minutes thinking about implications of sustainability of that environment in which business will have to operate.

Retrospective Look
First let us do a little retrospective look at the 1990s and say what it is that has really characterized successful businesses, the businesses that have done the best on the stock market, that have been the most respected in the world. I can list six major driving factors. If a company really meets the top level of all six of these, they are probably very highly correlated with successful business practice in the 1990s.

TQM 
First is total quality management, building products that have no defects which started out as kind of a zero error policy, ISO 9000 standards, but moved quickly on to designing products that met consumer needs, a whole field called quality function deployment, linking engineering to customer needs. Now today, companies practice total quality management as a company philosophy, that every part of the company should run on a total quality principle. So that moves out from production to marketing, finance, public relations, and the environment.

Re-engineering
The second factor is the "leaning-down" of industry, popularly known as re-engineering, where companies have downsized to become more efficient. They have taken out the slack; on the average across companies probably ten percent to fifteen percent of the employees have been cut back, and that has been across all levels, management as well as workforce.

Core Competencies
A third factor has been a focus on their core competencies. Companies are not trying to do everything for everybody. They are saying, we do what we are best at in the world, what few things can we do better than anyone else, and let us concentrate on that, and then we will build partnerships to fill in the rest of the capabilities.

There is a tremendous effort on productivity, things like time-to-market or cycle-time in new products. So you see automobiles going from design to market in half the time they did five years ago; software coming to market in six months; tremendous pressure overlapping in new product development to get products out that meet customer demands.

Globalization
As well, companies have gone global. The world is a factory. The world is the market. No longer can a successful company think of itself as existing in a national boundary. It really sees itself as operating everywhere so it will produce where the costs are lowest. It will sell where the demand is highest and where they can make the highest margins.

Customer Satisfaction
Lastly is a trend to move in on customer satisfaction, which reminds companies that they are in business to serve customers, so they go directly to their customers to measure how well they are doing and they drive their whole business based on that. So Xerox, for example, collects customer satisfaction measures, and the bonuses of all their management are related to those measures, whether you are in production, finance, marketing, or distribution.

If you know a company and they are at the top level of all six parts, I think they would be very successful. One of the things that is perhaps relevant relative to this conference is that environment is not on that list. I do not think in the last five years a kind of positive view to the environment has been an attribute of the successful companies.

Environmental Constraints
Most of the companies in the last ten years have viewed environmental issues more as a constraint, had a more adversarial relationship where they say, well, we will meet those needs or we will try to change the laws. We will try to do the things we can to just get past the legal constraints. You will see I am going to argue that that is going to change in the future; but I think over the past ten years, basically, managements have been more in an adversarial relationship and a reactive view with the environment.

If you look at what is going to happen in the next ten years -- and many of you probably have as good a view of this as I do, and we may want to in the discussion share some views on what is going to happen in the future -- those first six factors are going to be even more important.

Ticket to the 21st Century
In fact, what were success factors in the 1990s are going to be the ticket to admission to the 21st Century -- that is, if you are not making the best quality product at the lowest cost with a focused business strategy concentrating on your customers, you will not even be in the game.

Overcapacity
Most business markets over the next ten years are facing overcapacity. There is more than one-third on average capacity excess in almost every industry, whether that is automobiles, computers. Even in the energy market, people will look at the next five years or so and say that we will have excess on the oil supply side.

Certainly in the long run it will look very different than that, but many of these companies are going to face in the next ten years markets where there is dramatic excess capacity in almost every industry worldwide. That means the competitive intensity will go up. There will be even more push to try to become efficient, to get quality products out, to be successful.

Volatility
As well, I think volatility will go up over the next ten years.

Economic
On the economic side, probably in the developing world, most companies predict that the growth will be very slow and quite flat and that markets will be very saturated. In the U.S. there are now 350 models of automobiles. What is the market for a 351st automobile? So most of these companies are looking at the developing world as a holding action, try to do better there. But the real growth is going to occur in the emerging markets, so if you look at India, China, Indonesia, Malaysia, those are the economies where we are likely to see the five to ten percent real growth rates over the next ten years. So companies are concentrating very heavily on those parts of the world in terms of asset allocation.

Environmental Feedback
I do think also we are going to see in the next ten years some real environmental feedback. I am sure many of you who have been in Bangkok (I was there recently, and I know from talking to GM and other auto companies that they are planning to build big plants there) know that you have a hard time taking a breath, and secondly you have a hard time getting across town to a meeting, which takes one to two hours. You wonder where you are going to put any more cars. A business has to be feeding that feedback. You cannot put a billion dollars into Thailand to produce autos for Southeast Asia and not come to grips with the fact that you are going to have to deal with clean air or you are going to have to deal with transportation systems. In the next ten years, many of the things that maybe in the last ten years businesses might have been able to put on the back side and say we can deal with that later are in fact going to be in our face, and that is going to put a big pressure on companies who are trying to be succe
ssful, as they clearly see the environmental feedback.

Continuing Technological Change
Another change for the 21st century will be the continuing technological change. We look at changes in the information system area, computer costs going down 25% per year, the World Wide Web and Internet, bioengineering, material science, some of the things I am sure you talked about yesterday. So these will be drivers of the change coming up in the next years.

With that it causes me to think a little bit about what management will be doing to be successful. First of all, they are going to be super good at those survival skills, the six factors that worked in the 1990s. But in addition, they are going to have to develop new techniques to manage risk. With the volatility, political, social, economic, companies are going to be scrambling to try to develop risk procedures that allow them to diagnose risks and take actions to overcome them. You can see some of this in the banking system, where today banks will, on a daily basis and sometimes even an hourly basis, review their exposure to fluctuations in foreign exchange and fluctuations in interest rate and readjust their portfolios. That kind of risk management will become common in all business.

Also as you look at the 21st Century, if you want to make profit, which companies do in return for their shareholders, the opportunities are not going to be very large in reducing costs any more and quality will be up at almost its highest level. The profits will come from innovation. They will come from new products, developing new products and services. So organizations will shift dramatically from the downsizing, short-run negative atmosphere of many organizations today to a technology and innovation-driven company if they are going to be successful. They will also become learning companies, companies that can move up the learning curve progressively with the rapid changes so that they are able to adapt effectively with the new opportunities.

Different Management
This means -- in my scenario anyway -- that companies who are successful in the 21st Century will be ones that have much different management. They will be managers that have a longer range view of where they are going, of where the next quarter comes from but then how they are going to succeed over a five- to ten-year period. So they will be the managers who have the vision of where the company fits in not only to the economic system but also to the social political system of the world.

Organizational Form
Finally, we predict that organizations in the future are going to have to reinvent themselves in terms of organizational form. As you go global, you cannot operate effectively with the old hierarchical organization that has characterized business for the last 75 years. I am from the Sloan School of Management, and Alfred P. Sloan invented that paradigm; and in fact I sit behind his desk in my office with some trepidation, but I think Alfred did a great job for 75 years, 1920 until now.

Ten years from now we will look back and we will say, wasn't that a cute form of organization. How did it ever work? Because we will have to be flat, agile, interconnected worldwide organizations to meet the changes and opportunities worldwide.

Worldwide Organizations
You can see some of that going on now where Ford Motor Company has 24-hour design teams building new cars. So they work in Detroit for eight to ten hours, then pass it over to Thailand; they work eight to ten hours, then back to London; and they will get back here having done 24 hours of work. So there is a tremendous interchange of strategy, ideas, and information with teams that will be very agile, very flat-based organizations where teams have responsibilities to carry out specific tasks for the long-run vision.

Two Scenarios
In the panel we may want to discuss other people's vision of this, but for this session, I wanted to say, if this is where we are going and that is what it looks like, then what are the implications for sustainability and environmental policy? I think you can construct two cases here: a pessimistic case and an optimistic case. Let me give you both of those and tell you where I net out and again we may want to have some discussion.

Pessimistic Case
The pessimistic case would say we thought the 1990s were tough and environment was not the top of the list and that was because of cost pressures and short-run pressures. Maybe in fact what will happen is because of this increased intensity of competition, that will get worse, so companies will get even more short-run and more likely to dump waste and do anything they can to cut costs because the only way they can survive is to minimize their cost. That means they would do anything they can get away with.

