Rentschler, and Rozenberg 2019). Capacity building is essential for the effec-
tive utilization of techniques like decision making under deep uncertainty in
addressing climate change uncertainties.

Early warning systems are also crucial to know about and communi-
cate the occurrence of natural hazards, which allows timely response and
evacuation of those who might be affected (Noble et al. 2014). In 2004,
the Central America Flash Flood Guidance System (CAFFGS) was imple-
mented by Belize, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua,
and Panama to evaluate the risks of floods caused by intense rains (Magrin
2015). Before a disaster strikes, telecommunication services enable the dis-
semination of early warning systems and alerts, helping to minimize the
impacts on affected populations. Effective and timely communication is
essential to community preparedness and safety, facilitating the dissemina-
tion of evacuation plans, shelter details, and emergency procedures while
enabling efficient resource mobilization and coordination by authorities. In
the region, at least 16 countries report using early warning systems (Lacam-
bra et al. 2015).

During a disaster, telecommunication services serve as a lifeline,
enabling the transmission of vital information, including requests for assis-
tance, reports of medical emergencies, and situational updates. Countries
should establish a National Emergency Telecommunication Plan to define
the regulatory framework and actions for all disaster management phases,
including hazard mapping, response planning, and international coopera-
tion. Yet, an assessment by the International Telecommunication Union
found that only 19 percent of Latin American and Caribbean countries (5 out
of 26) have these plans.

Finally, the importance of actions to strengthen institutions should
not be underestimated. Although laws, regulations, and zoning and build-
ing codes are often adopted at high government levels and involve issues,
such as urban planning, whose scope is larger than just adaption to climate
change, these norms have a direct impact on the exposure and vulnerability
of infrastructure to climate-related effects. Zoning can prohibit construc-
tion in the most at-risk areas, and countries routinely set strength standards
for infrastructure. Budgetary rules are also important to allow government
agencies to redirect some of their funds toward reconstruction in the after-
math of an event without requiring the legislature to vote on another budget
(Lacambra et al. 2015).

On average, countries in the region can do much more to use such
norms and regulations to improve risk management. The IDB's Index of Gov-
ernance and Public Policy for Disaster Risk Management (iGOPP) enables
the uniform measurement of governance conditions for effective disaster
risk management in these countries, covering its legal, institutional, and
budgetary aspects (Lacambra et al. 2015). While a country can theoretically
achieve the maximum score on the iGOPP of 100, indicating excellent pre-
paredness, the average score for the region is 31.7, reflecting an "incipient"
preparedness. Heterogeneity in the region is evidenced by the significant
variance among the countries, with Mexico having the highest score (63.3)
and Haiti the lowest (8.5), underscoring the importance of institutional
reforms throughout (Lacambra et al. 2015).

In Latin America and the Caribbean, building resilient infrastructure
services faces many challenges. A viable path forward exists, however,
demanding political decisions, citizen involvement, and a clear definition
of how these policies will be financed. All of these need to be addressed if
the region is to make its infrastructure services more resilient to the ever-
increasing impacts of climate change.
<figure><img src="image_68.png" /></figure>
<figure><img src="image_69.png" /></figure>

# The Road to Net Zero

Investing in low carbon solutions in Latin America and the Caribbean could generate between US$1 trillion and US$3 trillion in net benefits—about 40 percent of gross domestic product—mainly from fuel cost savings and improvements in health, safety, and productivity. While transformations are needed across all economic sectors, cutting emissions from agriculture, forestry and land use, which is responsible for nearly half of the region's emissions, is particularly important.

Claims of $20 bills lying on the sidewalk waiting to be picked up are invariably met with skepticism, and rightfully so. Although perhaps not the unwavering utility maximizers featured in Economics 101 texts, people—whether acting as consumers, firm managers, or government administrators—generally take advantage of opportunities. That is, unless something stands in their way.

A key theme of this chapter and the next is that when it comes to decarbonization, more than a few $20 bills are real. The technological and behavioral transformations needed to decarbonize countries in Latin America and the Caribbean are not only well understood and readily available, they can generate substantial net benefits. But a variety of regulatory, institutional, and financial barriers block the implementation of these transformations. Fortunately, policies and programs are available to lower those barriers.

This chapter focuses on the transformations needed to reach net-zero greenhouse gas (GHG) emissions by 2050 and their costs and benefits, while the next one examines obstacles to their implementation and how they can be overcome. More specifically, this chapter addresses three sets of questions:

First, what is the nature of the decarbonization problem? How do GHG emissions in Latin America and the Caribbean compare to those from the rest of the world? And what countries and sectors are the biggest emitters?
<figure><img src="image_70.png" /><figcaption>**Figure 8.1.** Contribution to Total Global GHG Emissions, by Region, and Contribution to Total Latin American and Caribbean Emissions, by Country</figcaption></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

Second, how can this problem be addressed? What transformations are needed to reach net zero, and how much progress has the region made in implementing them?

And, finally, what are the benefits and costs of the transformations needed to reach net zero? In other words, will net zero pay?
<figure><img src="image_71.png" /><figcaption>**Figure 8.2.** Latin America and Caribbean Emissions, by Sector and Year</figcaption></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

## The Region's Emissions, Comparatively Speaking

Latin America and the Caribbean is responsible for a small but growing share of total global greenhouse gas emissions (Figure 8.1). In 2020, the region contributed 8 percent of total emissions, about the same percentage as three other developing regions—the Middle East and North Africa (7 percent), South Asia (8 percent), and Sub-Saharan Africa (8 percent)—but significantly less than East Asia and the Pacific (39 percent). Its contribution was also smaller than those of the two industrialized regions—Europe and Central Asia (15 percent) and North America (13 percent).

While emissions from Latin America and the Caribbean have been growing over time (Figure 8.2), the region's percentage contribution to global emissions has been shrinking. Between 1990 and 2020, its emissions increased by 6 percent, but at a lower rate than the world average. As a result, the region's contribution decreased by 3 percent.

On a per capita basis, the region's GHG emissions in 2020 (5.98 metric tons of carbon dioxide equivalent, or tCO₂e) were slightly lower than the global average (6.12 tCO₂e) and much lower than per capita emissions for North America (16.28 tCO₂e; Figure 8.3). The region's per capita emissions fell 29 percent between 1990 and 2020.
<figure><img src="image_72.png" /><figcaption>**Figure 8.3.** Per Capita GHG Emissions, by Region and Year</figcaption></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

<figure><img src="image_73.png" /><figcaption>**Figure 8.4.** World and Regional Contributions to GHG Emissions by Sector, 2020</figcaption></figure>

(continued on next page)

Within Latin America and the Caribbean, just six countries contributed almost 82 percent of total regional GHG emissions in 2020 (Figure 8.1, above). The leader by far was Brazil (38 percent), followed by Mexico (16
<caption>**Figure 8.4.** World and Regional Contributions to GHG Emissions by Sector, 2020 (continued)</caption>

B. Latin America and the Caribbean

<figure><img src="image_74.png" /></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

<caption>**Figure 8.5.** World and Regional Energy Sector Contributions to GHG Emissions, 2020</caption>

A. World

<figure><img src="image_75.png" /></figure>

(continued on next page)

percent), Argentina (10 percent), Colombia (7 percent), Venezuela (6 percent), and Peru (5 percent). The remaining countries each contributed less than 4 percent.
<caption>**Figure 8.5.** World and Regional Energy Sector Contributions to GHG Emissions, 2020 (continued)</caption>

**B. Latin America and the Caribbean**

<figure><img src="image_76.png" /></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

In 2020, the sources of GHG emissions in Latin America and the Caribbean were similar to those in the rest of the world in some ways but quite different in others (Figure 8.4). As in the rest of the world, the sector with the largest percentage contribution was energy (75 percent in the world versus 41 percent in the region). And within the energy sector (Figure 8.5), the largest contributions were from transportation, electricity generation and heating, and manufacturing and construction. In Latin America and the Caribbean, however, the contribution to emissions from the “green” sectors—agriculture, forestry, and other land uses (AFOLU)—was disproportionately large (48 percent, versus 15 percent globally).

At the country level, the sources of GHG emissions vary markedly (Figure 8.6). Among the six countries that together are responsible for 80 percent of the region's emissions, for example, the contribution from AFOLU ranges from 63 percent in the case of Brazil to 19 percent for Mexico. This variation implies decarbonization policies and programs need to be targeted and tailored to individual countries; a one-size-fits-all approach is unlikely to be either efficient or effective.

As will be discussed below (Figure 8.7), some AFOLU activities absorb CO₂ emissions. These include forest conservation, forest restoration, afforestation, and agricultural practices that increase the carbon storage capacity of soils. In seven Latin American and Caribbean countries, AFOLU sequesters more CO₂ than it emits.
<figure><img src="image_77.png" /><figcaption>**Figure 8.6.** Sector Contributions to Regional GHG Emissions, by Country</figcaption></figure>

Source: IDB staff calculations, based on World Resources Institute Climate Tracker Database.

Note: For Chile, Costa Rica, Cuba, Dominica, the Dominican Republic, Saint Lucia, and Uruguay, the total of GHG emissions excludes land use change and forestry (LUCF).

## Transformations, Sector by Sector

To achieve net-zero GHG emissions, all countries, including those in Latin America and the Caribbean, will need to transform the ways they produce and consume certain goods and services and how they manage certain natural resources. This section draws on a study by Fazekas, Bataille, and Vogt-Schilb (2022) to briefly describe twenty specific net-zero transformations across the six economic sectors that are the main sources of emissions
globally: AFOLU, energy production, transportation, buildings, waste, and industry (Table 8.1).<fnref n="1" /> It also identifies the principal private and public benefits of each transformation. Private benefits are mostly captured by the parties that invest in the transformation. They stem primarily from switching to cost-saving technologies and fuels. Public benefits, by contrast, are shared more widely by a range of different parties.

<table><caption>**Table 8.1.** Net-Zero Transformations and Progress Indicators by Sector</caption><thead><tr><th>Sector/transformation</th><th>Indicators</th><th>Scope for progress (% change)</th></tr></thead><tbody><tr><td><strong>A. AFOLU</strong></td><td></td><td></td></tr><tr><td>A1. Conserve, expand, and restore forests and other high-carbon ecosystems</td><td>Ala. Area with forest cover (ha)</td><td>39</td></tr><tr><td rowspan="2">A2. Modernize agriculture to boost productivity, sequester carbon, and reduce methane and nitrous oxide emissions</td><td>A2a. Ratio of crop yield (metric tons) to crop area (ha)</td><td>100</td></tr><tr><td>A2b. Methane and nitrous oxide emissions from agriculture (tCO<sub>2</sub>e)</td><td>54</td></tr><tr><td>A3. Reduce expansion of agricultural lands, including pasture</td><td>A3a. Area with agriculture and pasture (ha)</td><td>43</td></tr><tr><td><strong>B. Energy production</strong></td><td></td><td></td></tr><tr><td>B1. Shift from fossil fuels to renewables in electricity generation</td><td>B1a. Fraction of electricity from renewables</td><td>137</td></tr><tr><td>B2. Reduce methane emissions from fossil fuel production</td><td>B2a. Methane emissions from fossil fuel production (mtCO<sub>2</sub>e)</td><td>86</td></tr><tr><td>B3. Use CCSU to reduce carbon emissions from residual fossil fuel generation</td><td>Minimal implementation in 2020</td><td>N/A</td></tr><tr><td><strong>C. Transportation</strong></td><td></td><td></td></tr><tr><td rowspan="2">C1. Mode-shift:<ul><li>from private to public transportation</li><li>from trucks to rail, waterborne</li><li>from conventional motorized transportation to micromobility and walking</li></ul></td><td>C1a. Fraction of local passenger kms by public transit</td><td>1,123</td></tr><tr><td>C1b. Fraction of local passenger kms human powered</td><td>117</td></tr><tr><td>C2. Switch to low-emission fuels (electricity, biofuels, green hydrogen)</td><td>Minimal implementation in 2020</td><td>N/A</td></tr></tbody></table>

(continued on next page)

<footnote n="1">¹ Note that the definitions of the sectors used in this section differ somewhat from those used to present statistics on GHG emissions in the previous subsection. The latter are taken from World Resources Institute Climate Tracker, a widely cited source of GHG data. Here, the definitions used are consistent with the net benefits modeling exercise presented later in the chapter.</footnote>
<table><caption>**Table 8.1.** Net-Zero Transformations and Progress Indicators by Sector (cont.)</caption><thead><tr><th>Sector/transformation</th><th>Indicators</th><th>Scope for progress (% change)</th></tr></thead><tbody><tr><td>C3. Shift to fuel-efficient light- and heavy-duty vehicles</td><td>Insufficient data</td><td>N/A</td></tr><tr><td>C4. Increase private vehicle occupancy ("shared mobility")</td><td>Insufficient data</td><td>N/A</td></tr><tr><td>C5. Reduce transportation demand through urban redesign and remote work</td><td>Insufficient data</td><td>N/A</td></tr><tr><td><strong>D. Buildings</strong></td><td></td><td></td></tr><tr><td>D1. Enhance energy efficiency of building shells and appliances</td><td>Insufficient data</td><td>N/A</td></tr><tr><td>D2. Fuel-switch to electricity, onsite renewables, and heat pumps</td><td>D2a. Fraction of building energy electrified</td><td>5</td></tr><tr><td><strong>E. Waste</strong></td><td></td><td></td></tr><tr><td>E1. Promote circular economy</td><td>Minimal implementation in 2020</td><td>N/A</td></tr><tr><td>E2. Reduce food loss and waste</td><td>E2a. Food waste per capita (metric tons)</td><td>27</td></tr><tr><td>E3. Reduce methane emissions from solid waste and wastewater</td><td>E3a. Fraction of landfill gas recovered</td><td>933</td></tr><tr><td><strong>F. Industry</strong></td><td></td><td></td></tr><tr><td>F1. Fuel-switch:<br/>• Low-heat industry: switch to electricity<br/>• High-heat industry: switch to lower-emission fuels (electricity, natural gas, bioenergy, hydrogen) and feedstocks</td><td>F1a. Fraction of industry electrified<br/>F1b. Fraction of clinker in cement</td><td>649<br/>29</td></tr><tr><td>F2. Enhance energy and materials efficiency</td><td>F2a. Ratio of industrial emissions (megatons) to industrial production (metric tons)</td><td>73</td></tr><tr><td>F3. Use CCSU in cement, steel, chemicals, and plastics</td><td>Minimal implementation in 2020</td><td>N/A</td></tr><tr><td>F4. Reduce noncarbon GHG emissions</td><td>Minimal implementation in 2020</td><td>N/A</td></tr></tbody></table>

Sources: IDB staff calculations, based on United Nations Food and Agriculture Organization's Production database (A2a, A3a), United Nations Food and Agriculture Organization's Land Use database (A1a) and Land Cover database (A1a), Climate Watch Historical GHG Emissions database (A2b, E3a), World Resources Institute Climate Tracker database (B1a), United Nations Statistics Division's Energy Statistics database (B1a), Kalra et al. (2023; B2a, C1a, C1b, C1d), International Energy Agency's World Energy Balance database (F1a, F1b, F2a), International Energy Agency's World Energy Balance Highlights database (D2a), and UNEP (2021; E2a).

Note: Scope for progress is the GHG weighted average, across the eighteen countries for which the requisite data are available, of the percentage change in the 2020 level of the indicator needed to reach the maximum or minimum "feasible level" in 2050 (as defined for each country by Kalra et al. 2023). These eighteen countries are: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, and Uruguay. AFOLU refers to agriculture, forestry, and other land uses. CCUS refers to carbon capture, utilization, and storage.
## Agriculture, Forestry, and Other Land Uses: Green Opportunities

Three transformations in the AFOLU sector, which contributes 48 percent of the region's GHG emissions, are key for achieving net zero. The first has to do with the forests and other ecosystems that absorbed approximately one-third of the global anthropogenic carbon emissions in the last decade and that could provide 20 to 30 percent of the mitigation needed to reach net zero (IPCC 2023). Intact ecosystems can be conserved, and those that are degraded can be restored. In addition, opportunities exist to expand such ecosystems, through afforestation and reforestation, to land now used for other purposes. Second, agriculture can be modernized to reduce emissions of methane and nitrous oxide—which typically account for the majority of agricultural GHG emissions (FAO 2020)—and to boost productivity on existing agricultural land, thereby reducing pressure on forests and other land uses that sequester significant quantities of carbon (Box 8.1). Finally, it will be important for Latin American and Caribbean countries to reduce the expansion of agricultural lands, including cattle pasture, which is the leading proximate driver of deforestation in the region (Fritz et al. 2022; De Sy et al. 2015).

### Box 8.1. Will Agtech Deliver on Its Climate Change Potential?

While innovation in carbon-intensive sectors like energy, transportation, and construction has driven global carbon avoidance over the past two decades, that in food systems has lagged (IPCC 2022b). This is particularly concerning in Latin America and the Caribbean, where food systems are a major contributor to CO₂e emissions. Few innovations in these systems have demonstrated potential for either deep carbon avoidance or sequestration. And, for those that have, wide-scale adoption—particularly by smaller producers and those in developing countries—has been elusive (Finger et al. 2019). Unless this changes, the sector's growth will exacerbate climate change and biodiversity loss (Springmann et al. 2018).

Today, the capacity of agricultural technologies to deliver on their promise of decarbonizing food systems has been improved by the advent of artificial intelligence and other digital technologies, accompanied by falling costs for soil and remote sensing and earth observation, the Internet of Things and robotics, and gene editing. Early evidence shows that, when adopted, Agtech innovations can significantly reduce the carbon footprint of agriculture at the farm level by optimizing field preparation, crop choice, and the use of water, fertilizer, and other resources; by monitoring and managing yields; by protecting crops; and by reducing the costs of harvest and post-harvest processes (Ramachandran 2023).

*(continued on next page)*
Box 8.1. Will Agtech Deliver on Its Climate Change Potential? (continued)

Agtech can also help reduce emissions in livestock management, an important consideration given the magnitude of CO2e emissions attributed to ruminant livestock. Small-scale and field experiments show significant reductions in enteric methane from the use of additives to and modification of feed, the better management of manure, and vaccination (Tseten et al. 2021; Almeida, Hegarty, and Cowie 2021). Adopted at scale, these approaches can yield large reductions in CO2e.

Also relatively novel are biotech solutions, including alternative proteins and cell-based meats whose overall carbon and resource footprint is much lower than that of traditional food sources (Detzel et al. 2021). New Agtech approaches are now being developed to address barriers to growth in the alternative food segment, such as concerns related to cost, taste, and healthfulness (Eastham and Leman 2024). Furthermore, advances in fermentation technologies, which use engineered microorganisms to reproduce in many alternative foods substances found in natural foods, promise to expand the sustainability impacts of Agtech, with potential use cases in retail packaging and construction materials, among others.

Despite the slow adoption of many Agtech solutions, evidence indicates rates are accelerating, with these technologies increasingly integrated into food systems by both startups and established food companies. Recent survey data from large producers show adoption rates between 50 percent and 80 percent in South America, among the highest in the world (Fiocco et al. 2023). Another indication of adoption, is the proliferation of connected devices generating data on crop health, soil conditions, and other key agricultural variables; roughly 300 million devices were connected in 2024, three times as many as in 2020 (Sharpington, Eschinger, and Middleton 2024; Ramachandran 2023).

The main challenge to accelerating the adoption of Agtech solutions in the region is how to do it on a massive scale, across lower-income contexts, and among smallholders. But even here the evidence is encouraging, with field experiments showing successes in addressing key producer concerns, such as profitability, risk, and the integration of technology with current practices, as well as behavioral considerations (Magruder 2018; FAO and IPA 2023). Agtech may, indeed, be poised to deliver on its climate promise.

Among these three transformations, the one with the clearest private benefit is agricultural modernization. By definition, the adoption of productivity-enhancing technologies and practices has the potential to increase producers' net returns.

