Box 10.6. Improving Resilience by Transferring Risk

Some alternative financing tools available to developing countries include reserve funds (which imply saving ex ante to build up a reserve, as Chile was able to do in the early 2000s); contingency credit lines (for example, the IDB's Contingent Credit Facility for Natural Disasters); regional risk pools (like the Caribbean Catastrophic Risk Insurance Facility, or CCRIF);³ and insurance and reinsurance contracts. Use of all these mechanisms requires the political will to pay upfront costs to reduce the ex post fiscal impacts of disasters.

One of the most promising forms of disaster insurance is what is known
as a catastrophe (or cat) bond—a tradable financial instrument that spreads
risk across global capital markets. These bonds are usually issued by govern-
ments or reinsurance companies—the insurers of the insurers—and backed
by U.S. treasury bills. Although they typically only cover a fraction of the dam-
age, they can provide financial relief very swiftly in the case of a severe event,
as the financial terms are based on the characteristics of the event rather than
an estimate of the losses; in this way, they resemble parametric insurance. As a
result, the financial benefits tend to be less contentious, and governments can
provide relief quickly before foreign aid arrives.

Catastrophe bonds provide an additional, perhaps less understood, benefit. Countries at high risk of a natural disaster are also more in danger of defaulting on their debt if a catastrophe strikes.ᵇ Consequently, they have less credibility in capital markets and must sell their debt at higher yields. By reducing the risk of default and lowering financing costs, the bonds allow countries to borrow more. Estimates from Borensztein, Cavallo, and Jeanne (2017) suggest governments could increase their external borrowing from around 30 percent to more than 60 percent of GDP on average, providing welfare gains equivalent to several percentage points of overall consumption.

On the downside, catastrophe bonds cost up to four times or more what the typical country is willing to pay to reap the welfare gains.c This is due in part to the uncertainty of insurance premiums that are priced based on estimates of the damage that could be inflicted by a once-in-a-century event. Moreover, private companies may face disincentives to invest in the costly risk analysis and modeling required, as their work may end up in the public domain. The result is an information-starved environment in which investors shy away and coverage is expensive. In this area, the public sector, as well as multilateral institutions, can play a critical role.

Developing countries face three types of obstacles to implementing ex ante financing mechanisms: the paucity of markets (insurance markets remain undeveloped, especially in developing countries); political resistance (politicians may balk at supporting expenditures to protect from risks that may not materialize and, if they do materialize, may provide benefits that other politicians can capitalize on); and inadequate institutional frameworks (the risk

(continued on next page)
Box 10.6. Improving Resilience by Transferring Risk (continued)

assessment analysis is lacking, and the legal framework to enforce contracts is weak in many countries).d

technical specifications used in risk analysis are produced by entities other than ministries of finance.<fnref n="40" /> And, in the region, only Colombia and Mexico have “green taxonomies”—frameworks that define what economic activities are environmentally sustainable—to facilitate ex ante identification and evaluation of public investment projects and improve their prioritization based on sustainability criteria (Delgado et al. 2023).

Investing in resilient infrastructure can reduce the negative fiscal impacts of climate change by reducing contingent liabilities. This can have positive ripple effects. Fiscal accounts are strengthened by the high multiplier effect of investment spending and the benefits accruing from a faster recovery after extreme weather events. According to International Monetary Fund estimates, investing in resilient infrastructure could increase GDP growth by 2 to 6 percent in Caribbean countries and 0.2 to 1.4 percent in Central American countries. And, three years after a disaster, the GDP would be 0.25 percent higher in the Caribbean and 0.1 percent higher in Central America, while the rate of public borrowing would fall by 0.75 percent and 0.25 percent, respectively (IMF 2021).