They will have clean factories maybe in the U.S., where the regulations are high but have dirty production abroad where they can get away with it, where the regulations are not so tough -- maybe just meet the constraints.

If you can get away with violating and it is not enforced, let it happen, and continue the 1990s adversarial government-customer relationships, where we say we cannot do that; we are going to produce a lot; we are going to make a lot of money; the rest of you people worry about the world.

This pessimistic scenario also has a continuing driver of the stock markets and the quarterly returns phenomenon. So if this case is true, business will do nothing and in fact probably do harm to the efforts for environmental policy and sustainability.

Optimistic Case
Now the optimistic case is the following. If in fact the successful company in the next ten years is innovative and has vision and is more long-run, then we may find that this new visionary management and its long-run perspective dramatically changes the kinds of things people did in the 1990s. So we would expect to see companies saying, well we are in the same boat as everybody else. If we are going to produce cars in Thailand, we are going to have to have a proactive policy on the environment. We are going to have to cut our emissions not only because we can become more efficient and save money but also because this is the right thing for the world in which we are going to compete in the long run.

They would be very sensitive to customers' preferences and looking for opportunities where customers are willing to substitute for products that are environmentally responsible or pay a little bit more for a green product. They will be putting a lot of their innovative effort into materials that are more friendly, into creating products that are recyclable, products that customers will view as positive.

They will also be setting up global standards so they will find that if you are an innovative organization, you cannot have a dirty plant in China and a clean plant in the U.S. If you are truly global in this flat, team-based organization, you have to have the same global standards on your ethics, your culture, and if it is high-quality products, you cannot maintain that culture of high quality worldwide if you allow certain parts of the world not to be at that global standard.

In this specific scenario now, we will also be responding to government incentives. In fact, probably you will find these companies trying to work with government to define the regulations and the incentive systems that cause them to take the actions that are best for the world.

So the basic argument here is one of quality of management. It says that correlating activities for high profit and share are also the culture and mentality that is going to cause business to be positive with respect to the environment.

It would suggest in this optimistic case that then we will see business as a dialogue partner with government and consumer groups and other groups working to bring about long range policies that make sense in balancing the very complex equation of economic, political environmental growth.

So the question to each of us is: are you an optimist or a pessimist?

We really did define the extremes here, didn't we? One of the things we may want to have in some of the discussion is some views about where this is. Let me just indicate a couple of precursors, though, that make me feel that we will be a little more toward the optimistic end than the pessimistic end.

Precursors of the Future
For example, look at companies like Monsanto: Monsanto has reinvented itself as a pro-environmental company. Pesticides are being replaced at Monsanto by biogenetic engineering of plant species that are resistant to pests. So they have basically taken their old core chemical technology and gone to a biotech technology and say, our business in the long run is to create new species that do not need pesticides. For the few pesticides they do need -- they have a product called Roundup, for example, which is a pesticide and after exposure to water and sun over time, breaks down into harmless chemicals -- there is no toxic pesticide residue to recycle or do anything. It breaks down completely into natural substances.

Now all these precursors are not the large companies, and I am sure you have heard other ones, 3M and others. Let me tell you a story of a little company called the Dexter Corporation in Connecticut. The Dexter Corporation makes specialty materials and paper products, paints airplanes, coats cans, and produces plastic and high-tech resins. In 1990, they were fined $20 million for polluting the Connecticut River by the release of toxic elements into the river from their paper non-woven fabric factory.

I would characterize them as typical of what was happening just around 1990s, adversarial, negative on the environment: if we get caught, the penalties are not going to be that high. Well, $20 million off the bottom line was quite a wake-up call for a small company with sales less than a billion dollars. What they did was instead of saying we are going to fight this and well, okay, we will improve this plant, they took on a complete proactive stance.

They hired a health safety environment officer, set up a committee of the board to indicate how they could become proactive rather than an enemy of the environment. As a result, they set up standards that led them to exceed all the requirements for emissions on all their waste products below the national standards. They also developed a new product development process which led to some new products, for example, a low-toxicity paint system for painting large jet airplanes, which was one core part of their business.

As a result of that innovation, they have been able to increase their market share substantially and increase their profitability. But it meant new technology and high density, new training procedures, new application procedures which had to be standardized and certified at Boeing and other companies. They developed the water-based coating for the inside of cans rather than an earlier, more toxic form. So they actually were making more money after the proactive environmental stance than before.

They are continuing to set goals to exceed the standards and are trying to position themselves as a positive environment firm. In fact, last year they were given an award by the Connecticut EPA as an outstanding firm in Connecticut with respect to the environment. So it really shows even for a little company that you are seeing tremendous transformation from adversarial to proactive.

DuPont, again, could be an example, and we could talk about for a long time. They define themselves as moving from compliance to trust and sustainability. Compliance is where they were in the old days. They got rid of the CFCs.

Trust is a step where not only the government but also the people trust DuPont as a positive participant in the process. Sustainability would be the complete clean technologies, reduction in consumption role of DuPont as a complete sustainability company. You may know DuPont was a pioneer of the Chemical Manufacturers' Association with the responsible care initiatives, and they would say that fits somewhere between compliance and trust. Their long-run view in this sustainability is a partnership with nature.

General Motors would be another example, with its electric vehicle program. Even though it is quite clear to most people in the industry that the California regulations on electric vehicles are going to erode and perhaps go away, GM has retained its commitment to the electric vehicle program, putting in upwards of a billion dollars, with no sales results yet, to produce a car that is 80% recyclable, electric-vehicle clean, and is now offering that car in California, the EV-1, and they were also a series signer.

These precursors are not restricted just to the U.S. In Thailand, for example, Siam Cement makes more than cement. They are one of large diversified companies that has defined themselves to a commitment to a greener, safer world, and they back that up by going to water recycling, air scrubbing, reforestation that vastly exceeds the requirements of the government.

Transitions to Optimistic Results
So these kinds of precursors would kind of suggest that at least there are some examples that indicate business is making this transition towards the longer run, towards our more optimistic case. Of course there is one precursor on the partnership and natural dialoging between industry in Sweden. The Natural Step system had very heavy industry support: Electrolux, for example, is designing a cleaning apparatus that will be completely recyclable; and unbleached paper products; and new retailing and packaging methods. That case was based on a dialogue where the companies along with customers and farmers and national municipalities led to what I think could be a precursor on national dialogues about "how to cope" with the issues of sustainability.

So it is encouraging that we have some positive aspects here. If this in fact goes on, then what we could look for over the next ten to fifteen years is that business would be active participants in a potential partnership in that we would have our proactive companies going beyond the restraints, looking at incentives, looking for flexible regulations, perhaps output-based regulations, allowing the companies various ways to achieve those goals, agreed-upon consensus of goals to get to particular global levels, global standards, and basically a responsibility for the long run.

To back that up, we need high consumer demand. One of the things when we look at business and their role is that we have to realize that business is basically driven by the customer. It is critically important that the customer develop attitudes and preferences toward products that are sustainable.

As important as trying to push business to take actions, equally important in this system is to educate customers and make them active components, because business does listen to them. Total quality customer satisfaction are the key components of listening to your customer.

Universities of course have a big role to play, and I think you have had a chance over this conference to see some of the specifics of the MIT role. We have many initiatives in place here from global sustainability to climate change. This might be a good point to indicate that the Sloan School itself has a component program on global warming, particularly the economic effects and feedback of global warming policies. We have a Center for Energy and Environmental Policy, and our Learning Center has just begun a new program on sustainability. So it is important not only that we develop technology but also give people a leadership profile in all fields of how they can react to the environment and train people in policy interaction.

The government, for their part, needs to step up and move away from the kind of adversarial, regulatory constraint view and look more for constraints as minimums and try to participate with the community to develop incentives and flexible regulations that lead to the achievement of a consensus of shared goals. Most of the record on enforcement of strict government regulations is not very good. Without an attitude of cooperative agreement on where we are going, it is very difficult. So we see a lot more negotiated goals and a lot more incentives.

Well, you may ask, who is this guy Urban? What an optimist. I guess I am.

I tend to feel we have some good trends in place and I think we will see some more enlightened management. But I do not want to be too naive. I think there will still be a lot of stockholder dominance driving companies towards quarterly returns. Leadership companies are consistently going to have to sell the fact that their long-term vision is the long-term success for their stockholders, not the quarterly results.