These transformations would also generate a variety of public benefits. First, as discussed in Chapter 4 on the links between climate change and
biodiversity, the conservation, restoration, and expansion of forests and other high-carbon ecosystems would ensure the continued supply of ecosystem services that are enormously valuable to humans. Such ecosystems supply food, fuelwood, and fiber; help to purify water, control floods, and facilitate pollination; offer opportunities for recreation and tourism; and provide important cultural amenities (MEA 2005). A shift to climate-friendly agriculture—in particular, improvements in the efficiency of fertilizer use—can reduce soil and water pollution (Bijay-Singh and Craswell 2021). And, as discussed in Chapter 5, boosting the productivity on existing agricultural lands would have a variety of benefits, including improving rural livelihoods and enhancing food security. Finally, to the extent that reducing the expansion of pasture entails a reduction in the growth of the domestic consumption of red meat, it would have significant health benefits (Hartinger et al. 2024; Springmann et al. 2016) and could create new jobs in plant-based agriculture (Saget, Vogt-Schilb, and Luu 2020).<fnref n="2" />

## Energy Production: Shining a Light on Renewables

According to the World Resources Institute Climate Tracker database, energy production entails both electricity generation, which in 2020 accounted for 12 percent of Latin American and Caribbean GHG emissions, and fossil fuel exploitation, which contributed 5 percent of emissions by means of leaks and irregular releases. To reduce emissions from electricity generation, countries can substitute renewable energy sources, such as wind, solar, bio-electricity, hydropower, and geothermal, for fossil fuels, such as coal, natural gas, and diesel. This transformation is absolutely critical for decarbonization because electricity will become the energy “backbone” of net-zero economies (WEF 2023). Wind and solar will be the most important sources of renewable energy because their unit costs have fallen dramatically in recent years, as has the unit cost of energy storage needed to control for the fact that they only supply energy intermittently (Box 8.2). In addition to switching to renewables, countries can improve the efficiency of electric power transmission and distribution, which by itself could significantly cut emissions (Yépez-García and Jiménez Mori 2024).

Second, countries can use carbon capture, utilization, and storage (CCUS) to reduce carbon emissions from any remaining fossil fuel electric power generation. CCUS entails capturing CO₂ from large immobile sources and using it (either onsite or offsite after compressing and shipping) or

<footnote n="2">² According to Hartinger et al. (2024), approximately 870,000 deaths in Latin America were associated with imbalanced diets in 2020, of which 155,000 (18 percent) were linked to high intake of red and processed meat and dairy products.</footnote>
Box 8.2. More Renewables, More Savings

Of the twenty net-zero transformations discussed in this chapter, using
renewable energy sources instead of fossil fuels to generate electricity (trans-
formation B1 in Table 8.1) will probably produce the largest monetized benefits.
The reason is simple: on average, renewable energy is already cheaper than
fossil fuels, and this cost differential is likely to widen in the future. Accord-
ing to the International Renewable Energy Agency (IRENA), the reductions
in the costs of renewable energy have, over the past decade, been “seismic.”
The most remarkable decreases have been for utility-scale photovoltaic (PV)
energy and onshore wind (Figure B8.2.1). The global weighted average level-
ized cost of electricity (LCOE)ª for utility-scale PV fell from 710 percent above
the least expensive fossil fuel option in 2010 to 29 percent below it in 2022,
while for onshore wind, the relevant statistics were 95 percent above and
53 percent below, respectively. Although current LCOEs of concentrating solar
power and offshore wind remain above that of the cheapest fossil fuel option,
past cost reductions have been remarkable, and future trends are promising.
Because of these dramatic reductions, according to one estimate, investments
in renewable energy in 2000 have already saved US$521 billion in fuel costs
globally, of which US$71 billion were in South America (IRENA 2023).

<figure><img src="image_78.png" /><figcaption>**Figure B8.2.1.** Change in Competitiveness of Solar and Wind Energy, 2010–22</figcaption></figure>

Source: IDB staff calculations, based on IRENA (2023).

Note: The error bars (the vertical lines in the figure) are the 95 percent confidence interval.

<footnote>ª LCOE is the lifetime cost of an electricity plant, divided by the amount of electricity it is ex-
pected to generate over its lifetime.</footnote>
storing it by injecting it into deep geological formations, like depleted oil and gas reservoirs. Although CCUS deployment has lagged expectations, use has ticked up recently, with over five hundred projects in development globally at various stages of the value chain (IEA 2023a).

Third, countries can reduce methane emissions from fossil fuel pro-
duction. A potent GHG, methane has been responsible for 30 percent of
the rise in global temperature since preindustrial times. Energy produc-
tion accounts for nearly 40 percent of anthropogenic methane emissions
(IEA 2023b).

The main private benefit of these energy production transformations is the cost saving associated with switching from fossil fuels to less expen- sive renewables in electricity generation. After years of precipitous cost decreases, solar photovoltaics and onshore wind today are the lowest cost options for new electricity generation in most countries; they can provide electricity at prices 30 to 50 percent lower than those in contracts that spec- ify the price buyers will pay in the future (IEA 2023c; Box 8.2). In principle, cost savings from the switch to renewables can be passed on to investors in the form of higher returns and to consumers in the form of lower elec- tricity rates.

The switch to renewable energy in electricity generation would also gen-
erate at least three kinds of public benefits. First, it would create new jobs in
the construction, operation, and maintenance of renewable energy genera-
tion. According to a joint study by the International Labour Organization and
the IDB, the potential exists to generate 100,000 jobs in the region by 2030,
a 22 percent increase as compared to a business-as-usual scenario (Saget,
Vogt-Schilb, and Luu 2020). Second, it would reduce air pollution, which is a
serious problem in Latin America and the Caribbean (Box 8.3). Third, it would
strengthen energy independence for countries that rely on imported fossil
fuels; in the region, fifteen countries are net importers of oil and natural gas
(Balza 2023). Finally, the switch to renewable energy in electricity generation
would enhance resilience by decentralizing energy generation.

Transforming Transportation

The transportation sector contributes 15 percent of the region's GHG emissions. The first of five transformations in the sector needed to achieve net zero entails shifts in the modes of transportation used to move people and freight. For people, low-occupancy private vehicles must yield to public modes like trains, metros, and buses and to micromobility—that is, the use of small, low-speed devices, like scooters, e-scooters, bikes, and e-bikes. For freight transportation, shifts are needed from trucks to rail and ships.
Box 8.3. Less Combustion, Better Health

Fossil fuel combustion generates two types of air pollutants: global and local. Global pollutants like carbon dioxide and methane are the main causes of global warming. However, they have limited direct effects on human health. Their main effects are indirect, stemming from changes in temperature and precipitation and from extreme weather (see Chapter 3). By contrast, local air pollutants, such as particulate matter, carbon monoxide, and sulfur oxides, have more limited effects on global warming but much more severe direct effects on human health. Each year, local air pollutants cause 5 million to 9 million premature deaths globally and many more cases of bronchitis, asthma, and other cardiopulmonary illnesses (World Bank and IHME 2016; GBD 2021; Vohra et al. 2021). More than 90 percent of these deaths and illnesses are in developing countries. In Latin America, 84 percent of the population lives in places with unsafe or hazardous air quality, which causes more than 170,000 premature deaths per year—5 percent of all such deaths. Associated welfare losses exceed 2 percent of gross domestic product (GDP; Rentschler and Lenova 2022; World Bank and IHME 2016).

Many of the net-zero transformations in Table 8.1, including shifting from fossil fuels to renewables in electricity production (B1) and, in transportation, shifting modes of travel and shipping, switching to clean fuels, and increasing fuel efficiency (C1-C4), would dramatically reduce local air pollution as well as GHGs. It should not be surprising, then, that the second largest monetized benefit (after fuel cost savings) of the transformations will likely be reduced death and illness from local air pollution. For four of the five decarbonization strategies modeled later in this chapter, discounted monetized benefits between 2020 and 2050 total hundreds of billions of dollars for the region as a whole.

Complementary evidence comes from World Health Organization studies that estimate the health benefits of the net-zero transformations for a handful of individual countries, using a modeling framework focused more specifically on local air pollution. One such study for Colombia finds that implementing the transformations needed to meet Nationally Determined Contribution (NDC) goals by 2030 would reduce levels of fine particulate matter by 13 percent, nitrogen oxides by 26 percent, and sulfur dioxide by 66 percent (WHO 2023). Those reductions would, in turn, prevent 3,800 premature deaths per year and result in US$1.9 billion in health savings annually, equivalent to 0.6 percent of the country's projected 2030 GDP.

Second, it will be important to increase occupancy in private vehicles through shared mobility, such as the use of car and van pooling. Third, fuel efficiency can be increased in both light- and heavy-duty vehicles. Fourth, all modes of transportation can switch from fossil fuels to lower-emission fuels, like electricity, biofuels, and green hydrogen.

And, finally, it will be important to reduce transportation demand by making remote work more common and increasing urban density.
The private benefits of these transformations stem from cost savings for those involved in the transportation sector. Although they often have higher upfront capital costs than conventional fossil fuel vehicles, electrified buses and cars also often have lower lifetime costs because electric drivetrains are simpler, more reliable, and more energy efficient than conventional ones and because per unit fuel costs for electric vehicles are often lower. In Mexico City and Santiago de Chile, for example, lifetime costs of electric buses are 10 to 20 percent lower than the costs of diesel buses (World Bank 2019). A second private benefit has to do with road infrastructure: reducing the number of vehicles on the roads would reduce the costs of building and maintaining them.

An important public benefit of these transformations is cleaner air. In many cities in Latin America and the Caribbean, cars, trucks, and buses are leading sources of air pollution (Huneeus et al. 2020). Also beneficial is a reduction in traffic congestion, which imposes enormous costs as a result of lost time. Estimates of these costs for the ten large cities in the region with significant congestion range from 0.5 to 1.1 percent of city-level GDP (Calatayud et al. 2021). A third benefit is reduced traffic accidents, which have been projected to cost the region US$115 billion in 2010 dollars between 2015 and 2030—the equivalent of 0.12 percent of its GDP (Chen et al. 2019).

## Flipping the Switch in Buildings

In the buildings sector, which contributes 3 percent of the region's GHG emissions, building shells and appliances can be modernized to enhance energy efficiency (IDS 2015; Gillingham et al. 2021). Also, buildings using onsite fossil fuels for energy can switch to electricity, onsite renewables, and heat pumps.

The principal private benefits of these transformations are the cost savings associated with higher energy efficiency and less expensive energy. The main public benefits are improved indoor and outdoor air quality resulting from fuel switching and improved resilience from energy decentralization.

## Reducing and Recycling Waste

In Latin America and the Caribbean, 6 percent of GHG emissions are generated by the waste sector, including by waste incineration, landfills, wastewater treatment, and biomass burning in agriculture, forestry, and other land uses. The three transformations needed to decarbonize this sector are, first, reducing waste through circular economy practices, such as reusing, repurposing, repairing, and recycling materials at the end of their
usefulness (CEC 2022; Van Hoof, Núñez, and Miguel 2023); second, reducing the loss and waste of food, the production of which in the region takes place on roughly a quarter of the world's arable land and amounts to more than a quarter of total food production globally (HLPE 2014; WFP 2021); and, third, reducing methane emissions from solid waste and wastewater treatment and disposal, which contribute 20 percent of global emissions (IEA 2023b).

The main private benefits of net-zero transformations in the waste sector are reduced costs for firms and farms that use circular economy measures and that cut losses in food supply chains. The main public benefits are the improved environmental quality and job creation associated with greater use of circular economy practices and the avoided conversion of forests and other valuable ecosystems to agriculture.

## Turning Down the Heat in Industry

Industrial processes contribute 10 percent of the region's GHG emissions. They can be broken down into those using low heat and those using high heat. The former, which include light manufacturing and food processing, entail temperatures of 250 C° or less. The latter require much higher temperatures and include the manufacture of, for example, iron and steel, cement and concrete, and chemicals.

Four transformations are needed to decarbonize industrial processes. First, industry can switch to lower-emission energy sources and feed-stocks. Most low-heat processes are easily electrified. High-heat industries, however, are not. Here, lower-emission alternatives include natural gas, bio-energy, and green hydrogen (IPCC 2022). Second, industry can boost energy and materials efficiency (Lamb et al. 2021). Third, it can use CCUS to reduce emissions from cement, steel, chemicals, and plastics. And, fourth, it can reduce emissions of noncarbon GHG emissions, such as fluorinated gases, methane, and nitrous oxide (IPCC 2023).

The main private benefits of net-zero transformations in industry are cost savings associated with lower-cost energy and energy and materials efficiency. The main public benefit is the improvement in air quality associated with reduced emissions from burning fossil fuels.

## Measuring Progress

How much progress must Latin America and the Caribbean make to implement fully each of the net-zero transformations described above? The first column of Table 8.1 sets out the transformations that are needed in each sector to achieve net-zero emissions, and the second lists one or more
quantitative indicators for each. For the transformation numbered A1, for example—"conserve, expand, and restore forests and other high-carbon ecosystems"—the single quantitative indicator (A1a) is the area with forest cover, measured in hectares (ha).

The third column presents a region-level statistic called “scope for progress” that sheds light on the progress the average Latin American and Caribbean country needs to make to implement each net-zero transformation fully. More specifically, for each indicator, this statistic is the GHG weighted average, across the eighteen countries for which the requisite data are available, of the percentage change in the 2020 level of the indicator needed to reach the maximum or minimum “feasible level” in 2050 (as defined by Kalra et al. 2023 for each country).<fnref n="3" /> So, for example, for the indicator “area with forest cover in ha” (A1a), the scope for progress is 39 percent, meaning that the average country in the region can expand its area with forest cover by 39 percent above 2020 levels before reaching the maximum feasible 2050 level (determined by, among other things, the need to use land for agriculture and urban development). And for the indicator, “methane emissions from fossil fuel production in $tCO_2e$” (B2a), the scope for progress is 86 percent, meaning that the average country can reduce methane emissions by 86 percent before reaching the minimum feasible level in 2020 (determined by, among other things, the difficulty of completely eliminating methane emissions). Large scope-for-progress statistics identify transformations for which more progress is feasible.

For four indicators, as noted in column 2, the requisite data needed to calculate the scope-for-progress indicator are not available. For five of the transformations, with indicators designated “minimal implementation in 2020” in column 2, the average 2020 level of implementation is either zero or

<footnote n="3">³ The eighteen countries analyzed by Kalra et al. (2023) are Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, and Uruguay. The region-level scope-for-progress statistic (in column 3 of Table 8.1) is a weighted average of country-level statistics calculated for each of these. Each country-level statistic represents the difference between the 2020 value of the indicator and the desired feasible level in 2050 as a percentage of the 2020 values. The desired feasible level of the indicator is a maximum in the case of indicators for which higher levels are associated with net zero (such as the fraction of electricity from renewables) and a minimum in the case of indicators for which lower levels are associated with net zero (such as the average annual percentage change in forest area). Kalra et al. (2023) estimate these maximum and minimum feasible levels for each country based on the literature on each transformation in each country. Our region-level statistic is simply the average of the eighteen country-level percentages, weighted by country-level GHG emissions.</footnote>
quite small, implying that, in principle, the scope for progress is quite large. Note, however, that, for two of the five, progress will depend on the future development and deployment of cost-effective CCSU technologies.

Among the remaining transformations for which data are available, the scope for progress is greatest for mode shifting in the transportation sector (C1); reducing methane emissions from solid liquid waste (E3); and fuel switching in the industry sector (F1).

Among the transformations for which the scope-for-progress indicators are particularly low, fuel-switching in the buildings sector (D2) is notable. Our data suggest the average country in the region can increase the fraction of building energy that is electrified by only 5 percent. The main reason is that most buildings in Latin America and the Caribbean are already electrified and are not heated.

Finally, it is important to point out that, as weighted averages, these scope-for-progress indicators disproportionately reflect the situation in the largest GHG-emitting countries. Also, they are not meant to indicate how any of the countries ought to prioritize net-zero transformations; that depends on the net benefits of each transformation, which, in turn, depend on country-specific factors. The scope-for-progress statistics are meant only to identify transformations for which considerable opportunities for progress are or are not available.

## Benefits and Costs of Net Zero

This section summarizes a 2023 study commissioned by the IDB that estimates the benefits and costs of achieving net zero in Latin America and the Caribbean (Kalra et al. 2023). That study scales to the entire region the findings of four other IDB studies, each of which estimates the net benefits of net zero in a single Latin American or Caribbean country (Groves et al. 2020; Benavides et al. 2021; Quirós-Tortos et al. 2021; Arguello et al. 2022). The discussion below first briefly describes the methodology used by Kalra et al. (2023) and then summarizes the main results.

## Empirical Approach

Kalra et al. (2023) estimate the net benefits of net-zero emissions for all of the eighteen Latin American and Caribbean countries that had the requisite data to be included in the "scope for progress" indicator appearing in Table 8.1, above. To ensure the results can be compared and aggregated across these countries, they use a standardized modeling approach—the SiSePuede modeling suite (Box 8.4)—and consistent comparable data for each country.
Box 8.4. The SiSePuede Modeling Suite

The methodological foundation of the study by Kalra et al. (2023) is SiSePuede (Simulation of Sectoral Pathways and Uncertainty Exploration for Decarbonization), a free open-source suite of bottom-up, partial-equilibrium models for eighteen Latin American and Caribbean countries. Each country model includes submodels for the six sectors listed in Table 8.1—AFOLU, energy production, transportation, buildings, waste, and industry—and each submodel is built using the ASIF framework, originally developed for the transportation sector and based on standard methods of the Intergovernmental Panel on Climate Change for estimating GHG emissions (Schipper and Marie-Lilliu 1999; Eggleston et al. 2006; Buendia et al. 2019).a This framework features the following analytical components, represented in the acronym ASIF:

*   **Activity levels:** Production of food, electricity, and transportation and other activity levels are modeled as functions of GDP and population growth.

*   **Mode Shares:** Levels of activity are, in turn, apportioned to production modes. For a given level of residential heat production, for example, a share is apportioned to natural gas furnaces, another share to wood burning stoves, and another share to heat pumps.

*   **Emissions Intensity and Fuel sources.** Finally, each production mode is associated with a GHG emission intensity, which, in turn, is a function of energy efficiency and the type of fuel used—for example, oil, natural gas, wind, or solar.

Each of these analytical components is conditioned on country-specific characteristics that include the existing capital stock and technology; the costs of activities and investments; demand elasticities; and mitigation options and costs. In each country, sector submodels are linked to one another so that, for example, the progress of electrification in the transportation sector affects the demand for electricity in the energy production sector. The data used to parameterize the models are drawn from international organizations that standardize indicators across countries, including the IDB, World Bank, International Monetary Fund, International Energy Agency, and United Nations Food and Agricultural Organization.

The SiSePuede modeling suite is used to simulate the year-by-year effects of decarbonization strategies (described below) on GHG emissions, benefits, and costs from 2020 to 2050. Given this thirty-year timeline, model results depend on a range of assumptions about future conditions that are highly uncertain, including population growth, GDP growth, technological change, consumer preferences, and the sequestration capacity of forests. To test the sensitivity of the results to such assumptions, Kalra et al. (2023) use robust decision making (RDM), a stakeholder-supported process for conducting

*(continued on next page)*
Box 8.4. The SiSePuede Modeling Suite (continued)

exhaustive “what-if” analyses that essentially entails generating results based on hundreds of different sets of modeling assumptions (Marchau et al. 2019; Lempert, Popper, and Bankes 2003).

Through this approach, Kalra et al. (2023) simulate the effects of six
decarbonization strategies, each of which is defined by different combi-
nations and levels of the twenty transformations previously discussed. The
first strategy serves as a benchmark against which to evaluate the others:

*   *Traditional Development.* This business-as-usual strategy assumes that Latin America and the Caribbean continues its historical development trajectory without making major progress on the net-zero transformations. Thus, for example, the region's countries continue to rely heavily on fossil fuels and transportation in private vehicles and do not stem deforestation.

The next three strategies represent different broad conceptual approaches to decarbonization. Each is the same as *Traditional Development* but emphasizes different types of transformations:

*   *Incremental Improvement.* This strategy includes transformations that allow the countries to achieve more quickly the levels of productivity, energy efficiency, waste management, and water treatment found in industrialized countries.

*   *Supply-Side Solutions.* This strategy includes transformations that require producers to innovate and adopt lower-emission means of production, including zero-emission electricity, green hydrogen, and electrified transportation and industrial production. It does not include any changes to consumer behavior, such as switches in transportation modes or changes in diet.

