Advanced country options to accelerate decarbonisation in emerging and developing economies (EMDEs) (Summary)

The Role of Advanced Countries in Decarbonizing Emerging and Developing Economies

At Bruegel, substantial efforts have been directed towards promoting decarbonization within the European Union (EU), with notable contributions having been made to the discourse on the European Green Deal. A recent paper delves into the complex governance of the Green Deal, given the involvement of multiple governments and the EU. Departing from that topic, this discussion shifts focus to a less emphasized dimension in Europe—exploring the role of advanced countries, particularly the EU and its global collaborators, in hastening decarbonization in emerging markets and developing economies (EMDEs).

The four charts sourced from last year’s synthesis report on nationally determined contributions (NDCs) under the Paris Agreement reveal the impact of NDCs until 2021 on the likely temperature trajectories that will occur based on different mitigation scenarios. Despite substantial efforts, the current contributions fall short, projecting a temperature increase above 2%, which is considered catastrophic. While the voluntary nature of the Paris Agreement matters, it’s evident that relying solely on these efforts will not be sufficient to limit temperature increases to 1.5 or even 2 degrees, which is considered desirable. The opinion that countries won’t act without hard incentives is also incorrect, and we must acknowledge that the NDCs have been successful to a large degree, but are insufficient.

The second chart breaks down emissions since 1990, revealing that EMDEs and China are the primary contributors to the recent increase. Advanced countries, including the EU27 and the United States, show declining emissions. The notable spikes are in Chinese emissions (yellow line) and those from other EMDEs (green line). To curb global emissions effectively, there’s a clear need for more significant efforts from emerging markets.

However, the same emissions data, when depicted based on per capita figures instead of absolute emissions volumes, reveals that emissions per capita remain significantly lower in emerging markets compared to advanced countries, with only China surpassing the EU. Interestingly, the green line, representing other EMDEs, shows only a miniscule increase in per capita emissions, with the increases actually primarily driven by population growth rather than economic growth. This underscores a fundamental challenge in decarbonizing emerging markets, which is that those in the green region can argue that their individual emissions are minimal. Addressing this requires navigating the dilemma of decarbonizing EMDEs without impeding their growth.

The various scenarios based on different plans for decarbonization that consider the remaining carbon budgets will lead to from 1.5 to 2 degrees or above increases in temperature, which is very disturbing. The current business-as-usual approach to NDCs will still lead to temperature increases that are as high as 2 degrees, which will be catastrophic, as mentioned earlier. If countries move their targets forward from 2050 much earlier to 2030, there is a chance of a reducing the increase to 1.6. The main point is that what is done in the immediate future will have much greater impact than even more substantial actions that are taken later and there is a great benefit to making significant changes before 2030 as opposed to using a target of 2050.

In conclusion, despite the need for increased efforts in advanced countries, there’s an economic argument to allocate a larger share of resources to developing countries. The rationale is that there’s likely a more significant impact for the money spent in these countries. Abatement costs in EMDEs are expected to be lower due to factors like the current delay in shutting down old coal-fired plants, lower opportunity and factor costs, and in some cases, in fact, building green infrastructure from scratch is cheaper than retrofitting such existing plants. The overarching message is that we should focus on prioritizing and incentivizing EMDE decarbonization.

Possible approaches to achieving climate change mitigation

The main question is how to achieve such decarbonization, and there are three possible ways. One approach is through trade-based incentives, which has a history in economics and was discussed in a paper by William Nordhaus in 2015. Another option is providing financial incentives, specifically conditional climate finance, as proposed in a paper by Alissa Kleinnijenhuis and co-authors, for transitioning away from coal in developing countries. Lastly, international emissions trading with differentiated targets for advanced countries is another approach, as highlighted in a recent paper by Beckers and Cariola. This approach could have significant effects while avoiding negative impacts on developing countries, which is crucial for economic and political acceptability.

