Publication: Global Ripple Effects: Knock-on Effects of EU, US, and …

Publication: Global Ripple Effects: Knock-on Effects of EU, US, and …

As the world’s leading economies forge ahead with ambitious climate mitigation strategies, the ripple effects on developing countries are becoming increasingly evident. The European Union (EU), United States (US), and other major economies are implementing policies to accelerate their shift to renewable energy, phase out fossil fuels, and promote green technologies. These actions, while crucial for global decarbonization, are also reshaping international trade, investment, and technology flows in ways that can significantly impact developing economies.

Knock-on Effects of EU Policies

The EU’s European Green Deal and associated legislation, such as the Fit for 55 package, are driving a profound transformation of the continent’s energy and industrial landscape. The EU’s aggressive targets for renewable energy expansion, energy efficiency, and emissions reduction are creating new market opportunities and challenges for its trading partners.

One of the key EU policies poised to have far-reaching consequences is the proposed Carbon Border Adjustment Mechanism (CBAM). This mechanism aims to level the playing field for EU producers by imposing a tax on imports of certain carbon-intensive goods, such as steel, cement, and aluminum, from countries with less stringent climate policies. While the CBAM is designed to prevent “carbon leakage” and incentivize global decarbonization, it could also disrupt the trade patterns of developing countries that rely heavily on these exports to the EU.

Knock-on Effects of US Policies

Across the Atlantic, the US has also ramped up its climate ambition with the Inflation Reduction Act (IRA), a landmark piece of legislation that includes significant investments in renewable energy, electric vehicles, and carbon capture technologies. The IRA’s provisions, such as tax credits and subsidies for clean energy deployment, are expected to spur domestic green technology manufacturing and innovation, potentially creating new export opportunities for developing countries.

However, the IRA’s “Buy American” provisions, which prioritize the use of US-made components in eligible projects, could also limit the access of developing countries to the US market for renewable energy and electric vehicle parts and equipment. This could create trade tensions and affect the competitiveness of developing economies’ green industries.

Knock-on Effects of Other Major Economies

While the EU and US are at the forefront of the global climate action, other major economies, such as China, India, and Japan, are also implementing their own ambitious climate policies. These policies, ranging from emissions trading systems to renewable energy targets, will also have significant knock-on effects on developing countries.

For instance, China’s push for electric vehicles and battery storage technologies is already driving up global demand and prices for critical minerals, such as lithium, cobalt, and nickel. This could pose challenges for developing countries that rely on the export of these commodities, as they may need to navigate volatile price swings and potential supply chain disruptions.

Interconnected Global Markets

The knock-on effects of climate policies in major economies are amplified by the increasing interconnectedness of global markets. Trade interdependence, financial linkages, and supply chain dynamics mean that changes in one part of the world can have far-reaching consequences elsewhere.

Trade Interdependence

Developing countries are deeply integrated into global value chains, supplying raw materials, intermediate goods, and services to the EU, US, and other major markets. Disruptions in these trade flows, driven by climate policies, can have significant ripple effects on the economic performance of developing economies.

Financial Linkages

The shift towards green finance and sustainable investment in the EU, US, and other advanced economies is also shaping the availability and cost of capital for developing countries. As investors and lenders increasingly prioritize climate-related risks and opportunities, developing countries may face challenges in accessing climate finance and green investment.

Supply Chain Dynamics

The transition to renewable energy and green technologies is also transforming global supply chains. Developing countries that are well-positioned to supply critical components, such as solar PV panels, wind turbines, or lithium-ion batteries, may see new opportunities. However, those reliant on fossil fuel exports or energy-intensive manufacturing could face disruptions and the need for economic diversification.

Macroeconomic Transmission Channels

The knock-on effects of climate policies in major economies are transmitted to developing countries through several macroeconomic channels, including trade flows, capital movements, and exchange rate fluctuations.

Trade Flows

Changes in the demand and prices of fossil fuels, energy-intensive goods, and agricultural commodities can significantly impact the export earnings and trade balances of developing countries. Shifts in global value chains and the competitiveness of their exports can also affect their overall economic performance.

Capital Movements

As investors and lenders adjust their portfolios to account for climate-related risks and opportunities, developing countries may experience volatility in foreign direct investment, portfolio flows, and access to international credit markets. This can affect their ability to finance development projects and investments in renewable energy and green technologies.

Exchange Rate Fluctuations

Changing trade patterns and capital flows can also lead to exchange rate movements that can impact the purchasing power of developing countries, the competitiveness of their exports, and the servicing of their foreign-denominated debt.

Sectoral Implications

The knock-on effects of climate policies in major economies are not evenly distributed across different sectors in developing countries. Some industries may be more vulnerable, while others may find new opportunities.

Manufacturing Industries

Energy-intensive manufacturing sectors, such as steel, cement, and chemicals, may face increased pressure to decarbonize their operations or risk losing access to EU and US markets due to the CBAM. Developing countries with a strong presence in these industries will need to find ways to improve their carbon footprint and remain competitive.

Services Sectors

Developing countries with a strong services sector, such as tourism or financial services, may be less directly affected by climate policies in major economies. However, they may still be impacted through indirect channels, such as changes in trade flows, investment patterns, and consumer preferences.

Commodity Markets

Developing countries that rely heavily on the export of fossil fuels, minerals, or agricultural commodities may face volatility in global prices and demand as a result of climate policies. This could lead to terms of trade shocks and the need for economic diversification.

Developing Economy Vulnerabilities

Developing countries are particularly vulnerable to the knock-on effects of climate policies in major economies due to their export dependence, remittance flows, and debt sustainability challenges.

Export Dependence

Many developing countries have economies that are heavily reliant on exports, often of primary commodities or energy-intensive goods. Disruptions to these export markets can have severe consequences for their economic growth, employment, and fiscal revenues.

Remittance Flows

Developing countries that depend on remittances from workers in the EU, US, or other major economies may also be affected by changes in employment, wages, and exchange rates in these countries, which can impact the flow of funds to their domestic economies.

Debt Sustainability

Some developing countries are already grappling with high levels of public debt, which can become more challenging to service if their export earnings and economic growth are negatively impacted by the knock-on effects of climate policies in major economies.

Multilateral Policy Coordination

Addressing the knock-on effects of climate policies in major economies on developing countries will require multilateral policy coordination and collaboration among international institutions, national governments, and the private sector.

International Institutions

Organizations such as the World Bank, International Monetary Fund, and United Nations can play a crucial role in providing technical assistance, climate finance, and policy frameworks to help developing countries navigate the challenges and seize the opportunities presented by the global energy transition.

Cooperative Frameworks

Developing countries can also benefit from regional and international cooperation frameworks, such as trade agreements and investment partnerships, that can help them diversify their export markets, access green technologies, and secure climate finance.

Spillover Mitigation Strategies

Developing countries can also adopt domestic policies to mitigate the negative spillover effects of climate policies in major economies, such as industrial diversification, skills development, and targeted social protection measures to support affected communities and sectors.

The global ripple effects of climate policies in the EU, US, and other major economies present both challenges and opportunities for developing countries. By proactively addressing these knock-on effects through multilateral cooperation and tailored domestic strategies, developing economies can navigate the transition to a low-carbon future and unlock new pathways for sustainable development. The European Future Energy Forum provides a platform for stakeholders to collaborate on these critical issues and explore innovative solutions.

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