*   *Changing Consumption.* This strategy includes transformations that require consumers to change their behaviors to reduce GHG emissions. It assumes, for example, that consumers shift from private vehicles to public transit and micromobility, that they increase car and van pooling, and that they eat less red meat. Importantly, this strategy

<footnote>ª SiSePuede is available on GitHub at https://github.com/jcsyme/SiSePuede and is document-
ed at https://SiSePuede.readthedocs.io/en/latest/</footnote>
assumes deforestation of primary forests is permanently halted by 2030. It does not include any of the changes in *Supply-Side Solutions*.

The fifth strategy is a maximalist approach:

*   **All Actions.** All of the transformations in the *Incremental Improvement, Supply-Side Solutions, and Changing Consumption* strategies are included in *All Actions*.

Finally, the sixth strategy emphasizes cost effectiveness:

*   **Critical Actions.** While this strategy features differing levels of implementation (ranging from 0 to 100 percent) of all twenty transformations listed in Table 8.1, only the five transformations determined to be essential for achieving net zero by 2050 are implemented at high levels. To identify these five critical transformations, Kalra et al. (2023) first define one thousand decarbonization strategies, each featuring different levels of implementation of the twenty transformations. They then use the SiSePuede modeling suite to estimate the effect of each strategy on 2050 net GHG emissions. Finally, they use multiple regression analysis to identify the transformations that have the biggest effect on emissions.

## Key Takeaways

The following are the most notable findings from Kalra et al. (2023).

**Reaching net zero requires the region to change what both producers and consumers do.**

A comparison of the simulated GHG emission trajectories from the first five decarbonization strategies (Figure 8.7) finds that, with *Traditional Development*, the region's emissions increase 71 percent by 2050, falling far short of net zero. Although they rely on mutually exclusive sets of transformations, both the *Incremental Improvements* strategy and the *Supply-Side Solutions* strategy reduce emissions by the same amount: 36 percent. Under both strategies, however, AFOLU continues to be a major net emitter rather than a net sink. Therefore, neither comes close to achieving net zero by 2050. *Changing Consumption* does better, reducing emissions by 73 percent by 2050, mainly because it halts deforestation and therefore converts forests to a net sink. This strategy also does not
<figure><img src="image_79.png" /><figcaption>**Figure 8.7.** GHG Emissions under Five Different Development Strategies</figcaption></figure>

(continued on next page)
<figure><img src="image_80.png" /><figcaption>**Figure 8.7.** GHG Emissions under Five Different Development Strategies
(continued)</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).

achieve net zero by 2050, however. The only one that does is All Actions, which achieves net zero by 2041.

The implication of this comparison is that a whole-economy approach that changes what both producers and consumers do is needed; changes by only one are insufficient.

**To reach net zero, the region must dramatically reduce emissions from AFOLU.**

A comparison of sector-level emissions for the All Actions strategy (Figure 8.8) shows that the largest emission reductions are from forests and
<figure><img src="image_81.png" /><figcaption>**Figure 8.8.** GHG Emissions by Sector under Traditional Development and All Actions</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).

land use. As noted above, halting deforestation while undertaking reforestation converts this subsector from a net emitter into a net sink, reducing emissions by 274 percent, from 1.8 to -3.1 gigatons of carbon dioxide equivalent (GtCO₂e); this enables the region to reach net zero almost a decade ahead of 2050.
**Net-zero transformations can yield trillions of dollars in net benefits.**

Under the first four decarbonization strategies—*Traditional Development, Incremental Improvements, Supply-Side Solutions, and Changing Consumption*—costs arise from the investments needed to boost energy efficiency in all sectors of the economy, switch fuels used in industrial processes to electricity and hydrogen, improve waste collection and management, and capture and use biogas from all available sources. Benefits, on the other hand, stem from features of decarbonization:

* Improved agricultural productivity

* Improved environmental quality, mostly in terms of avoided mortality from better air quality

* Improved health, safety, and productivity, arising from reductions in household grocery costs, better sanitation and waste management, and improvements in traffic congestion and road safety

* The provision of ecosystem services by conserved and expanded forests and other beneficial land uses

* Avoided fuel costs, driven by improvements in energy efficiency, fuel-switching to electricity, and reductions in the cost of generating electricity

* Benefits associated with improvements in efficiency in the electricity sector

* Other sector savings, stemming mainly from reductions in materials used in cement and steel production

How do these benefits compare to the costs of the four decarbonization strategies (Figure 8.9)? For three of them—all except *Supply-Side Solutions*— the net benefits are positive and large, ranging from US$1.4 trillion for *Changing Consumption* to US$2.7 trillion for *All Actions* (assuming 2019 U.S. dollars and a 7 percent discount rate). What's more, even ignoring the hard-to-value public benefits (those associated with avoided pollution and improved health safety, productivity, and ecosystem services) and considering only private benefits (associated with fuel cost savings, improvements in productivity in the electricity sector, other sector savings, and increases in agricultural output), net benefits for all strategies except *Supply Side Solutions* are positive, ranging from US$0.2 trillion for *Changing Consumption* to US$1 trillion for *Incremental Improvements*.

It is important to emphasize that all aforementioned estimates depend on numerous assumptions about uncertain parameters subject to deep uncertainty. This includes population growth, GDP growth, and technolog-
<figure><img src="image_82.png" /><figcaption>**Figure 8.9.** Costs and Benefits of Reaching Net Zero under Four Development Strategies, Compared to Traditional Development</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).

Note: Figure shows the present value of costs and benefits in each category of transformations, compared to a future under Traditional Development. The benefits are discounted at 7 percent, and negative values imply costs. The black dot shows the net value of all costs and benefits; the labeled red diamonds show the net value of costs and benefits that are largely incurred by sector actors and exclude hard-to-value (and largely external) costs and benefits of health, safety, and productivity, avoided pollution, and ecosystem services.

However, as discussed below (see Figure 8.12 and associated paragraphs), the broad qualitative result—that net benefits are large and positive—is robust to a range of different assumptions.

**The net benefits of net-zero transformations are highest in the transportation and AFOLU sectors.**

As noted above, the All Actions strategy is the only one that achieves net zero by 2050 (Figure 8.10). How are the costs and benefits of this strategy distributed across economic sectors? The largest net benefits (US$1.2 trillion) are in the transportation sector, with the lion's share arising from fuel cost savings (US$775 billion), transportation system savings (US$215 billion), safety and congestion benefits (US$200 billion), and benefits of avoided air pollution (US$150 billion). The second largest net benefits are in the AFOLU
<figure><img src="image_83.png" /><figcaption>**Figure 8.10.** Net Benefits by Associated Sector under All Actions</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).

sector (US$936 billion) and are mainly generated by shifts to healthier diets and the continued provision of ecosystem services. Net benefits in the remaining three sectors are more modest but still significant, ranging from US$147 billion to US$213 billion. Note that benefits associated with each sector are enjoyed by parties outside as well as inside the sector.

**Among all twenty transformations, just five are essential for reaching net zero by 2050.**

Among the twenty transformations listed in Table 8.1 (A1–F4), five are essential for achieving net zero by 2050:

* Conserving, expanding, and restoring forests and other high-carbon ecosystems (A1)

* Modernizing agriculture to boost productivity, sequester carbon, and reduce methane and nitrous oxide emissions (A2)

* Reducing expansion of agricultural lands, including pasture (A3)

* Shifting from fossil fuels to renewables in electricity generation (B1)

* Switching to low-emission fuels in transportation (C2)
The average levels of implementation of these five transformations explain almost three-quarters of the variation in 2050 net emissions from a sample of one thousand more-or-less randomly constituted decarbonization strategies (Figure 8.11). All of the others explain only about a quarter of the variation. All of the decarbonization strategies that implement at least 70 percent of these five critical transformations reach net zero by 2050.

**A decarbonization strategy emphasizing the five critical transformations (Critical Actions) is likely both to achieve net zero and generate substantial net benefits, regardless of uncertainty about future conditions.**

Kalra et al. (2023) use the robust decision making (RDM) process to test the sensitivity of the *Critical Actions* strategy to deep uncertainty. They define a set of one thousand decarbonization strategies, each featuring high levels of implementation (50 to 100 percent) of the five critical transformations listed above, along with a range of different assumptions about, first, the levels of implementation of the remaining strategies listed in Table 8.1 and, second, exogenous parameters subject to deep uncertainty, such as population growth, GDP growth, and technological change. Then they use the

<figure><img src="image_84.png" /><figcaption>**Figure 8.11.** Emissions in 2050 versus Implementation of Critical Transformations</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).
SiSePuede modeling suite to estimate the effect of each of these strategies on 2050 net GHG emissions and on net benefits.

A plot of the discounted net benefits and 2050 net emissions for the thousand decarbonization strategies (Figure 8.12) illustrates three results. First, the benefits of reaching net zero far outweigh the costs, regardless of how deep uncertainty is resolved. Of the decarbonization strategies, 95 percent generate positive net benefits. The median discounted net benefit across all strategies is US$1 trillion, and the maximum is US$2.5 trillion. Second, overshooting net zero does not reduce the net benefits. On average, decarbonization strategies that overshoot net zero generate roughly the same level of net benefits as those that undershoot it. And, finally, most decarbonization strategies that feature high levels of the five critical transformations achieve net zero by 2050: 13 percent overshoot and reach net zero sooner than 2050; another 45 percent reach net zero by approximately 2050; and 42 percent miss net zero by 2050.

<figure><img src="image_85.png" /><figcaption>**Figure 8.12.** Net Benefits and Net 2050 Emissions of Critical Actions Variants under Uncertainty</figcaption></figure>

Source: IDB staff, based on Kalra et al. (2023).
## Do Citizens Care about Net Zero?

US$2.7 trillion: that is the central estimate by Kalra et al. (2023), the authors of the study discussed above that uses eighteen country-level bottom-up simulation models to assess the net benefits of the transformations needed to reach net zero by 2050. But what does the average citizen in Latin America and the Caribbean think about these benefits and costs? Their opinions matter; the willingness of the region's policymakers to decarbonize their economies depends on their constituents' perceptions. In countries where most citizens believe net benefits are negligible, policymakers may have limited latitude and/or incentives to promote decarbonization. In addition to estimating the net benefits of decarbonization, therefore, it is important to understand citizens' perceptions of them.

Contingent valuation (CV) surveys are a useful tool for eliciting citizens' perceptions about the net benefits of policy interventions. They provide respondents with information about an intervention and then ask a series of carefully worded questions, including whether or not the respondent would be willing to pay a randomly selected amount to fund the intervention. The answers to these questions are then used to estimate econometrically the respondents' average willingness to pay (WTP) for the intervention. WTP, in turn, can be interpreted as a measure of the respondents' perceived net benefits. The product of decades of experimentation and debate, best practice protocols for the design and implementation of CV surveys help to ensure they generate reasonable, dependable, comparable WTP estimates (Hanley and Czajkowski 2019; Johnston et al. 2017). Recently, CV surveys administered in a number of countries have been used to study cross-country variation in WTP for climate mitigation policies (Carlsson et al. 2021; Schwirplies 2018; Winden, Jamelske, and Tvinnereim 2018; Ziegler 2017; Jamelske et al. 2015).

The following presents results from such a CV survey administered to representative samples of 775 respondents in each of three large Latin American countries: Argentina, Brazil, and Chile (Blackman, Jeuland, and Leguizamo, forthcoming). These countries span the gamut in terms of their contributions to the region's total emissions (Table 8.2). The survey elicits respondents' WTP for government programs that reach net zero in each country by 2050.

WTP estimates for Argentina, Brazil, and Chile are US$43, US$31, and US$60 per month, respectively. To help interpret the magnitude of these estimates, it is helpful to make them comparable across countries by expressing them in terms of income and national GHG emissions. WTP estimates for the three countries represent 6 percent, 2 percent, and 3 percent, respectively, of mean household income in those countries. And, per ton of
<table><caption>**Table 8.2.** GHG Emissions and Estimated Willingness to Pay (WTP) for Net Zero, by Country (standard error)</caption><thead><tr><th></th><th>Argentina</th><th>Brazil</th><th>Chile</th><th>All</th></tr></thead><tbody><tr><td>Total emissions (tCO<sub>2</sub>e)</td><td>394.8</td><td>1,469.60</td><td>49.7</td><td>1,914.10</td></tr><tr><td>Share of region's emissions (%)</td><td>10.2</td><td>37.9</td><td>1.3</td><td>49.4</td></tr><tr><td>Per capita emissions (tCO<sub>2</sub>e)</td><td>8.7</td><td>6.9</td><td>2.6</td><td>6.8</td></tr><tr><td rowspan="2">WTP (US$ per month)</td><td>42.90</td><td>30.90</td><td>60.30</td><td>45.90</td></tr><tr><td>(4.80)</td><td>(4.36)</td><td>(3.36)</td><td>(2.38)</td></tr><tr><td>WTP per mean household income (%)</td><td>6.2</td><td>1.9</td><td>3.1</td><td>—</td></tr><tr><td>WTP per ton CO<sub>2</sub>e (US$)</td><td>18.70</td><td>19.00</td><td>78.60</td><td>—</td></tr></tbody></table>

Source: IDB staff, based on Blackman, Jeuland, and Leguizamo (forthcoming).

Note: WTP is in purchasing power parity and inflation-adjusted U.S. dollars for 2022. It is estimated using a double-bounded design. Mean household income is for the members of a survey panel of an internet survey research firm.

CO₂e emitted by each country, they are US$19 for Argentina and Brazil and US$79 for Chile.

These estimates are in the same ranges as those obtained from CV studies conducted in other regions. Carlsson et al. (2021), for example, find that respondents in China, Sweden, and the United States are willing to pay US$75, US$71, and US$78 per month, on average, for an 85 percent reduction in their countries' GHG emissions within forty years, equivalent to 3 percent, 2 percent, and 2 percent of mean income and to US$44, US$129, and US$31 per month per ton of CO₂e.

Hence, these WTP estimates suggest that, like citizens in Asia, Europe, and North America, those in Latin America perceive that reaching net zero will confer substantial net benefits. That finding, in turn, is a reason to be optimistic about the political prospects of decarbonization policies in the region.

## A Road to a Better Future

For Latin America and the Caribbean, reaching net-zero emissions by 2050 will be no mean feat. It will require fundamental changes in a range of important economic sectors. But the evidence presented here suggests that reaching net zero not only is feasible; it will generate significant net benefits.

The brief outline this chapter provided of the evidence on the transformations needed for net zero demonstrated that the vast majority of them are proven and readily available. Because of the dramatic recent reductions in the cost of wind and solar energy, for example, the switch to renewable
energy sources essential to low-carbon electricity generation—the backbone of net-zero economies—is already underway.

Beyond feasibility, the eighteen-country bottom-up simulation study by Kalra et al. (2023) summarized above suggests that the transition to net zero will generate trillions of dollars in net benefits for Latin America and the Caribbean, mostly as a result of fuel cost savings and improvements in health, safety, and productivity.

That study, along with the statistics on the region's GHG emissions, provides some broad guidance for net-zero transformations. A key finding is that because AFOLU contributes a disproportionate share of the region's GHG emissions—48 percent versus 15 percent for the rest of the world—dramatically cutting emissions from that sector will be absolutely critical. Fortunately, Kalra et al. (2023) suggest doing so will generate significant benefits from, among other things, the continued provision of ecosystem services.

Unfortunately, the roadmap for net-zero transformations sketched here and the evidence that following it will generate these benefits are unlikely to be sufficient to spur the requisite changes. Policymakers in Latin America and the Caribbean face significant political and economic obstacles to implementing net-zero transformations. The next chapter discusses these obstacles and offers strategies for overcoming them.
<figure><img src="image_86.png" /></figure>
# Barriers En Route to a Net-Zero Economy

The transition to a low-carbon economy requires a comprehensive and staged approach. While carbon pricing is theoretically optimal for reducing emissions, its impact has been limited by low coverage, inadequate pricing, distributional impacts, market design flaws, inadequate infrastructure, and knowledge gaps that hinder climate spending. As a result, targeted interventions, such as green infrastructure investment, regulatory reforms, and capacity building, are important. Policy sequencing should begin with socially and politically feasible reforms and gradually advance to more transformative measures as political and institutional capacity grows.

The transition to a net-zero economy is technically feasible and comes with substantial benefits. So, why is it not happening faster? Two factors are pivotal. First, significant, interrelated, and sequenced changes are needed in all major sectors of the economy, ranging from electricity production to agriculture. Second, a host of regulatory, informational, capacity, and even crime-related barriers—sometimes accidentally created by government—deter private and public investment in key net-zero solutions, even when they are cost competitive. Achieving net zero, then, calls for a wide-ranging strategy to remove barriers in all sectors of the economy through pricing reforms, distributional impact management, regulatory reform, infrastructure development, capacity building, and data provision. It also necessitates empowering the right actors within the government, taking advantage of international assistance, and sequencing reforms in a politically viable way.

## Carbon Pricing: Theory and Practice

Carbon pricing entails imposing a higher effective price for greenhouse gas emissions on the businesses and consumers responsible for producing them. This approach first came to the fore in the 1990s, at a time when fossil fuel-based technologies were far less expensive than net-zero ones
like solar panels, wind turbines, and electric vehicles. At the time, raising the effective price of fossil fuel technologies to make clean technologies more competitive seemed a logical, if not obvious, choice for policy.

Beyond this intuitive sense that it should work, the economic rationale for carbon pricing is compelling. Greenhouse gas emissions carry a *negative externality*, meaning that, when businesses and consumers produce them, they do not bear the full social cost of their actions. Carbon pricing internalizes this negative externality by turning the full cost back on them (Pigou 1920). In theory, this is an elegant means of creating incentives to use all available economic levers to cut emissions across all economic sectors (Nordhaus 1991). In the transportation sector, for example, the higher pricing of fossil fuels signals consumers to buy smaller and more energy-efficient vehicles and forgo some trips by walking or moving closer to where they work, and it signals automakers to develop electric vehicles and other new technology that reduces fossil fuel use. It even signals power generators to use lower-carbon sources of electricity, which, in turn, reduces the carbon emissions associated with charging electric vehicles.

Governments can use two main types of policy instruments to price carbon: carbon taxes and emission trading systems (Goulder and Schein 2013). Carbon taxes impose a fixed cost per unit of emissions, usually a metric ton of CO₂ equivalent (tCO₂e), that can be levied on both mobile and stationary sources of emissions (examples of the latter are aluminum, steel, and cement manufacturing plants). In practice, they are typically levied on the carbon content of fuels used by these sources.

Emission trading systems, on the other hand, set a maximum allowable level of emissions for a given jurisdiction and distribute allowances to polluters in that jurisdiction for free, through auctions, or by other means. The allowances are tradable, which creates incentives for polluters who have cheap alternatives for emission abatement to sell the allowances to polluters whose emission reduction costs are higher. The market-clearing carbon price that emerges makes markets and taxes equivalent in most respects, although taxes tend to be easier to administer and interact better with other policy instruments (Goulder and Schein 2013).

A third type of carbon pricing is the carbon credit market (Talbot-Wright et al. 2024). Carbon credits are created when companies invest in projects that reduce emissions or remove carbon from the environment. Once verified by third parties, the companies can sell the credits to other companies or to individuals who can use them to reduce their own carbon tax liabilities or for ethical or marketing reasons. Emission reduction projects might include forest conservation efforts or plant closures, while carbon removal projects may involve reforestation or carbon capture use and storage. While emission
<table><caption>**Table 9.1.** Carbon Taxes in Latin America and the Caribbean, 2023</caption><thead><tr><td>Country</td><td>Price (US$/tCO<sub>2</sub>e)</td><td>% of emissions covered</td><td>Since</td><td>Estimated 2023 tax revenue (millions US$)</td></tr></thead><tbody><tr><td>Argentina</td><td>3</td><td>20</td><td>2018</td><td>167</td></tr><tr><td>Chile</td><td>5</td><td>29</td><td>2017</td><td>171</td></tr><tr><td>Colombia</td><td>5</td><td>23</td><td>2017</td><td>92</td></tr><tr><td>Mexico</td><td>4 (kerosene)<br>0.4 (oil)</td><td>44</td><td>2014</td><td>239</td></tr><tr><td>Uruguay</td><td>156</td><td>11</td><td>2022</td><td>271</td></tr></tbody></table>

Source: IDB staff, based on World Bank (2023).

reduction credits are generally cheaper than emission removal credits, they are more suspect because they often fund projects that would have been undertaken anyway (Calel et al. 2021) and overestimate reductions (West et al. 2020).

