World Development Report 2024: The Middle-Income Trap

Diffusion of upstream clean energy technologies in middle-income countries

As the costs of low-carbon technologies decline, growth using cleaner energy sources and energy efficiency technologies is for the first time a possibility in today’s middle-income countries. Currently, these countries’ rate of adoption of key low-carbon energy technologies is, in fact, growing more rapidly than for that of high-income countries, but levels of adoption remain significantly lower. In levels, middle-income countries are still lagging on the deployment of three key low-carbon energy technologies—solar energy, wind energy, and EVs—compared with high-income countries (figure 6.4). In 2021, the average share of electricity generated from wind and solar power in middle-income countries was about half of that in high-income countries (respectively, 4.1 percent versus 9.5 percent for wind and 2.7 percent versus 5.3 percent for solar). The uptake of EVs in middle-income countries also remains about half as much as that in high-income countries (measured as number of EVs per million inhabitants). But today in middle-income countries, the average growth rates of key clean energy technologies have overtaken those of high-income countries.

Research for this Report found that after controlling for income, countries with higher rates of deployment of solar and wind energy have more favorable renewable energy policies and a more favorable regulatory environment (captured by a higher value on the Regulatory Indicators for Sustainable Energy, or RISE, Index); higher carbon pricing (as measured using the net effective carbon rate of the Organisation for Economic Co-operation and Development, OECD); and lower fossil fuel reserves. Countries with higher solar potential (measured using the World Bank PVOUT Index) also have higher solar deployment rates.

Diffusion of downstream low-carbon energy technologies in middle-income countries

Adoption of low-carbon technologies by firms and households in middle-income countries remains far more limited than in high-income countries. In 2021, the emissions intensity of energy consumption in middle-income countries was 49 percent higher than that in high-income countries, while energy consumption per unit of GDP was 2.5 times higher. Measures of downstream technology adoption across a wide range of countries are not readily available, but emissions intensity within narrowly defined industries can serve as a proxy for technology adoption. On average, of 63 middle-income countries, two-thirds (41) have higher carbon intensity across industries—in terms of direct emissions that are owned or controlled by a company (Scope 1 emissions)—than the high-income country average, while about one-third (22) have lower carbon intensity.

Firms in middle-income countries vary widely in their adoption of low-carbon technologies, even within narrowly defined industries. Firms’ overall management practices and technological sophistication, skill intensity, and international orientation are correlated with their adoption of low-carbon technologies and energy-saving practices. In Argentina, for example, firms’ capacity to adopt more advanced low-carbon technologies has been shown to be correlated with their share of skilled workers. Exporters usually have lower emissions intensity relative to nonexporters. Foreign-owned firms generally have better environmental performance, as has been shown for Côte d’Ivoire, Mexico, and República Bolivariana de Venezuela.

Production of low-carbon technologies is concentrated in a few middle-income countries

Substantial manufacturing or innovation in low-carbon energy technologies is occurring in only a handful of middle-income countries with competitive manufacturing sectors. In terms of production, only one middle-income country—China—is competitive in all three key low-carbon technologies in terms of breadth (across the full value chain from raw materials, processed materials, subcomponents, to the end product of the supply chain) and depth (a high average market share) (figure 6.5). By contrast, other middle-income countries have either depth or breadth and typically only in one product. For example, countries with well-established manufacturing sectors such as India and Türkiye show a high breadth of export competitiveness in the production of wind turbines. Middle-income countries with large mineral deposits (such as Brazil and Russia) have high depth in the export of critical minerals for EVs.

Patenting for low-carbon technologies is also highly concentrated in just a handful of countries, with China in the lead, according to data from the International Renewable Energy Agency (IRENA). Over the last two decades, China has filed the largest number of such patents, followed by the United States, Japan, Korea, and Germany. Such patenting has been very limited in other middle-income countries, with the second-highest middle-income country, Brazil, filing only 2 percent as many patents as China over the last 20 years.

Costa Rica and China are global front-runners in terms of job creation related to low-carbon technologies. In 2022, Costa Rica accounted for about 8 percent of all online job postings related to low-carbon technologies and China for 5 percent—just below the global maximum of 8 percent for Denmark (figure 6.6). Five other countries have exceeded the high-income country average: Brazil, Georgia, Senegal, South Africa, and the Dominican Republic. In terms of emerging spatial clusters in 2022, 28 of the 30 cities with the largest number of new online job postings related to low-carbon technologies were in China. Only Bangalore and São Paolo were the other middle-income country cities in the top 30. These sectors and jobs are clustered both within and across countries. For middle-income countries to successfully seize the opportunities of the green economy, the right policy mix, financing, regulatory environment, and infrastructure need to be in place.

