World Development Report 2024: The Middle-Income Trap

Middle-income countries aspire to grow their economies and achieve living standards closer to those of high-income countries. But economic expansion in middle-income countries could lead to a significant surge in the demand for energy if efficiency is not improved. A country does not, however, need to grow at the expense of steps to reduce emissions if it can reduce both the amount of energy required to fuel its economy and the carbon emissions per unit of energy used by the economy. Growth has become less energy-intensive (figure 9.9). Most notably, the amount of energy needed to fuel the economy (per unit of GDP) is much lower for today’s upper-middle-income countries than for upper-middle-income countries in the past. In other words, there is evidence that leapfrogging is advancing over time as middle-income countries move closer to the technology frontier.

Economic growth is also accompanied by structural and spatial transformations that help reduce the carbon emissions of an economy. The carbon emissions of the global economy—a combination of energy intensity (energy consumed per dollar of GDP) and carbon intensity (carbon emissions per unit of energy)—have declined globally from about 0.69 million tons of carbon dioxide (CO2) per billion dollars of GDP in 1980 to 0.46 million tons in 2018 (figure 9.10). In particular, China’s drop in carbon intensity is globally material because China is the world’s largest emitter. More broadly, the carbon emissions per unit of GDP over time of upper-middle-income and lower-middle-income countries have declined, even when supply chain emissions are taken into account. A recent study covering 137 countries also finds that countries with higher GDP per capita have lower energy intensity. Furthermore, countries with a high level of energy intensity experience a stronger reduction in energy intensity.

Past oil crises motivated high-income countries to lower energy intensity and to accelerate innovation and research into renewables. Those measures substantially compensated for the increase in these countries’ emissions arising from a growing economy (figure 9.11). Today, a combination of reductions in carbon emissions and improvements in carbon efficiency are offsetting the increase in emissions stemming from economic and population growth. By contrast, economic growth is the key driver of emissions in middle-income countries, and those emissions more than outweigh the reductions in emissions from lowering energy intensity and improving energy efficiency. The effect of economic growth on emissions is especially strong in upper-middle-income countries. According to projections from the Network for Greening the Financial System, if middle-income countries continue their current policies, there is an 83 percent chance that even if today’s high-income countries achieve their 2050 net zero goals, global emissions will exceed the remaining carbon budget required for limiting the change in global warming to less than 2 degrees Celsius by 2050.

In deciding how to “decouple” emissions from a growing economy, middle-income countries will need to consider their country’s concerns with energy security and access to reliable energy. Although low-carbon and renewable energy can improve energy security by reducing price volatility through lower exposure to fuel price shocks during supply disruptions, energy from these sources cannot be produced consistently throughout the day. Because electricity systems must always be balanced—that is, ensure that the supply of electricity is meeting the demand at all times—countries will have to consider a balanced mix of energy sources in which low-carbon and renewable sources cannot provide 100 percent of the supply and to incentivize energy-intensive users to adopt energy-conserving technologies. What can these countries do to reduce energy intensity and accelerate energy efficiency?

How middle-income countries can reduce energy intensity

In 2022, middle-income countries were experiencing energy intensity (energy consumption per unit of GDP) 2.5 times higher than that in high-income countries. The first set of insights on middle-income countries’ adoption of energy-saving technologies is now available through the World Bank’s Firm-level Adoption of Technology (FAT) survey of seven countries—Bangladesh, Brazil, Cambodia, Chile, Ethiopia, Georgia, and India.

Adoption of energy-saving technologies varies significantly across the countries sampled for the FAT survey. For example, the primary green building certification, Leadership in Energy and Environmental Design (LEED), reflects the level of technologies used in buildings. Research suggests that firms operating in green-certified buildings use 8 percent less energy than those in noncertified buildings. The adoption of the LEED certification varies significantly. The highest adoption rates are in Brazil and Chile, where more than 20 percent of firms are LEED-certified. In Bangladesh, 7 percent of firms are certified, whereas less than 3 percent of firms in Georgia and 1 percent in India are LEED-certified.

Scale economies matter in the adoption of energy-saving technologies. Technologies such as advanced end-of-pipe treatment entail large installation costs, making adoption more likely among larger firms. Competition also matters. In Georgia, markets with a higher concentration have lower energy efficiency (concentration measured as the average price markups of the top 25 percent of firms in the markup distribution within their sector-size group and municipality). In addition, of firms with similar capital intensity, entrants are more energy-efficient than incumbents. In Argentina, for example, firms with a higher share of skilled workers are better able to adopt advanced green technologies. Exporters also tend to have lower emissions intensity than nonexporters. And foreign-owned firms generally perform better on environmental standards, such as in Côte d’Ivoire, Mexico, and República Bolivariana de Venezuela.