To date, governments have used carbon prices to reduce greenhouse gas emissions with limited results. Globally, seventy-three initiatives, including five in Latin America and the Caribbean, have priced carbon (Table 9.1). While little credible counterfactual evidence exists on the efficacy of these projects, the available evidence suggests their impacts have been modest: they have reduced emissions by 0 to 2 percent per year (Green 2021). The best performer is, perhaps, the European Union's Emissions Trading System (EU-ETS), the world's oldest, most lauded, and most studied emission trading system. It is estimated to have reduced emissions in the sectors it covers by 3 to 9 percent over the historical periods studied (typically up to 2012 or 2016) and to have the potential to reduce them further in the future if the allowance price remains high (Hoppe et al. 2023).

Importantly, while carbon pricing has clearly spurred low-cost operational changes, such as boosting energy efficiency and the use of electricity produced by existing natural gas-fired plants instead of coal-fired ones, it is less clear that it has prompted transformative net-zero investments, such as switching to renewable energy (Hoppe et al. 2023; Lilliestam, Patt, and Bersalli 2021). Empirical evidence is stronger that other policies directly targeting such changes—for example, subsidies for or mandates to use solar and wind power—have had an impact, albeit at a higher economic cost (Hoppe et al. 2023).

The effects of existing carbon pricing initiatives are limited for three main reasons. First, they suffer from low coverage (Talbot-Wright et al. 2024). Collectively, the seventy-three initiatives noted above cover only 23 percent of global greenhouse gas emissions. In Latin American and Caribbean countries, the initiatives cover 11 to 44 percent of emissions (Table 9.1).
Second, carbon taxes are set at low nominal rates. Among countries in the region, Argentina, Chile, and Colombia tax carbon at around US$5/tCO2e, and Mexico taxes different fuels and their uses at different rates, between US$0.40 and US$4/tCO2e (World Bank 2023; see Table 9.1). In contrast, analysts estimate that reaching the goals of the Paris Agreement would require taxing all emissions at between US$35 and US$150/tCO2e (Stiglitz and Stern 2017); and, indeed, higher carbon prices reduce emissions more. Sweden's carbon tax, for example, which has been progressively raised to US$109/tCO2e, has reduced transportation emissions by 6 percent (Andersson 2019). In Latin America and the Caribbean, only Uruguay taxes carbon at a relatively high rate. Its rate for carbon in gasoline is $156/tCO2e, a value it achieved only by relabeling preexisting fuel taxes as "carbon tax."

Third, carbon prices are often offset by energy subsidies. In 2022, governments around the world spent US$1.3 trillion (1.3 percent of world GDP) subsidizing fossil fuels, including US$44 billion (0.7 percent of regional GDP) in Latin America and the Caribbean (Black et al. 2023). The combination of low taxation and high fuel subsidies means that, in 2018, the region collected the second lowest net tax revenue from fossil fuels in the world: just 0.06 percent of GDP (Conte Grand, Rasteletti, and Muñoz 2022). A logical first step toward improving the efficacy of carbon pricing should, therefore, be to reduce fossil fuel subsidies.

That said, political economy considerations make pricing reforms difficult. A few groups would bear most of the immediate costs of a high carbon price—for example, owners of coal power plants that would be forced to close and the communities that depend on them (Jenkins 2014; Rozenberg, Vogt-Schilb, and Hallegatte 2020). Groups of households that expect negative effects of carbon pricing or energy subsidy reductions can also organize to block policy reforms (Olson 1971). In France, for instance, the so-called "yellow vest movement" formed in 2018 to block a carbon price increase for transportation fuels (Douenne and Fabre 2022). Similarly, violent protests led the government of Ecuador to withdraw a previously enacted fossil fuel subsidy reform.

## Spreading Around the Costs

International experience suggests that reforms to tax carbon or reduce energy subsidies are more likely to be successful when accompanied by compensation measures that soften their adverse impacts on households (Rentschler and Bazilian 2017). One frequently proposed option is to redistribute carbon pricing revenues in equal per capita cash transfers (Baranzini et al. 2017). In that case, poorer households would receive more money from revenue recycling than they would pay in additional costs associated with
the price reforms. The combination of cash transfers and carbon prices would thus reduce economic inequality, helping to align social development goals with emission reduction goals (Bastagli et al. 2016; Fay et al. 2015).

In principle, redistributing a small share of the fiscal revenues from energy subsidy reductions or carbon pricing would be enough to make price reforms progressive (Feng et al. 2018). Take, for example, a carbon tax of US$30/tCO2e implemented across the region. It would drive up, among other prices, those of natural gas (30 percent), transportation fuels (14 percent), electricity (9 percent), public transportation (4 percent), and food (3 percent; Vogt-Schilb et al. 2019). In most countries, the poorest households would bear the brunt of the price increases because they spend a large share of their income on food, public transportation, and electricity. Even so, it should be possible to compensate this population by using a small portion of the fiscal revenue. The reason is that, on average across the region, the increased costs of a carbon tax paid by the two poorest quintiles would comprise only 16 percent of the costs paid by all quintiles. In principle, governments could thus compensate poor households for the carbon tax with only 16 percent of its revenues, using the remaining 84 percent to fund other development priorities or reduce other taxes (Chapter 10).

But identifying households to be compensated is complicated. Simply using income to do so overlooks important differences within groups. In Latin America and the Caribbean, factors like car ownership, access to electricity, cooking fuels used, and location (urban or rural) lead to variation in carbon footprints even among households with similar incomes (Mardones, Di Capua, and Vogt-Schilb 2023; Missbach, Steckel, and Vogt-Schilb, forthcoming). As a result, some low-income households will be more affected by carbon pricing than higher-income ones; for instance, poor families who use cars will be more affected than some higher-income urban households without them.

Compounding matters, reaching affected households would not be easy. While all countries in the region have at least one cash transfer program—Bolsa Familia in Brazil is perhaps the best known—these programs suffer from imperfect coverage. Only 55 percent of Latin American and Caribbean households in poverty, for instance, receive any cash transfer from the government (Stampini, Medellín, and Ibarrarán 2023). Hence, the households most affected by carbon pricing are not necessarily those who benefit from existing transfer programs (Missbach, Steckel, and Vogt-Schilb, forthcoming). Paraguay is an extreme example; only 5.5 percent of the households that would be most affected by carbon prices currently receive government transfers.

Compensating consumers may thus require governments to expand existing cash transfer programs or to use in-kind transfers—providing funding, for instance, for public transportation or incentives for electric vehicles,
electric cookstoves, or affordable pricing of food (Missbach, Steckel, and Vogt-Schilb, forthcoming; Schaffitzel et al. 2019).

Rethinking Climate Policy

Carbon pricing is a seemingly elegant policy tool for reaching net zero. If distributional impacts could be managed, would carbon pricing alone be sufficient to achieve it? At least two factors suggest the answer is no.

The first is that greenhouse gas emission is not the only externality in play. Knowledge spillovers are a second important one. These occur when knowledge about new technologies spreads throughout the economy. If a firm comes up with a more efficient airplane design, for example, other firms can copy it at low cost. As a result of knowledge spillovers, firms that invest in researching and developing green technologies are not able to capture all the benefits of their investments (Arrow 1962; Romer 1990). From society's point of view, this leads to underinvestment in inventing and deploying green technologies (Jaffe, Newell, and Stavins 2002). The implication is that governments should support innovation in these areas by funding research directly, subsidizing research done by the private sector, and enforcing intellectual property rights on new green inventions through the patent system (Acemoglu et al. 2012; Jaffe, Newell, and Stavins 2005).

A second reason carbon pricing is not a panacea is that some green tech-
nologies are already cheaper than fossil fuel technologies (Chapter 8). For solar
panels, wind turbines, and electric cars, research and deployment has already
happened and delivered. If the market is not picking up these cheaper options
at scale, then other barriers than cost must be preventing their adoption.

Recent research suggests that, in every country, *government failures* prevent public and private investment in net-zero solutions (Fazekas, Bataille, and Vogt-Schilb 2022; Hallegatte, Fay, and Vogt-Schilb 2013). Such failures occur when government actions—with regard, for example, to regulation design, public infrastructure deployment, or even law enforcement—end up hindering the adoption of profitable technology by the private sector. The term mirrors the better-known *market failure*, a situation where free markets left alone do not produce good societal outcomes because, for instance, they fail to internalize externalities, as discussed above.

The existence of cheap clean technology and government failures does not cancel the benefits of energy subsidy reform and carbon pricing. The fiscal impacts can be substantial (Chapter 10), and adequate pricing can still provide incentive for people to take measures, such as driving fewer miles per year, that produce some emission reductions. But governments willing to enable a transition to net zero will need to analyze the issue from a broader perspective.
When Government Regulation Gets in the Way

An important and underappreciated barrier to the transition to a net-zero
economy concerns inefficient market rules and red tape. Outdated reg-
ulations often favor incumbent fossil fuel-based technologies over new
net-zero solutions.

In the energy sector, for instance, the rules surrounding the electricity market can implicitly require generators to guarantee production twenty-four hours a day, effectively blocking the use of solar or wind power. Power purchase agreements have been pivotal to circumventing this barrier and attracting investment in renewable energy (ESMAP 2022). With them, governments provide the certainty of revenue to investors, locking in a price for five to twenty years. Importantly, renewable energy is typically given priority by the utility, meaning that whenever the sun shines or the wind blows, producers can sell electricity at the agreed-upon price, as long as a powerline is available for them to do so (see Box 9.1).

Box 9.1. Synchronizing Power Transmission Capacity with Solar and Wind Uptake in Chile

The Chilean power market is privatized and unbundled—that is, separate energy companies in Chile operate in the generation, transmission, and distribution segments. The role of the government is to ensure regulations and market design enable private investment in the provision of cheap, reliable, and clean power, and its experience with renewable energy uptake in the last decade has underlined the crucial role of market design in enabling or impeding private spending on net-zero solutions.

A decade ago, Chile was reliant on imported coal and natural gas; in 2013, these accounted for 46 percent and 17 percent of generation, respectively, while solar and wind contributed less than 1 percent (most of the rest came from hydropower). But since then, the country has made stunning progress in its transition to net zero: by 2021, 22 percent of power generation came from solar (13 percent) and wind (9 percent), while coal decreased to 34 percent, and gas remained at 18 percent (CEN 2024).

The main drivers of the transition have been the falling cost of renewables, along with regulatory design that allows the private sector to take advantage of this opportunity. Thanks to the clearest skies in the world in the Atacama Desert and the mighty winds that blow in Patagonia and Magallanes, Chile is home to some of the cheapest and most abundant renewable energy sources in the world (Paredes 2017). Since 2015, auctioned power purchase agreements have provided a very effective business model for producers. Private genera-

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Box 9.1. Synchronizing Power Transmission Capacity with Solar and Wind Uptake in Chile (continued)

tors, most of them foreign, have invested billions and built seven gigawatts of solar and wind capacity in a few years—this in a country where peak demand is eleven gigawatts.

But distance is a challenge. Chile spans 6,000 kilometers on a north-to-south axis. Producers have to sell electricity to a third party, which uses long transmission lines to carry solar and wind power to the center of the country, where most of its economic activity is concentrated. And as producers invest in the best sunny and windy areas, transmission capacity gets congested. While auctions lock in a price, producers are paid only if the network can accommodate the energy they produce. This puts them in financial stress, as was shown in 2022, when MaríaElena Solar S.A. and Ibereólica Cabo Leones II declared insolvency.

In response, the government proposed legislation to reduce congestion by expediting the tendering processes for transmission lines and promoting large-scale energy storage projects. The proposed law also includes provisions to share congestion rents (that is, money the transmission utility collects when congestion does happen) with producers who are left without a market during these episodes.

At least two lessons can be drawn from the Chilean experience. First, in the transition to net zero, countries will need to expand transmission and production capacity in parallel. Second, the process will involve learning-by-doing for all actors involved. Innovation is disruptive, and an iterative process will likely be necessary to get regulation right.

Regulations create barriers to decarbonization in other sectors, as well. In transportation, for example, market design can impede or enable investment in electric buses (Box 9.2), while land use regulations in urban areas often discourage dense housing and commercial developments that are pedestrian-friendly and public transit-oriented. Buildings, for instance, are often required to provide a certain number of parking spaces (Russo, Van Ommeren, and Dimitropoulos 2019). Such conditions implicitly subsidize car use, as they allocate space for cars irrespective of private demand and can limit developers' ability to build dense, walkable communities. The availability of more parking spaces motivates more people to drive cars, which also leads to traffic congestion, which results, in turn, in more carbon emissions.

Finally, in buildings, construction codes are an essential predictor of energy efficiency. Yet only ten countries in the region have energy efficiency codes for new residential buildings, and only four of these require audits to verify compliance (ESMAP 2022).
Box 9.2. Market Design Can Make or Break Business Models for Electric Buses

Electric vehicles are cheaper to operate than diesel alternatives, are quie-
ter, and are a key technology for reaching net-zero emissions (Chapter 8).
But in 2022, according to the International Energy Agency's Global EV Data
Explorer, fewer than forty thousand electric vehicles were registered in Latin
America and the Caribbean, compared to millions in China, Europe, and the
United States. In particular, the region had fewer than five thousand elec-
tric buses (E-Bus Radar 2023), and evidence of freight electrification was still
anecdotal.

Policy hurdles help reduce the adoption of electric vehicles in the region. While fourteen nationally determined contributionsª include explicit electrification objectives, limited coordination between climate change and transportation agencies means the NDCs rarely translate into concrete policy interventions (Calatayud et al. 2023). Similarly, even though most countries in the region have developed electric mobility strategies, they tend to be only partially implemented.

Two notable exceptions are Bogotá, Colombia, which has 1,589 electric buses in operation, and Santiago, Chile, which has 1,223 (E-Bus Radar 2023). To put these buses into place, the cities had to change their public procurement rules to enable innovative financing mechanisms and business models for their use.

The principal problem in need of solution was that the upfront cost of an electric bus can represent several years of income for individual bus drivers or transportation operating companies. Banks, which have little experience financing electric vehicles, may be wary of underwriting these costs, or they may charge prohibitive interest rates.

In Bogotá and Santiago, the answer is to separate the market for fleet acquisition from the market for fleet operation. This way, large energy companies, such as national gasoline distributors, utilities, or multinational power producers, can finance the upfront cost of buses and of charging infrastructure. These firms have the relevant technical expertise, and for them the upfront cost is financeable. The energy companies then lease the buses to established transportation operating companies, whose expertise is in serving local routes—including obtaining permission from local governments to do so (Beltrán Real et al. 2021).

The success of the two cities in developing electric mobility shows how market design can empower different parts of the private sector to fund net-zero solutions: the key is to identify risks in the value chain of decarbonized technologies and split the market in a way that enables each actor to focus on a risk it knows how to manage.

<footnote>ª An NDC is the climate plan each country submits to the United Nations as part of the Paris Agreement.</footnote>
When the Infrastructure Is Inadequate

The transition to a net-zero economy in Latin America and the Caribbean is also hindered by a lack of supportive infrastructure. Perhaps the most obvious example is the transportation sector. According to the World Bank's World Development Indicators, the region's urban population grew from 108 million in 1960 to 508 million in 2022 (World Bank 2024). But investment in high-quality public transportation systems did not kept pace (Rivas, Serebrisky, and Suárez-Alemán 2018; Yañez-Pagans et al. 2019). The resulting service gaps in terms of frequency, safety, and reliability have reduced access to workplaces and health and education centers and pushed residents to use private transportation (Box 9.3). Partly as a result, the number of cars per person increased by 60 percent between 2005 and 2015, creating traffic congestion, restricting public spaces, and producing air pollution (Rivas, Serebrisky, and Suárez-Alemán 2018).

The region could improve the accessibility, coverage, and quality of public and nonmotorized transportation systems by spending at least 0.3 percent of GDP every year on efficient metros, light rail lines, and high-capacity buses (Brichetti et al. 2021). That would, however, require overcoming low fiscal revenues, unfavorable political cycles, low institutional capacity, and a lack of institutional coordination (Scholl et al. 2022).

To support electric vehicles, countries need to provide convenient and affordable public charging options for drivers, such as those who live in apartments and can't charge their cars at home. Investment in charging infrastructure is also essential to enable long-distance travel through fast charging networks and manage grid impacts through smart charging (IEA 2023). In 2022, there were around 3 million public charging points globally, but some 13 million to 14 million are needed by 2030 to stay on track for reaching net-zero emissions by 2050. Ways to reach this objective include policies and funding to support the rollout of public chargers, especially fast chargers along highways; mandates to include charging in new multi-unit dwellings; and anticipating infrastructure upgrades to support fast charging, including for trucks.

Improvement of infrastructure is important in the energy sector, too. Electricity grids, hydrogen pipelines, and energy storage facilities are essential to link areas of clean energy production with demand centers. Over 185 percent more transmission lines, for example—80 percent of them in emerging economies—are needed globally by 2050 to handle increased flows in electricity from renewable sources. But building electric grids typically takes a long time. While construction usually needs only two to four years, permitting can take half a decade. In the meantime, a congested transmission network can be a bottleneck to renewable power uptake, as has been
Box 9.3. Making Transportation Systems Inclusive and Accessible

In Latin America and the Caribbean, as in other parts of the world, high-income groups tend to rely on private vehicles, while low-income groups depend on public transportation. The latter use public transportation to get to work and to have access to basic services that allow them to build social, economic, and cultural capital (Lucas et al. 2019). Poor infrastructure connectivity to peripheral urban areas where poorer groups settle limits their mobility (Brichetti et al. 2021; Oviedo et al. 2019).

Public transportation systems connect far fewer people than private cars. In Mexico City, a person taking a 60-minute car trip can reach 13 times more other people than someone taking a 60-minute public transit trip, even after accounting for peak-hour congestion and time spent looking for parking (OECD 2019). In Montevideo, Uruguay; Santiago; and Bogotá, 5.5, 3.7, and 3.5 times more people, respectively, are reachable by car.

Poor access to transit widens inequality by forcing low-income residents to rely on slower, less safe modes of transportation, like walking or motorbike taxis (Crankshaw 2014). In Bogotá, Santiago, and São Paulo, Brazil, 30 to 45 percent of trips by low-income groups are on foot, versus 20 percent for high-income groups. Poorer households also suffer disproportionately from the externalities of private transportation; in Buenos Aires, Argentina, and Mexico City, road fatality rates in low-income areas are two to four times higher than in high-income areas (Scholl et al. 2022).

Inequality is also present in the higher risk to children than adults from the transportation system. Designing or redesigning urban streets by viewing them through the eyes of children can improve road safety and mobility (NACTO 2019). In Ativa, Brazil, the Olhe o Degrau ("Careful where you walk" in Portuguese) project reduced the risk of road injury by renovating abandoned and degraded pedestrian infrastructure and street furniture. As a result, the presence of children in the vicinity increased by 40 percent, and their perception of safety jumped to 100 percent, from 30 percent before the project.

Finally, poor infrastructure disproportionately affects people with disabilities by limiting accessibility, forcing reliance on costly private mobility services, and restricting opportunities. In Bogotá, richer people with disabilities use private transportation, while poorer ones mainly walk, use wheelchairs, or take public transit (Scholl et al. 2022). In Bogotá and Medellín, Colombia, and Curitiba, Brazil, barriers include cracked pavements, missing ramps and audible signals, and insufficient staff awareness and training. Wheelchair users and visually impaired people report the greatest difficulties in multiple cities.

demonstrated in Chile (Box 9.1). Here again, outdated regulations and policies present an obstacle to progress. To relax the bottlenecks, regulators can streamline permitting processes, provide incentive for investment in net-zero
compatible infrastructure, and incorporate network connections and geo-
spatial analysis in energy planning (ESMAP 2022). In Ecuador, for example,
the 2020 Electricity Master Plan proactively addresses expected renewable
energy growth by including measures to connect intermittent wind and solar
power to the grid and upgrade power control systems to maintain reliability.

