The macroeconomics of the green transition

The green transition will have an impact on the region’s economies beyond aspects strictly related to sustainability. On the one hand, it may have an impact on external balances, on price formation, on the stability of the financial system and, especially, on the fiscal sphere. On the other hand, it may favor a structural transformation with implications for the labor market and productive development.

Regarding the external balance, although most Latin American and Caribbean countries are net energy importers, some, such as Colombia, Bolivia, Trinidad and Tobago, Ecuador and Venezuela, are strong hydrocarbon producers and their net exports of energy products exceed 20 % of total exports. In these cases, decarbonization of the global economy could have a negative impact on sources of foreign exchange.

The green transition could also affect price levels, structure and volatility. The increase in extreme weather events may affect the supply of agricultural goods and increase their price, and the removal of energy subsidies and the imposition of green taxes may have effects on energy prices, while the increase in demand for inputs for the green transition may affect their price and that of other goods that use them. In the financial sphere, the loss of value of assets linked to the fossil economy (stranded assets) could also have an impact on stability if they affect the value of goods or assets held by banks and, by the same effect, the access to credit of companies directly or indirectly associated with fossil energy production.

The fiscal impacts are possibly the most relevant. The study by Cárdenas and Orozco (2022), for example, presents estimates of the costs of meeting the targets set out in the climate change response commitments for six countries in the region. The authors find estimates ranging on average from 7 % to 11 % of GDP per year, higher than the amounts required in the developed world.

To these financing needs, the deterioration of fiscal revenues for countries with fossil resources should be added. In Latin America and the Caribbean, fiscal revenues from hydrocarbons reached 4.2 % in 2022; but the importance in countries such as Ecuador, Guyana and Trinidad and Tobago exceeds 9 % of GDP this year (OECD, 2023). The decarbonization of the global economy significantly reduces this source of tax revenues.

We cannot continue to subsidize activities that generate major sustainability problems, such as, for example, fossil fuel consumption. These subsidies are regressive, they go to sectors that do not need them, and they are bad from the point of view of sustainability. We have to ensure that these subsidies, which today demand a lot of resources from the State, are gradually dismantled.

Based on an interview with Mauricio Cárdenas

There are no reasonable justifications, from an economic point of view, for allocating public budget to subsidize fossil fuel consumption […] This is an element of public policy that does not even require so much institutionalization […] We have to approach the problem from a perhaps broader economic perspective.

Based on an interview with Juliano Assunção

In response, in a context of shrinking fiscal space (see chapter 1), some Governments have potential savings linked to the removal of energy subsidies. Environment-related taxes, such as levies on energy, transport, pollution and carbon emissions in general, as well as the auctioning of emission allowances can also provide sources of financing for the green transition.

In Latin America, energy subsidies (both direct and indirect) are equivalent to 4.7 % of GDP, which is more than twice as much as in more developed countries (around 2.2 %). For countries with critical mineral resources for the energy transition, the revenue associated with mining activity is likely to grow significantly.

In the aggregate, green finance needs are expected to exceed these potential sources of tax revenues. Unfortunately, international climate finance is often very limited with respect to investment needs and biased towards mitigation (Brassiolo et al., 2023). Multilateral funds climate can help channel finance towards green activities by increasing the visibility of each country’s contributions to climate goals, as well as helping to ensure that a larger amount of funds take the form of non-refundable transfers or concessional credits, i.e., those granted on more favorable terms than those available in the traditional financial market. This allows developing countries to meet climate objectives without sacrificing resources available for other development goals. Indeed, access to concessional credit for some countries seems key to be able to make adaptation investments, especially in the area of resilient infrastructure (Arreaza et al., 2023). 

Bonds tied to climate objectives can also attract funds and investors motivated by environmental conservation. Uruguay’s pioneering experience, with a bond issued in October 2022, points in this direction. This bond incorporates a reduction in the interest rate associated with good performance in two climate objectives: reduction of GHG emissions and conservation of native forest areas (Perelmuter, 2023). 

Additionally, the development of accurate green taxonomies could help increase transparency and improve the distribution of funds (Allub et al., 2024). Green taxonomies define environmental objectives and establish sectors, subsectors and economic activities that meet them. They also establish the criteria and thresholds that each activity must meet to be considered environmentally sustainable. Their main usefulness is to establish a common language for finance in this area and to give a clear signal to investors and public and private sector actors about what a green investment is. They also facilitate the creation of regulatory frameworks that promote investment and the development of sustainable activities and contribute to the advancement of policies aligned with sustainability and emissions reduction objectives. 

There are currently multiple global initiatives for green taxonomies or classifications. One of them is that of CAF, which identifies green businesses in ten strategic sectors and establishes the criteria and indicators that must be met to move towards more sustainable businesses (Gómez García et al., 2022). The Climate Bonds Initiative (CBI) taxonomy, launched in 2014, serves as a guide in the development of certification criteria for sectors and activities in the global economy.

In Latin America and the Caribbean, Brazil was the first country to have its own green classification in 2015. It is currently joined by Colombia and Mexico (since 2022 and 2023, respectively) and several countries that are in the process of developing one (e.g., Argentina, Chile, Peru and the Dominican Republic).

At a more structural level, one challenge of the green transition has to do with labor market adjustments, as some sectors will expand while others will contract. The challenges of this labor adjustment are compounded by the differences in skills required between green and non-green jobs. Fortunately, the green transition also brings important opportunities for the region. Our potential to produce clean energy and our abundance of critical minerals for the energy transition means productive development potential to attract industries and insert ourselves into clean energy value chains. More generally, exploiting natural resources, including the region’s rich biodiversity, is an enormous lever for advancing towards sustainable development and, at the same time, helping to alleviate the major global challenges the planet is facing in terms of environmental sustainability.