Carrot and Stick
I am not so naive to think that all businesses are going to be like our precursors. There will be some who violate. We do need a carrot and a stick policy. We really have to have effective regulation, and I think you will see the leadership companies supporting that. The leadership companies want a level playing field where the sustainable product will give them a competitive advantage. They do not want someone out there low-cost polluting that destroys their attempts to create positive, sustainable products.

Consumer Pays? 
Another concern obviously is: Will the customers pay? In a lot of products, in fact a sustainable product can be less expensive by substitution of materials, better production. We may actually be able to lower costs, but that is not going to be true for all of them. If you look at the electric vehicle program, for example, the electric vehicle EV-1 being sold in California will probably be around $30,000. Except for the environmental impact, it will be functionally equivalent to a car you could buy for about $15,000. How many people will pay that premium? Then how do you bootstrap this so you can get to enough markets so the $30,000 comes down to the $15,000? Well the answer is to build market, to build new technologies in batteries, to build the systems to encourage customers to want to step up to the environmental side of the equation.

Beyond Management
Lastly, I think, although I have given kind of an upbeat view of what management would like to do, there are some problems that are much larger than management. Obviously a key one of those is population growth and the aspiration of people worldwide to consume.

When I was in India in 1970, I was at the Indian School of Management in Calcutta, and there were about 450 million people at that time. I was doing marketing in family planning. I was recently there last summer, and now there are 960 million people in India today. Now those people have aspirations and legitimate rights to a standard of living worldwide. How are we going to cope with the growth in consumption that is going to occur there?

At the same time, the developing world is consuming many resources. So with the equity issues, the political issues, obviously technology change is important, but will it happen fast enough to overcome the dramatic increase in the populations and the standards of living? Those areas are the ones with the eight to ten percent growth rates, and much of the eight to ten percent growth is coming in consumption that is not clean technologies and sustainable products.

I indicated that there may be a short-run surplus in oil, but it is hard for any of us in the long run to believe that we are not going to run out of these non-renewable resources.

Cautious Optimism
So I guess I would say that I am cautiously optimistic, and I would conclude that I definitely see a very strong trend among the leadership companies towards seeing business as proactive. I believe that business will be increasingly interested in being a partner in a dialog to achieve global sustainability.

Wallace R. Baker

Thank you very much, Dean Urban, for that comprehensive and focused speech. Now we turn to Hugh Faulkner who is Executive Chairman, Sustainable Project Management. Mr. Faulkner has had a distinguished career as a member of Parliament in Canada. He was also Executive Director of the Business Council for Sustainable Development, a business organization which has led the way in sustainable development in the private sector.


Action to Mobilize Investments via Public-Private Partnerships
J. Hugh Faulkner P.C. 
Executive Chairman, Sustainable Project Management

Yesterday there was an interesting discussion about whether or not we had made any progress since Rio. Reflecting on that last night, I remembered, and some of our guests outside the United States realized, that about 400 years ago this land came out of the jurisdiction of the Great Law of the Iroquois Confederacy. That was a confederacy of five indigenous tribes, and there was a provision in the Great Law. It reads like this:

"In our every deliberation, we must consider the impact of our decisions on the next seven generations."

When one thinks about that, one cannot be wildly optimistic about the degree of progress we have made in the last 400 years.

Background
Now what I have got to do today, what I have been asked to do, is touch on a specific initiative in the area of public-private partnerships. I represent here today the Sustainable Project Management, which we will call SPM. It was a spin-off of the Business Council for Sustainable Development, which was created in 1991 at the instigation of Maurice Strong to provide an industry business input into the Rio conference. We produced a report. It was called Changing CourseA copy is outside.

Two Concepts
It had, amongst other things, two important concepts. One was the new concept of eco-efficiency, which was a word that did not exist in the English language before, which basically means adding value to a product and service while minimizing resource input and eliminating pollution or minimizing pollution. The other concept was the concept of technology cooperation, as opposed to the concept that was being developed by the UN system at the time, called technology transfer.

In 1994, the SPM was formed by the Business Council post-Rio in conjunction with the UNDP. It was a collaboration, and in 1995 we were spun off to demonstrate how concepts like eco-efficiency and technology cooperation could be built into viable business projects.

Goals
The purpose of these public-private partnerships (let me just come back for a second) was to focus on public-private partnerships as a vehicle for transferring, developing movement of technology plus mobilizing private sector finance. We also decided to focus a bit on the urban environmental issues, urban environmental services in the developing world, basically water, waste, and energy.

Our objective was to try and turn some of these development problems in urban areas into viable businesses, joint ventures, but we were focused particularly on some of the small and medium-sized types of projects. The larger projects, $200-$300 million would generate their own commercial and political interests. It is the smaller projects that need attention, and there are a lot more of those than the larger ones.

Logic
Why public-private partnerships? Yesterday we heard the stronger argument that in fact in the world today, development assistance (i.e., ODA monies) is declining, and private sector capital flows are expanding.

It seems to me that therefore the challenge is trying to use diminishing ODA flows far more strategically than we have heretofore, and one of the strategic options appears to be to work with the private sector. That is the origin of the partnership concept.

Leveraging
In that process, leverage private sector investment to try to meet some of the broader development goals of governments. In other words, leverage them to try to achieve some of your development goals as opposed to trying to achieve it through traditional aid flows.

That is the first argument for these partnerships. It is a way of bringing together these two constituencies.

Alternative to Privatization
A second argument is that is an alternative from privatization. Privatization is an option. In some places it may not be the best option. There is a case to be made for encouraging public sector involvement in the project. It does reduce some of the political risk, particularly for smaller projects, and it maintains the public sector's involvement and concern for the broader questions of the public good. The public-private partnerships are also an alternative to the traditional delivery of municipal services through public-owned monopolies.

We know the problems of these in every developing country, indeed in some of the developed world: lack of technology, lack of finance, lack of management. Those are the precise skills that the private sector can bring to bear. But you have to get them in as investors, not just simply equipment of suppliers.

Building Bridges
The third argument for public-private partnerships in our view is that they are indeed not easy to make work. But when they do, they are very effective. Let us not minimize the difficulty of this innovation. But they do tend to build bridges. I happened to have spent part of my career in public life, as I think the Chairman pointed out, and the other part of my career in business. These are two separate cultures, and building bridges between these two cultures is not self-evident. But if you start off by trying to become partners, you have to come to grips with both some of the constraints and indeed some of the opportunities.

In our judgment, it facilitates negotiation and contractual arrangements, which are always part of any business deal. We think, in fact, it becomes an instrument of platform, if you like, for policy reform. If you are sitting around the table with your public-sector partner and you try to explain to them why you cannot proceed with this water recycling plant unless you have a user fee built into it to build your cash flow, so they begin to see policy reform in the light of something real and reasonable that will happen.

I think it improves risk management for smaller projects, and for the smaller projects it reduces project development cost because there is a high level of replication.

Methodology and Examples
Let me quickly touch on our methodology just to illustrate, and it is a bit complicated so I will not go over it in detail. There are four phases when we develop a project. I want to cite two or three key points here.

Phase one, this phase here, is really where public sector money is involved. It is seed money. It is low cost. It is a small element of the total cost of the project. It is in there that we do the pre-feasibility.

We check out whether the political will is there within the municipality, for instance, etc. We create at this point in time, if all the elements are there and it appears to be a viable project, what is called a project development company (we have entity there). That really is to get the partners to the deal to sign on.

You will see in the two cases that I am going to give you how that is critical to the step forward.

One is East Europe, where the shareholding structure is creating this new, if you like, project development company, in which the city became a partner. That in turn becomes the vehicle for these other sorts of businesses which they were (jointly) going to get into.

What happened is that project development company brought in EDS, which is a subsidiary of Tractor Bel, a large Belgium company. They came with 55%. A French company came with 20%, they are an equipment supplier, creating a new company called EMCO BEL, and its first business is the district heating system.

EMCO has a five percent share; those are the employees I think or some of the employees of the old district heating company which has now been refigured, regenerated by this new EMCO BEL, so the old company shareholders are now shareholders in the new one. There are some of the features of it. The new company will manage the district heating. They have a 25-year cost plus contract, and if you want to hear an interesting story: How did you negotiate a 25-year cost plus contract, but that is the condition precedent of getting the company going and getting the investors in. The municipality retains the ownership of the assets, etc., etc. But that is another model of a public-private partnership.

