By Ida Uusikyla, Dominic Hofstetter, and Matti Tervo
A Systems Transformation Towards Circular Economy in Viet Nam: Using Financial Levers to Catalyze Change
January 25, 2022
Viet Nam is a global success story when it comes to large sustainability transformations. It emerged from war and its consequences and achieved middle-income status and high levels of Human Development in record time. Most recently, Viet Nam has made ambitious commitments to embark on another transition: reaching carbon neutrality by 2050.
Achieving this ambition is critical, as decades of stable and relatively high economic growth have come with a heavy cost to the environment. Further, as a low-lying delta country, Viet Nam is also among the most vulnerable to the impacts of climate change, so it’s in the country’s best interest to lead on climate action.
The transition towards a carbon-neutral circular economy has therefore recently gained significant momentum within government at the highest level. The adoption of an official definition of “circular economy” in the revised Law on Environmental Protection (LEP) marked a cornerstone in including CE principles in policy frameworks. However, Viet Nam is now at a critical juncture where it is key that conditions are created to allow investments to flow in such a way as to support the country’s circular economy transition and let it meet the ambitions declared at COP26.
Against this backdrop, in 2021, we started a collaboration of the curious – between the Embassy of Finland in Viet Nam, UNDP Viet Nam and Climate-KIC. What brought us together was the interest in exploring the role of financial capital in accelerating systems transformation towards a carbon neutral circular economy. That’s because financial capital is among the most powerful levers of change influencing the behavior of systems. It plays a key role in either accelerating or slowing down progress toward the Sustainable Development Goals (SDGs) and the Paris Agreement targets. This is particularly true for lower middle-income countries like Viet Nam, whose successful transition through the development continuum has significantly shifted the development financing landscape for SDGs: fast-declining direct grant ODA, a declining tax-to-GDP ratio, and lack of public financing and misaligned priorities.
We shared the same pain coming from different corners of the development sector – a donor, an international development organization, and a public-private innovation partnership - seeing how many actors there were working on climate finance and circular economy and how little was done to seek strategic synergies and align investments in a way that potentially would have a transformative impact. We wanted to explore how a systemic approach to development finance, as conceived by Climate-KIC through an emerging investment logic called “transformation capital”, would look like in this context.
The transformation capital logic is rooted in the notion that human systems are complex and adaptive and that addressing societal problems requires a systemic intervention approach spanning multiple levers of change. Looking at the developing finance challenge through a systems lens naturally leads one to conclude that investing in single projects – the dominant paradigm in development finance – will almost never unleash transformative effects and that, instead, we need to compose portfolios of multiple assets selected for their potential to create combinatorial effects amongst each other. The corollary is that such portfolios will span multiple asset classes (project finance, venture capital, loans to MSMEs, etc.) and need to be nested within a broader systems intervention approach that pull on other, “non-investable” levers of change (such as policy, education, and the like) – implying that development finance institutions must undergo a shift in mindset and financial practice if their actions are to generate transformative effects in the human systems they care about.
We started our journey by speaking to different people working on development financing and exploring their views on financing systemic transformation. It quickly became clear that, to make meaningful inroads within the world of DFI, we needed to have something more tangible in our hands to make the case for such an investment programme.
We therefore started to work on a case study to describe more concretely the potential of systemic investing in accelerating a circular economy transition in Viet Nam. The case study aimed to explore the role of systemic investing as a holistic approach to contribute to the transition towards a well-functioning waste management system in Da Nang city. Da Nang was selected due to the significant previous work UNDP had been conducting in the city. Waste management – as a sub-system of circular economy – was chosen because we felt that some boundary to the system under inspection was needed and because the waste management and recycling system in Da Nang is emblematic of the linear economy’s predominance and classic systemic failure, as most of the waste ends up in landfills and valuable materials are not reused.
The case study describes how one could start looking at the sub system of waste management through a more holistic lens and understand investing as a mechanism to unlock transformative change. It offers a first set of ideas around the question of how an investment programme seeking to bring about systemic change might be designed, using the waste management sector as an example.
The study first describes the national and municipal level waste management systems using the Malik Sensitivity and Simulation Model (MSS Model). It aims to capture the complexity of the WM&R system in Viet Nam – its interconnections, control loops and variables – at both the National and Municipal-Levels. At each level of the system, the MSS Model seeks to identify (a) the key variables, (b) how each of these variables is dynamically interconnected, and (c) which of them are the most efficacious ‘control levers’ to nudge the system in the desired direction of change. The model illustrates the interconnections within the system with the caveat that it doesn’t fully uncover emergence or the dynamism of these interactions.
Our MSS Model demonstrates the overwhelming importance of effective and informed government participation and collaboration to the success of system transformation at both the National- and Municipal-Levels. Among the biggest barriers to private equity investments in the municipal WM&R system is the considerable underfunding both in Da Nang but also in Viet Nam more widely. While figures are not available for Da Nang, World Bank estimates for Ha Noi put the total cost of providing waste management services at US$39 per ton versus household fees of only US$9.7 per ton. Waste management expertise, financing capacity and investable opportunities were considered critical for nudging the system towards a better state.
Based on these insights, the case study presents a hypothetical investment portfolio of assets that are mutually reinforcing of each other in support of systemic transformation. This is key to the transformation capital theory of change. The ‘investments’ within a transformative strategic portfolio may comprise assets beyond traditional debt and equity instruments (or their hybrids). The transformation capital logic therefore strategically blends assets across multiple asset classes within a deliberately designed and nurtured portfolio. The nurturing includes a rigorous Sensemaking process which is a collaborative and ongoing process of observing and measuring how interventions in a system are producing the change sought. It is a way to extract insights and generate strategic intelligence that inform future investment decisions. The Sensemaking and learning process also provides a mechanism to assess sequencing of such investments and in the context of the WM&R system which is critical in yielding transformative impact.
Finally, the case study proposes an outline for a Systemic Investment Programme which would need a consortium of challenge owners to come together with a strong support of the local government. Even though assets within it are potentially owned by separate entities, the aggregate investment that the ‘portfolio’ represents is managed cooperatively to encourage synergies between and among the constituent assets.
If you would be interested in learning more or joining such a consortium this is an open invitation to join us and continue learning about the power of systemic investing in accelerating a transformative change!
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