Such evidence indicates that market contestability, as well as opportunities for value-adding firms to grow, is compatible with adopting energy-saving technologies. As for renewable energy, firms’ adoption of energy efficiency technologies has been hampered by the high up-front costs of acquiring the technology, lack of access to accurate information about the technology and its costs and benefits, and low returns from early adoption of technologies that require a large network of users. Policies that improve the efficient allocation of resources by subsidizing technology adoption, to the extent that environmental benefits are not fully captured by adopters, or ease the financing constraints that prevent technology adoption are important in decoupling emissions from economic growth.

There is reason to be optimistic that ongoing energy price increases will encourage firms and other users to reduce energy intensity. In the long term, countries spend 5–9 percent of GDP on energy, and increases in energy prices tend to be fully compensated by higher efficiency. In the short term, however, price shocks may pose a cost to an economy, so complementary policies may be needed to compensate for economic and welfare impacts. Governments can help provide firms that use energy intensively with access to energy-conserving technologies and finance for adoption as part of a reform program. Proactive programs that offer a mix of information, finance, and support can encourage changes in production technology and investment in energy-saving equipment.

How middle-income countries can reduce emissions intensity

Access to reliable, affordable energy is an important consideration for growing middle-income countries, which must choose the appropriate mix of energy sources that reduce emissions while ensuring stable energy supplies. Moving across energy sources is a slow process. Despite commitments by high-income and low- and middle-income countries, fossil fuels continue to account for more than 75 percent of global energy consumption (figure 9.12). Although there has been significant growth in renewable energy in recent years—particularly wind, solar, and hydroelectric power—the relative contributions are still small.

Create a market for technologies

To hasten the expansion of today’s low-carbon technologies and support research and development (R&D) to create new technologies in the future, should government policies in middle-income countries subsidize development of specific technologies? This Report has highlighted that most middle-income countries would benefit from infusing global technologies, not innovating prematurely, before the necessary complements are in place. To promote energy efficiency, middle-income countries need a cluster of technologies that affect energy production, storage, and consumption.

Policy should be directed at creating markets for low-carbon technologies. This would include removing subsidies for fossil fuel–related technology (see chapter 8) so that low-carbon technologies can compete on a level playing field. Furthermore, middle-income countries need complementary investments in transmission infrastructure, as well as interoperability standards. As in China, demand-side “pull” may be needed to create a market for these technologies. Sectoral policies such as government feed-in tariff programs were particularly significant in creating a market for renewable energy, first in Germany in the 1990s, followed by Italy, Spain, the United States, China, and India by the 2010s. Notably, as technologies have matured, feed-in tariffs have been replaced by more cost-efficient procurement methods, such as auctions (for example, in Brazil, India, South Africa, and, more recently, the Middle East and North Africa and Sub-Saharan Africa). Auctions have achieved record lowest prices per unit of electricity.

Consider resource endowment

A country’s likelihood of switching from energy sources related to fossil fuels depends heavily on its resource endowment. For example, if solar radiation is not sufficiently powerful, the market value of producing such renewable energy would be low and would not justify the switch for an incumbent firm or energy company. But irradiance is not the full story in measuring the solar potential of a region—it is also influenced by temperature (the higher the temperature, the less efficient is the solar potential), the type of terrain, the extent and type of mountains and hills, and so on. Taking these factors into account, the solar potential of each location within a country can be computed—the so-called PVOUT, the ratio between energy obtained (in kilowatt-hours, kWh) and installed power (in terms of kilowatt peak, kWp). This ratio serves as an assessment of the efficiency and productivity of solar plants in each region.

To switch to a renewable energy source, a country must have the potential to create an abundant supply of that energy. Meanwhile, countries with a rich endowment of fossil fuels may find it more difficult to embrace an energy transition due to the forces of inertia and the uneven playing field from fossil fuel subsidies.

Optimize the choice of technologies

Multiple sources of low-carbon technologies offer a myriad of possibilities for alleviating the heavy reliance on fossil fuels. Among the options are emerging and next-generation technologies, including, on the supply side, carbon capture, utilization, and storage (CCUS), carbon capture and storage (CCS), green hydrogen, blue hydrogen, and carbon removal technologies (DACCS and BECCS), and, on the demand side, hydrogen technologies in transport (hydrogen fuel cell trucks, aircraft) and industry (green steel). According to a comprehensive modeling exercise focusing on Europe and Central Asia, these new technologies have a critical role to play in the energy transition. Their growth rates will need to replicate the rapid rates of solar and wind energy to stay in line with climate targets, as most net zero modeling of these new technologies indicates. But they are not on such a trajectory now.

Although the multiple sources of low-carbon technologies offer countries options for weaning off carbon and other fossil fuels, infrastructure constraints related to generation, transmission, and storage, as well as limits on the availability of renewable resources, present challenges. Renewable energy sources depend on geographic location, climate, and weather. Thus regions have different needs for and availability of specific renewable sources. Moreover, connecting renewable sources to the electricity grid is a major issue in terms of cost and efficiency. Currently, there is a bottleneck in transmission lines because the existing transmission grids are supporting conventional energy resources. Legacy power grids that have been in place for several decades occupy the routes and land needed to set up additional power lines supporting renewable sources.