When Information Is Lacking

Another impediment to the transition is lack of information. Firms and households, for instance, may not be aware of lifetime energy costs when they purchase long-lived equipment or appliances (ESMAP 2022). Energy efficiency labels can provide that information, but when they are voluntary or the information provided is fragmentary, they can be a source of confusion rather than enlightenment. Such labels are more effective when governments mandate a design for them—for example, requiring the inclusion of ratings on a scale from A (very efficient) to G (very inefficient)—and enforce accuracy. They also work best when supported by minimum standards, consumer awareness campaigns, and incentives for higher-tier products. While energy efficiency labels are widely used in Latin America and the Caribbean, they tend to focus on consumer appliances; as of 2021, fourteen countries mandated them on refrigerators and thirteen on heating and air conditioning equipment, while only ten required them on industrial motors and four on vehicles (ESMAP 2022). Expanding these mandates and updating them regularly would help keep them caught up with the best available technology.

Energy efficiency aside, consumers have limited information on the relative merits of different behaviors. They often underestimate emissions associated with air travel and overestimate those associated with food transportation and processing, and they underestimate the impact of beef consumption (Sanchez-Sabate and Sabaté 2019; Wynes, Zhao, and Donner 2020). Providing information can help correct these misperceptions.

Relatedly, providing citizens with information about climate policy can affect their attitudes toward it (Chapter 14). Surveys conducted by the Inter-American Development Bank (IDB) in eleven countries show that citizens did not know how much governments spent on energy subsidies. When informed of the size of the subsidies, their negative impacts, and the potential benefits of subsidy reform, they were much more likely to support reform (Vieites et al. 2022).

Overall, making more information available through education and label-
ing may help facilitate behavioral change; the most promising government
intervention, however, is to use regulations and investments to make the cli-
mate-friendly choice the most convenient one (Thøgersen 2021). Consider,
for example, the choice about whether to drive or take public transportation. Someone who lives in a midrise building with no parking space and easy access to a metro station may be more likely to take public transportation than someone who lives in a sprawling suburb with no access to the metro, regardless of how much each knows or cares about greenhouse gas emissions.

## Ensuring a Just Transition

In the same way energy subsidy reform and carbon pricing have social benefits but come with negative consequences for some consumers, the transition to a net-zero economy will likely generate winners and losers (Vogt-Schilb and Hallegatte 2017). Governments have a role to play to ensure a so-called *just transition*, also referred to as a *just and equitable transition*, happens. This means making sure people and groups who stand to be affected by climate policy are consulted; that the positive consequences of the transition materialize and are shared broadly; and that the losses and costs that result are minimized and compensated for (Saget, Vogt-Schilb, and Luu 2020).

Employment is an essential element of a just transition. An IDB study found that a shift toward a net-zero carbon economy in Latin America and the Caribbean could generate 15 million net new jobs, creating 22.5 million in areas such as agriculture, renewable energy, and construction but destroying 7.5 million in sectors like fossil fuels and cattle (Saget, Vogt-Schilb, and Luu 2020). Compounding matters, job losses will be concentrated in a few places. In Chile, for example, most of the four thousand coal power jobs at risk in a transition are located in fewer than a dozen towns and represent up to 7 percent of local employment (Feng et al. 2023). It is crucial to have strategies in place to help the workers and communities displaced by these changes adapt to them. Ensuring job quality, access to markets, and robust social protection are vital components of the transition (Alfonso et al. 2023).

Skills can also be an issue. Millions of new green jobs will emerge during the transition, and existing jobs across industries will start to incorporate sustainability (Alfonso, Herrera, and Mondragón 2022; Saget, Vogt-Schilb, and Luu 2020). Strategies to equip workforces with the requisite skills include labor market research to identify demands; technical reskilling programs; revamped curricula in diverse disciplines; public campaigns on the future of work; and inclusive access to vocational training.

In short, a just transition means sharing broadly the benefits of the transition by aligning decarbonization goals with inclusion and equality goals. In the case of transportation, for instance, that means planning and operating infrastructure that serves poor communities, children, and people with disabilities (Box 9.3).
Improving Law Enforcement

Improving law enforcement can also be part of a broad strategy to enable a just transition. In cities, for example, crime makes individuals—particularly women—less willing to use public transit or walk (Box 9.4). And in rural areas, illegal logging and changes in land use hinder efforts to preserve forests. Finally, in informal settlements, households and businesses are much less likely to follow energy efficiency standards. Helping them to graduate to the formal economy can enhance the efficacy of regulations to reduce emissions.

**Box 9.4. Addressing the Fear Factor**

The connection between crime and net-zero transportation is often overlooked. Yet insecurity on public transit or in public spaces could discourage households from riding buses and metros or biking and walking.

The perception of insecurity in Latin America is very high. Five of the six cities worldwide with the lowest level of perceived public transit safety are in the region (Bogotá; Mexico City; São Paulo; San José, Costa Rica; and Rio Claro, Brazil). In Barranquilla, Colombia, middle-aged adults and low-income individuals report an elevated fear of crime on buses and at bus stations (Soto, Orozco-Fontalvo, and Useche 2022). Similarly, walking is deterred in high-crime areas, especially for women and the elderly (Foster and Giles-Corti 2008).

Women are especially affected by insecurity. In some Latin American countries, over 90 percent of women have reported experiencing sexual harassment on public transportation (Benites and Corazón, 2016; Gutiérrez Centeno and Lovo Martinez 2015). In Buenos Aires, Santiago, and Quito, Ecuador, women who regularly use the bus, metro, and train have consistently reported higher levels of insecurity and worry than men (Allen et al. 2019). Insecurity makes women less likely to travel, limiting their access to education and better paid work and restricting their time for rest, self and other care, and political participation.

Improving security and creating safe public spaces can encourage the use of sustainable transportation and reduce reliance on polluting private vehicles. The perceived risk of crime can, for instance, be mitigated by creating well-lit, clearly marked, and adequate pathways along walking and cycling routes (Lusk et al. 2019). A case in point is the city of Buenos Aires, which, during the COVID-19 pandemic, built 17 kilometers of bicycle lanes. The result was a 28 percent increase in the number of bicycle trips compared to 2019, with the share of women among cyclists increased from 11 percent to 28 percent—perhaps thanks to a better perception of the safety of this infrastructure (WRI 2022).

In sum, building safer communities is not only essential for the well-being of their inhabitants; it can help address environmental sustainability.

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**Box 9.4. Addressing the Fear Factor (continued)**

<figure><img src="image_87.png" /><figcaption>**Figure B9.4.1. Feeling Safe on the Bus after Dark**</figcaption></figure>

Source: IDB staff, based on Ceccato and Loukaitou-Sideris (2020).

**A Holistic Approach**

Even with adequate market design, inclusive infrastructure deployment, and actionable information, not all the necessary clean technologies will be profitable for the private sector. Some net-zero solutions are likely to come at a net financial cost for firms and households. The conservation of forested areas, for example, bestows social benefits that often exceed the opportunity costs in the form of lost income from forgone agriculture production. But most of the benefits are externalities—that is, they are enjoyed by those not living on forested land, leaving a net cost for the landowners (Box 9.5). Municipal waste management is another costly activity whose benefits are mostly externalities. To make the expansion of these activities profitable, the government will often need to subsidize or directly procure them. This means raising public funds, most of them through the general tax system, and in some cases using specific green funding sources (Chapter 12).

Compounding matters, market and government failures often add up to hinder progress. Deforestation is a prime example (Box 9.5).
**Box 9.5. The Multiple Barriers to Slowing Deforestation**

A variety of economic and institutional factors make deforestation hard to stop or even slow down. The following are some of them.

*Economic incentives to clear forests.* People living in rural areas typically have strong economic incentives to clear forests. They decide whether to do it by comparing the private returns to uses of cleared versus forested land, and the former are generally far higher. In the Brazilian Amazon, for example, the typical market value of one hectare of cleared land is US$1,200 and that of forested land is just US$100, a tenfold difference (Figure 9.5.1). Even though forested land uses provide a host of valuable ecosystem services to society at large—the per hectare value of carbon sequestration in the Brazilian Amazon, for instance, is US$55,000—most firms and households completely ignore them.

<figure><img src="image_88.png" /><figcaption>**Figure B9.5.1.** Value Comparison for Cleared and Forest Land in Brazilian Amazon</figcaption></figure>

Source: IDB staff, based on Nepstad et al. (2020).

Note: The left and middle columns show the typical price of land in the land market of the Brazilian Amazon. The right column shows the value for the global economy relative to avoided damage associated with climate change.

*The tragedy of the commons.* Most forested land in the region is owned and managed by the state, which, in principle, regulates how people use it. But, in practice, governments tend to not have the political, financial, or technical resources to monitor and enforce compliance with land use regulations in expansive and remote forests. As a result, most forests in the region

(continued on next page)
**Box 9.5. The Multiple Barriers to Slowing Deforestation (continued)**

are de facto common property resources prone to overexploitation, a type of problem that Garret Hardin famously labeled “the tragedy of the commons” (Hardin 1968).

*Conservation policy implementation.* Protected areas are the cornerstone of conservation efforts world-wide, but problems related to implementation can blunt their impact. Most important, many protected areas historically have been “paper parks”—polygons drawn on maps, without the resources needed to manage them effectively (Balmford et al. 2003). In the 1990s, for instance, Mexican funding for national protected areas averaged less than US$1 per hectare per year, except in a few of the more notable parks (versus US$28 for Canada, Europe, and the United States). Partly as a result, these areas had no substantial effect on forest loss within their borders during this time (Blackman, Pfaff, and Robalino 2015). A related issue has to do with the location of protected areas. Governments tend to site them in remote sparsely populated areas where political opposition to land use restrictions is relatively weak (Joppa and Pfaff 2009). But these are also areas where deforestation pressure is weakest, so there is little deforestation to prevent.

*Conflicts with rural development policies.* Forest conservation sometimes comes into conflict with policies to further economic development in rural areas. The construction of roads and other transportation infrastructure is a leading enabler of deforestation (Vilela et al. 2020). In the Brazilian Amazon, for example, more than three-quarters of forest clearing has been within fifty kilometers of an all-weather highway (Soares-Filho et al. 2006). Agricultural subsidies also contribute to forest loss. In Mexico, a national agricultural subsidy for livestock (PROGAN) increased deforestation by 7 percent (Moffette and Alix-Garcia 2024). Finally, land tenure regulations that prioritize the titling of cleared land ahead of forested land create perverse incentives for deforestation. Land managers in the Brazilian Amazon often clear the forest to demonstrate “productive” use, which, in turn, reduces the risk of the land's being expropriated (Araujo et al. 2009).

Finally, the barriers to making progress toward net zero differ across sectors—they are very different for electric vehicles than for renewable energy, for instance. To enable the transition, governments thus need first to identify specific sector objectives, such as expanding the use of renewable energy or promoting reforestation, and then identify the barriers to achieving them.

The capacity of public institutions (or the lack of it) to identify objectives and barriers can itself be a barrier, however (Mosqueira and Alessandro 2023). Infrastructure ministries may lack expertise in renewable energy, electric mobility, or sustainable development. Small teams in environmental
ministries, which are often charged with leading climate policy, may struggle to ensure the inclusion of climate change considerations in agriculture, transportation, or industry policy. And subnational governments often lack climate know-how (Rakes et al. 2023). Key deficiencies in climate governance capacity in Latin America and the Caribbean include the inability to monitor deforestation, inexperienced climate policy teams in finance ministries, and insufficient or nonexistent greenhouse gas inventories (Cárdenas, Bonilla, and Brusa 2021; Delgado, Eguino, and Lopes 2021). Solutions may include the dedication of funds to capacity building, hiring reforms, temporary transfers of knowledgeable personnel between institutions, mandatory training, and collaborative processes.

## One Step at a Time

A key theme of this chapter is that the transition to net-zero prosperity requires a comprehensive approach that marshals an array of interventions. But how should governments prioritize and sequence these interventions? There is no one-size-fits-all answer because most barriers to climate action depend on the local context. Different regulations, a different stock of infrastructure, and different economic and social structures translate into different hurdles to public and private spending on net-zero solutions. Every country's plan will, therefore, be different.

Still, governments can follow a few guidelines to prioritize and sequence emission reduction policies, assign them to appropriate agencies, and take advantage of international cooperation. One rule of thumb is to time measures with an eye not only to the net-zero goal but to the political economy—the configuration of economic interests, ideological beliefs, institutional arrangements, and distribution of power that shape policy-making (Hallegatte et al. 2023).

Governments can sequence climate policies pragmatically by starting with reforms that are socially and politically feasible. These can shift ideas, cultivate new interests, and build capacity over time to make further progress toward net zero more viable (Hallegatte et al. 2023; Meckling, Sterner, and Wagner 2017). Rather than being a fixed constraint, the political economy landscape evolves dynamically in response to public policy.

Governments, for instance, can kick-start the transition to renewable energy by subsidizing the installation of new solar panels and wind turbines, a policy that does not directly threaten the owners of coal or natural gas power plants (Rozenberg, Vogt-Schilb, and Hallegatte 2020) but creates new constituencies in the renewable power industry that favor further change (Pahle et al. 2018). After interests and ideas shift and capacities expand,
countries can implement more transformative policies, such as carbon pricing, reforms to energy markets that favor intermittent sources of power, and just-transition plans to phase out fossil-fueled capacity (Meckling, Sterner, and Wagner 2017). But near-term policies must prepare the groundwork for these reforms—for instance, by focusing early on green skills, social safety nets, and regional development to reduce opposition to coal phaseout plans.

Countries can also prioritize feasible, no-regrets climate policies that deliver clear development benefits (Vogt-Schilb, Hallegatte, and De Gouvello 2015). Investing in energy access, for example, supports sustainable growth, and upgrading to electric buses improves the quality of life of constituents while reducing costs (Chapter 8).

Importantly, political economy considerations should not lead countries to consider technical options that reduce emissions only marginally without enabling a transition to net-zero emissions. Improving the efficiency of internal combustion engines or replacing coal power plants with natural gas power plants, for instance, comes with the risk of carbon lock in—that is, these options commit the country to difficult-to-reverse, emission-intensive development pathways, based on technologies that risk becoming obsolete as soon as they are deployed (Binsted et al. 2019; Marinkovic and Vogt-Schilb 2023). It makes more sense to implement options, such as electric vehicles and renewable power, that are consistent with a net-zero economy (Fay et al. 2015; Vogt-Schilb, Hallegatte, and De Gouvello 2015).

## Governance Matters

Effective climate governance is exceptionally challenging for a variety of reasons (Mosqueira and Alessandro 2023). It requires intertemporal tradeoffs, as costs are incurred in the short term but benefits accrue over the long term. Such tradeoffs reduce the incentives for action by politicians whose priority is the short term (Mosqueira and Alessandro 2023). Climate governance also entails tradeoffs between sectors, with difficult cost allocation choices that produce winners and losers across government agencies and levels with conflicting incentives and perspectives. Energy ministries, for instance, govern power markets, while municipalities manage transportation and waste (Rakes et al. 2023).

To tackle intertemporal challenges, governments can pass climate laws that force every new administration to abide by targets and plans already set out (Mosqueira and Alessandro 2023). The laws can also make governments set interim goals—in terms, for example, of renewable energy targets for 2030—breaking up the long-term challenge into smaller milestones (IDB and DDPLAC 2019). These climate laws can then be connected directly to
annual budgeting and policymaking. This requires agencies to show that any new program or spending aligns with decarbonization goals, making it harder for them to ignore the long-term targets. Finally, independent oversight agencies, like the comptroller general, can monitor progress, and criticize governments if they fall behind—a form of public accountability that may motivate politicians to keep up climate efforts.

Conflicts between goals over time can also be mitigated by making long-term climate plans adaptive rather than rigid and updating them periodically. Climate policy involves massive uncertainty about climate change impacts, technologies, and other socioeconomic factors (Kalra et al. 2023). By using adaptive management—the iterative process of monitoring outcomes, testing policy variations, and making adjustments based on evidence—public administrations can account for emerging science and technology shifts and incorporate lessons learned. The Paris Agreement mandates countries to update climate pledges every five years, giving them an opportunity to make such adjustments (see below).

Finally, involving the center of government can help address cross-sectoral complexity and tradeoffs in climate policy (Mosqueira and Alessandro 2023). Coordination from the head of government's office or a council of ministers enables a whole-of-government approach and decisions to be made on sectoral tradeoffs. Legislatures also play a role. Chile's climate law, for example, attributes carbon budget milestones to be reached by different sectors by 2030 and requires each ministry to design and implement action plans to reach them (Chile, Ministry of Environment 2020).

## Working with the World

The instruments of the Paris Agreement may help governments engage in international cooperation to make the transition to a decarbonized economy. Nationally determined contributions are the main mechanism for countries to set and commit to emission reduction targets, typically for 2030 or 2035, and they must be updated every five years with the expectation that emission reduction commitments will increase over time.

Most Latin American and Caribbean countries have updated NDCs (LEDS LAC 2022); Argentina, Chile, Colombia, and Peru, for example, have moved from intensity-based to absolute emission targets. Unfortunately, the commitments are still insufficient globally to limit warming to between 1.5 and 2°C above preindustrial levels (UNFCCC 2023). In the region as a whole, NDCs allow emissions to remain roughly stable by 2030, when halving them by then would be more consistent with a transition to net zero by 2050 (Binsted et al. 2019).
The Paris Agreement also invites parties to develop long-term strategies (LTSs). These are aspirational strategies to achieve the transition to low-emission economies, typically to reach net zero by 2050 (IDB and DDPLAC 2019). By establishing a long-term vision and pathways to get there, LTSs can help countries map priority transformations in key sectors that would put them on track toward achieving this goal (as in Chapter 8). From there, they can diagnose barriers holding back public and private investment and lay out priority policy reforms, spending programs, and other interventions to lift them (Fazekas, Bataille, and Vogt-Schilb 2022; IDB and DDPLAC 2019).

LTSs can be built through an inclusive process involving government, academia, civil society, and the private sector (Calcufoy et al. 2022; IDB and DDPLAC 2019). Research and modeling inform the strategies, while stakeholder engagement ensures their relevance to the country context (Bataille et al. 2020; Jaramillo et al. 2023). To date, seven countries in the region have communicated official long-term strategies to the United Nations,<fnref n="1" /> although only those from Chile, Colombia, Costa Rica, and Uruguay explicitly target net-zero emissions. At least nine more countries are in the process of developing their first LTSs (LEDS LAC 2022).<fnref n="2" />

International cooperation can help countries design long-term strategies, in particular by boosting the capacity of local universities and other analysts to study decarbonization pathways (Bataille et al. 2020; IDB and DDPLAC 2019). An IDB project that organized knowledge exchanges between universities in the region eventually helped Chile, Colombia, Costa Rica, the Dominican Republic, and Peru model the costs and benefits of net-zero-compatible pathways and inform climate policy (Arguello et al. 2022; Benavides et al. 2021; Groves et al. 2020; Jaramillo et al. 2023; Quirós-Tortós et al. 2021, 2023).

International cooperation can also provide practical assistance by investigating barriers to and interventions that enable emission reductions. Support can be offered one transformation at a time; multilateral development banks can, for instance, help governments design business models that enable the use of electric buses (Beltrán Real et al. 2021). Or it can be offered for a whole strategy. In Costa Rica, the IDB helped the government design the National Decarbonization Plan it issued in 2019, which defines seventy immediate public investments and policy reforms to be enacted before 2022 to enable a transition to net-zero emissions by 2050 (Costa Rica Bicentennial Government 2019).

<footnote n="1">¹ Argentina, Chile, Colombia, Costa Rica, Guatemala, Mexico, and Uruguay.</footnote>

<footnote n="2">² Belize, Ecuador, El Salvador, Guyana, Honduras, Panama, Peru, Trinidad and Tobago, and Venezuela.</footnote>
Finally, international financial institutions can open their coffers to finance the implementation of climate change plans. In Costa Rica, the IDB and the French Development Agency jointly disbursed hundreds of millions of dollars, conditioned on the government's implementing some of the milestones of its National Decarbonization Plan (Jaramillo et al. 2023). The loan came with a pledge for a second loan after further reforms, helping provide some continuity in government action despite a change of administration. This approach helped attract US$2.4 billion while giving changing governments incentive to stay on track. Country platforms that bring together central governments, international development partners, and other key stakeholders to strategically direct and coordinate activities can help enhance the impact of climate finance (Gilmour, Tanaka, and Colenbrander 2024).

