Patrick Bolton, Alissa M. Kleinnijenhuis and Jeromin Zettelmeyer / Jun 2024
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EU’s CO2 emission have been on a downward trend for about 15 years now, albeit too slowly. In contrast, emissions in emerging market and developing economies (EMDEs) continue to rise. Unless these countries significantly accelerate their decarbonisation, global temperature rises will be impossible to contain to 1.5-2 degrees above pre-industrial levels, even it advanced countries fully comply with their net zero commitments.
One way to accelerate decarbonisation might be to encourage EMDE’s to adopt carbon pricing. The EU is about to do so: starting in 2026, it will apply a “Carbon Border Adjustment Mechanism” (CBAM), requiring importers to buy carbon emission allowances corresponding to those that EU producers have to buy under the EU’s exchange trading system (ETS). Because any carbon price that firms exporting to the EU have already paid will be rebated, this may lead export country governments to apply carbon taxation to goods that are exported to the EU. But this will not necessarily help to decarbonise non-traded goods and domestic energy systems. And will cause tensions with developing countries, who may feel that a rich-country carbon price is being unfairly imposed on them.
CBAM should therefore be complemented with climate finance. In a policy brief published this week, we make the case for a specific form of such support: financing the replacement of coal with renewable energy. A pathbreaking paper by Adrian et al (2022) showed that the economic benefits of such support exceed its costs not just globally, but from the perspective of advanced countries that would be financing the coal exit. In a new Bruegel paper, we extend their analysis in three ways.
First, we show that conditional financial support is generally necessary because most EMDEs will not have an incentive to exit coal without such support. The reason is that while they would pay the full costs, they obtain only a small share of the economic benefits of the CO2 emissions reduction of stopping the use of coal.
Second, the net benefits of financing the coal exit of EMDEs (except China) are positive even for a relatively small coalitions of advanced countries: the G7 or G7 plus EU. Because these countries cover a relatively large share of the World Economy – and hence suffer a relatively large share of the economic losses inflicted by global warming – their combined benefit from EMDE coal exit exceeds its cost.
Finally, while the fiscal costs of financing coal exit in EMDEs (without China) are large in absolute terms, they are modest as a share of G7+EU GDP: in the order of 0.3 percent of GDP per year, assuming public sector participation in renewable energy investment costs through blended finance of around 25 percent.
We conclude that large-scale international climate finance is both economically desirable and feasible from the perspective by the G7 and the EU. Yet, it is not happening at the requisite scale, partly because of incentives and political economy challenges. Advanced countries' are reluctant to commit financing to climate action outside their borders unless they have significant control over how this money is spent. Developing countries are reluctant to phase out coal unless sufficiently large financial support is forthcoming for renewable investments that are consistent with their development goals.
These problems could be overcome by tying renewable finance to a coal phase-out. “Just Energy Transition Partnerships” with South Africa, Indonesia, and Vietnam are embryos of this approach. But in their present state, they are insufficient. On the one hand, the financing promised is far too low; on the other, financing is not explicitly linked to specific policy actions. JETPs should be developed to scale and expanded to additional countries, with sufficient grants to pay for coal closures and the social transition of coal communities, by explicitly conditioning funding to a coal phase-out, and through a stronger governance structure to implement these deals.
