Low-Carbon Macro

Carsten Jung, Theresa Löber, Anina Thiel and Thomas Viegas

Governments have pledged to meet the Paris Target of restricting global temperature rises to ‘well below’ 2˚C.  But reducing CO2 emissions and other greenhouse gases means reallocating resources away from high-carbon towards low-carbon activities. That reallocation could be considerable: fossil fuels account for more than 10% of world trade and around 10% of global investment.  In this post, we consider the macroeconomic effects of the transition to a low-carbon economy and how it might vary across countries. While much of the discussion has focussed on the hit to economic activity and the potential for job losses in higher-carbon sectors, we highlight that the transition also offers opportunities. And the overall impact depends crucially on when and how the transition takes place.

A transition to a low-carbon world could have significant implications for global trade flows…

Carbon-intensive energy is a widely traded good. Fossil fuels made up about a sixth of global trade in the last years (Chart 1).  The euro area, Japan and India are among the countries that have sizeable fossil fuel trade deficits, meaning they import more fossil fuels than they export.  By contrast, in the Middle East and North Africa fossil fuels make up nearly 70% of exports. And China is a key player in global trade of high-carbon goods, accounting for more than half of total global coal demand and just under half of steel demand.

Chart 1: Fossil fuels as share of total imports and exports (2011-2016 average)

* Middle East and North Africa. Sources: World Bank and authors’ own calculations.

That means the transition could result in a significant reallocation of resources, and a disruption of existing patterns of trade. Fossil fuel exporters would face a deterioration of their terms of trade – the relative prices of imports to exports – as demand for their exports falls. On the flip side, fossil fuel importers would benefit from lower fossil fuel prices, improving their external balances.  Countries could boost their exports by exploiting opportunities related to low-carbon products in areas ranging from the manufacturing of batteries to financial services that provide funding for the transition.  In addition, economies could reduce their foreign energy dependency by producing renewable energies domestically.

…and the transition could have big implications for investment

The energy sector accounted for 10% of global capital investment in 2016, with around two-fifths of that in oil and gas (Chart 2).  The bulk of these investments are made in emerging market economies (EMEs). Countries in the Middle East and Latin America invest heavily in fossil fuels, but China and India remain the two largest investors.

Chart 2: Annual energy investment by sector, 2016

Sources: International Energy Agency and Bank calculations.

For economies with large fossil fuel investments, the move to a low-carbon economy could lead to the risk of “stranded assets”. Such assets stop earning a return before the end of their expected economic lifetime when fuels they extract, or other products and services they provide, are no longer in demand. When assets are stranded, the invested capital is no longer productive.  New investments need to make up for the loss in capital stock, in addition to investment already needed to support the transition. These investments would boost GDP growth, but from a lower level, and so is not welfare enhancing. The later and more abrupt the transition to a low-carbon world is the greater the stranded asset problem will be. The IEA (2017) estimated that a late and sudden transition could mean about three times as many stranded assets as a smooth and early transition (Chart 3).

Chart 3: Estimates for stranded assets under different forward-looking scenarios, 2015-2050

Sources: International Energy Agency and Bank calculations.

While the risk of stranded assets is important, the flipside is often overlooked – the transition to a low-carbon economy provides investment opportunities for growth-enhancing investment, for example in renewables, end-use efficiency and infrastructure. Timely investment will be important to avoid technical bottlenecks to integrating renewable energy into total energy supply.  And upfront investment in electric vehicle infrastructure as well as investment to make buildings more sustainable will be needed to allow for a smooth transition.

In most countries the effects on employment of the transition may be small, as carbon-intensive sectors employ proportionately fewer people than low-carbon sectors

Perhaps the most discussed channel is the loss of jobs in carbon-intensive industries.  The worry is that if certain jobs are eliminated in energy-intensive and polluting industries and not replaced elsewhere, this could create potentially damaging dislocations and employment mismatch issues.

But the effects are likely to be small.  In many countries the shift of workers from high to low-carbon industries has been taking place for decades, for reasons unconnected to the low-carbon transition. In the UK, for example, 1 in 20 workers were employed in the coal industry in the 1920s. But in 2016, this had fallen to a low of 1 in every 40,000 workers.

And new jobs will be created as a result of the transition, in emerging green sectors such as renewable energies where the demand for goods and services is expanding.  There is evidence that this is already happening. In 2016, US employment in both the solar and wind energy sectors increased markedly, by 25% and more than 30% respectively.  This explosion in “clean” jobs in the US means that nearly as many workers are now employed in low-carbon generation technology jobs as in the coal, oil, and gas sectors.