To provide further incentive for the implementation of climate policy, development banks can also subsidize loans. In 2023, the IDB launched the Biodiversity and Climate Linked Incentive Mechanism for Action (BID CLIMA), a US$1 billion pilot program. Under it, the IDB returns 5 percent of the capital of a qualifying loan to the borrowing country if it achieves agreed-upon targets. These loans are designed to improve the capacity of public institutions to mainstream considerations of nature or climate into public investments; develop climate-friendly projects and policies in sector ministries; and monitor, report, and verify the impact of reforms on greenhouse gas emissions and other development indicators.

In summary, enabling the net-zero transition requires a comprehensive approach spanning regulations, infrastructure, capacity building, information provision, the sequencing of reforms based on political economy, central coordination, and international cooperation. Pragmatic policies tailored to local contexts can start with the most feasible reforms, keeping an eye on the end objective: redirecting hundreds of billions in private spending every year to unlock trillions in net benefits from the transition to net-zero economies.
# Fiscal Policy: A Two-Way Street

<figure><img src="image_89.png" /></figure>

The combination of lower expected revenues from fossil fuels, higher spending needs to address climate impacts, and more expensive borrowing puts upward pressure on fiscal deficits and debt levels. Fiscal policy also plays a significant role, however, in climate change mitigation and adaptation. It requires phasing out fossil fuel subsidies, rethinking carbon pricing to support a low-carbon transition and help fund adaptation, and designing fiscal strategies that align with climate resilience. Emphasizing the importance of proactive investment in resilient infrastructure can help alleviate present and future fiscal pressures.

Fiscal policies and climate change are interconnected, like a two-way street. In one direction, more frequent extreme weather events and reduced productivity can increase costs. To drive safely in this direction, countries—especially those dependent on fossil fuel revenues—must support a transition to cleaner energy sources in a fiscally responsible way. Strategies to do so may include cutting fossil fuel subsidies, taxing greenhouse gas (GHG) emissions, and promoting new revenue streams from clean energy. In the other direction, fiscal policies can exacerbate climate change. The move toward net-zero economies, for example, can be delayed by keeping subsidies that promote the production and consumption of fossil fuels or discourage the adoption of clean technologies.

Combatting climate change requires new, sound fiscal strategies that manage climate-related expenditures, create the right incentives structure for redirecting resources toward clean energy, and implement risk transfer mechanisms and investments in climate-resilient infrastructure. This approach not only mitigates present and future fiscal risks but improves the use of resources and enhances stability in the face of climate change impacts. Effective adaptation policies are crucial in this regard.
Box 10.1. Fiscal Impacts of Disasters

From a fiscal perspective, extreme weather events tend to decrease govern-
ment revenue as a result of lower tax collection from the affected productive
sectors and raise public expenditure toward the emergency response and
the reconstruction process. Alejos (2018) finds the occurrence of at least one
extreme weather event associated with an increase in the fiscal deficit of
0.8 percent of GDP for lower-middle-income countries and 0.9 percent of
GDP for low-income countries. The observed negative effect on the bud-
get balance comes primarily from the decrease in government revenues.
For lower-middle-income and low-income countries, the fall in revenues is
between 0.8 and 1.1 percent of GDP. Contrarily, the average effect on public
expenditure is less and, in the case of low-income countries, spending even
decreases.>a

The study, however, shows only the net effect on revenues and spending.
Possible budget reallocations, for example, are not accounted for as part of the
estimated fiscal cost, although they can be high (see Benson and Clay 2004).
A recent analysis of the fiscal impact of tropical storm Agatha in Guatemala
shows the extent of budget reallocation. In the aftermath, the cumulative
impact on government revenues was -1.1 percent of GDP, the effect on capital
expenditure was 1 percent of GDP through a substantial level of budget real-
location (0.5 percent of GDP), and the net impact on the fiscal deficit reached
1.8 percent of GDP (Alejos and Cabrera, forthcoming).

How Climate Change Affects Fiscal Outcomes

Climate change presents significant fiscal risks in Latin America and the Caribbean. Higher temperatures and extreme weather events diminish productivity and economic growth (see Chapter 2), leading to lower tax revenues and greater spending needs (Box 10.1). And efforts to mitigate climate change can also have fiscal implications through changes in government revenues and spending. These factors affect government budgets through various channels.

One key channel is government revenue. Latin American and Caribbean countries, especially major fossil fuel producers, rely on revenues from sources that are expected to diminish. Countries in the region derive, on average, between 2 and 4 percent of their gross domestic products from fossil fuels (OECD et al. 2023). Even those that are not major fossil fuel producers earn 0.7 to 1 percent of their GDPs from fuel taxes, which are favored because they

<footnote>a This could be the result, for instance, of borrowing constraints on the public sector to raise spending on emergency response.</footnote>
are easy to enforce.<fnref n="1" /> The demand for oil and gas will, however, be reduced by climate change mitigation policies at the global level, leading to a decrease in consumption and government revenues from these sources (IEA 2022). Under a scenario limiting global warming to 1.5°C above preindustrial levels, for example, cumulative oil revenues could fall by US$1.4 trillion to US$4.2 trillion by 2035 from baseline in oil-producing countries (Solano-Rodriguez et al. 2019). This represents a reduction of 1.3 to 3.9 percent of GDP for countries in the region.<fnref n="2" /> Additionally, between 66 and 81 percent of oil reserves and up to 65 to 71 percent of gas reserves may become “stranded assets” by 2035, meaning they will be unviable for economic extraction because there are no buyers (Solano-Rodriguez et al. 2019; Welsby et al. 2021).

On the expenditure side, climate change necessitates increased investment in adaptation efforts and social safety nets, as discussed in Chapters 3 and 7. The problem is aggravated by inadequate public spending on disaster preparedness and lack of monitoring, which create contingent liabilities. Only about a third of countries in the region, for instance, track their risk management budgets effectively (Delgado, Eguino, and Lopes 2021). This shortfall in oversight distorts assessments of fiscal readiness for disasters and hampers the efficient allocation of funds to prepare for them. Remarkably, less than 30 percent of these countries have established funds for proactive disaster risk management. Technical deficiencies in risk assessment pose further challenges. Few countries comply with established standards for calculating probable losses, and, often, no designated entity exists to standardize disaster risk analysis, complicating effective risk management.

Climate change can also affect the government's cost of financing. Klusak et al. (2023) analyze the impact of climate change on the sovereign credit ratings of 109 countries under various global warming scenarios. They project credit rating downgrades resulting in higher borrowing costs as early as 2030, with the number of downgrades rising through 2100. A Caribbean-specific study (Agarwala et al., forthcoming) assesses climate impacts on tourism revenues and, based on that assessment, on climate-induced variations in default probabilities. The results indicate that climate change can lead to sovereign credit downgrades within a few decades that could result in higher borrowing costs for governments and corporations in the region. This may also have negative repercussions on financial stability, as discussed in Chapter 6.

<footnote n="1">¹ More than two-thirds of environmentally related tax revenues (ERTRs) in the region (1 percent of GDP on average in 2021) were derived from taxes on energy, most commonly excises on diesel and petrol (0.7 percent of GDP on average; OECD et al. 2023).</footnote>

<footnote n="2">² The calculation assumes that GDP grows through 2035 at the same average rate as in the past 30 years.</footnote>
The combination of lower expected revenues from fossil fuels, higher spending needs to address the consequences of climate change, and more expensive borrowing puts upward pressure on debt levels. In a detailed study of highly exposed countries in the Caribbean basin, Cavallo et al. (2024) find that debt accumulation accelerates by 10 percent two years after severe storms compared to the pre-storm pace. As a result, three years after severe storms, average debt levels are 18 percent higher than would have been expected if the disasters hadn't occurred. On average, the increase in debt that is directly attributable to anthropogenic climate change is approximately 3.8 percent of the pre-storm debt stock.

The fiscal challenges posed by climate change in Latin America and the Caribbean underscore the need to assess how current fiscal strategies may inadvertently exacerbate the threat and to explore reforms that would align fiscal policies with climate resilience.

## Pillars of Policy

The first pillar of fiscal actions to reduce the impact of climate change should be to stop policies that exacerbate the problem. Global fossil fuel subsidies, both “explicit” (that is, undercharging of supply costs) and “implicit” (undercharging of externalities) have reached 7.1 percent of global GDP.<fnref n="3" /> In the case of Latin America and the Caribbean, explicit and implicit subsidies amount to 5.9 percent of the region’s GDP (Black et al. 2023).

Explicit subsidies entail higher government spending. The fiscal cost of a subsidy is the difference between the unit cost of production of the subsidized good and the price consumers pay for it, multiplied by total consumption. Explicit fossil fuel subsidies reached 1.8 percent of GDP in the typical Latin American and Caribbean country in 2022.<fnref n="4" /> And twenty-two out of the twenty-six Inter-American Development Bank (IDB) borrowing member countries were subsidizing fossil fuels and/or electricity at that point. Venezuela was the largest subsidizer of fossil fuels, with an estimated 13.8 percent of GDP, while Bolivia, Ecuador, and Suriname spent more than

<footnote n="3">³ Explicit subsidy is calculated as the difference between the sectoral unit cost and the fuel user price, times the sectoral fuel consumption: (sectoral unit supply costs – fuel user price) x (sectoral fuel consumption). Implicit subsidy includes the cost of global warming, local air pollution, broader externalities from road use, and forgone consumption-tax revenue. It is calculated using the formula: (sectoral efficient fuel price – sectoral unit supply cost) x (sectoral fuel consumption).</footnote>

<footnote n="4">⁴ Excluding Venezuela, the average for explicit fossil fuel subsidies in Latin American and Caribbean countries in 2022 was 1.3 percent of GDP, based on data from Black et al. (2023).</footnote>
4 percent of GDP, and Argentina, 2 percent of GDP (Figure 10.1).<fnref n="5" /> The largest subsidies went to oil products (diesel, gasoline, kerosene, liquified petroleum

<figure><img src="image_90.png" /><figcaption>**Figure 10.1.** Fossil Fuel and Electricity Subsidies in Latin America and the Caribbean, 2022</figcaption></figure>

Source: IDB staff calculations, based on International Monetary Fund data.

Note: The map shows the sum of explicit subsidies in 2022, as a percentage of GDP.

<footnote n="5">⁵ According to alternative estimates, which incorporate excise taxes, value-added taxes, and carbon taxes into the supply costs of fossil fuels, the subsidies in Canada, Latin America and the Caribbean, and the United States averaged 0.57 percent of GDP in 2018, only slightly below the subsidies in Europe, estimated at 0.64 percent of GDP (Conte Grand et al. 2022).</footnote>
gas, and other oil products), which accounted for 52 percent of the total, followed by electricity, with 28 percent, and natural gas, with almost 19 percent.<fnref n="6" /> The types of subsidies varied across countries, however. Suriname, for example, explicitly subsidized diesel and electricity, while Bolivia subsidized gasoline, diesel, kerosene, liquified petroleum gas, other oil products, and residential electricity. Ecuador subsidized gasoline, diesel, liquified petroleum gas, natural gas for industries and power generation, residential electricity, and other oil and gas products. Subsidies in the region are regularly given to consumers rather than producers.

The second pillar of fiscal actions to reduce the impact of climate change should be to institute policies that mitigate the problem. The term “effective carbon rates” (ECRs) refers to the total costs imposed by policies on carbon emissions, often calculated per metric ton of CO₂ emitted. ECRs comprise a variety of policy instruments, including carbon taxes, fuel excise taxes, and indirect pricing mechanisms, like emission trading systems (ETSs). Ahumada et al. (2023) find that, on average, 98 percent of the ECRs in Latin America and the Caribbean in 2018 comprised fuel excise taxes. ECR rates were higher for road transportation (averaging US$71 per metric ton of CO₂ equivalent) than for other sectors, like agriculture (US$28/tCO₂e), because of the transportation sector’s heavy use of fuels. Still, over half of the emissions in the region were subject to zero ECRs. Moreover, adjusting ECRs for gasoline and electricity subsidies reduced them by US$10/tCO₂e, on average, in the region, compared to only US$2/tCO₂e in OECD countries.<fnref n="7" /> Subsidies made net ECRs negative in Argentina, Bolivia, and Ecuador. Similarly, OECD data covering twelve Latin American and Caribbean countries show that 60 percent of carbon emissions in the region had zero or negative ECRs once subsidies were accounted for.<fnref n="8" />

Carbon taxes, which, unlike fuel subsidies, would tend to discourage the use of fossil fuels, are not yet common. As of 2023, only Argentina, Chile, Colombia, Mexico, and Uruguay had an explicit carbon tax, with low average rates of US$5/tCO₂e covering, on average, only 26 percent of total GHG emissions.<fnref n="9" /> Instead, the region has relied heavily on fuel excise taxes to generate revenues. This is a mixed blessing because, while fuel taxes act as implicit

<footnote n="6">⁶ The only country in the region subsidizing coal is Brazil. Electricity subsidies have a negative effect on climate change to the extent that the energy matrix relies heavily on fossil fuels.</footnote>

<footnote n="7">⁷ Net ECR = (fuel excise tax + electricity excise tax + carbon taxes + carbon emission permit prices) – (pre-tax fossil fuel support + pre-tax electricity support).</footnote>

<footnote n="8">⁸ See OECD (2021).</footnote>

<footnote n="9">⁹ See https://carbonpricingdashboard.worldbank.org.</footnote>
carbon taxes,<fnref n="10" /> they generate government revenues from a resource whose demand is likely to wane, creating long-term fiscal vulnerabilities.

The tendency to rely on fuel excise taxes as the primary contributor to ECRs in the region while simultaneously offering subsidies that undermine these efforts illustrates a broader challenge in aligning fiscal policy with climate objectives. While countries are charging for greenhouse gas emissions through fuel excise taxes, they are also supporting them via fuel and electricity subsidies. The net impact on GHG emissions is likely small or may even be negative (meaning emissions are increasing) as a result of the conflicting price signals.

Fiscal policies also affect climate change in more subtle ways. Spending composition matters because different components of public spending—specifically, investment and current spending—have different carbon footprints. Governments usually cannot optimize budget allocation based on climate criteria because their information about the carbon footprint from public expenditure is limited; this issue is explored in Box 10.2. The criteria used to prioritize public investment projects and public procurement can also affect a government's contribution to decarbonization and resilience. In Latin America and the Caribbean, only Chile and Peru use social carbon pricing—an approach to valuing carbon emissions that takes into account the societal costs of carbon dioxide and other greenhouse gas emissions—to evaluate public investment projects (Eguino, Alvarenga, and Gonzales, forthcoming), while few countries report having strategies regarding “green” public procurement (OECD 2024).<fnref n="11" />

Box 10.2. GHG Emissions from Public Spending in Brazil

As the climate crisis worsens, governments are increasingly compelled to identify the share of public resources dedicated to mitigation and adaptation efforts. A first step is to gauge the implications of public expenditure for emission levels.

In a recent study, Alvarenga et al. (forthcoming) estimate the greenhouse gas emissions generated by Brazilian public expenditure across three levels

(continued on next page)

<footnote n="10">¹⁰ Belfiori and Rezai (2024) show that conventional taxes (like consumption, energy, and income taxes) can implicitly serve as effective tools for carbon pricing. Their analysis underscores the potential of adjusting existing consumption, energy, and income taxes to achieve implicit carbon pricing and thereby align fiscal policies with climate mitigation goals.</footnote>

<footnote n="11">¹¹ Barbados, Chile, Colombia, Costa Rica, El Salvador, Panama, Paraguay, Peru, and Trinidad and Tobago are the only countries in the region that report having central</footnote>
Box 10.2. GHG Emissions from Public Spending in Brazil (continued)

of government (federal, state, and municipal) between 2000 and 2019.ª They conduct a structural decomposition analysis (SDA) of emissions from public expenditure to identify the main drivers of change arising from six factors: (i) scale (level of expenditures); (ii) composition (consumption versus investment); (iii) sectoral allocation (spending on high- versus low-emission sectors); (iv) trade patterns; (v) technology; and (vi) emission-intensity effects.

The study finds the emission intensity of public investment in Brazil is around 2.7 times higher than that of government consumption. This is because public investments rely on a larger material base and involve larger production chains. Therefore, whenever public investment takes a higher share of public spending, government emissions rise.

Emissions from Brazilian public expenditure show two distinct phases. From 2000 to 2014, the growth rate in GHG emissions was 11 percent, driven by positive growth in all types of public expenditures. Emissions increased as a result not only of a larger expenditure—referring, that is, to factor (i) in the list above—but an increasing share of public investment (factor ii). As the government cut spending (especially public investment) to reduce fiscal deficits starting in 2015, the growth rates of emissions became negative through a reinforcing combination of (i) and (ii). The impact of factor (iii) on GHG emissions in Brazil was neutral during the period.

These results highlight a relevant tradeoff from the perspective of climate change and fiscal policy. Increasing expenditure, especially public investment, can lead to higher carbon emissions as a result of the combination of scale and composition effects.ᵇ Still, countries must increase productive public investments to achieve both development and climate goals. The hope to resolve the tradeoff resides in factors (iv) to (vi). A further study by Young et al. (forthcoming) analyzes the impact on emissions of projected public expenditure scenarios in Brazil for 2024–30. The analysis reveals that emissions can increase between 4 and 31 percent based on conservative or optimistic scenarios for public spending growth. The study also shows it would be possible to offset the projected increase in emissions entirely through a combination of technology and emission-intensity effects. Policy simulations indicate, for example, that under conservative spending scenarios, increasing electricity efficiency and reducing emission intensity in key sectors through technological improvements can offset all the projected increase in emissions from higher expenditure.

These studies underline the need to align public expenditure allocation with climate objectives, and they suggest policies to achieve that.

<footnote>ª The study estimates the emissions generated in the production of public expenditure (for example, the production of goods and services required to build a road). New studies should also account for the net emissions coming from households’ consumption of these public goods and services (for example, the use of the road).</footnote>

<footnote>ᵇ Resources for climate adaptation are substantially insufficient, and developing countries will need to increase their adaptation spending five- to tenfold to cope with extreme climate events (UNEP 2022).</footnote>
## Fiscal Strategies to Encourage Mitigation: The Complexities of Carbon Pricing

Economists advocate for carbon pricing policies to mitigate emissions. Carbon pricing derives from economic theories on externalities. The objective of these policies is to include in the prices of goods and services the environmental costs of supplying them and thereby guide economic resources away from carbon-intensive activities and toward cleaner alternatives.

Carbon pricing is commonly associated with carbon taxes, but it includes other instruments, like emission trading systems (ETSs, or cap-and-trade), feebates,¹² and environmental regulations that affect market prices (IMF 2019). To date, seventy-three carbon pricing initiatives have been implemented around the world, covering approximately 23 percent of global GHG emissions. In Latin America and the Caribbean, Argentina, Chile, Colombia, Mexico, and Uruguay have implemented carbon pricing through carbon taxes. Chile, Colombia, and Mexico have implemented carbon offset mechanisms designed to reduce GHG emissions through the trading of carbon credits. And, as of the time of writing, Mexico was working on a pilot scheme for an emission trading system (Talbot-Wright et al. 2024).

Pricier emissions can prompt producers and consumers to identify cost-effective methods for making a transition to greener energy options. One strand of the literature has advanced the “double-dividend hypothesis,” suggesting that the imposition of carbon taxes, for example, can lead to the dual benefit of better environmental and fiscal outcomes (Tullock 1967; Goulder 1995; Parry 1995; Bovenberg 1999). Empirical research, on the other hand, provides a varied picture of the effects of carbon pricing on environmental and economic outcomes. A meta-review suggests its overarching impact to date has been generally limited, with annual reduction of global emissions ranging between 0 and 2 percent (Green 2021).