The computable general equilibrium (CGE) model detailed in Box 10.4 is applied to ten countries in the region to evaluate the potential benefits of investing in resilient infrastructure. The analysis contrasts two scenarios: a baseline scenario, where countries face a climatic shock that causes output to fall by 3 percent of GDP on impact based on empirical estimates for

<footnote>a CCRIF was developed in 2007 under the technical leadership of the World Bank. Formed as a multi-country risk pool, it provides parametric policies backed by both traditional and capital markets.</footnote>

<footnote>b See Borensztein, Cavallo, and Valenzuela (2009).</footnote>

<footnote>c See Borensztein, Cavallo, and Jeanne (2017).</footnote>

<footnote>d Borensztein, Cavallo, and Valenzuela (2009).</footnote>

<footnote n="40">⁴⁰ Out of the twenty-six IDB borrowing member countries, only 38 percent had regulations determining the party responsible for standardizing disaster risk analysis methodologies; only 15 percent had established a probabilistic approach and determined the appropriate scale for the risk analysis; 61 percent had building codes that included special design parameters for critical infrastructure; and just over half had integrated disaster risk analysis into environmental impact assessments (Delgado, Eguino, and Lopes 2021).</footnote>
the region,<fnref n="41" /> and a proactive investment scenario, where countries allocate 1 percent of GDP annually toward resilient infrastructure in the years preceding the climatic shock. Additionally, the study compares the outcomes of the baseline scenario with a third one, where governments compensate households for the impacts of a climatic shock through direct financial transfers in the first two years after it.

The findings favor proactive investment in resilient infrastructure to increase resilience (Figure 10.4). Preemptive investments mitigate the economic impacts of extreme weather events, potentially reducing output losses by 0.5 percent on average in the year of the shock (period t) and by more than half the accumulated impacts in years t, t+1, and t+2. In contrast, post-catastrophe transfers, while offering immediate relief to those directly affected, do not facilitate a similar recovery at the aggregate level. Investing in resilient infrastructure, therefore, not only acts as a crucial safeguard against climate-related damage but also represents a fiscally prudent strategy, akin to reaping the benefits of insurance, by minimizing future contingent liabilities.

<figure><img src="image_93.png" /><figcaption>**Figure 10.4.** Impact of a Catastrophe on Real GDP under Different Scenarios</figcaption></figure>

Source: IDB staff calculations.

Note: The figure shows the average change in real GDP of the counterfactual (i.e., a scenario with a catastrophe in period t, a scenario with a catastrophe following proactive investment, and a scenario where the government compensates poor household for the climatic shock) minus the benchmark (i.e., business as usual) in periods t, t+1, and t+2 for ten Latin American and the Caribbean countries.

<footnote n="41">⁴¹ The calibration of the size of the shock is based on empirical literature assessing the cost of extreme weather events in Latin America and the Caribbean (see Cavallo, Becerra, and Acevedo 2022).</footnote>
There is another, less salient, benefit of proactive risk management. Higher sovereign risk leads to wider credit spreads, as investors demand a higher yield for the increased risk of lending to that country. Gomez-Gonzalez, Uribe, and Valencia (2024) show that sovereign risk affects credit spreads asymmetrically. Specifically, high-risk countries (those with higher sovereign risk) are more sensitive to climate change than low-risk countries. This is because climate change can lead to physical risks (like extreme weather events) and transition risks (costs associated with making a transition to a lower-carbon economy), which may affect a country's economic stability and, thus, its ability to meet financial obligations. Investing in climate change preparedness is a way to reduce that vulnerability. Importantly, Gomez-Gonzalez, Uribe, and Valencia (2024) estimate that reducing vulnerability ex ante has a more significant impact on credit spreads than the actual occurrence of extreme weather events. This finding emphasizes the importance of proactive risk management—that is, taking steps to mitigate risk before disasters occur can be more beneficial to a country's creditworthiness than simply reacting to disasters as they happen.

## Directing the Policy Traffic

Climate and fiscal policies interact like traffic on a two-way highway. The alignment of fiscal policies with climate change objectives holds the promise of advancing both mitigation and adaptation efforts, as well as enhancing fiscal health in Latin America and the Caribbean. By fostering investments in clean energy and sustainable sectors, well-aligned climate and fiscal policies in the region can contribute to the global fight against climate change, help countries build resilience to the increasingly frequent and intense extreme weather events and other consequences of it, and strengthen fiscal policy management. As in many other policy areas, sound climate and fiscal policies can be mutually reinforcing.

