World Development Report 2024: The Middle-Income Trap

Key messages

• The climate and energy crises are providing an opportunity for middle-income countries to infuse global technologies domestically and become producers of green intermediates for global markets. By doing so, they will help reduce the cost of decarbonization worldwide.

• To accelerate the diffusion of technologies, middle-income countries will need to improve their investment climate so that contestable markets will give domestic incumbents an incentive to upgrade their technology. Alongside these efforts, high-income countries will need to reduce the scope of industrial policies that protect domestic incumbents and prevent middle-income countries from accessing technologies and markets.

• Middle-income countries should assess viable investment opportunities for renewable energy technologies and the cost of capital.

• To reduce emissions intensity, middle-income countries will need to create a market for renewable technologies, take into account their own natural resource endowment, and optimize the choice of technologies.

Using crises to destroy outdated arrangements

To ensure it has the appropriate balance of investment, infusion, and innovation, a country must pursue the destruction of outdated arrangements—enterprises, jobs, technologies, private contracts, policies, and public institutions. In many countries, however, the forces of destruction are weak during boom times.

Because middle-income countries will need to recalibrate their mix of investment, infusion, and innovation, crises are, in a sense, a necessary evil because they weaken the forces of preservation that maintain the status quo. Today, the climate crisis is one of the most pressing challenges facing not only the global economy, but also humanity at large.

To effectively tackle the climate crisis, middle-income countries will need to direct investment, infusion, and innovation toward reducing greenhouse gas emissions, bringing them to net zero. In support of climate action, more than 140 countries have set a net zero target, covering about 88 percent of global emissions. This chapter explores what it will take for middle-income countries to capitalize on the climate crisis to overcome structural stasis and advance decarbonization both locally and globally.

Low-carbon sources of energy such as wind and solar are technologically sophisticated and benefit from increasing returns to scale in production and deployment. Thus middle-income countries have an opportunity to infuse global technologies domestically and become producers of green intermediates for global markets, thereby reducing the cost of decarbonization worldwide. To accelerate diffusion of such technologies, these countries will need to improve their investment climate so that contestable markets give domestic incumbents the incentive to upgrade. Alongside these efforts, major Group of Twenty (G20) and Organisation for Economic Co-operation and Development (OECD) countries will need to reduce the scope of industrial policies that protect domestic incumbents and prevent middle-income countries from accessing technologies and markets. Indeed, the globalization of protectionist industrial policy poses the risk of slowing down the globalization of decarbonization. Global coordination of the use of green industrial policy will ensure that industrial policy does not hinder the climate transition of or penalize low- and middle-income countries.

Middle-income countries could also diffuse low-carbon technologies at home by building green to meet their significant demand for infrastructure systems. For example, one-third of projected urban growth will occur in large middle-income countries such as China, India, and Nigeria by 2050, and three-quarters of the world’s urban infrastructure that will exist in 30 years has not yet been built. By building green, investments in middle-income countries can help reduce emissions at a lower cost than in high-income countries that would have to retrofit green. But there is a challenge—despite the falling cost of green infrastructure and potential for high economic returns in middle-income countries, capital does not flow from high-income to low- and middle-income countries to undertake these infrastructure investments.

Finally, where capital costs are high, low-carbon energy may be unaffordable. Moreover, the intermittency of variable renewables and high storage costs pose risks to energy security if not managed well. Middle-income countries will need flexibility in choosing emissions-reducing strategies.

Globalizing decarbonization

Upgrade and compete through global low-carbon value chains

Izmir, Türkiye, a vibrant city of nearly 4.5 million people on the Aegean Sea, has been historically significant for more than 5,000 years. Its settlement goes back to the third millennium BCE. Now it is poised to become a significant producer and exporter of intermediate products in Europe’s wind energy value chain. Thirteen factories produce towers, blades, gearboxes, and generators, and 80 percent of the production from this value chain is exported—primarily to Europe. Türkiye is increasing its competence and competitiveness in the wind turbine value chains, as well as developing capabilities in a broader range of technically sophisticated green products (so-called green complex products).

As this example suggests, middle-income countries could join global low-carbon energy value chains by supplying intermediate products, thereby reducing the cost of green energy faster than would be possible through national efforts alone. Moreover, through their participation, middle-income countries can infuse global knowledge into their own industries and subsequently increase their “economic complexity.”

An example is the solar photovoltaic (PV) industry (figure 9.1). From 2008 to 2020, the globalized market for PV modules saved PV installers in China US$36 billion, those in the United States US$24 billion, and those in Germany US$7 billion when compared with the cost of having domestic manufacturers supply an increasing share of installed capacity over a 10-year period. China produced about 80 percent of solar PV cells and modules globally in 2023. From 2020 to 2023, China’s PV module prices plummeted to US$0.15 per watt, or to more than 60 percent lower than the US price of US$0.40 cents per watt. It succeeded by infusing global technologies through start-ups backed by foreign finance, international collaboration among researchers, and licensing and the mass production of technologies developed in foreign labs.