The first option of trade-based incentives, originating from Nordhaus’ 2015 climate club concept, involve countries with high mitigation and similar resulting carbon price forming a club that is open to new members with equivalent levels of mitigation. Lower mitigating countries face tariffs to trade on exports to the club, encouraging adoption of a carbon price. Despite the appeal, significant issues arise. The approach risks worsening non-club members’ situations, potentially causing political tensions. Additionally, these tariffs violate WTO rules, and determining club entry criteria is challenging. Particularly in today’s complex political landscape, forming a club with tariffs on EMDEs could strain relationships, making it an undesirable option.

Border carbon adjustments (BCAs) are a less aggressive approach to trade-based incentives, implementing tariffs, taxes, or emission certificate requirements to level the playing field in the domestic market and prevent leakage. The European Union was just recently the first WTO member to introduce BCAs. However, despite the necessity of these measures to reduce leakage, BCAs are not overly strong and do not strongly incentivize mitigation outside the carbon price area. Firms with high standards can still export goods to the carbon price zone, while others export elsewhere, and there is little incentive to decarbonize further inside the country for non-traded items like energy. The effectiveness improves with scale, suggesting the benefits of expansion beyond the EU to prevent leakage more effectively.

Climate clauses in free trade agreements, which are particularly significant for the EU, involve urging trading partners to safeguard the environment or climate in exchange for access to the EU market. This aims to prevent the impression that trade with those areas is simply a matter of exploiting lower regulatory standards, which would encourage a race to the bottom in terms of regulatory standards. However, this imposes the EU’s views on other countries’ climate policies while lacking financial incentives as carrots and having potentially too severe of a stick—the suspension of access to the common free trade area for non-compliance is an extreme measure, together meaning the measures are actually less effective, or even unfeasible in terms of enforcement. This approach may lack credibility and can be politically sensitive, as seen in the EU-Mercosur Free Trade Agreement, which has been delayed due to a clause requiring the protection of the Brazilian rainforest.

The overall conclusion is that trade-based sticks may not be effective as they impose strong costs on trading partners or lack strong incentives, as in the case of border carbon adjustments.

Conditional climate finance: supporting green development practices

The second main topic is conditional climate finance, where advanced countries provide financial support to developing countries in exchange for adopting green development practices. This support can be in the form of grants, debt relief, or through multilateral development banks. Private investments in green projects can also be subsidized, which is known as “blended finance”. The goal is not only to finance investments but also to encourage policy reforms such as carbon pricing and protection of forests, etc. However, the transition away from brown assets like coal mines may have political and social implications that need to be handled carefully.

The approach to reducing emissions in developing countries faces two challenges: monitoring and enforcing conditions in EMDEs, particularly because these are politically sensitive conditions that are imposed, and addressing the collective action problem among advanced countries who are essentially trying to avoid the climate free riding problem of EMDEs by introducing a problem that could result in free riding by advanced nations in terms of providing finance. The country platform idea, which focuses on country-level relationships and policy partnerships, can address these issues. Several parties must come together to solve the issues related to this approach: a funding coalition of advanced countries that is an international partners group to address the free rider problem, multilateral development banks and the IMF can help in project selection criteria and monitoring, local financial institutions play a crucial role in project selection, and the private sector adds leverage through blended finance. This approach aims to address both challenges while achieving collective emissions reductions.

Development of instruments and institutions to mitigate exchange rate risk

Lastly, an area requiring more attention is the development of instruments and institutions to mitigate exchange rate risk. This is crucial for reducing the cost of capital and enhancing the appeal of projects to international sources of finance.

Addressing the collective action problem involves selecting the largest funding coalition capable of managing internal incentives against free riding, potentially the G7 or the G7 plus some smaller advanced economies. If the benefits of conditional climate finance to this group exceed the associated costs, the collective action problems are solved. Calculations from a paper titled “The Great Carbon Arbitrage,” authored by a colleague, indicate that such a coalition already exists.

In the paper, the net benefit of replacing coal with renewables is calculated by adding the cost of renewable investment and the opportunity cost of early retirement of coal. The benefit is the social cost of carbon emissions that can be avoided by replacing coal with renewables. The size of the country (represented by its social cost of carbon (SCC)) and how much the public sector will contribute determine whether this project will be profitable or an unacceptable cost. It is suggested that many of these projects can become profitable if the public sector covers around 20% of the investment cost.