Implementing such mechanisms as carbon pricing and the gradual replacement of fuel taxes with taxes on the minerals required for the clean energy transition while phasing out subsidies for fossil fuels would help to redirect fiscal resources toward environmentally friendly initiatives. Moreover, a comprehensive overhaul of the tax and spending frameworks to align them with climate goals would support a low-carbon transition and ensure long-term economic and climate resilience in the region. It would also provide a proactive and pragmatic response to the intersecting challenges of fiscal management and climate change.
Like navigating a vast network of highways, managing climate and fis-
cal policies requires attention, coordination, and a clear understanding of
the destination. With careful planning and management, the journey can
lead to a future where economic prosperity and environmental sustainabil-
ity coexist harmoniously.
<figure><img src="image_94.png" /></figure>
# Navigating Climate and Trade Policies

The region's geographical and economic characteristics make it particularly susceptible to the impacts of climate change on trade. This vulnerability could alter traditional comparative advantages and dynamics, requiring adjustments in trade policies and practices. Climate change poses distinct risks and opportunities for sectors like agriculture, critical minerals, and energy. Agricultural outputs, for example, could be severely affected, while the demand for critical minerals for green technologies may increase. Unilateral and multilateral trade measures, such as carbon border adjustments and sustainability standards, can effectively bring environmental considerations into trade policies. Cooperation is essential to ensure trade contributes to climate change mitigation and adaptation.

As temperatures rise and extreme weather events follow, trade ministers around the world have their hands full. For one thing, the pressure is on for governments to use all the public policy tools available to address climate change. Trade policy is no exception. Between 2009 and 2020, countries around the world reported having taken 3,460 trade-related climate measures to the World Trade Organization (WTO 2023). Among the most prominent were carbon border tariffs, the inclusion of enforceable environmental chapters in preferential trade agreements, and a myriad of public and private sustainability standards.

For another, climate change and climate policies have been disrupting comparative advantages. The production and shipment of goods and services are frequently interrupted by major droughts and powerful storms, and climate policies—for all their environmental benefits—often take a protectionist turn. This is particularly true among the world's largest economies, and it threatens to undercut export growth opportunities for developing countries in the clean energy transition.
Both trends are especially consequential for Latin America and the Caribbean. The location of most of the region's territory in low latitudes increases its exposure to higher temperatures and extreme weather events (IPCC 2023a). Its reliance on trade for a significant part of its growth (Mesquita Moreira and Stein 2019) calls for a speedy adjustment to trade-related climate measures. And its significant comparative advantages in clean energy (IEA 2023c) mean considerable losses from “green” protectionism, at home and abroad.

This challenging environment poses fundamental questions, not just for trade ministers, but for entire governments. How are they to mitigate the region's trade carbon footprint? How can they reduce adaptation costs? And how should they respond to “green” protectionism abroad, while preserving and expanding the gains from trade?

Taken at face value, answering these questions may seem to require the navigation of impossible tradeoffs. In fact, the narrative of some analysts—for example, Nobel Prize-winning economist Paul Krugman—reinforces the idea of a tight tradeoff between trade and climate objectives.<fnref n="1" /> A careful analysis of the complex relationship between these objectives, however, particularly in the context of Latin America and the Caribbean, suggests otherwise. To understand this, it is important to look at the positive and normative aspects of the relationship from the standpoint of two key environmental concepts: adaptation and mitigation.

## A Positive Take: Measuring Adaptation and Mitigation Challenges

A positive analysis focused on adaptation considers the current and future changes in comparative advantages driven by climate change, while the analytical goal on mitigation is to measure the carbon footprint of the region's trade.

## Adaptation: Stormy Weather Ahead for the Region's Trade

Climate change and related extreme weather events can have short- and long-term impacts on countries' patterns of trade. While the evidence is still scarce and anecdotal, short-term impacts are already noticeable around the world (Osberghaus 2019), including their propagation throughout value chains. An IDB study, for instance, estimates that disaster-hit regions experience an average sales reduction of 3.2 percentage points. Crucially, these

<footnote n="1">¹ According to Krugman (2009), when it comes to possible tradeoffs between climate and trade policies, “saving the planet [is] more important than the trading system.”</footnote>
effects are also transmitted to their foreign customers within one quarter, leading to an average drop in sales growth of 3.1 percentage points (Alviarez, Fujiy, and Święcki, forthcoming).

