Photo: Inter-American Development Bank
With the UN climate talks starting at the end of October and the Intergovernmental Panel on Climate Change’s latest stark warning that the world has scant time to avoid climate catastrophe, the international community urgently needs to find ways to meet the challenge.
To limit the increase in the global average temperature to 1.5 degrees Celsius called for by the Paris Agreement, finance ministries in Latin America and the Caribbean have to do their part to take climate action to the next level and play a much greater role than they have previously. While environment ministries in the region have done incredible work to advance climate policy, finance ministries are needed to make finance flows consistent with climate-resilient and net zero economies. They are well-positioned to establish taxes, reform subsidies, mobilize private resources, and oversee public spending, all toward the goal of sustainable and inclusive growth.
Climate Risks
As recent extreme weather events have shown with devastating clarity, we are not prepared to live with the consequences of climate change. From the forest fires in North America to the drought in South America and the floods in Europe and China, recent events depict a world that has warmed 1.1 degrees Celsius above pre-industrial levels, according to the Intergovernmental Panel on Climate Change.
In Latin America and the Caribbean, the average annual frequency of extreme weather events has increased by more than 50 percent in recent decades from 0.2 per year from 1980-2000 to 0.3 per year between 2001 and 2019. These events affect the most vulnerable, with an estimated fiscal impact between 0.2-0.3 percent of annual GDP in the last two decades. Given the effect of climate change on food security, more than 30 million people could seek to migrate from Central America to the United States by 2050 in the most extreme scenarios.
One of the most effective actions that finance ministries can take to manage these risks is to strengthen public investment systems, requiring that all new infrastructure be resilient to climate impacts and aligned with the goals of the Paris Agreement. This would come with major benefits: Every dollar invested in making the economy more resilient can generate up to four dollars in economic benefits.
To avoid being left behind, Latin America and Caribbean countries will have to move quickly to reap the other benefits of global decarbonization and manage the risks of the transition to green economies.
Fossil Fuels
The increased production of renewable energy, which is now cheaper than fossil fuel energy in many countries, and the growing use of electric vehicles will reduce the demand for fossil fuels from exporting countries. To keep global temperature rise below 1.5 degrees Celsius, Latin American oil production needs to fall to less than 4 million barrels per day by 2035—60 percent less than levels before the pandemic. This would mean that 66 percent to 81 percent of proven, probable, and possible oil reserves will not be used before 2035. Regional oil exporters could lose up to around US$2.6 trillion in fiscal revenues by 2035 if strong global climate action materializes.
It is important for countries to avoid being trapped in high-emission growth strategies that prevent them from decarbonizing their economies. Countries run the risk of being stuck in investments that are not consistent with a decarbonized world, with the additional costs that stranded assets will imply for economies and public finances. Having been devalued or retired before the end of their expected useful life, stranded assets could also create political instability due to the loss of wealth among the owners of affected capital assets and workers.
Finance ministries can design fiscal strategies to anticipate the risks of lower fossil fuel revenues and plan the transition by implementing alternative fiscal measures. They must design policies that consider and address the distributional impacts on economic sectors and affected workers, through proper fiscal, tax, public investment, and spending management.
While decarbonization can cause job losses in the fossil fuels sector, finance ministries can outweigh this effect by boosting job creation in other industries. Adequate fiscal planning to support the decarbonization of the region’s economies would create 15 million net new jobs by 2030 in areas such as plant-based food production, renewable energy, construction, and manufacturing.
Towards a Post-Pandemic Sustainable Recovery
Now is the time for finance ministries to act. As countries design their post-pandemic recovery plans, finance ministries can incentivize firms to decarbonize and adapt to climate change. They can also ensure that public funds avoid bailing out polluting industries.
While the required resources for climate action far exceed the financial capacity of governments, public policies and finances play a crucial role in catalyzing private investment. Finance ministries can contribute to the development of new markets, such as green bonds, taking advantage of the strong interest of capital markets in sustainable projects.
The public policy and investment decisions that countries make now to reactivate their economies from the pandemic will determine whether they can meet their goals under the Paris Agreement and achieve a sustainable and inclusive recovery. At the Inter-American Development Bank (IDB), we are committed to helping countries achieve these goals. Mainstreaming policies to address climate change is one of the key strategic pillars of our institutional strategy Vision 2025 and we are investing heavily in climate-related projects and technical assistance.
Governments can no longer afford for finance ministries to be on the sidelines. We need them front and center now to reduce the risks presented by climate change and to take advantage of the opportunities of the green economy that will benefit people today and future generations.
Huáscar Eguino, Raúl Delgado, and Aloisio Lopes are specialists at the Inter-American Development Bank and the editors of the book, Fiscal Policy and Climate Change: Recent Experiences of Finance Ministers in Latin America and the Caribbean.