Those are two examples of the public-private partnership in the urban environmental service area. We are also doing other things. There is a very interesting new business we are developing, and that is capacity-building centers. I do not have time to do that apparently, but if any of you are interested in it, there is a very interesting approach to capacity-building. It is making the people whose capacity is being built shareholders in the training process itself. I can explain to those of you who are interested how it works. We have two projects developing, one in Vietnam and one in Colombia. I think it is one of the really new and radically interesting approaches to capacity-building.

The new thing we do is the Indian Microenterprise Development Fund in New Delhi. We have discovered that if you are really talking about sustainability in the developing world, unless you can find an instrument for help financing the small and microscale and a system financing that encourages them to move sustainably, it is not going to happen.

So that is what SPM does. We do it in partnership with the UNDP, and let us give them marks. They have got a lot of flak, but they have been great partners of ours and they have been very helpful and I would like to acknowledge it publicly. That is what we do.

May I just say as a last word: Thank Nazli very much because she has been an important bridge between some of us in the private sector and institutions like MIT and others, and I think that is going to be critical to the future. Thanks very much.

Wallace R. Baker

Our next speaker is Norio Yamamoto. He has a Ph.D. in Communications Engineering. He is Research Director for Mitsubishi Research Institute, and perhaps more importantly he is Managing Director and Secretary General of the Global Infrastructure Fund, GIF, a research foundation in Japan. This organization and he have been active in promoting global infrastructure projects such as environmental rehabilitation of the Ural Sea and water resource development in the eastern Himalayan region.


Meeting the Demand for Global Infrastructure Requirements
Norio Yamamoto
Managing Director and Secretary General, Global Infrastructure Fund (GIF) Research Foundation, Japan

Professor Nazli Choucri gave me an assignment to make a presentation of "Meeting the Demand for Global Infrastructure Requirements." My remarks are from a private sector perspective.

Background
About 20 years ago in 1977, the late Mr. Nakashima, Chairman of Mitsubishi Research Institute of that time, a good friend of Mr. Maurice Strong, launched the proposition named Global Infrastructure Fund for sustainable development of the global community by making use of the peace dividend based on the idea of the globalism and of the expectation of the termination of the East and West confrontation. Say, if we could have $500 billion in cash now, what do we do for the future of all humankind? This was the question.

The idea resulted in an investment into infrastructure as a confidence-building project for a global committee to stimulate the mind of entrepreneurs to think about the future of mankind for sustainable development aiming at the coming 21st Century. This was the idea. In 1992, we gathered at Rio with the expectation of a peace dividend in our minds, but of course the situation was somewhat different. Rio, though various efforts have been made, unfortunately has not generated as much in the way of results as previously expected.

Demand for Infrastructure
I would like to talk about the factors that shape the demand for infrastructure in relation to sustainable development.

Economic Growth
The first one is of course rapid economic growth. For example, we have seen a rapid increase of population in Asia and also in the rest of the world, and we have seen rapid growth in the economy in Asia, particularly China and the Indian sub-continent.

Population Growth
Rapid expansion of population leads to food shortage as well as energy and water resources -- as predicted recently by Dr. Lester Brown. But this trend is apparent not only in Asia but also the rest of the developing countries of the world, as all of you know. The demand for large-scale investment infrastructure -- for instance, in Asia, say, from now until the end of the year of 2010 and in the rest of the developing countries -- should be fulfilled as soon as possible. Otherwise we are going to go beyond the point of no return.

GIF Case
I would like to describe our typical effort to devise an effective strategy in the area of infrastructure development for sustainable development, especially related to activity with GIF from now.

Ural Sea
The fourth largest inland sea has dried up and is going to disappear in central Asia due to the failure of management of water resources at the cost of environment and human resources. The former Soviet Union jumped up to the second largest cotton producer in the world, especially for the production of military uniforms. Inhabitants are suffering from one of the lowest life averages in the world. As a typically infrastructure-related failure of design and planning and operation, we have been studying and supporting the possibility of the rehabilitation of the dried-up sea since 1990.

We encouraged the local government and facilitated the establishment of the local organization interstate council of the Ural Sea, and also an interstate fund for the Ural Sea. We had expected this institution and organization to become counterparts to communicate with each other and receiving this support from the rest of the international committee for rehabilitation. But what resulted was somewhat different from our expectation. We have not reached even yet a definition and a consensus for what rehabilitation of the Ural Sea is and what action is needed.

There are three countries upstream of the two rivers pouring into the Ural Sea; people use more water for their own welfare, and so there is less water for the sea. We will have to find the way how to pay the cost of the negative heritage or legacy of the command economy as we make a transition to the global community. So the question is: Do we need the Ural Sea from the global point of view or not? Yes or no? But one thing is very clear, the Ural Sea is still dying.

Euro-Asian Continental Bridge
On another subject, we at GIF, in cooperation with our German friends, started the Euro-Asian Continental Bridge Initiative in Berlin in 1993. The idea is the design of a transportation system for efficient management of the united continent called Euro-Asia.

One of the most expensive transportation systems from the point of systemic development is the Euro-Asian Continental Bridge Railway System, which will link the fast-growing East with the West through deep, untapped central Asia.

For example, in April of this year, 1996, in China, the agreement signed by leaders of the neighboring countries tells us to withdraw our military force from the sensitive area, away from the border, and suggests a joint effort to develop infrastructure for mutual interest such as a gas pipeline for natural gas. The Chinese government and the Worldbridge Foundation of Hong Kong and Taiwan have an idea to construct a new artificial city called Cities of Hope in the so-called new demilitarized area along the border.

Greater Basin Development
So this kind of initiative is going on and also the next one related to the new development which we are promoting. It is the Greater Basin Development among the so-called Asian Ten Countries with the support of the United States, Korea, and Japan. The new railway of this region will be also linked to the track line of the Euro-Asian Continental Bridge. The Asian Ten includes Thailand, Vietnam, Cambodia, Laos, Indonesia, Malaysia, the Philippines, Burma, Singapore, and others. Our friend, Mr. Chuck Lankester of UNDP, who was with us yesterday, made a tremendous effort for this program in the past.

South American River Basin
The next one is the South American River Basin System. We also are studying ways of promoting the development of the river basin in South America such as for original sustainable development. This concept was integrated and elaborated into the South American River Basin System by our friend at MIT, Professor Moavenzadeh, and also Professor David Marks.

Next Fall, in Bogota, our Colombian and Brazilian friends, with support from MIT and GIF, Japan, will organize the inaugural meeting for the long-standing institution. Also yesterday we had the Minister Lorenzo from Colombia with us. He is one of the organizers of the Bogota conference. We are doing other experimental projects which will be accelerated if our Euro-Asia Continental Bridge is completed.

Nepal Water Resource Development
The last, most important, project which we are promoting is, as the Chairman of this Session noted with my introduction, the Nepal Water Resource Development. We have come to a successful consensus-building among our friends of India, Bangladesh, and Nepal since 1985. Of course, this was with support from our friend Professor Moavenzadeh and also Professor Oldman of Harvard.

One of the successful outcomes was the river basin development agreement for hydroelectricity integration and water management between Nepal and India in 1996 (this year in February). Also it was appreciated from this concept that hydroelectricity development is essential for the economic sustainable growth of such a country as Nepal with untapped, huge resources. Today we have our friend from Nepal, Dr. Vaidya, with us and he is one of the supporters of this project.

Finance and Support
So, finally I would like to turn to new trends of financing and support. ODA budget is reduced in almost every donor country, and the condition of environmental ODA approval makes the decision-making process more complex and costly for recipient countries. Better capacity-building efforts between recipient and donors are more frequently and intensively needed.

We at GIF are doing capacity-building in relation to infrastructure policy development. So, again we have been collaborating with our colleagues at MIT and Harvard, in Katmandu and Dacca, and in New Delhi. Also, so many members of international organizations, as global citizens, participate in our activities. Mrs. Elizabeth Dowdeswell kindly contributed to our gatherings in the Indian subcontinent several times in the past and has encouraged us lately.

At present private investment into the infrastructure of developing countries are getting popular especially in Asia.

As the Chinese government says they will welcome foreign investment into their infrastructure project, we hope this trend will facilitate and accelerate the development of infrastructure for sustainability.