Three scenarios in the research assume the public sector of advanced countries cover the costs in full, half or 20% of the investment. Even with the most optimistic scenario, where only a 20% contribution is needed and the private sector covers the rest, it would never be worthwhile for Japan to undertake this alone due to its relatively small share (about 3%) of the world’s social cost of carbon, resulting in only 3% of global benefits. Asking a country with such a small share to fund the entire decarbonization process would consistently yield a negative outcome.

The European Union faces a similar situation, with its share of the world’s social cost of carbon estimated at about 11%. However, for the U.S., the dynamics change significantly, as it is estimated to have almost 30% of the world’s social cost of carbon. With the assumption that the private sector covers half of the cost of coal replacement, it would be profitable for the U.S. to subsidize decarbonization in countries like India, potentially yielding a profit of around 50 billion dollars. When considering the collective efforts of the G7 countries, which together have close to half of the world benefits of decarbonization, it becomes economically viable. As long as there is agreement not to free ride within the G7, with the group possibly extended to include non-G7 EU countries, pursuing this strategy makes sense.

Just Energy Transition Partnerships (JETPs) and their progress

In practice, the Just Energy Transition Partnerships (JETPs) closely resemble the theoretical approach just discussed. Initiated two years ago, they involve political declarations between an international partner group and a specific country, on a country-by-country basis. JETPs have been established for South Africa, Indonesia, Vietnam, and Senegal, with international partner groups primarily being G7-based or EU- or UK-led. These partnerships aim to phase out coal in the power sector, except for Senegal, where the focus is on transitioning away from heavy oil, and South Africa, which includes various objectives, such as transport sector transformation. While progress has been made, detailed investment plans exist for only one country, and no investments have been realized yet.

The primary goal of these partnerships varies. Some aim to fund existing emissions reduction pledges, especially in cases where countries acknowledge the challenge of meeting these commitments without sufficient financial support. In other instances, like Indonesia and Vietnam, the objective is to make emissions targets more ambitious than existing pledges. This aligns with the idea that encouraging countries to bring forward emission reductions in the short term can meaningfully impact the likelihood of achieving or staying within the Paris Agreement objectives. However, a significant challenge exists as these partnerships are severely underfunded. For example, the committed amount for South Africa is $8.5 billion, while government estimates suggest the actual needs range from $50 to $100 billion. The estimates from “The Great Carbon Arbitrage” paper propose even higher figures, emphasizing the substantial underfunding across these initiatives.

In conclusion, achieving the Paris Agreement objectives requires advanced countries to emphasize incentives for decarbonization in poorer countries. Trade instruments prove inadequate, as they are either ineffective or detrimental to developing nations, causing political discord. The preferred approach is large-scale, conditional climate finance supporting country-level decarbonization plans, which would be impactful enough to make it in the interest of advanced country coalitions.

However, despite promising developments in this direction, there’s a significant gap between principle and practice. Committed amounts are far too low, potentially due to fiscal constraints, but they pale in comparison to currently employed domestic decarbonization costs. Scaling up requires confidence in the effectiveness and ambition of these plans, trading higher finance for increased ambition and implementing robust monitoring and verification systems.

Comment

Importance of addressing decarbonization in emerging and developing countries—an Asian perspective

KIHARA Shinichi:
Addressing the acceleration of decarbonization in emerging and developing countries is crucial for global carbon neutrality. This approach is emphasized by the G7 Presidency, recognizing the need for all countries, developed and developing, to achieve carbon neutrality. Despite frustrations and disparities between the north and south, trade instruments alone are insufficient. Measures like the Climate Club or Carbon Border Adjustment Mechanism lack incentives for outside countries to adopt ambitious policies unless the club is substantial enough to encourage such participation. Conditional climate finance is deemed vital, with a focus on strong policy commitment and ownership by the receiving country. It’s acknowledged that building effective finance structures must align with genuine commitment from recipient nations.