From an economic perspective, the evidence shows carbon taxes have negative impacts on GDP (Timilsina 2018), with magnitude varying according to different economic structures and capacities for fuel substitution (Timilsina 2018; Kober et al. 2016). Most of the studies available for Latin America and the Caribbean are based on projections rather than ex post

<footnote>government strategies on green procurement. In contrast, all thirty-two surveyed OECD countries have green public procurement frameworks.

¹² “Feebates” refers to a system that either charges a fee or offers a rebate (or subsidy) on products and activities with higher or lower than average emission rates. Power generators, for example, pay a fee (or receive a rebate) in proportion to their output, multiplied by the difference between their emission rate per kilowatt-hour and the industry average emission rate.</footnote>
assessments, and, hence, evidence of the effect of carbon taxes in the
region is limited.<fnref n="13" />

Finkelstein-Shapiro and Metcalf (2023) show that, in a general equilib-
rium model, accounting for features such as firm entry (the creation of new
firms) and exit (the destruction of old firms) and the adoption of green tech-
nology significantly ameliorates the estimated adverse impacts of carbon
pricing on GDP that arise in the model when the technology adoption and
firm creation/destruction channels are not present. The negative impacts
of carbon pricing can also be lower when it serves as a catalyst for techno-
logical innovation. But the empirical evidence on technological adoption is
not conclusive.<fnref n="14" /> The level of adoption varies according to the design and
implementation features of carbon pricing schemes and the overshadow-
ing influence of policy measures, such as renewable energy subsidies, and
of barriers to adoption unrelated to price (see Chapter 9).

A number of studies examine the distributional impacts of carbon pricing on various income groups, geographical regions, and ethnicities.<fnref n="15" /> Country-specific studies on fuel taxes reveal that their distributional effects can be progressive, neutral, or regressive, depending on economic conditions and factors like the intensity of public transportation use. Overall, the distributional impacts of carbon pricing can be managed through careful policy design. Box 10.3 analyzes the issue of the distributional impact of carbon taxes in Latin America through the application of general equilibrium models.

While carbon pricing is popular among economists, its implementation
presents the practical challenges discussed in Chapter 9. The actual effects
of carbon pricing depend on policy design, effective rates, covered sectors,
and potential exemptions, among other factors. Studies focused on Latin
America and the Caribbean underscore the varied effectiveness and design
of carbon pricing policies, noting such concerns as too many exemptions
and poor design features that might weaken a policy's impact (Conte Grand,
Rasteletti, and Muñoz 2022). An additional problem is carbon leakage—the
phenomenon in which a reduction in emissions in one country leads to an
increase in emissions in another—which can occur if carbon pricing poli-
cies are not implemented evenly across countries (Talbot-Wright et al. 2024).

Still, despite its limitations, carbon pricing has the advantage of raising
revenue to fund other spending policies or improve fiscal balances. And the

<footnote n="13">¹³ See, for example, García Benavente (2016) for Chile, Calderon et al. (2016) for Colombia, and Landa Rivera et al. (2016) for Mexico.</footnote>

<footnote n="14">¹⁴ See, for example, Aghion et al. (2016), Noailly and Smeets (2015), Lilliestam, Patt, and Bersalli (2021), and Van den Bergh and Savin (2021).</footnote>

<footnote n="15">15 See Rausch, Metcalf, and Reilly 2011, Goulder et al. (2019), García-Muros, Morris, and Paltsev (2022), and Känzig (2023).</footnote>
**Box 10.3. What Would Happen? Comparing Carbon Taxation in Brazil and Mexico**

Two recent IDB papers explore what would happen from an economic and social standpoint if carbon taxes aiming to reduce emissions by 25 percent were implemented in Brazil and Mexico.

Finkelstein-Shapiro and Nuguer (2023) develop a model including features such as informality, unemployment, and the adoption of green technology to study the impacts of carbon taxation on energy-based emissions. At first glance, Brazil and Mexico exhibit striking similarities across various economic indicators, such as the prevalence of self-employment and informal employment, labor force participation rates, contributions to global carbon dioxide emissions, and household energy consumption patterns. Significant differences emerge, however, in the cost of firm registration, unemployment rates, informal sector size (as a percentage of GDP), and the proportion of polluting energy sources in the overall energy mix.

Model simulations indicate that, considering the similarities and differences between them, Mexico would experience more pronounced economic and social impacts than Brazil following the introduction of a carbon tax on energy emissions. As shown in Table B10.3.1, Panel A, achieving a 25 percent decline in emissions implies a higher increase in the unemployment rate, a bigger increase in informality, and a deeper fall in GDP in Mexico.

The differences across countries are explained by the disparities in the influence of the carbon tax on energy prices. The tax's larger impact on prices in Mexico leads to substantial shifts in economic dynamics, including greater reductions in formal job creation and increased self-employment.

Furthermore, the differences in changes in GDP, informality, and unemployment are primarily attributed to the two countries' initial differences in polluting-energy shares and the sizes of their informal sectors. Simulations show that reducing the baseline share of polluting energy in Mexico and aligning it with Brazil's would lead to lower output and other losses resulting from the carbon tax. Similarly, a larger informal sector in Mexico, similar in size to Brazil's, would exacerbate the economic impact of the tax. These findings underscore the intricate interplay of baseline factors and policy outcomes.

Santos and Torres (forthcoming) use the model developed by Cavalcanti, Hasna, and Santos (2022) to study the effects of a carbon tax in the same two countries. The novelty of this framework is that it features a network model with input-output flows across the different sectors of the economy and allows for workers to choose in which sector to work. Using their results, Panel B in Table 13.3.1 shows that Mexico requires a higher carbon tax—US$160/tCO₂e, compared to Brazil's US$125/tCO₂e—to achieve a 25 percent reduction in emissions. This discrepancy arises from Mexico's heavier reliance on dirty energy sources, making emission reductions more costly to attain. As a consequence

*(continued on next page)*
Box 10.3. What Would Happen? Comparing Carbon Taxation in Brazil and Mexico (continued)

of the higher carbon tax rate it requires to achieve the emission reduction objective, Mexico experiences a larger drop in GDP than Brazil.

Another finding from the model is that carbon taxes reduce inequality by having a greater effect on higher-earning workers in polluting sectors. The Gini coefficient declines for both countries, but the changes are small.

In sum, while the countries' shared characteristics set the stage, nuanced disparities in baseline conditions, sectoral composition, and policy implementation generate different outcomes. Understanding these complexities is crucial to crafting effective environmental policies that achieve emission reduction goals without disproportionately burdening specific sectors or exacerbating inequalities.

<table><caption>Table B10.3.1. Effects of a 25 Percent Decline in Emissions via Carbon Taxation</caption><thead><tr><th></th><th>Brazil</th><th>Mexico</th></tr></thead><tbody><tr><td colspan="3"><strong>Panel A</strong></td></tr><tr><td>Unemployment, in p.p.</td><td>0.035</td><td>0.132</td></tr><tr><td>Informality, in p.p.</td><td>0.262</td><td>0.575</td></tr><tr><td>GDP, in p.p.</td><td>-0.38</td><td>-0.73</td></tr><tr><td colspan="3"><strong>Panel B</strong></td></tr><tr><td>Carbon tax, in US$/ton CO<sub>2</sub></td><td>125.45</td><td>160.44</td></tr><tr><td>Gini, difference</td><td>-0.0003</td><td>-0.001</td></tr><tr><td>GDP, in p.p.</td><td>-0.36</td><td>-0.97</td></tr></tbody></table>

Source: Panel A is based on Finkelstein-Shapiro and Nuguer (2023) and Panel B on Cavalcanti, Hasna, and Santos (2022) and Santos and Torres (forthcoming).

Note: The table shows the simulated long-run differences between a scenario without a carbon tax versus one with a carbon tax calibrated to generate a decrease of 25 percent in emissions.

carbon leakage problem can be mitigated through timely and coordinated regional implementation of carbon pricing policies, which can yield global climate dividends and reduce the cost of implementation at the country level (IMF 2021).<fnref n="16" />

A full assessment of how carbon pricing can support climate objectives requires a general equilibrium approach. Computable general equilibrium

<footnote n="16">¹⁶ The Regional Climate Change Platform of Economy and Finance Ministries, supported by the IDB, provides a mechanism for climate policy coordination in Latin America and the Caribbean.</footnote>
(CGE) models provide a means to quantify the potential impacts.<fnref n="17" /> For Latin America and the Caribbean, the exercise (described in detail in Box 10.4) considers the effects of different carbon pricing policies on ten countries for which the necessary data are available.

Box 10.4. A Bird's Eye View of the Economy

An economy is a complex array of connections among people, firms, govern-
ments, and institutions. To assess the impact on the economy of policies to
mitigate and adapt to climate change, this chapter uses a computable general
equilibrium model (CGE); see Brichetti et al. (2020) and Brichetti et al. (forth-
coming). It provides a useful toolkit that is calibrated for Argentina, Bolivia,
Brazil, Colombia, Costa Rica, Chile, Ecuador, Jamaica, Panama, and Peru—a set
of countries with different growth experiences and economic structures and
for which the necessary data to perform the analysis are available.

The basic structure of the model consists of approximately thirty produc-
tive sectors on the supply side of each economy. a On the demand side are five
representative households (with different income levels) and the government.
Economies are open to commercial and financial trade with the rest of the
world and are assumed to be small (hence, they cannot affect international
prices). In CGE models, behavior in the markets is guided by production and
consumer utility functions, which determine how producers and consumers
interact. Prices are recalculated regularly to ensure all markets clear simulta-
neously (meaning that supply meets demand across the board). Producers
buy inputs from other sectors, sell goods domestically and internationally, pay
wages and taxes, and make profits. Consumers, earning wages, spend some
of their earnings on goods and save or invest the rest. Governments also play a
role, collecting taxes and spending on public services and investments. These
activities influence the prices of goods and services, which adjust to balance
the markets. The price adjustments then drive economic growth and change
the economic structure and income distribution by reallocating resources
across sectors. b

The first step in “calibrating” the model to a specific country is to construct
a social accounting matrix (SAM). The SAM is a representation of the flow of all
economic transactions that take place within an economy in a year and, at its
core, a matrix representation of the national accounts of a country. c It refers to
a single year and provides a static picture of the economy, which is the starting
point for the analysis. For the models used in this report, the base year is 2019
in the case of Panama; 2018 for Argentina, Brazil, Colombia, and Chile; and 2015
for Bolivia, Costa Rica, Ecuador, Jamaica, and Peru. d

(continued on next page)

<footnote n="17">¹⁷ The results of these exercises will be published in a study by Brichetti et al. (forthcoming).</footnote>
**Box 10.4. A Bird's Eye View of the Economy (continued)**

Using each country's SAM, an initial path (or equilibrium) is obtained for the variables, providing a benchmark for growth over a ten-year horizon. In this solution to the model, the calibrated parameters governing the production functions of the sectors are determined by the country's input-output tables and national accounts as reflected in the corresponding SAM and do not consider the negative impacts climate change may have on the economy. In other words, the initial equilibrium is the “business-as-usual” (or baseline) scenario. It provides a benchmark against which to compare the counterfactual scenarios, in which new equilibria are simulated assuming a variety of shocks that perturbate the baseline scenario.

Computable general equilibrium models offer a comprehensive way to understand the economy by showing how different parts are connected. These models simulate the economy as a whole, considering how sectors, companies, and consumers interact and using mathematical equations to ensure all spending matches income across the economy. In this way, they reflect how changes in one area can affect others and reveal the ripple effects of economic decisions, using prices as signals that guide these interactions. This approach allows for an analysis of the potential impacts of economic policies or changes on multiple outcomes simultaneously, from both the demand and supply sides. A drawback, however, is that CGE modeling does not consider the non-price barriers, government regulations, and other obstacles described in Chapter 9 that undermine the efficient reallocation of economic resources across sectors despite the price signals from the tax. For this reason, the results from the exercise conducted here should be interpreted as the gains that could accrue to the economy from carbon pricing if the complementary policies described in Chapter 9 were also implemented.

The production process in each economic sector employs a combination of productive factors (labor, physical and financial capital, land) and intermediate inputs (goods produced by other sectors). In each case, a uniform carbon tax is imposed on the production value of each sector, calculated in accordance with its GHG emissions-intensity coefficient, taken

<footnote>a In some cases, the sectors are split into subsectors according to the individual country's SAM.</footnote>

<footnote>b The model is recursive dynamic, meaning that economic growth is the result of the savings of the agents who, in turn, make investment decisions based on their current (rather than future or anticipated) income and factor remuneration.</footnote>

<footnote>c The SAM is represented in the form of a double-entry box (or matrix), with the income of each sector in the rows and the expenses in the columns.</footnote>

<footnote>d The accounting of the entries in the matrix must comply with the basic budget restrictions—that is, income must be equal to expenses.</footnote>
from national accounts.<fnref n="18" /> In a basic scenario, the government's carbon tax revenue is spent based on the current spending structure. In alternative policy-relevant scenarios, the revenue is allocated to one of the following: reducing payroll taxes; reducing value-added taxes; reducing taxes on capital; reducing taxes on capital, plus subsidizing clean investments; or increasing transfers to poor households.

For each of the ten countries, an initial equilibrium is obtained, providing a benchmark for GDP growth over a ten-year horizon. This is the “business-as-usual” scenario. In the counterfactual exercises, a new equilibrium is simulated, assuming selected policies starting in the first year of simulation. The simulated tax rate varies from US$25/tCO₂e to US$75/tCO₂e.

GHG emissions arise from the production and use of fossil fuel-based energies, production processes, land use, and waste management. The carbon tax is levied on the emissions produced by each economic activity. In Argentina, Bolivia, Brazil, Chile, Colombia, and Peru, the *primary* economic sectors (agriculture, mining, and so on) are responsible for the highest percentage of carbon emissions. On the flip side, forests absorb carbon from the atmosphere, and, therefore, in economies with relatively extensive coverage by native forests—for example, Costa Rica and Panama—the *primary* sectors are cleaner. Still, in all countries, the *secondary* economic sectors (including industry and manufacturing) are the most interconnected, and they account for the largest share of demand for energy and fuels. The introduction of the tax leads to varying levels of reduction in GHG emissions in all countries, depending on their economic structures, their sector-level variations in greenhouse gas emission and consumption patterns, and their tax rates. On average for the ten countries, the introduction of a carbon tax with a rate of US$25/tCO₂e leads to a 4 percent reduction in GHG emissions compared to the no-tax scenario by year 10. In Jamaica, where the energy matrix relies heavily on oil, the reduction in emissions by year 10 reaches 9.5 percent compared to the no-tax baseline. In Panama and Peru, with cleaner energy matrices and higher weights of tertiary sectors (services) in the economy, the same tax rate leads to smaller declines in emissions (0.9 and 0.02 percent, respectively). Higher tax rates lead to greater reductions in emissions. A tax rate of US$50/tCO₂e, for example, yields a 14.7 percent reduction in emissions on average for the ten countries by year 10 compared to the no-tax baseline.

Despite the reduction in emissions, results from the simulations show that, if the revenue were spent proportionally to the government's spending structure, the carbon tax would end up *reducing* aggregate output in

<footnote n="18">¹⁸ The tax applies only to domestic transactions.</footnote>
seven out of the ten countries by year 10.<fnref n="19" /> Specifically, for a carbon tax rate of US$25/tCO₂e, the forgone real GDP by year 10 would be 1.7 percentage points (p.p.) of GDP on average for the ten countries. The median reduction would be 0.5 p.p., the maximum would be 2.9 p.p. (Brazil), and the minimum (in Bolivia) would actually be a gain of 6.3 p.p. of GDP (see Table 10.3 and Figure 10.2).<fnref n="20" />

Higher tax rates (up to US$75/tCO₂e, which is the maximum simulated) increase aggregate output losses (or reduce output gains in the countries where simulated GDP increases follow the introduction of the tax) compared to the US$25/tCO₂e scenario. This implies that, on average, higher tax rates have an impact on economic activity in high-emission sectors that exceeds whatever compensation is provided by the growth of clean sectors (see Brichetti et al., forthcoming). Thus, there is a tradeoff policy-makers should weigh between the reduction in GHG emissions achieved with higher carbon tax rates and the cost of the tax in terms of forgone economic activity.

The silver lining is that the economic loss from the carbon tax in terms of forgone GDP is dampened, and even reversed, by alternative revenue rebate strategies. Rebating carbon tax revenues by lowering payroll taxes, for example, increases real GDP by 2.4 p.p. by year 10 compared to the no-tax scenario in the average country; it increases it by 1.6 p.p. in the median country and by 4.9 p.p. in the country with the maximum impact. Lowering payroll taxes is a particularly effective rebate policy in the region because it yields higher GDP by year 10 in nine out of the ten countries considered (see Figure 10.2).<fnref n="21" />

As shown in the figure, other tax rebate strategies also yield positive aggregate GDP results by year 10. The only one that yields output loss in all countries vis-à-vis the no-carbon-tax scenario is that which uses revenues to make compensatory transfers to the poor. This is because transfer recipients are concentrated in the lowest quintiles of the income distribution and, therefore, have a high marginal propensity to consume. This, in turn,

<footnote n="19">¹⁹ In the cases of Bolivia, Ecuador, and Peru, where public investment constitutes a significant portion of tax revenue, GDP tends to increase when the carbon tax is relatively low, driven by the effect of increased tax revenue on public investment (see Brichetti et al., forthcoming).</footnote>

<footnote n="20">²⁰ The combination of emission reduction and output loss determines the cost per unit of reduced emissions. In the cases of Argentina and Brazil, these costs are positive and increase over time. On the other hand, in the rest of the economies, they decrease over time, even turning negative in Peru by year 10 (see Brichetti et al., forthcoming).</footnote>

<footnote n="21">²¹ The only exception is Bolivia, where the policy results in a minimal GDP loss of 0.1 p.p. by year 10.</footnote>
<figure><img src="image_91.png" /><figcaption>**Figure 10.2.** Impact of Carbon Tax on Real GDP under Alternative Tax Rebate Strategies</figcaption></figure>

Source: IDB staff calculations.

Note: The figure shows the change of the counterfactual (that is, carbon tax of $25/tCO₂e plus different revenue recycling alternatives) minus the benchmark (business as usual) by year 10, for the ten Latin American and Caribbean countries.

implies that the rebate policy does not yield higher aggregate investment. Still, while aggregate output may be lower with the income transfers, poor households would be unequivocally better off, both in absolute terms and relative to the rest of the income quintiles. Moreover, well-targeted transfers may be cost effective in ways that are not captured by the simulations. Vogt-Schilb et al. (2019), for example, estimate that allocating 30 percent of carbon tax revenues to an expanded program of cash transfers in the region would be enough to compensate poor and vulnerable households in most cases, leaving 70 percent of carbon tax receipts available for other forms of rebate or to fund other spending priorities.

The effectiveness of alternative tax rebate strategies in response to carbon tax revenues in Latin America and the Caribbean is closely tied to the tax structures, economic characteristics, labor market conditions, fiscal capacities, levels of tax compliance, and socioeconomic priorities of each country. These factors shape how different tax strategies affect GDP by year 10 (see Figure 10.2). In Argentina, Brazil, Chile, Colombia, Costa Rica, and Panama, for example, reducing labor taxes proves more effective in augmenting
<table><caption>Table 10.1. Estimated Impact of Rebate Strategies on Real GDP by Year 10</caption><thead><tr><th></th><th>Mean</th><th>Median</th><th>Min</th><th>Max</th></tr></thead><tbody><tr><td>US$25/tCO<sub>2</sub>eq carbon tax (government's carbon tax revenue is spent proportionally to the government's initial spending structure)</td><td>-1.7</td><td>-0.5</td><td>-2.7</td><td>6.3</td></tr><tr><td>US$25/tCO<sub>2</sub>eq carbon tax + reduction in payroll taxes</td><td>2.4</td><td>1.6</td><td>-0.1</td><td>4.9</td></tr><tr><td>US$25/tCO<sub>2</sub>eq carbon tax + reduction of value-added taxes</td><td>1.8</td><td>1.5</td><td>-2.1</td><td>11.1</td></tr><tr><td>US$25/tCO<sub>2</sub>eq carbon tax + reduction of taxes on capital</td><td>-2.8</td><td>-2.0</td><td>-4.1</td><td>0.1</td></tr><tr><td>US$25/tCO<sub>2</sub>eq carbon tax + reduction taxes on capital plus subsidizing clean investments</td><td>5.5</td><td>1.3</td><td>-0.9</td><td>11.5</td></tr><tr><td>US$25/tCO<sub>2</sub>eq carbon tax + increasing transfers to poor households</td><td>-5.0</td><td>-4.2</td><td>-11.1</td><td>-2.1</td></tr></tbody></table>

Source: IDB staff calculations.