The type of financing, of course, is co-financing, joining with financing from various funding sources and including, we hope, the peace dividend as a funding source.

Funding Mechanism
If we look at the future from the long-term point of view, we may now need a global infrastructure funding mechanism for sustainable development.

Further integrated approach is needed to promote infrastructure for sustainable development. This must be done under the framework of global cooperation.

Thank you very much.

Wallace R. Baker

Our next speaker is Heinrich Siegmann, who is Vice President of the Union Bank of Switzerland (UBS). He is the Chief Political Analyst and Head of Economic Research Emerging Markets. He is no stranger to MIT, since he got his Ph.D. here, and he has also studied computer science.


How Financial Signals Reflect Political and Economic Conditions and Crises
Heinrich Siegmann
Chief Political Analyst and Head of Economic Research Emerging Markets, Union Bank of Switzerland (UBS)

Thank you very much, Mr. Chairman. Let me, just for the record, preface that what I am saying here is basically my point of view and not necessarily that of UBS.

Four Key Points
I want to make four points in this talk:

First, the financial signals exist; and in the long run we believe that they fairly accurately reflect economic and political conditions in the country we are talking about.

Second, we do have a trend towards more markets. It has been commented upon repeatedly yesterday and today and we believe that the fact that there are more market factors in force actually makes for better, for more continuous, for more empirically based signals to look after.

Third, the financial community has been observing these signals and is probably more and more observing and heeding these signals.

Fourth, and this might not come as a surprise, as far as sustainable development is concerned, these signals do not yet really reflect what in terms of sustainable development would probably be valued highly. So there still is something to do in terms of, for one thing, education, but also in terms of having markets internalize the concerns of sustainable development.

Long Records
These are the four main points. Let me try in the short time available to substantiate them. Unfortunately, it is a bit more anecdotal than really direct scientific evidence.

Let me go back 2000 years. We have been back 400 years an hour ago or so showing that yes, there have for quite some time been financial signals indicating the perception at least of economic and of political conditions. About 160 years ago, a James Rothschild made a statement to his brother that in times of peace there is a higher value to government bonds than in times of war. We have a risk premium, or we have had a risk premium, based on international conditions early in the last century already.

Financial Indices
There are a variety of signals one can look at, obviously. Coming to mind, first, are stock markets, bond prices, commodity prices, interest rates, things like that. Here, for example, is a 25-year track record of the U.S. stock market index based on Standard & Poor's 500. We did put in a couple of political events occurring during that period.

You can see in the longer run shown here, these political events -- like the Kuwaiti crisis, not the one this week but the one five years ago -- sometimes show up it seems, but over a while if one looks at this general trend, it does not make all that much difference. If markets are perceiving that economic fundamentals are right and that the management practices overall are successful, then you will have sort of a very clear trend which might be intermittently interrupted but not all that much.

If one looks sort of at percentage changes of a monthly basis -- taking account of the fact that for the grand picture that we have seen in the previous light, there is a tendency to neglect percentage changes in the lower parts of the chart -- again, you can see the ups and the downs not so much driven apparently by political events. Federal reserve interest rate decisions, for example, will certainly have a stronger impact many times. But again, this Kuwaiti crisis of five years ago certainly does show a bit.

Emerging Economies
There is a whole literature -- and I will skip through that indicating what findings are -- how the Vietnam and Korean Wars and so forth have been reflected in American stock prices. Let me come to the part that deals more with the emerging countries, which are at the center of interest of this conference. Again, something which I think is a signal is a chart like this one, showing that in the 50-year time frame, it is much, much longer than we usually look at from a bank's perspective.

We see a very clear signal here.

The share of world output is more and more moving in the direction of the developing countries. It just happens to be a coincidence that we seem to be fairly, fairly close to this point here where we had a 50-50 percent situation. But a generation from now we will have two-thirds of world production coming from the developing countries.

This is too obviously the considerably higher growth rates developing countries have been showing for quite some time and will be showing in the foreseeable future. Just a couple of aggregate growth rates according to geographic regions. Here the heavy red line of industrialized countries, and of course what comes to attention is the considerably higher rates in Southeast Asia. Here in Latin America you see more volatility, but overall clearly higher rates than in the industrialized countries on the average. The same is true for the Middle East, for example. So this is the underpinning at least in data terms.

Future to LDCs
Now another signal that has also been repeatedly referred to has a dramatically increasing flow of funds into developing countries. Here we are talking about net flows in the last six years; the absolute flows have about tripled from $80 billion to about $230 billion or so. What is striking here is that the official flows have more or less remained at level here, official grants, official loans. They made up more than half in 1989 and now they are down to perhaps 15-20% today.

So we do see this massive increase of private flows, and within that we do see especially the massive increase of foreign direct investment, which of course makes for much more of a commitment in these countries than if we just look at portfolio flows, which can go in just a few minutes but also come out within a few minutes or maybe days.

Recipients of the flows have been mostly Southeast Asia, to a lesser extent Latin America, and that is the focus of attention.

Interruption from the Floor: Carlos Suarez
Executive Vice President, Ingeniero Qu’mico, Funda■ion Bariloche

But this is not real investment. It is money going to buy an already existing investment ,and this is not the productivity effort made by generations of people in Latin America. I think that you have to cite the real world. These investments are not real. All of these examples are going for these purposes.

Heinrich Siegmann

No, this is not so. There is clearly foreign direct investment occurring in these countries which is bringing, producing something new in these countries. If General Motors built a new plant in a Latin American country, then this is a new investment going into this country, and there are many other instances.

We talk about a complex world, and we talk about investment flows going into many targets and into many different purposes. Some of them might be going along the lines you are suggesting. Certainly many others are bringing something new into these countries. We were talking here about net flows.

I am not here to make any value judgments. I was asked to describe how flows are, at least how my perception or the perception of others in the financial industry indicate and how they respond to such signals. So I think that the answer is that there are signals emanating from these countries which are utilized as main contributors to investment decisions and business decisions. Some of these decisions might be less favorable than others from the point of view of where the investments are happening.

Impacts of Markets
Here is a signal indicating how a variety of developing countries has been treated by the markets in a roughly ten-year time period since the mid- to late seventies and we can see a clear slump of market pricing from something of 70% of nominal value approaching the 30% level, but then in the early 1990s up to today more or less moving upwards, with some interruptions, I grant you that.

Here is part of that, just to exemplify the situation: We have Argentinean bond prices since mid-1994 indicating in particular the effects of the Mexico peso crisis in late 1994, showing that the bond markets in Argentina were reacting fairly significantly to this event. It has recovered since, but this does indicate the reaction of one particular indicator to one particular event.

Just to visualize the amounts of the Mexico peso change in late 1994, and again here in terms of comparison to some of the other currencies in Latin America, we have this major drop of the Mexican peso. Due to the currency pact, we have remained at a constant level for the Argentinean peso and there has also not been too much of a change in Brazil and Chilean currency values, indicating that there is a discriminate few of the markets, two individual country conditions. But it does matter how the economics -- how the politics in these individual countries -- are being perceived by the markets.

Again, the stock market reaction in Argentina following the currency crisis in Mexico. Again, these reactions do matter. Just to show sort of the opposite picture here is a 25-year trend of Hong Kong stock market. Just look at the red line here. We are seeing roughly a twelve-fold, thirteen-fold rise of this market in a nominal scale, again reflecting a perception of great performance of the Hong Kong economy, not really being bothered by the fact that in 1997 Hong Kong will be changing over to Chinese government.

International Rating
Much of what I can refer to is anecdotal material. What banks are looking for (what banks are doing) are ratings by the international community and, more importantly, by organizations like Standard & Poor's and Moody's. Just here, a signal, different kind of signals. This is the rating of various countries by Institutional Investor, which is an outfit that gathers the ratings of various countries from a variety of institutions and averages them out. You can tell here, for example, that the Chinese rating did drop markedly after the event of 1989.

Then moving up again, many other countries are being rated that way just here. The Kuwait crisis bringing Kuwait down markedly after 1990. So Moody's, Standard & Poor's, they have been rating these countries, for quite some time increasing the number of countries being rated dramatically the last ten, fifteen years, showing the need for having these ratings and again the ratings do matter.