Middle-income countries may be able to partially leapfrog legacy grids located near large fossil fuel power plants in urban areas. But it may be difficult to leapfrog to a grid that is entirely powered by wind and solar plus energy storage—at least not while also expanding electricity access and driving economic growth. Even in advanced countries such as the United States, transmission lines need to increase by at least 25 percent over the next decade. Expanding distribution for power through renewable sources requires not only investments in new transmission lines, but also in renovating legacy lines to integrate them smoothly in new frameworks. As long as energy storage options remain both economically and technically limited, the appetite may increase for other technologies to maintain baseload energy supplies. Examples are natural gas and hydro technologies, as well as other technologies at different levels of maturity (ranging from geothermal to green hydrogen), along with fuels such as nuclear power. Box 9.1 discusses the role of alternate technologies as system stabilizers.

In view of the high cost of capital, the risk of intermittency, and the high storage cost for low carbon energy, middle-income countries will need flexibility in managing how they go about reducing their own emissions, while expanding energy access and maintaining security. Furthermore, to support global decarbonization, they will need to ensure coordination on the use of green industrial policy so that it does not limit their participation in low-carbon value chains.

Box 9.1 Technologies that can act as “stabilizers” of energy supply

Different technologies can play different roles as stabilizers of energy supply.

Hydropower. In addition to being a low-carbon source of energy, hydropower is a dispatchable and flexible technology. Hydropower with storage is currently one of the most cost-effective low-carbon solutions for integrating large-scale variable renewable energy capacity. For example, 1 megawatt of hydropower in Bhutan and Nepal can help integrate 5–6 megawatts of variable renewable energy in India and Bangladesh. There is an urgent need to scale up investment in rehabilitating and upgrading the existing hydropower installed capacity as well as restoring the current reservoir storage capacity. By 2030, more than 20 percent of the global hydropower infrastructure is expected to be more than 55 years old, the age at which major electromechanical equipment needs to be rehabilitated and upgraded. The risk-return profile and long gestation period of large hydropower projects has resulted in the limited participation of private financing in hydropower projects. Only 27 percent of the added hydropower installed capacity from 2011 to 2020 was privately owned—a rate that is even lower for large hydropower projects.

Geothermal. Geothermal power is one of the cleanest energy resources. It is also associated with some of the lowest land use of any energy technology, including other renewable sources. Although traditionally a baseload source of electricity, geothermal power can offer flexibility because plants can run continuously or adjust quickly to match demand and supply. Adopting appropriate pricing structures that recognize geothermal power’s up-front costs can increase the flexibility in generating and dispatching geothermal power. Geothermal energy and heat pumps can also play a key role in enhancing the stability and flexibility of the grid, particularly with the rise of renewable energy sources.

Hydrogen. Hydrogen has a role to play in storing energy and providing grid flexibility, as well as serving as a fuel in sectors in which carbon emissions are hard to abate. The cost of renewable hydrogen production depends on the cost of renewable power and the capital cost of equipment—notably, electrolyzersa—as well as on the financing cost represented by the cost of capital. In today’s best locations and under optimistic assumptions, the production cost can be as low as US$3 per kilogram, although this level cannot serve as a benchmark for low- and middle-income countries due to lower-quality renewable resources and high capital costs of equipment. For example, the cost of an electrolyzer system varies significantly, from less than US$500 per kilowatt in China to as much as US$2,000 per kilowatt elsewhere.b Electrolyzer costs are expected to fall rapidly in the coming years, and so future projects will benefit from large-scale electrolyzers that will be cheaper. Although the current investment in hydrogen is significantly less than that in mature renewable energy technologies such as wind and solar, hydrogen technology has seen strong inflows of early stage capital as well as high levels of national funding in recent years in Europe and the United States. Regions with abundant solar and wind endowments, especially in Africa, can provide cheap green hydrogen for both domestic use and export. Demand for green hydrogen can also reciprocally boost investments in renewables and provide a salient business case for investment in renewables while facilitating electrification in some middle-income countries.

Natural gas. The use of natural gas reduces emissions if it displaces coal and if fugitive emissions are sufficiently low. Natural gas can empower industrial development as a chemical feedstock, fertilizer component, direct energy source, and electricity provider. However, switching from coal to natural gas does not help to shift or avoid path-dependency. It can lead to a carbon lock-in—that is, a long-term reliance on the built fossil fuel infrastructure.c Wealth losses from stranded gas reserves could be significant. Estimates range from US$1.7 trillion to US$3.8 trillion based on climate targets that are aligned with the Paris Agreement on climate change.d This force for preservation is further exacerbated by the large share of government ownership of natural gas reserves—approximately 80 percent. As a result, governments may be reluctant to abandon these assets due to windfall profits and rents.

a. An electrolyzer is a device that uses electricity to split water or other components into their constituent elements. It is a critical technology for producing low-emission hydrogen from renewable electricity.