World Development Report 2024: The Middle-Income Trap

Preservation worsens obsolescence; dynamic firms and mobile people are needed

The low-carbon transition poses a major risk of accelerating the obsolescence of capital, skills, and industries. It is a form of directed technical change away from carbon-intensive production processes. In perfectly competitive markets, the associated reallocation of labor and capital would have minimal transition costs because workers and capital would smoothly and quickly adjust by switching jobs, moving to areas with growing demand, and supporting expansion of greener firms. In practice, however, search complications, costs to acquire human capital, or ties to particular geographic areas may give rise to significant transition costs. Higher social, occupational, and geographic mobility facilitates the rapid movement of people out of declining industries and into expanding ones, which in many countries requires a move to another geographic location. Likewise, dynamic enterprises and low barriers to entry can lower transition costs within countries.

Meanwhile, fossil fuel resources that cannot be burned and fossil fuel infrastructure no longer used risk becoming “stranded assets.” Stocks of unburnable carbon (such as coal reserves) could become stranded resources if their future value becomes lower than their current expected value. This disconnect could lead to overly high investment in and maintenance of infrastructure that supports, and is supported by, the burning of fossil fuels, which later becomes stranded capital. In middle-income countries, coal-fired power plants are the most exposed to the risk of becoming stranded and may have to be retired 10–30 years earlier than they did in the past. Several expectations influence whether assets become stranded. They include expectations about the implementation of climate policies, about technological progress, and about legal action against high emitters. Stranding could occur based on today’s projections of fossil fuel production solely due to the current rate of technological change, which is faster than expected. The extent of stranding will depend on how policy choices today shape expectations about the future, along with efforts today to facilitate the reallocation of resources from sunsetting industries to growing ones. Efforts by countries, industries, or firms to preserve sunsetting industries longer than is economically viable rather than reallocating resources to expanding ones risk increasing transition risks and obsolescence.

Overvalued assets also pose the risk of a carbon bubble in financial markets. The scale of the fossil fuel industry is large enough to potentially trigger broader financial crises. The exposure to correlated risks within and across portfolios, with many potentially stranded assets at risk of being devalued simultaneously, alongside the underexposure to assets in low-carbon technologies with potentially higher returns, also pose systemic risks that could affect the financial system as a whole. If undermanaged, this instability could result in policy swinging away from transition to protecting the financial system more broadly. Ensuring an orderly transition and clarity in direction is necessary to limit the potential of this crisis.

These financial risks are heightened in countries with more vulnerable financial systems. Countries more dependent on resource revenues would be particularly exposed, limiting their capacity to respond to the shock. The degree to which sectors are linked within the economy is also associated with the exposure of the financial system, with greater links acting to potentially multiply the effects of an initial shock, creating ripples through the wider economy, and exposing financial systems to further pressures.

Countries with rich reserves of critical green minerals will also need to ensure they avoid repeating the mistakes of past natural resource booms and contracting “Dutch disease” or a green “resource curse.” The transition is also expected to significantly increase the demand for minerals that are critical inputs in low-carbon technologies such as lithium, cobalt, copper, and rare essential earths. This demand could present countries with large reserves of such minerals, such as Chile, the Democratic Republic of Congo, and Namibia, with a potential economic opportunity. However, critical minerals are often located in regions characterized by poor labor and environmental standards and considerable political fragility and corruption. Thus these increases in demand could contribute to a proliferation of problematic mining practices and conflict. The failure of many hydrocarbon exporters to use export revenue to diversify their economies, which now renders them vulnerable to the transition, should serve as a cautionary tale to mineral exporters. To avoid another resource curse, revenue from a higher demand for minerals could be used to support investment in education, infrastructure, and the development of economic sectors that are higher in value added.

Infusion of global technologies and diversification will be crucial for middle-income countries

Andres et al. (2023) have compiled a list of traded “brown products,” whose use is likely to decline if the world is to mitigate climate change. They then explore which countries are most at risk of seeing their productive capabilities “stranded.” They find that, on average, brown products tend to be less complex than green products. Although countries that export technologically sophisticated brown products, such as internal combustion engine vehicles, could find it relatively easy to transition, those with exports highly concentrated in a few low-complexity brown products (such as commodities) have fewer opportunities for diversification. Of the top 10 countries facing the greatest risk of such “brown lock-ins,” as measured by an index constructed by these authors, six are middle-income countries. Panel a of figure 6.7 displays the 10 middle-income countries most exposed: Iraq, Libya, Angola, Equatorial Guinea, Azerbaijan, Nigeria, Algeria, Turkmenistan, Timor-Leste, and Gabon.

Middle-income countries with a high degree of specialization of physical, institutional, and human capital in declining sectors that cannot be easily transitioned to new opportunities face the highest risks. The production of some carbon-intensive products is similar to the production of green ones—for example, there is a high degree of overlap in the manufacture of internal combustion engine (ICE) vehicles and electric vehicles. In general, the risk of brown lock-ins is negatively and significantly associated with the ease of transitioning to green or overall non-brown products. This risk is displayed in panel b of figure 6.7, which shows the correlation between the Brown Lock-in Index and the Transition Outlook, also constructed by Andres et al. (2023) to measure a country’s ease of transitioning from brown to green products.

Workers with obsolete occupations and skills will need support to avoid stranding

The energy transition will lower the demand for workers who extract and refine coal, natural gas, and oil. Employment in these activities tends to be disproportionately occupied by workers without a college education. Workers at legacy suppliers of electricity, such as the coal-fired power plants that are now being retired, will also be affected. At risk as well are those employed in energy-intensive manufacturing industries such as basic chemicals, nonmetallic minerals, and primary metals, and in industries like ICE vehicle manufacturing. Park et al. (2023) explore fossil fuel jobs in China and how their economic geography compares with that of low-carbon technology jobs. In China, fossil fuel jobs are concentrated around Shanxi and in the north of China, whereas low-carbon technology jobs are concentrated in the cities on the east coast and particularly in the south, demonstrating the challenge for workers to transition (map 6.3).

Recent research on job transitions has demonstrated the challenge of transitioning workers out of high-carbon jobs. Using microdata representing more than 130 million online work profiles, Curtis, O’Kane, and Park (2023) explore transitions away from carbon-intensive production technologies. They find that in 2021 only 0.7 percent of workers who transitioned out of a carbon-intensive job found work in a green job. Conversely, the vast majority of workers obtaining green jobs do not come from carbon-intensive industries, but from a wide range of other industries and occupations (such as sales manager, software developer, and marketing manager). On average, 20 percent of transitions out of carbon-intensive jobs are into other carbon-intensive jobs, whereas transitions into manufacturing are the most common, accounting for more than 25 percent of all transitions out of carbon-intensive jobs. Although in some US states, such as California, the rates of transition from dirty to green jobs are relatively high, in others, such as West Virginia, the rates of green transitions are low even though these states have a high density of existing carbon-intensive jobs.

In conclusion, middle-income countries will need to amplify the forces of creation, weaken the forces of preservation, and manage the forces of destruction to advance technological progress. The chapters that follow focus on policies that these countries can implement to help them achieve these goals.