Need for New Indices
If I tried to be a lobby for sustainable development, which has to focus its resources, I would try to go to Moody's and Standard & Poor's and educate them that in the long run it certainly does matter how a country is performing, how stable it is politically, economically, and also ecologically.

Internal Rankings
In our ratings which we do internally, this is still marginal but in countries where we think there is a major environmental risk, it is being incorporated. So I think it is picking up, but it certainly is not where it probably should be in the minds of most of the people here.

Wallace R. Baker

Thank you, Mr. Siegmann, for that valuable contribution. Our next panel member is Michael Walsh, who is Senior Vice President, Center for Financial Products Limited. Mr. Walsh has a Ph.D. in Economics and was Senior Economist with the Chicago Board of Trade, where he directed efforts to develop exchange-based environmental markets and directed auctions of sulfur dioxide emissions conducted on behalf of the U.S. Environmental Agency.


Financing Market Mechanisms for Sustainability
Michael J. Walsh 
Senior Vice President, Centre Financial Products Limited

Thank you, Mr. Chairman. Thank you, Professor Choucri, for the kind invitation to participate in this symposium. I am with a small company based in Chicago and New York that has a history of involving itself in the design, implementation, and participating in numerous new exchange-based and over-the-counter markets.

Historically this has ranged from futures contracts on financial instruments, option contracts on energy products, to more recently a shift towards introduction of market mechanisms as a tool for addressing social problems. For example, we have participated in the introduction of insurance futures contracts designed to allow for additional transfer of risk in the property and casualty area as well as the agriculture area.

Re-Insurance
As a primarily re-insurance company, we have a particular interest in the issues associated with climate change. Intersecting with that interest has been our more recent involvement in the introduction of environmental markets that were just mentioned. Those include the recyclable materials exchange that we helped introduce at the Chicago Board of Trade, and most pertinent to this discussion is the trading in the emission entitlements that has gone on here in the United States, which we feel is an outstanding model from which we can base a greenhouse gas emission entitlement trading program. So that is the essence of my presentation.

Context
Let me provide some perspective. As you all know, the Rio Conference helped highlight the need to introduce effective policies to prevent climate change. There was also reference made, particularly in the closing remarks by Mr. Maurice Strong, of the attractions, the benefits of market-based policies for protecting the environment. Throughout the discussions, there was a tone that there needs to be improved, expanded mechanisms for transferring clean, economic development technologies to developing countries.

Emission Trading
It is our feeling that an emission trading program helps solve several of these problems at the same time and is therefore politically more acceptable than all of the alternatives and socially more powerful in achieving many of those objectives. To that end, we intend to help move this issue forward and help introduce a pilot program for trading in greenhouse gas emission reductions.

We believe that the model has been proven and a strong success here in the U.S. both at the national level and at the local and regional level.

One of the primary appeals of an emission credit trading program relative to other market instruments -- which we do feel should be explored, developed, and tested wherever they can -- is,we feel, that you get certainty in reducing the emissions that are believed to contribute to the greenhouse gas problem.

The economic benefit is clearly a lower cost in achieving those reductions in emissions, and there is substantial potential for major side benefits to facilitate clean technology transfers to developing countries. So we think these are strong foundations from which to pursue this issue.

The Model
Now let me address the model. You probably heard a little about emissions trading. I have placed out on the table some studies related to this topic that were prepared by the UN Conference on Trade and Development. We have contributed to some of those reports.

There are many misconceptions as to what an emission trading program means, so let me try to just spell out the elements and clear up some of those misconceptions.

Problem
In the U.S., the problem of sulfur dioxide emissions, primarily from the burning of coal and electric power plants, is thought to contribute to numerous problems throughout the eastern third of the country and Canada. Primarily these problems consist of higher acid levels in streams, lakes, and forest soils; reduced visibility in important scenic areas such as our national parks; direct physical damage to structures; and accelerated corrosion as well as some direct human health concerns.

Property Rights
So to address this problem, a ten-year debate ensued here in the United States and we gravitated to a solution that will require a 50% reduction in overall emissions. So there was some form of consensus that the carrying capacity of the environment would be able to tolerate half of what we had previously been emitting from our power plants which are the dominant source of these emissions. A property rights mechanism was adopted.

Markets
Ronald Coase won his Nobel Prize largely because he said that if you let the market work, society will figure out the most cost effective means to get to the solution that is desired. So allowances, credits, certificates, if you will, were given to each of the power plants that are operating in this country. But they were only given half the certificates compared to their prior emission levels. There were very strict monitoring standards required from each of the power plants. So calibration devices to quantify the amount of pollution that was going into the air are mandated.

This is not the market deciding how much pollution there will be, the free enterprise deciding how to do this -- not at all. This is command-and-control regulation. A 50% emission cut is required. Monitoring is required.

There is no latitude there. The latitude comes in how we get the job done and allowing a flexibility in the market to achieve this at lower costs.

Buying Credits
So at the end of every year, each of the affected power plants has to hold enough of these credits to cover the amount of emissions that have come out of their power plant during that year. Now, if you have higher emissions than the standard, you can buy credits from somebody else. But the only way somebody has credits to sell is if they made an extraordinary emission cut, if they cut their emissions 60% or 70%.

Basic Responsibility
So there is no way out. There is no way to buy your way out of the problem. You are responsible for your emissions, and if you cannot solve the problem within your own company, hire somebody else to do it. That is the essence of this program.

Now, I should emphasize, though, that there is a whole additional layer of environmental regulations that require compliance with local air quality standards. So you cannot get away with it and just buy all the certificates that you want and pollute the air in your local area.

The problem that we are addressing here with the sulfur dioxide program is really a long-distance transport problem where emissions come out of the Midwest and land in the East for the most part. So the local environmental rules remain in force, but the essence, the purpose of this program is to provide for economic savings, and it is documented now that the program costs far less than it would have under traditional regulations.

Market Guiding Choices
What we have instead of the government deciding who and how emission reductions will occur is the market guiding affected firms to the best choice. For example, if the market value of these tradable credits is $100 and your alternatives to reduce emissions would cost you $200/ton then you are better off buying credits, that is, hiring somebody else to do the job. If your cost of controlling emissions is $50/ton and the credits that you can free up sell for $100/ton then you are encouraged to make extra emission cuts and sell those credits, to hire yourself out to another party.

So this is the same way we produce most goods and services in a market economy. Those who can produce it cheapest are encouraged to do more of it. Those who can find a cheaper way to control pollution to protect the environment are rewarded. There is a profit if you can find a better way to protect the environment. That is just the opposite of what we have got now.

There is no reward. There is no financial incentive to reduce carbon dioxide emissions. I say: Let us pay people to do the right thing, and that is what this program does.

Least Cost
So now we have a program where those who can cut emissions cheapest make more of the emission cuts. We have a program that allows for flexibility and innovation. So it is not the government telling people how they must comply with this. It is the private enterprise figuring out what is the cheapest way.

If you want to turn off certain power plants that you used to run more frequently, turn those down and run the cleaner plants more often. If you can come up with a better way to control emissions at lower costs, the market gives you a financial reward. Innovation is a very important concept that we should incentivize.

Now what we have seen is that the cost is far less, perhaps one or two billion dollars per year, to get the emissions down by half, as opposed to four or five billion dollars per year, had a traditional regulatory scheme been applied. First we saw there is the notion that there needs to be a fine if somebody does not hold enough of these certificates at the end of the year. We have to make this fine high enough to make sure that people comply, so that we do not have confrontation. We have people avoiding regulatory conflict. So they set the fine at $2000 figuring that would be high enough, and the government sells some of these allowances at $1500 to make sure there is a ready supply and there is not a problem with monopoly power. In 1990, the industry asked everybody what they thought these credits would go for. How much is it going to cost per ton to clean up the air, and they said $600. The first trades that we saw come out in 1992 and 1993 saw these credits going for $300 per ton, and in the first auction
that we administered at the Chicago Board of Trade, the prices were about $130/ton, and more recently they are in the $60-$80/ton range. So the prices are something like 20% of what honest and engineering studies concluded they would be. The program cost far less. The market worked far better than anybody ever expected.

Added Benefits
There have been additional benefits. Power plants that are affected in the first and biggest part of the program, which is ongoing now, were allowed in 1995 (this is a phased-in program; I have made the story a bit simpler than it really is) in the phased-in program to emit almost 9 million tons per year, but in the first year of the program we see that they have only emitted 5 million tons per year. Now this is not out of the goodness of their hearts.