Studies more specific to the region are in line with the patterns found elsewhere. These studies are mostly related to the increasingly frequent extreme weather events among smaller and poorer economies that have inadequate material and institutional resources.<fnref n="2" /> Several, for example, have documented the negative short-term trade impacts in the Caribbean of recent extreme events, mostly hurricanes and floods (Heger, Julca, and Paddison 2008; Mohan 2017; Erman et al. 2021). Comparable results are seen for Central America's Northern Triangle (Rios et al. 2022).

Elsewhere in the region, most of the damage has been associated with more frequent and intense droughts. The prolonged drought in the Rio de La Plata basin between 2019 and 2023, for example, affected agricultural productivity, transportation costs, and exports in Argentina, Paraguay, and Uruguay (WMO 2022). Droughts did not spare the all-important Panama Canal, either, which handles approximately 5 percent of the world's trade. In 2023, the Panama Canal Authority limited daily transit and vessel draft because of low water levels. This triggered a backlog of waiting ships, increasing freight rates not just for the region but for the entire world.<fnref n="3" />

The spotty evidence is frightening enough, but it is likely to mark just the beginning of changes to come as temperatures rise. Predicting the future is a fraught business, especially at this complex intersection of climate change and economic activity. Economic models of climate change, however—also known as integrated assessment models (IAMs)—can shed considerable light on trade adaptation in the most likely climate scenarios.<fnref n="4" /> By bringing together mitigation and adaptation, as well as the spatial and sectoral dimensions of climate change, these models provide a better understanding of the dynamic and generable equilibrium nature of the trade–climate relationship. Unfortunately for the region, the picture that emerges is not reassuring.

Two of the most revealing counterfactual exercises for the region are done by Conte et al. (2021) and Cruz and Rossi-Hansberg (2023),<fnref n="5" /> who work

<footnote n="2">² See also Chapter 2.</footnote>

<footnote n="3">³ https://www.reuters.com/world/americas/panama-canal-water-levels-historic-lows-restrictions-remain-2023-09-06/</footnote>

<footnote n="4">⁴ See the Integrated Assessment Model Consortium (IAMC) for a more precise definition and extensive list of the available IAMs (https://www.iamconsortium.org/what-are-iams/).</footnote>

<footnote n="5">5 Conte, Desmet, and Rossi-Hansberg (2022, 4) call their IAM version a "dynamic spatial integrated assessment model (S-IAM)" to account for the more refined geographical resolution and dynamics of the model compared to other versions.</footnote>
<figure><img src="image_95.png" /><figcaption>**Figure 11.1.** Gains and Losses from Global Warming in 2050</figcaption></figure>

<figure><img src="image_96.png" /></figure>

Source: IDB staff calculations based on Cruz and Rossi-Hansberg (2023).

Note: The figures display the relative levels of amenities and productivities in 2050 without climate change. A value of 1 represents no changes from a scenario with no warming, while a value of 0, for instance, 1.02 indicates an increase of 2 percent in the targeted variables. Model run for the RCP 8.5 scenario.

with a two-century horizon with temperatures reaching between 6°C and 7°C above preindustrial levels.<fnref n="6" /> They find, first, that with most of the region in low-latitude, tropical areas, the damage from rising temperatures to fundamental amenities and productivity is likely to be, on average, among the highest in the world. Even when the model is run for a shorter period (50 years), these impacts are clearly visible (see Figure 11.1). Second, the damage is likely to hit agriculture harder, with the region, particularly South America, losing market share to colder countries, such as Canada and Russia, and regions, such as Central Asia (Conte et al. 2021). Third, a shift toward manufacturing activities is likely to be hindered by the sector's sensitivity to elevated temperatures. The region's start from relatively low productivity levels does not help, either. And, finally, ceteris paribus, larger trade

<footnote n="6">⁶ This follows closely the most pessimistic scenarios (RCP 8.5 and 6.0) of IPCC (2013).</footnote>
costs make global warming more damaging for the region, as it restricts
the option to soften the impact from changes in specialization and imports.