As highlighted in chapter 6, four technologies—solar panels, wind turbines, lithium-ion batteries, and electrolyzers used for green hydrogen—follow Wright’s Law (learning curves): costs fall as a power function of cumulative deployment due to the positive effects of learning by doing or increasing returns to scale in the production of technologies. By contrast, more complex technologies and those that require a greater level of customization to local environments (type 3 technologies in figure 9.2) tend to “learn” more slowly. Small “granular” technologies (type 1 and type 2 technologies in figure 9.2) can diffuse much more rapidly. Middle-income countries can create value by becoming suppliers in global value chains of type 1 and type 2 technologies.

To date, however, participation by most middle-income countries in value chains producing low-carbon energy technologies has been limited. These value chains are highly concentrated, as discussed in chapter 6. Many inputs into clean energy value chains are also highly concentrated. For example, the Democratic Republic of Congo supplies 74 percent of cobalt, China 68 percent of rare earth elements, and Indonesia 49 percent of nickel. Australia accounts for 47 percent of lithium mining, and Chile for 24 percent. Processing of these minerals is also highly concentrated, with China refining 90 percent of rare earth elements and 65 percent and 74 percent, respectively, of lithium and cobalt (figure 9.3).

One pathway for middle-income countries is to improve their firm capabilities and overall technological sophistication (as discussed in chapter 6). Middle-income countries tapping into manufacturing opportunities for clean energy technologies are typically those already competitive in manufacturing or exporters of high-technology products. Research conducted for this Report shows that the share of online job postings for all disruptive technologies is highly correlated with the share of online job postings related to low-carbon technologies. This finding suggests that countries experiencing a rapid diffusion of all emerging disruptive technologies are also witnessing a rapid diffusion of low-carbon technologies.

In fact, low-carbon production has been higher in countries with greater overall competitiveness. The green complexity index—which measures a country’s current ability to export green complex products competitively—reveals that middle-income countries currently able to competitively export a wide range of green complex products include China, Bulgaria, India, Mexico, Türkiye, Serbia, Belarus, Thailand, Bosnia and Herzegovina, and Tunisia (figure 9.4, panel a). The green complexity potential index measures countries’ potential to export green, technologically sophisticated products in the future, and it reveals that many middle-income countries have untapped potential to export green complex products. China, Türkiye, India, Bulgaria, and Thailand have the highest untapped potential based on other products they are currently manufacturing (figure 9.4, panel b). Türkiye, for example, has high potential in the value chains for wind turbines and electric vehicles. Although production is growing rapidly, these industries could become even greater drivers of growth.

Only if middle-income countries are able to join low-carbon value chains can they effectively contribute to global decarbonization and realistically aspire to tilting their own markets green.

Resist uncoordinated and protectionist industrial policy

In the climate context, there is a strong case economically for countries to use industrial policies to support far-from-market low-carbon technologies. Furthermore, countries are faced with legitimate concerns about energy security and the need for politically feasible climate policies, which warrant certain unique considerations in making energy-related trade policy. Nevertheless, to ensure a successful low-carbon transition, it is essential to implement well-coordinated, balanced industrial policies that avoid protectionism and minimize market distortions.

Research using the New Industrial Policy Observer (NIPO) reveals the significant implementation of new industrial policy measures in 2023, particularly by high-income and large middle-income countries (figure 9.5, panel a). For industrial policies targeting low-carbon technologies specifically, a similar pattern holds (figure 9.5, panel b). Policies in the NIPO classified as potentially trade distorting and that target low-carbon technologies have been spearheaded by a few large G20 countries. These include the European Union’s Green Deal Industrial Plan, the US Inflation Reduction Act (IRA), Japan’s Green Growth Strategy, and the Korean New Deal. However, green industrial policies are rapidly spreading across low- and middle-income countries. Many middle-income economies are designing and deploying state-led projects to foster green industrialization. Notably, the Arab Republic of Egypt, Kenya, Morocco, Namibia, South Africa, and Tunisia have launched initiatives to support the development of green hydrogen. This shift introduces significant challenges, often imposing a “development tax” whether or not countries engage in industrial policies. For example, policy response options for International Development Association and other low-income countries are typically limited to nontariff measures (NTMs) due to financial constraints and World Trade Organization (WTO) commitments. Subsidizing their own industries can divert funds from essential public services, and NTMs can strain economies, potentially leading to impoverishing growth and a global race to the bottom.

Such policies may also risk slowing down knowledge transfer and the diffusion of low-carbon technologies. Policy makers in the world’s major economies must therefore coordinate on the appropriate use of green industrial policies. Indeed, they should consider that the energy transition has outcomes that extend beyond its effects on climate, but also on technology diffusion and the economic development of middle-income countries.

To support middle-income countries as they move toward global decarbonization, policy makers will need to update global trade policy rules to clearly define the appropriate use of green subsidies, export controls, and import controls. Such reforms are already being discussed and designed at the WTO level. The Villars Framework 2.0 has also detailed various potential reforms of the WTO to bring the international trading system into harmony with a global “commitment to a sustainable future.” These reforms include, among others, carefully distinguishing between subsidies that benefit sustainability and subsidies that impair it. Other possibilities include modifying existing agreements with supplementary clauses in much the same way that Articles 20 and 21 of the General Agreement on Tariffs and Trade (GATT) were used to carve out exceptions. Such clauses could acknowledge that countries may need to nurture emerging domestic industries if they are to achieve a transition with energy security, but the use of subsidies should also be restricted to specific circumstances, such as the commercialization of far-from-market low-carbon technologies.