The credits can be retained and used in later years, but by slowly phasing the program in and allowing for carry forward of these credits, we have actually got earlier action. Incentives for early action I think are something that has been referenced many times in the dialog on greenhouse gas emission reductions. How do we get people to take early action? This program seems to be encouraging that.

Earth Council
So based on the model, Center Financial Products has been working closely with Mr. Strong's organization called the Earth Council, and we are preparing at this time what we have called the Global Environmental Trading System, which has as its purpose the introduction of a program, a pilot program, that tests the concept out and work out the bugs for trading in greenhouse gas emission allowances.

We are working with the Earth Council as the chief sponsor of this program and working extensively with UNCTAD as well. This will be a shareholder organization.

We are trying to leverage private capital and to attract public funding as well and we are just about to formally initiate the fund-raising effort. We are optimistic there based on preliminary responses.

We intend to make this program fully consistent with the parameters and the participation requirements that will arise from the Framework Convention on Climate Change. So we hope that the Framework Convention includes flexibility for groups of countries to work together to find better ways to solve this problem.

What we expect to do in the next two to three years is formalize all the parameters of the program, that is, fund a variety of studies and development initiatives that will identify the rules of the market, the participation guidelines, establish a clearinghouse for trading in these credits, and at the same time work with the Framework Convention on Climate Change to make sure that the parameters of the program comply with the Framework's mandates as may be arising next year out of Kyoto.

One Type of Market Solution
So the point is emissions trading can be one of the various market-based solutions that can fulfill the mandates and goals stated at Rio. Effective programs for preventing climate change and reducing greenhouse gas emissions, utilization of lower-cost tools to get the job done, and provision of secondary and tertiary benefits such as transfer of clear energy technologies to developing countries which have it is thought a comparative advantage at cleaning up the environment and helping the entire globe limit greenhouse gas emissions at lower costs.

GETS
The Global Environment Trading System (GETS) being developed with the Earth Council can, we think, help demonstrate (this is not the final solution) the viability of this approach on a limited scale, five to ten countries perhaps, trading among the countries, the industry participants in those countries, across sectors.

There is no reason to feel that it cannot work for both stationary sources as well as other fuel-consuming processes.

So with that I thank you for your time.


Question from the Floor

I have one question directed to Mr. Walsh. Who fixes the $2000/ton?

Michael J. Walsh

The $2000/ton criteria was put in by the legislation, that is, the U.S. Congress devised this law and required the U.S. Environmental Protection Agency to enforce that law. That was largely put there as a deterrent, and in fact there have been no violations. Nobody wants to pay $2000 (it is actually higher than $2000 -- they scaled it up for inflation) when one can turn around down the street and buy credits for $100. So that fine was put there to encourage the correct behavior, and certainly we have seen the correct behavior arise from the program.

Question from the Floor

This is a question for Dean Urban. It has to do with the leadership of the proactive companies that you described. I make the assumption that the decisions in the interest of sustainability were taken at very high levels, which then leads to the question as to whether you are able to observe any common characteristics of these leaderships beyond the courage and the vision that would be required for these kinds of decision.

Were they all educated at the Sloan School, for example? Were there particular political pressures in the areas where they are located? Was it the nature of their products that made it possible for them to institute these programs, or was it random? Do you find any common characteristics of the leaders?

Glen L. Urban

That is a good question because the people we see doing this are the ones that we would recognize as leaders in all areas of business, so in fact they are the leading edge at Shapiro, at Monsanto, and so forth. I do not think there is any single demographic one. The people who have risen to this level, moving out of this re-engineering world we are in now, are trying to look at their companies and say, how are we going to be successful in the future?

So I think it really is that the people who are rising up are the ones who have the vision, capture the long run, and within that view they have the perspective to see where this is going to fit. I would like to claim we did it, but we are not.

Question from the Floor

This is a question for Mr. Faulkner but was fired by the keynote address. Dean Urban's talk made me think that perhaps the specter that is haunting the market economies is in fact demand deficiency more than anything else. But we know this is not a deficiency in need.

There are billions of people needing clean water, better food, and so forth. It is in fact deficiency in effective demand, which is demand that can be backed up by purchasing power.

I am wondering whether the kind of public-private partnership that you were talking about is perhaps the way to break through that tension in market societies where you have deficient effective demand and yet real needs that are not being met.

J. Hugh Faulkner

Probably -- I am not quite sure. One of the ironies of effective demand is in fact that we deal with smaller projects in big places in poorer areas. The reality of life is that the poorer you are, the more certain you are to pay the bills. That is the credit rating of Gruman Bank. That rural extraordinary success in Bangladesh. Their losses on the boards are marginal, much better than you think in the United States. So in a way, we do not have a problem with effective demand. Even with the poor people, if you really deliver a service, and it is a predictable service and it is costed out reasonably well.

One of the important things about the public-private partnership is that really it is a vehicle for negotiating some of those other elements of cash flow, such as the user fee. There has got to be a cash flow associated with that.

It is too early to say (we have only been in business for a year-and-a-half), but in all the projects we have got started now, that idea has not been the roadblock. So many institutions, including the World Bank, have always been worried about it.

Question from the Floor

I have a question for Mr. Walsh and that is could you tell us a little bit more about the GETS, Global Environmental Trading System? Is it very much parallel to the system within the United States or is it something different?

Because when I think of that kind of profile, I do not know if anyone here has seen it, but he talks about a much larger scale program where countries like the U.S. or Canada that produce lots of greenhouse gas emissions actually do a technology transfer to the poor countries, so that the result is that each country has a certain so-called "win-win" position where you get the technology transferred and help the poor countries develop and yet you also get the environment cleaned up.

Michael J. Walsh

That logic is the spirit of our long-run goals, and while we think this is a profound concept, we have to be rather limited in our initial scope because as is obvious from the ongoing negotiations, consensus is literally impossible to achieve. So our objective is to demonstrate the viability of the concept on a manageable scale, and it is hoped that the concept will be proven and found the most attractive for an ideally universal application.

But that is a concept: to set a specific limit on the missions and allow for flexibility and achievement of those limits, but to absolutely be able to enforce those limits. The heart of the program is to develop answers to the questions you helped illuminate. Who will participate? What are the limits? How does one monitor and enforce these rules? How do we tabulate compliance with the program?

So while we think it has all been done before now, we are not recreating the wheel. It is nevertheless a significantly broad concept, and for that reason a limited participation base which ideally expands to a comprehensive base is our objective.

It took us two or three hundred years to get to this point of carbon concentrations. We think to take one hundred years to get back is not an unreasonable prospect and probably far less costly to society as a whole.

Now I have to throw in one little line that I always use.

Some people say, well this is a way for the North to pay the way out of the problems or something like that, which is absolutely wrong. There will be responsibility to everybody who is responsible for the current problem. In terms of the importance of cost efficiency, some say, well does that protect somebody's profit margin. Does that mean that folks in the North can drive bigger cars? That is not what we are talking about.

Any resources dedicated to protecting the environment are resources that cannot be dedicated towards other pressing needs like nutrition and housing and health. So it all comes from the same pool of money.

So we are strongly spirited and emotional about this concept of doing it more cost effectively because the environment is not the only topic on the agenda.

Question from the Floor

I guess a question also for Mr. Walsh. It seemed that in the U.S. there was a clear authority, a clear consensus about a need, an agreement, and a willingness to bear the cost, and I just wonder how you would foresee, for instance, the allocation of permits in a global scheme; on what basis that might occur?

How it would affect issues, such as transport, which occur in just billions of individual users? What are the challenges of going from a single authority base to a global one, and how does your pilot program begin to help illuminate this?

Michael J. Walsh

Well, you have just illuminated the questions. Those are the topics that we have to face head on. The allocation scheme, I do not know. We do not have the answer. We know what some of the proposed answers are per capita relative to efficiency, relative to economy. It is impossible to say what the right one is.

That design will critically affect the attractiveness of transferring technologies, I should note, but this is the heart of our development program to try to come up with workable answers. They are not going to be the best. They may be the ones that can work.