Note: Table shows cumulative change of the counterfactual (that is, carbon tax of US$25/tCO₂eq, plus different revenue recycling alternatives) minus the benchmark (business as usual) over 10 years for ten Latin American and Caribbean countries. Mean is the weighted average by GDP.

economic output than a reduction in value-added tax (VAT). Conversely, in Bolivia and Peru, where rates of labor informality are higher and the tax burden is greater from the VAT than labor taxes, a compensatory scenario involving a reduction in VAT yields better outcomes.

In all the countries, at least three tax rebate strategies result in an *increase* in GDP over the forecasting horizon (Figure 10.2). In Chile, Costa Rica, Ecuador, Jamaica, and Panama, the biggest GDP gains are obtained by lowering payroll taxes. In Peru, lowering the VAT tax would yield higher output. The positive results of rebating the carbon tax revenues by lowering taxes on capital and providing investment subsidies for the adoption of clean technologies to accelerate the transition are noteworthy in several countries; in Argentina, Bolivia, Brazil, and Colombia, it is the best strategy in terms of higher output by year 10. The impact of the same policy is significantly smaller for other countries, as can be inferred from the median. The rebate policy of reducing taxes on capital yields positive impacts on GDP only in Ecuador. In all the countries, the results from just lowering taxes on capital are less favorable (with a negative median impact) than when the same policy is combined with investment subsidies, which implies the subsidies are essential to catalyzing the sector-level reallocations that yield higher GDP by year 10, as is also discussed in Chapter 9.

The macroeconomic implications of a carbon tax are also heavily influenced by its design and the effectiveness of its implementation. A crucial aspect of the fiscal landscape in Latin America and the Caribbean
is the high level of tax evasion, which is partly attributable to widespread labor informality.<fnref n="22" /> This presents a significant challenge in the context of carbon taxation that highlights the complex interplay of tax policy, enforcement, and economic outcomes. In four out of the ten countries, the tax rate required to counter tax evasion and achieve the same level of emission reduction as in a scenario with perfect enforcement (that is, with no evasion) is at least double the base rate of US$25/tCO₂e (Figure 10.3). The higher rates lead to increased economic distortions, ultimately hampering growth and worsening the tradeoff between emission reductions and economic outcomes.

At the sector level, the introduction of a carbon tax promotes a shift in the composition of national production toward service sectors whose emission levels are lower than those of primary and industrial sectors, leading to a

<figure><img src="image_92.png" /><figcaption>**Figure 10.3.** Carbon Tax Rate Needed to Counter Tax Evasion</figcaption></figure>

Source: IDB staff calculations.

Note: The figure shows the carbon tax rate needed to attain the same level of GHG emission reduction under a fiscal evasion scenario as in a scenario with no fiscal evasion and a tax rate of US$25/tCO₂e.

<footnote n="22">²² Tax evasion is strongly related to informality. High informality restricts information to third parties, which allows more evasion. Income tax evasion is estimated to be more than 50 percent among the self-employed or those whose income stems from informal sources, while it is less than 5 percent among dependent workers; see Slemrod (2019).</footnote>
reallocation of labor and mobile capital to cleaner sectors.<fnref n="23" /> In almost all the countries, the introduction of a carbon tax affects industry most adversely (for example, manufacturing) as a result of both the direct effects of the tax and the high demand for affected inputs.<fnref n="24" /> The different tax rebate strategies can help override the negative impacts of those sectors most affected; rebating the tax revenue, for example, by lowering the payroll tax helps labor-intensive industries.

One possible benefit of the carbon tax is to encourage investment in clean technologies in all sectors. To assess the potential impact on technological change, a carbon tax scenario is simulated under a variant of the modeling strategy in which the productive sectors can adopt nonpolluting technologies. The approach assumes the existence of latent clean technologies that can be adopted, depending on relative prices. The main difference between installed and latent technologies is that the latter are cleaner—that is, they generate fewer GHG emissions—per unit of output. Production functions and the use of inputs and labor remain unchanged. Since latent technologies are clean, they remain exempt from the carbon tax if adopted.

The use of latent (nonpolluting) technologies increases baseline GDP between 0.5 and 3 p.p. by year 10 compared to the business-as-usual scenario, reflecting the growth-enhancing effect of the economic transformation toward cleaner economies (see also Chapter 9). The average GDP increase for the ten countries is 1.3 p.p by year 10. In most, the incremental growth leads to a decrease in the unemployment rate and in informal labor.<fnref n="25" /> The rate of adoption of latent technology varies in the simulations, from 1.5 percent (in Costa Rica) to 9 percent (in Chile and Peru) of the total valued added of the economies. The introduction of a carbon tax of US$25/tCO₂e accelerates the rate of technological adoption by 0.5 p.p. on average. Still, the simulations also show that, after year 5, some economies reach bottlenecks in terms of their capacity to absorb new capital that constrain further adoption, thereby putting a cap on incremental emission reduction.<fnref n="26" /> This

<footnote n="23">²³ Service sectors are cleaner in terms of emission content than the primary and secondary sectors. In Chile and Panama, economic activity increases in the service sectors in response to a carbon tax as a result of sectoral reallocation.</footnote>

<footnote n="24">²⁴ Although the industrial (secondary) sector does not usually have the highest level of emissions in the region, it is highly interconnected with the parts of the economy that demand a high share of fuels and is, therefore, indirectly affected by the carbon tax.</footnote>

<footnote n="25">²⁵ Exceptions are observed in countries that experience the adoption of latent technologies in sectors that are relatively less labor intensive (such as mining in Ecuador) or traditionally informal (such as agriculture and forestry in Jamaica).</footnote>

<footnote n="26">²⁶ Investment decisions generate capital stocks that can become “stranded assets” when technologies change, meaning they are still used for production only because they are available.</footnote>
suggests carbon pricing policies need to be complemented by other poli-
cies to promote investment and, therefore, to augment the capital stocks,
as discussed in Chapter 9.

In summary, the implementation of carbon pricing policies creates both opportunities and challenges. While a carbon tax can lead to significant reductions in greenhouse gas emissions, the economic cost in terms of for-gone output in some countries can be substantial. Still, the negative impacts can be mitigated, or even reversed, through well-designed tax rebate str-egies; in some countries, this implies reducing VAT and in others reducing labor or other distortionary taxes. The effectiveness of these strategies is influenced by factors like tax evasion and labor informality, which result in higher tax rates for given emission reduction targets. Other opportunities arise from the potential of a carbon tax—especially when combined with targeted investment subsidies—to catalyze the adoption of clean, nonpol-luting technologies, enhancing environmental benefits while also boosting economic growth and reducing unemployment and informality. In other words, the right carbon pricing policies can lead to both environmental and economic benefits.

The results of the general equilibrium model for carbon taxes and the use of revenues to reduce other taxes provide valuable insights into the fis-cal implications of climate change mitigation strategies. However, given the data constraints and the underrepresentation of less developed countries in the estimates, caution should be exercised in generalizing these findings to the entire region. The different levels of development among the 10 coun-tries included in the study suggests that the fiscal impacts of carbon taxes may differ significantly across countries with different economic structures and capacities for adaptation.

Fiscal Strategies to Boost Resilience

Even as emission mitigation policies are being implemented globally, the impacts of climate change are already being felt. And given the uncertainties regarding future climate trajectories and their impacts, countries must invest in adaptation to build resilience. Finance ministries are key stakeholders in this endeavor because they manage budgeting processes, execute and evaluate spending policies, and manage macro-economic and fiscal risks. In some cases, they also coordinate different agencies and levels of government to align policy goals at the national and subnational levels (see Box 10.5). In 2022, the finance ministries of Latin America and the Caribbean launched the Regional Climate Change Platform of the Ministries of Economy and Finance with the support of the
IDB.<fnref n="27" /> This initiative aims to enhance capacity for designing and implementing fiscal policies and instruments to address climate change challenges while maximizing contributions to national climate and sustainability goals.

A first step to inform public action is to understand the coherence between fiscal policies and climate objectives. Green budgeting is a framework often used for this purpose. It involves assessing the impact of budgetary and fiscal policies on climate and environmental objectives and their alignment with national and international commitments. By 2022, only Chile, Colombia, the Dominican Republic, Honduras, and Mexico reported implementing green budgeting (OECD 2024).<fnref n="28" /> An important tool for its implementation is green budget tagging, a mechanism that involves the identification and classification of expenditures and revenues that have a positive impact on the environment.<fnref n="29" /> As of the time of writing, only Costa Rica and the Dominican Republic were implementing green budget tagging systematically.<fnref n="30" />

Another key issue for fiscal policy in the region is a need to document the different costs climate change imposes on fiscal accounts. Knowing how much is spent on emergency and reconstruction efforts in the aftermath of extreme weather events, for example, would support accountability and transparency, facilitating the assessment of spending effectiveness and the development of financial strategies. Governments throughout the region, however, do not consistently track, analyze, and report information on post-disaster spending.

Fiscal risks from the region's transition toward clean sources of energy could cost governments up to US$2.6 trillion in forgone revenues from fossil fuels by 2035 (Solano-Rodriguez et al. 2019). To deal with this looming issue, countries must find alternative revenue sources. One possibility is to leverage the growing demand for minerals and metals that are needed for the global clean energy transition. To keep global warming below 2°C, the new technologies in renewable power generation, electrification, and

<footnote n="27">²⁷ See https://www.iadb.org/en/who-we-are/topics/climate-change/climate-change-finance/lac-regional-climate-change-platform.</footnote>

<footnote n="28">²⁸ In contrast, 67 percent of OECD countries had implemented green budgeting in the same period.</footnote>

<footnote n="29">²⁹ Green budget tagging involves assessing each individual budget measure and giving it a “tag” according to whether it is helpful or harmful to green objectives (OECD 2021).</footnote>

<footnote n="30">³⁰ Many countries have carried out climate spending assessment but do not systematically tag climate expenditure as part of their budget processes (Buttazzoni and Torres, forthcoming).</footnote>
Box 10.5. Climate Change and Fiscal Decentralization

Subnational governments are key to the successful implementation of climate policies. They oversee and regulate traffic and transportation activities, land use, solid waste, energy, water and sanitation, resilient local infrastructure, and environmental protection (Martínez-Vázquez 2021; Smoke and Cook 2022).

Fiscal decentralization can play an important role in supporting government actions. Local taxation on climate externalities limited to a specific jurisdiction, for instance, can complement national efforts.ª In Canada, provinces tax carbon emissions as part of the national emission reduction commitments, and in Spain, regional governments tax emissions, industrial waste, and environmental damage from large businesses, among others. In Latin America and the Caribbean, local carbon taxes have been implemented in six Mexican states: Durango, Guanajuato, Mexico, Querétaro, Yucatan, and Zacatecas;ᵇ these are levied on local sources of GHG emissions, and their proceeds are allocated to environmental uses (MÉXICO₂ 2023). Other taxes, like vehicle taxes, can be improved and expanded to support climate goals. In Peru, for example, existing tax policies at the local level encourage the use of old vehicles that pollute more. And no city in the region applies congestion charges yet (Almeida et al. 2022).ᶜ

Another example of complementary policies is provided by intergovernmental transfers within a country. National governments can include climate objectives in conditional transfers to local governments instead of using tax-sharing systems, which are usually unconditional. Brazil's ecological fiscal transfer (ICMS-e) redistributes tax revenues from states to municipalities based on land preservation objectives (Martínez-Vázquez 2021). ICMS-e implementation has been linked to an increase in municipal protected areas and a shorter average time to the designation of areas as protected (Busch et al. 2021). Other countries using ecological fiscal transfers include China, France, India, and Portugal.

Despite these examples, subnational government climate policies are still at an early stage of their design and implementation and present many opportunities for strengthening. In Latin America and the Caribbean, only the largest cities implement climate vulnerability assessments on a regular basis. Similarly, while some countries already identify and classify climate spending at the national level and have set environmental criteria for public procurement and investments, cases at the subnational level are incipient. The Mexican state of Guanajuato, for example, uses budget tagging to identify budgetary programs with climate impact, while the municipality of Mendoa in Argentina prioritizes purchases with an environmental impact (OAS 2020). Uruguay's subnational development and management program supports subnational investments in climate adaptation (IDB 2022b), and Mexico

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**Box 10.5. Climate Change and Fiscal Decentralization (continued)**

City and some Argentinean provinces have issued "green," or environmental, bonds. Still, the experience with green financing tools is limited in subnational governments throughout the region (Almeida et al. 2022).

electromobility will require more than 25 million tons of these materials by 2050 (Unzueta, Sucre, and Nunes da Cunha 2022).<fnref n="31" /> This implies a 95 percent increase in demand from 2020 levels. Demand for lithium is expected to increase by more than 1,000 percent, manganese by 147 percent, copper by 108 percent, and zinc by 105 percent. Argentina, Bolivia, Brazil, Chile, Mexico, and Peru are among the countries in an excellent position to supply them (Arrobas et al. 2017).<fnref n="32" /> For these countries, a tax structure that gradually replaces fossil fuel taxes with taxes or royalties on minerals while preserving the incentives to invest in mining can help make up for lost revenues from fossil fuels in a sustainable way, balancing economic and environmental needs with the damage that exploiting these resources can inflict on the local environments. Fiscal revenues could increase from US$194 million to US$951 million annually, depending on the speed with which the energy transition takes place.<fnref n="33" /> Taking advantage of this opportunity could also provide a significant boost to economic growth and job creation.<fnref n="34" /> The net economic effect of the transition is estimated at +0.1 to +0.5 percent of GDP by 2030 (Reyes-Tagle, Guajardo, and Marañon, forthcoming).

Successful adaptation to the threats of climate change will also require increasing resilience to weather-related shocks. To manage the fiscal risks

<footnote>a This kind of local taxation should be subject to national regulation to ensure similar rates and limit tax competition.</footnote>

<footnote>b Tamaulipas approved a carbon tax in 2020, but it was abolished in 2023. A new version was under review at the time of writing.</footnote>

<footnote>c Congestion charges are close to first-best policies to reduce GHGs, although they are politically difficult to implement (Domon et al. 2022).</footnote>

<footnote n="31">³¹ This includes the manufacture of windmills, solar panels, batteries for storage, electric vehicle engines, and carbon capture and storage systems, among other uses.</footnote>

<footnote n="32">³² Brazil, Chile, and Peru are among the top eight metal mining producers of iron and ferro-alloys, nonferrous metals, and precious metals (Bazel, Mintz, and Reyes-Tagle 2023), while countries in the so-called Lithium Triangle (Argentina, Bolivia, and Chile) account for more than half of the world's lithium resources (USGS 2022).</footnote>

<footnote n="33">³³ These estimates are based on an input-output model for different transition scenarios.</footnote>

<footnote n="34">³⁴ It should be noted, however, that this process, together with the impacts of climate change on agriculture, could push more people into artisanal and small-scale mining activities (Bansah, Arthur-Holmes, and Assan 2023).</footnote>
of disasters adequately, ministries of finance must first measure and quantify their impact on fiscal accounts. Once that is done, governments can use financial instruments to reduce the risks (see Box 10.6), and they can develop governance frameworks to manage those that are hard to mitigate.

Several Latin American and Caribbean countries have begun to identify the main risks posed by climate change, and many have gone further by starting to quantify them. Barbados, Colombia, El Salvador, Guatemala, Panama, and Peru have integrated their estimates into their fiscal projections.<fnref n="35" /> Still, few countries in the region have developed the ability to implement countercyclical fiscal policies in response to climate shocks. And medium-term fiscal frameworks<fnref n="36" /> usually do not incorporate disaster risk into the projections. Only half of the countries that have a fiscal rule,<fnref n="37" /> for example, include an “escape clause,” or exception to the rule, that can be triggered in the aftermath of climate-related disasters (Eguino, Alvarega, and Gonzales 2024, forthcoming).

Strategies that set out the lines of action in such areas as public spending, public investment management, risk retention and transfer instruments, and the use of risk transfer mechanisms are crucial elements of fiscal risk management. The evidence suggests, for example, that property risk insurance increases the likelihood of post-disaster reconstruction, reduces the financial hardship of the affected population, and speeds up the time to recovery (see Kousky 2019). Countries should strengthen risk transfer mechanisms. They should also redirect public investment toward resilient infrastructure to lower exposure to risk. Embedding monitoring mechanisms within the fiscal frameworks would help keep track of the progress achieved in these areas and improve implementation and accountability (Delgado et al. 2023). Still, important regulatory gaps limit the potential fiscal benefits of risk transfer instruments. Less than half the countries, for example, have regulations requiring public entities (ministries, secretariats, or their equivalents) to obtain insurance coverage for their public assets (Delgado, Eguino, and Lopes 2021).

<footnote n="35">³⁵ The majority of IDB borrowing countries (73.1 percent) have identified climate risks from events such as droughts, floods, rising sea level, and hurricanes and tropical cyclones. Country-specific studies in Ecuador and Peru have quantified investment needs in risk management and the most efficient ways to address them (see IDB 2018 and 2022a).</footnote>

<footnote n="36">³⁶ That is, planning tools used in government financial management that extend beyond the scope of a single year's budget, providing a more comprehensive and strategic approach to fiscal management.</footnote>

<footnote n="37">³⁷ “Fiscal rule” refers to specific guidelines or targets for key fiscal indicators, like budget deficits or debt levels, which the government commits to achieving within the framework’s timeframe.</footnote>
Catastrophe bonds are another financial instrument that is still scarcely
used in the region (see Box 10.6). These bonds provide a mechanism to
transfer risk from the issuing country to investors. In 2006, Mexico was a
pioneer when it issued a catastrophe bond for US$160 million to cover dam-
age caused by an earthquake. Twelve years later, in 2018, the ministries of
finance of the Pacific Alliance pooled their efforts and launched a catas-
trophe bond that provides risk coverage differentiated by country: US$500
million for Chile, US$400 million for Colombia, US$260 million for Mexico,
and US$200 million for Peru. The bond was originally issued to cover earth-
quake risks, but under the leadership of the Disaster Risk Management
Working Group of the Pacific Alliance's Council of Finance Ministers, the
countries have been analyzing the possibility of a similar bond to include
hydrometeorological hazards (Chile, Ministry of Finance 2020).

Countries have also employed contingent disaster financing mecha-
nisms, generally granted by multilateral institutions. These financial tools
and arrangements are designed to provide resources quickly in the event
of a disaster. In 2009, the IDB created the Contingent Credit Facility for
Natural Disaster Emergencies (CCF), which grants loans of up to US$300
million, with disbursements activated when a natural disaster occurs.<fnref n="38" />
Since its beginnings, the CCF has approved contingency funds for disas-
ters amounting to more than US$2 billion. The money has helped improve
the beneficiary countries' capacities in the emergency response stage and
strengthened their financial resilience.<fnref n="39" />

The integration of risk and vulnerability analyses into public sec-
tor investments is key to increasing resilience. In developing countries,
the direct damage to power generation and transportation infrastruc-
ture caused by floods, storms, and other disasters is estimated at around
US$18 billion annually (Hallegatte, Rentschler, and Rozenberg 2019). Dam-
age affecting public infrastructure can be managed by strengthening
public investment systems, but integrating disaster risk into the different
phases of public investment requires interagency coordination because the

<footnote n="38">³⁸ The CCF is a facility that provides liquid resources to borrowing member countries following a severe or large-scale, quick-onset disaster to help them deliver humanitarian relief and restore basic services to the population. The CCF offers parametric contingent loans that are prepared in advance through the IDB's regular investment loan process but can only be disbursed to the borrowing countries after verification that a contractually agreed-on disaster event of the appropriate type, location, and intensity has occurred. The maximum size of a CCF loan is US$300 million or 2 percent of the country's GDP, whichever is less.</footnote>

<footnote n="39">³⁹ Other multilateral development banks, such as the World Bank and the Development Bank of Latin America (CAF), have also established contingent financing for disasters.</footnote>