In terms of Asia, government-level communication with emerging countries is essential. The common trilemma faced by these nations is the tradeoff between carbon neutrality, energy security, and economic growth, for which balancing is difficult. Recognizing and addressing these intertwined priorities becomes a crucial starting point for effective engagement.

The energy transition pathways between different emerging countries also differ greatly. In developed nations, power demand has become quite stable, while emerging countries face a rapidly growing demand, doubling in 10-20 years, and the need to meet this demand trumps all other considerations. Currently, coal, gas, and hydro meet this demand, with a nascent shift towards renewable energy insufficient. Renewable energy potential also differs greatly from region to region, with North Europe having more wind resources than Southeast Asia. Japan initiated the Asia Zero Emission Community to support energy transition in Asian countries, engaging with governments, aiming to understand their unique situations, and provide financial, technological, and human resource support.

Energy transition is essential in achieving net-zero emissions, referring to a graph by the International Energy Agency. There are various different aspects to arriving at net zero from retiring outdated plants to constructing new, net-zero facilities, and each party should be encouraged to take the steps that are feasible as early as possible. Transition finance is also important, and Japan aims to create a framework to facilitate the transition by providing guidance and roadmaps for various sectors. Efforts are also underway to establish a transition finance framework in Asia, involving the Transition Finance Study Group with participation from Asian banks, governments, and other stakeholders in the region.

Q&A

Q:
Japan’s organizations, JICA and JBIC, provide significant funding for development initiatives including decarbonization initiatives in EMDEs. What is the potential for co-financing with the EU?

Jeromin ZETTELMEYER:
The collaboration between bilateral and multilateral institutions is important, particularly the European Investment Bank (EIB), the Asian Development Bank, and the World Bank. The EIB, the EU’s lending arm, is involved in two of the JETPs, and multilateral institutions like the Asian Development Bank and the World Bank are also involved.

Q:
Could the Asian Development Bank (ADB) or the International Monetary Fund (IMF), or the World Bank, or some international financial centers such as an international organization provide the initiative for collecting the funds or finances?

Jeromin ZETTELMEYER:
The International Monetary Fund (IMF) is a key player in identifying decarbonization projects and ensuring financial support from rich countries is well-spent. It provides criteria and frameworks for local financial institutions to identify these projects, and its Resilience and Sustainability Trust offers long-term lending to countries to address climate problems. The IMF’s role is to reform energy subsidies and phase out fossil fuel subsidies, but specific decarbonization policies must be set by institutions like the ADB or the World Bank.

Q:
The Conference of Parties is a global conversation and data collection opportunity on decarbonization. Which organization or occasion should be used to monitor EMDEs’ decarbonization initiatives, gather statistics, and approach the G7 or G20 for funding?

Jeromin ZETTELMEYER:
The country platform approach to decarbonization necessitates a dedicated structure for each JETP, developed by the country and negotiated with funders, which is implemented by a government institution and a multilateral development bank, which provides technical assistance and ensures policy implementation. Conditional lending can be beneficial, but a dedicated monitoring and steering structure is needed.

Q:
Is the EU’s carbon pricing scheme an effective approach, and could it also be used in African countries? What challenges might there be in implementing it there?

Jeromin ZETTELMEYER:
Emissions trading systems are a crucial approach in the EU and Japan, but their implementation in developing countries like South Africa may be limited due to political and administrative capacity issues. Direct plans to decarbonize power sectors may be more effective than Emissions Trading Systems, but they can be built in parallel. The expectation of tightening allowances may have influenced investment plans early on.

Q:
What is your impression about the Task Force on Climate-related Financial Disclosures (TCFD)? Japan is leading TCFD and hosts a TCFD Summit every year. How do you view the global TCFD project, and do you know about Japanese efforts to improve transparency? Many companies are aligned with TCFD efforts.

Jeromin ZETTELMEYER:
Transparency standards are crucial for equity investors to assess companies’ risk management strategies, determining capital cost, and enabling self-enforcing processes, thereby influencing their investments towards environmentally responsible companies..