Crucially, the overall magnitude of potential labour reallocation is smaller than often thought: the OECD estimates that job reallocation as a result of climate policies across sectors in advanced economies will amount to 1.5% of total employment by 2050.  This would be a relatively modest addition to the reallocation of labour between sectors, jobs, and tasks, which happens anyway. To put this into perspective, between 1995 and 2005, the amount of sectoral job reallocation in OECD countries amounted to 20% of employment.

A reduced reliance on fossil fuels could alter government finances, with differing consequences for fossil-fuel exporters and importers

In some economies, fossil fuels make up a significant proportion of government revenues as well as expenditures.  Between 2011 and 2014, the share of fossil fuel revenues in government revenue was 7% in G20 economies, 21% in the rest of the world and as high as 81% in OPEC countries.  For many governments the net effect on their finances from the transition could be positive, due to increased tax revenues from carbon pricing.   For governments of fossil-fuel exporting countries, the transition would be revenue-negative given the reduction in fossil-fuel-related revenues as global demand falls.  Consequently, several governments have already taken steps to reduce their support and dependence on fossil fuels such as Saudi Arabia’s Vision 2030 plan. And it’s easy to forget the other side of the balance sheet –  money that governments spend supporting the production of global fossils fuels would no longer be required – a saving of around $260bn.

The speed and timing of the transition matters

Policymakers sometimes talk about an “early and smooth” versus a “late and abrupt” transition. The former would allow adequate time for investment in alternative energy and infrastructure to support technological progress to keep energy costs at reasonable levels and help the economy adjust. But most governments’ current policies are not on track towards meeting their Paris Agreement commitments. Carbon prices would need to increase significantly globally and cover more sectors to meet the commitments. And the IEA estimates that to achieve a climate-friendly scenario, global oil demand would need to be more than 10% lower by 2025, and EMEs’ renewables capacity would have to increase twice as fast than otherwise (Chart 4).

Chart 4: Difference in global energy demand between business as usual and 2°C scenarios in AEs and EMEs

Sources: International Energy Agency and Bank calculations.

If policy is delayed, a late and abrupt transition will lead to large and persistent negative macroeconomic effect.  Alternative sources of energy could be low in supply and expensive, a quantity constraint on the use of high-carbon energy may need to be imposed, and costly technologies used to remove carbon from the atmosphere. But a late transition would also exacerbate the physical costs of climate change, as increased frequency and severity of climate- and weather-related events would damage physical assets and disrupt trade flows. And stranded assets – if not mitigated – could have significant implications for financial stability which would be transmitted to the real economy.

The sooner climate policies are put in place, the more certainty will be provided to firms and households to realise opportunities and minimise the costs of the transition to a low-carbon world.  Collectively, we think these add up to a strong economic case for an early and gradual transition.

The net effects of the transition will vary a lot across countries

What could the overall macroeconomic effects of the transition be?  Even a smooth and early transition might not be cost-free, as it requires climate-friendly policies that incentivise substitution to cleaner but possibly more expensive technologies. For instance, in many countries, carbon-intensive flying can still be cheaper than rail transport.  In addition, stranded assets and frictions associated even with an early and smooth transition would subtract from global activity. But most studies find the economic costs of this should be small.  That needs to be compared to the much bigger cost of inaction:  a recent study by the IPCC suggests that the risks to economic growth rise materially if global warming is not limited to 1.5° but 2°, with countries in the tropics and Southern Hemisphere subtropics projected to experience the largest impacts.

And others, such as the OECD, find that policies associated with the transition could in fact be growth enhancing (Chart 5).  They find that benefits to economic activity crucially rely on increases in both private and public investment to support the transition, as well as the effective implementation of structural reforms, such as carbon-pricing schemes with revenues invested into sustainable R&D.

Chart 5: GDP impact by 2021 of climate policies in line with 50% likelihood of limiting warming to 2°C

Source: OECD.


Whether the low-carbon transition is growth-enhancing or not depends crucially on when and how climate policies are implemented.  As macroeconomists, we need to deepen our understanding of how the transition to a low-carbon economy will affect the global economy.  Although much popular debate focuses on potential job and output losses in carbon-intensive industries, available research suggests these would be small, and will likely be more than offset by increases elsewhere.  And we think there could be significant effects via other channels – particularly a re-wiring of global trade flows and potential fiscal impacts for economies specialised in fossil fuel production.  It is important for economists and policymakers to incorporate the channels through which climate change could affect the macroeconomy into their mainstream thinking.

Carsten Jung works in the Bank’s Fintech Hub Division, Theresa Löber works in the Bank’s International Surveillance Division, Anina Thiel works in the Bank’s Global Analysis Division  and Thomas Viegas works in the Bank’s International Surveillance Division.

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