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How will climate change affect countries’ prospects for economic transformation?

Written by Mark Miller, Nathaniel Mason, Derrick Abudu

Hero image description: Migrant workers in Kuwait keep on toiling during a sandstorm Image credit:KUWAIT CITY, KUWAIT - OCTOBER 19, 2023: Migrant workers in Kuwait keep on toiling during a sandstorm. Credit: Shutterstock | Sebastian Castelier

The COP 28 negotiations are – as in so many years – at their most contentious over international transfers of money. While finance is obviously critical, history tells us that walls of new money will not necessarily translate into sustained and inclusive economic development.

By way of illustration, data on debt flows reveal that inward international financial flows increased markedly to the African continent in the 2010s, but there was no consistent corresponding growth in exports. Many countries on the continent are today facing external debt crises as a result.

A green industrial revolution is increasingly being heralded as a way to reduce emissions and create jobs following the examples of the US Inflation Reduction Act. While green manufacturing opportunities may be attracting the attention of politicians and journalists, all that is green is not necessarily gold. Climate change will have impacts on the prospects for structural transformation that run beyond the ‘green economy’. Five areas are especially worthy of attention:

1. The role of agriculture

Increasing agricultural productivity has been central to economic transformation in the past.

However, current emission pledges set us on a path approaching 3°C of global warming, implying a three-fold increased risk to agricultural yields compared even with 2°C warming. This jeopardises the rate at which agricultural productivity can increase and so release labour.

Simultaneously, climate change and wider environmental degradation can contribute to premature rural-urban labour migration where people leave farms for informal jobs in cities, before manufacturing has taken off to offer better paying, more secure jobs.

In short, farms will be less productive – especially in countries where agriculture currently contributes more to GDP and employment. This means that the workers who leave rural areas will do so because of lack of options rather than the allure of better job and education opportunities, creating a poor and precarious urban underclass.

2. The cascading effects of disasters

The macro-economic impacts of climate-related disasters have, comparatively, received substantial attention from economists, and there is broad consensus that disasters suppress growth and poverty reduction at least in the short term.

Climate disasters impose a threefold ‘tax’ on a country:

  • The costs of recovery;
  • The costs of making infrastructure more resilient to more frequent and severe extremes in future; and
  • via increased costs of borrowing.

Those costs fall hardest on poorer, more vulnerable countries, many of which face an increasing climate-debt trap. Within countries, the impacts fall most heavily on low-income and other marginalised people. Dominica’s “Climate Blueprint” illustrates the radical transformation and substantial investment necessary for countries to thrive in a hotter world.

3. The changing value of natural resource endowments

Over the medium-term, climate change is likely to change the relative value of countries’ natural resource endowments. At some point, this will be bad news for countries with large oil and gas reserves who will face diminishing public revenues and a deteriorating balance of trade as international demand declines. Countries that have historically imported fossil fuels to meet their energy needs would stand to benefit.

Meanwhile, there has also been significant interest in the growing value of critical minerals (although current trade in fossil fuels dwarfs the potential size of markets for critical minerals), as well as clean energy exports and carbon sinks.

Even as countries from Indonesia to Morocco to Liberia jostle for these opportunities, questions are emerging about how their exploitation can benefit the wider population.

4. The ‘green squeeze’ on access to markets and finance

The size of domestic markets and demand is a major constraint to development in relatively poor and/or small countries. Historically, a focus on encouraging growth in export sectors has been a way to get around these ‘demand-side constraints’.

However, high-income countries are now introducing a suite of climate policies that could reduce access to their markets, choking off a critical path for sustained poverty reduction. ODI has promoted the idea of the ‘green squeeze’ to describe these new constraints on countries’ economic prospects.

Perhaps the most notable policies driving the green squeeze are the Inflation Reduction Act in the US, which subsidises domestic producers of clean tech, and the EU’s carbon border adjustment mechanism, which extends the bloc’s carbon price to imports. Both are also experimenting with mandatory disclosure of climate-related risks, which could impose reporting requirements that curtail access to affordable finance, and measures to secure critical mineral supplies and climate-proof supply chains.

5. Leapfrogging to cleaner technologies

Technological innovation is a key complement to structural economic transformation, and countries are now scrambling to access, and preferably originate and produce, the green technologies of the future.

The ascendance of a few non-OECD countries in this area – notably China in renewable energy, batteries and electric vehicles – gives a glimpse of a more rapid path to technological leadership. Countries from Namibia to Chile are placing bets on frontier technologies such as green hydrogen.

However, most countries are technological followers and likely to remain so. Even if they create an enabling policy environment at home, technology costs and intellectual property regimes will be heavily determined by the raft of rich countries attempting to fire their own green economic engines – including the US, EU and Australia.

Decarbonised factories or farms could potentially have a competitive advantage in years to come if large multinationals seek to ‘green’ their supply chains. This could have implications for jobs in more traditional labour-intensive export sectors like textiles or food and beverages.

The limits of financial creativity

International finance obviously still has a critical role to play in tackling climate change. It can affect the volume and composition of investments, the ability to minimise the lasting impacts of climate disasters, and above all, global political consensus on tackling climate change in a context of differentiated historical responsibilities. There are however limits to what can be achieved through financial creativity and innovation.

Politicians are promoting ‘green industrial policy’ as a smart way to bind together concerns around jobs, productivity and climate. That especially makes sense for countries who can develop cutting edge technologies.

For many countries, climate change simply presses home the importance of overcoming some of the age-old challenges of economic development: supporting transformation of the agricultural sector, making effective use of economic rents, finding ways to deal with new non-tariff barriers, securing access to new technologies and so on. The changing climate changes many things, but not everything.