Though both insightful and sobering, results from this sort of long-term
exercise should not be interpreted as predictions, particularly because of
the uncertainty over the long horizon and the model's assumptions that
public policies and mitigation technologies do not change.<fnref n="7" />

Mitigation: Trade's Carbon Footprint

If climate change is already underway and likely to have a significant long-
term impact on trade in Latin America and the Caribbean, what about the
reverse impact? How much is the region's trade contributing to climate
change? Does trade matter for its overall greenhouse gas (GHG) emissions?
What are the main drivers of the impact? Is it getting worse?

No serious discussion about the role of trade policy in mitigation can
ignore these questions. Finding answers involves obtaining data and mak-
ing methodological tradeoffs in terms of country, GHGs, and time coverage.
No single database available can cover all these dimensions satisfactorily.

Figure 11.2 shows a snapshot of the region's carbon footprint, based on
the multi-region input-output (MRIO) Global Trade Analysis Project (GTAP)
database (Aguiar et al. 2019). It covers direct emissions (that is, emissions
from resources used or burned for an industry's production) and indirect
emissions (from resources used or burned in the production of inputs for
this industry and for transportation) and accounts for all the GHG gases
(CO2, methane, nitrous oxide, and fluorinated gases).

Not Too Big, Not Too Small: The Size of the Region's Footprint

Based on this analysis, the carbon footprint of the region's trade seems too
large to be ignored but small enough to dampen expectations that countries
will be able to meet all emission reduction commitments just by reducing
trade-related emissions. From a production perspective—considering only
what is produced domestically for external consumption, including inter-
national transportation—trade-related emissions account for between 19.8
and 26.5 percent of the region's emissions, depending on whether house-
hold and land use emissions are included in the denominator. From a

<footnote n="7">⁷ See also Gouel and Laborde (2021) for a more conventional computable general equi-
librium (CGE) exercise. Focusing on agricultural yields, with a 2080 horizon and a rise
in temperature of 4°C, their analysis estimates welfare gains for the region driven by
an increase in trade that more than offsets the negative impact on productivity—a
result that contrasts with that for most of the world.</footnote>
<figure><img src="image_97.png" /><figcaption>**Figure 11.2.** Trade-Related Production and Consumption GHG Shares by Country</figcaption></figure>

consumption perspective—that is, emissions generated abroad and consumed domestically—they have a similar magnitude.<fnref n="8" /> These estimates are somewhat lower than that of the world's trade-related emissions.<fnref n="9" /> Direct and indirect emissions are, on average, split evenly, with a slight edge for indirect emissions (56 percent).

It is also important to bear in mind that these are likely to be lower-bound estimates because they do not include those emissions associated with land use, land use change, and forestry (LULUCF), arising from changes to the so-called carbon stocks embedded in vegetation and soil. The input-output framework does not allow for these emissions to be traced accurately to a particular sector (Wood 2017).

The difference in the accounting perspectives from the production and consumption sides reveals the distinct position of Latin American and

<footnote n="8">⁸ Li (2021), using a different methodology which includes only domestic input-output linkages and a different data source (EORA), produces similar estimates.</footnote>

<footnote n="9">⁹ Peters and Hertwich's (2008) estimate for the world in 2001 is 21.5 percent (excluding household and LULUCF emissions). Copeland, Shapiro, and Taylor's (2021) WIOD-based world estimate for 2009, including just CO₂ and excluding household and LULUCF emissions, is 29 percent.</footnote>
<figure><img src="image_98.png" /><figcaption>**Figure 11.2.** Trade-Related Production and Consumption GHG Shares by Country (continued)</figcaption></figure>

Source: Mesquita Moreira and Dolabella 2024.

Note: Data are from 2014 GTAP-10 MRIO. Countries are ranked according to the shares of exports in production emissions and imports in consumption emissions, excluding land use and household emissions. A negative value means changes in land use reduced rather than increased emissions. Domestic emissions are those produced and consumed domestically. Exports account for emissions produced domestically and consumed abroad. Imports account for emissions produced abroad and consumed domestically.