Now in terms of addressing, say, emissions from the transport sector, billions of automobiles, there are many points in the "pipeline" where one can impose a requirement to hold credits. It does not have to be at the retail gasoline station. It can be farther up the processing curve. It can be at the big pipeline. Perhaps an oil company has to have the credits each year, and I would hope that they would pass that cost on to their consumers so consumers better recognize the cost that they are imposing on the climate.

So I do not have the answers. We think the model is there. We are sure markets work. Now all the other answers we have to put together over the next few years.

Question from the Floor

I just wanted to say I enjoyed very much all of the presentations, and I have a comment which I would like for Dean Urban maybe to add to. That is, a number of us who work in international organizations are faced with the concern that people express that many of these worthy efforts are probably not enough to deal with what many perceive as a livelihood problem. They say it is like building a house on a second set of assumptions.

Once you thought the ground was firm, you thought it was sandy, you thought it would not get eroded; and then you found out there was a problem, and you start by fixing the roof, and you fix some walls, and you add something to the sewage system, and so on.

Some are saying basically the kinds of problems we are facing in terms of sustainability, given that the business systems that we have were built on a different set of production and consumption patterns that it almost calls for tearing the whole thing down (I do not know how one does that) and starting afresh. How does one counter this and still accept the fact that because of the magnitude of the problem, you feel like it goes beyond just responding to what might be consumer demands for green goods or the effectiveness of government regulations?

Glen L. Urban

That may be tough to respond to. Certainly the problems of the world are complex and big. Look at the interaction of population with resources and economic development and business can make a positive impact, but there are a lot of other things that have to fall in place to get a sustainable environment.

I do not think that tearing down the business system is likely to be a good next step. If anything, the world has moved to a market-based economy, and probably that market-based economy has shifted resources dramatically to the emerging nations.

I do not think voters in the developed world have really realized how much they have given up in terms of real wages and economic benefits as the system has actually worked to transfer substantial resources to the developing, emerging world. So I think there are some positive trends there, but it is only a small piece in the total puzzle of controlling the emissions and sustainable products and population growth.

Comment from the Floor

I wonder if I could make a comment about where we started in this meeting when we were thinking about next year's post-Rio review.

It picks up on a number of points that have been made this morning and yesterday. I was very struck by Jonathan Lash's indication that we are still going downhill fast on every sort of indicator of sustainable development. I ask myself how one might turn that around.

One thing that was extremely interesting this morning was the description of the emissions trading thing. One point in it strikes me as perhaps important for the review next year. That was that it worked because there was certainty. We are in a market economy. There is no point, it seems to me, in pretending we are not or trying to go back, and the other model did not work any better either.

The challenge, it seems to me, is to find ways of enabling the market economy to make the right choices from the point of view of sustainable development. This is where the trading regime is a very interesting though small example. It does seem to me that one of the challenges for the review conference next is in what ways could the world community or individual nations (because some nations can just go ahead and do it) create conditions, create economic frameworks in which the market would choose what is sustainable rather than what is unsustainable.

The trading regime could be extended, obviously, very complicated, to greenhouse gases, but there are many other things that if the review conference were minded to could give certainties to economic operators which would enable them to work out a solution. Suppose, for example, that next year's conference said, right, let us decide as a community of nations that by, let us say, 2025, 50% of energy requirements in all countries -- there would be exceptions obviously -- should be met from renewable sources. The goal is to phase out fossil and phase out nuclear. That is a suppose. That would provide some target. It would be goals.

This is what is interesting, to me, about the trading scheme. There is a goal. There is a clearly mandated goal. It is, as Mr. Walsh said, command and control, but without some guidance from public authorities which cannot escape it, it seems to me their responsibility, without some clear guidance as to where they think the world ought to be going in terms of targets for achievement of sustainability, I do not see how the market can use its skills to respond to them. If it has those guidelines, perhaps it can use its skills, and perhaps, coming back to Mr. Urban's very interesting analysis, we should no longer be relying upon the public-spiritedness of certain major corporations, but they would be able to operate in a condition which facilitates their commitment to sustainability and at the same time profits.

Because after all, in a market economy we cannot expect, we should not expect, private business to do things for love. It does it for profit.

I would hope that out of this meeting could come some sort of challenge to the Review Conference to provide some guidance as to what the goals should be for sustainability that the market could respond to. Thank you.

Comment from the Floor

You kind of took my question in some respect, but I will try to state it a little bit more generally. That is, often when one is studying the environment, people say the market will handle it, and after you look at the way the market is supposed to handle it for a long time, one normally sees environmentally that it does not.

What I hear you saying, Mr. Walsh, is that a properly constructed market can generate environmentally beneficial outcomes.

My question is, would you see yourself being set up for the criticism that you are introducing market imperfections and in some sense you are trying to not let the market handle it in a general laissez-faire sense.

What you are trying to do is set up some middle ground between command and control and a laissez-faire system.

Michael J. Walsh

I think my economics professors would remind us that what we are addressing here is the "missing market." That is, nobody is responsible for protecting the environment in this particular domain. We have been giving away the air. There is no price on it. There is no limit, no budget. Take all that you wish.

So the existing market economies are incomplete, so to speak.

This is not one of these organically arising markets like the wheat market. People wanted wheat and people wanted to grow wheat. This is one that has to be in some sense mandated to internalize the costs that are now external to the market economy, and must be organized. It will not just pop up on its own.

We have to agree on rules, and that is what our mission is here. We view ourselves as helping to more fully complete the existing market economy by providing a market that has been missing.

Question from the Floor

This is a short one but a big one.

I have heard a lot of interesting ideas on doing things to affect greenhouse gas emissions, but the other major problem is the problem of poverty, and some of these things will, as Jonathan Lash said at the beginning, increase social inequity.

Are there some market mechanisms that can be coordinated with these other initiatives that might push us in the direction of better equity instead of going in the direction we are now going?

Glen L. Urban

May I take a quick stab at an answer?

Equity is served if efficiency is present. That is, I would rather have us all pay less to protect the environment so we have more money available for every other issue that needs to be addressed, and conceivably one could propose an emission entitlement scheme where entitlements are given out on a per capita basis. So if you are not emitting any emissions and you have the right to some, suddenly your portfolio is more valuable that it used to be. But I have to confess that this is not primarily an "equity-driven" concept.

It is an efficiency-driven concept. Now I have to leave the challenging equity questions and poverty questions to others, but we think this is not a harmful program. It could be helpful.

Question from the Floor

I have the last one: It is again to Mr. Walsh, and I think the number of questions asked to you show how high on the agenda the question of emission trading is for the time being. It definitely is in the climate change negotiations.

I think the concept has a lot of benefit and attraction and it seems to work in the SO2 area in the United States. But we are all aware -- and it has become clear with some of the questions -- that it will become much more difficult and complex for the greenhouse gases. If you include the other greenhouse gases, it gets even more complicated.

At the same time, the ideas that we heard so far are always that we should establish these systems between countries. I wonder if the concept is so good, and I think it has a lot of potential. Why doesn't one start to think about establishing it in one country, for example in the U.S.?

The U.S. is a huge market. Why not establish such a system first to implement the international commitment that a country like the U.S. and any other industrialized country, for example, has under or will have under the Climate Convention.

I am aware that the cost benefit or the situation might be better if you include developing countries, but it will be very difficult to get their agreement and that should not prevent us from testing the concept maybe at home.

Michael J. Walsh

There are discussions here in the US to try to initiate such a domestic program, but ultimately this is an international, global issue. Since we cannot solve the negotiation problem comprehensively to start off, let us try it on a limited basis. So issues of trade problems, border problems, different accounting, tax, legal and regulatory schemes, currency problems. The list is a very long one.

We have to start somewhere ,and limiting to a domestic program would not touch on those difficult issues. We have to start to address those difficult issues because if we are ever going to get this to work on a broad basis, it has to be a global one.

The reason we want it to be broad as opposed to a bunch of internal domestic programs is for the opportunity for cost savings and technology transfer. That is the whole idea that there are cost advantages in certain locations and clean, new generation technologies can be shifted to those developing economies that have the needs and the opportunities. So it has got to be an international program. We cannot do a comprehensive one to start, so we will start on a limited basis.

Wallace R. Baker

Thank you very much to our keynote speaker and panel members for their most interesting contribution to this program and to Professor Choucri and MIT for having brought us all together.