Incumbent state-owned enterprises, legacy policies, and path dependence—all block creative destruction

Incumbents in high-carbon industries erect barriers to entry of low-carbon technologies

The low-carbon transition will create winners and losers—and the losses are more concentrated than the gains, resulting in a political economy prone to inertia. Although 80 percent of the global population lives in a country that imports fossil fuel, fossil fuel revenues are highly concentrated. In 18 countries, fuel exports account for more than 50 percent of total merchandise exports; seven countries generate 90 percent or more of their export earnings from fossil fuel exports. Fossil fuel resources are more concentrated than renewable resources. Within countries, the losses to fossil fuel companies are also highly concentrated. Studies have shown that the concentrated nature of the losses from the low-carbon transition, compared with the distributed nature of the gains, makes the clean energy transition particularly prone to obstructionism by entrenched interests. Moreover, the incentives for lobbying are asymmetric. Incumbents, as a tightly defined group of actors, have a greater incentive to mobilize, and they face lower coordination costs. Smaller firms and individuals, by contrast, are more dispersed and face higher coordination costs. This results in political inertia, as has been evident from the persistent difficulty in phasing out fossil fuel subsidies globally.

Incentives, both explicit and implicit, that favor higher-carbon industries and production processes over lower-carbon ones are higher in middle-income countries than in high-income countries. Middle-income countries, particularly energy exporters, have significantly lower carbon prices. Consumer fossil fuel subsidies in middle-income countries totaled over US$800 billion in 2022, of a global total of US$900 billion. Estimates of explicit consumer and producer fossil fuel subsidies in 2022 from the International Monetary Fund (IMF) also show that middle-income countries account for 65 percent of the total. Fossil fuel subsidies have a sizable fiscal cost and exacerbate air pollution, contributing directly to premature deaths.

Middle-income countries also score lower on the RISE Index, particularly on the components of providing incentives and regulatory support for renewable energy and planning for the expansion of renewable energy. In addition, middle-income countries generally provide highly polluting industries with higher corporate tax incentives. Such incentives are particularly high in the Middle East and North Africa, as measured by the World Bank’s Global Corporate Income Tax Incentives Database.

Incentives that support incumbent firms and energy sources, as well as major barriers to entry in power markets, also severely limit private innovation in middle-income countries. Over the last 35 years, many countries have introduced competitive markets in parts of the electricity system to reduce costs and improve reliability. In many middle-income countries, however, power markets remain a monopoly: a state-owned entity operating under a vertically integrated utility. This state-owned entity carries out all functions in the electricity sector, including generation, transmission, distribution, and retail supply. Such an arrangement has generally hindered competition, and in many countries it has resulted in the inefficient use of resources. In addition, in many middle-income countries the first generators dispatched are often not those with the lower marginal prices (that is, power dispatch often does not follow merit order), serving as a barrier to the penetration of renewables with rapidly declining costs. Generally, the shift to more competitive market structures has lowered costs and enabled more innovation and penetration of renewables. In addition, the fact that energy supply technologies tend to be big, complex, expensive, and slow to develop and that new entrants must sell into entrenched markets dominated by incumbents severely limits incentives for private innovation.

Power purchase agreements with long time horizons and inflexible terms that create “lock-ins” also impede change in energy systems. PPAs are widely used to procure power by establishing a contract between a seller of power and a buyer, often a utility. If well-structured, PPAs offer certainty for buyers as well as sellers, protecting them from volatility in energy prices by locking in the price buyers pay for electricity for decades to come. This kind of long-term certainty offers sellers a steady source of revenue and improves the chances of securing low-cost financing. However, by their very nature, when used to generate power in emissions-intensive ways, such as coal-fired power, these agreements lock in polluting assets, often for decades at a time, resulting in significant inertia in energy systems. Against the backdrop of the rapidly declining costs of clean energy technologies, inflexible PPAs with “take or pay” clauses are also resulting in economically—and environmentally—suboptimal energy systems choices.