Caribbean countries in trade emissions. In contrast to most of the developing world, particularly in Asia (Copeland, Shapiro, and Taylor 2021), Latin America and the Caribbean tends to be a net importer of GHG emissions—that is, consumption-related emissions are higher than production-related ones, especially in the large countries: Brazil, Mexico, and Colombia. This suggests the region has not been a significant “pollution haven,” attracting investment in dirty industries because of laxer environmental regulations (see Box 11.1). Still, the regionwide result should be taken with caution because smaller countries are net exporters of emissions.

## Trends

Based on the MRIO database produced by the Organisation for Economic Co-operation and Development (OECD), trade-related emission trends are quite heterogeneous, with some of the largest economies showing almost
**Box 11.1. Trade and Climate Change Mitigation: Key Concepts**

What does the economic literature say about the climate impact of trade? Most of the work on trade and mitigation relies on an analytical framework created by Grossman and Krueger (1991), who refer to three channels by which trade can affect environmental outcomes: scale, composition, and technique effects.

Scale has to do with the positive effects of trade on economic growth, which raises the demand for fossil fuels for the production, consumption, and shipment of goods and services.

Composition is associated with the traditional trade push for specialization. The climate impact in this case is ambiguous. If specialization is driven mainly by differences in environmental regulation, the most likely result for developing countries, which typically have relatively lax regulation, is an increase in emissions; this is also known as “the pollution haven effect” or “carbon leakage.” If reallocation reflects mainly comparative advantages, however—say, on technology or labor, capital, or natural resources—the outcome is an open question. Whether or not developing countries, for instance, get “dirtier” will depend on the emission intensity of the specialization that eventually prevails.

Technique refers to the access brought by openness to trade to more energy-efficient technologies and the changes it can force in environmental regulations, either directly or indirectly. In the case of changes brought about indirectly, Grossman and Krueger raise the possibility of a “Kuznets environmental curve”—that is, a relationship between emission intensity and per capita income that follows an inverted U shape. As countries grow, their emission intensity may increase because of scale and composition effects but will eventually come down as higher income raises demand for stricter environmental regulations.

monotonic increases, while others seem to have reached a peak right before the financial crisis of 2008–9 (see Figure 11.3). A similar picture emerges in terms of the share of export-related emissions relative to total CO₂ emissions, except for Costa Rica, whose share shows a notable monotonic decrease.

The generally declining intensity in CO₂ emissions (see Figure 11.4) suggests in turn that a combination of technique and composition effects has played a role in either preventing even greater scale-driven increases or offsetting these increases altogether (see Box 11.1 for definitions). Most countries are slightly above the OECD's intensity level at the end of the period but well below East Asia's.

**Breaking it Down**

Research conducted by Li (2021) offers more precise clues about the balance of scale, composition, and technique effects behind the trends
<figure><img src="image_99.png" /><figcaption>**Figure 11.3.** CO₂ Emissions Embodied in Exports and the Share of Export-Related CO₂ Emissions</figcaption></figure>

Source: IDB staff calculations based on OECD data.

Note: Total CO₂ emissions embodied in gross exports captures the CO₂ emissions embodied in the exports of a given domestic industry to a partner country. The emissions can come from any domestic or foreign industry upstream in the production chain.

<figure><img src="image_100.png" /><figcaption>**Figure 11.4.** Intensity of CO₂ Emissions in Total Exports</figcaption></figure>

Source: IDB staff with OECD data.

Note: This indicator shows the amount of CO₂ emissions (in tons) per million of US$ exported. Includes direct and indirect domestic and foreign emissions.

of the region's trade-related emissions. Li performs a Grossman and Krueger decomposition (see Box 11.1) for the region's most intense trade liberalization period, covering the six GHGs governed by the Kyoto Protocol but focusing on just domestic (direct and indirect) emissions related
to the production of the exported goods.<fnref n="10" /> The results are presented in Figure 11.5.

As in the rest of the world (Copeland, Shapiro, and Taylor 2021), emission-reducing techniques tend to offset by a large margin the compositional changes that often worsen emissions. Put simply, gains in energy efficiency in the production of each exported good are more relevant than changes in the share of dirty goods in the countries' export basket. As with the evidence on net emissions discussed earlier, a modest compositional impact suggests trade has not turned Latin America and the Caribbean into a significant pollution haven (see Box 11.1). The bad news, though, is that none of the countries studied seems to have had big enough improvements in energy efficiency to offset emission increases brought by the scale effects of growth in trade.

This study also makes it possible to disentangle the production emissions of exported goods from those arising from their shipment.<fnref n="11" /> Looking at emissions related just to domestic exports, it finds international shipping

<figure><img src="image_101.png" /><figcaption>**Figure 11.5.** Decomposition of GHG Emissions from Production of Exports, 1990 and 2014</figcaption></figure>

Source: Li (2021).

Note: Excludes emissions from transportation and changes in land use.

<footnote n="10">¹⁰ That is, CO₂, CH₄, N₂O, and F-gases. As in all previous exercises, land use emissions are not included.</footnote>

<footnote n="11">¹¹ The use of the MRIO database makes this impossible. See Peters, Andrew, and Lennox (2011).</footnote>
accounted for 24 percent of the region's export-related emissions in 2014 (up from 12 percent in 1990). It also finds that the region is among those with the highest export-related transportation emissions, accounting for 17 percent of the world's total in 2018. The drivers behind this result are changes in the location of the partners these countries trade with—with an increase in exports to distant Asia—and increases in the emission intensity of their shipping.

## Land Use and Deforestation

As argued earlier, land use emissions are likely to play a significant role in trade emissions. Country case studies can shed light on this relationship. Just as with the other emissions, trade effects on land use (Box 11.1) are theoretically ambiguous, which leaves the empirical question an open one. This is particularly so in the case of the technique effect in agriculture. The Borlaug hypothesis, on the one hand, argues that trade-induced productivity gains reduce land use requirements, and therefore deforestation, as farmers can produce more with less. The Jevons paradox, on the other, draws attention to the possibility that lower costs and greater profitability will increase the demand for land more than they will offset efficiency gains (Jayachandran 2022).

The evidence for Latin America and the Caribbean is relatively scarce, inconclusive, and limited to a few countries. Carreira, Costa, and Pessoa (2024), for example, find no significant impact of agricultural trade on deforestation. Faria and Almeida's results (2016), in turn, suggest that openness to trade increased deforestation in the Brazilian Amazon.

Two recent IDB case studies for Colombia and Ecuador also support the Jevons paradox. They use more direct and reliable identification strategies, combining satellite-generated, high-resolution maps of forest cover with detailed measures of municipal exports. In the case of Colombia, the average growth of agricultural exports is associated with an annual reduction of 28,000 hectares in forest cover, equivalent to 17 percent of the average annual deforestation in the country (Blyde and Ramirez 2023). Such a change in forest cover is associated with roughly 3.3 million tons of carbon emissions per year (approximately 17 percent of Colombia's annual trade-related emissions). For livestock, the evidence of a negative effect is much weaker, and no impacts are found for mining exports. Two other findings are worth noting: first, the impact is smaller when exports originate in municipalities with nature reserves; and, second, the correlation between deforestation and the municipalities' share of illegal coca plantations is significantly higher than those related to (legal) agricultural exports. These suggest that, as in other geographical areas, deforestation is more closely related to illegal than legal trade.

In the case of Ecuador, the findings suggest that a permanent 1 percent increase in exports decreases forest cover by 0.6 percent (Molina, Mesquita
Moreira, and Saeteros, forthcoming). Back-of-the-envelope calculations indicate this loss of forest cover accounted for 4 percent (9,749 hectares) of the country's deforestation between 2001 and 2020. Agricultural exports led in terms of negative impacts on forest cover, followed by manufacturing and mining.

## At the Policy Helm

The normative side of the analysis is the question of how governments in the region can use trade policy to meet both adaptation and mitigation goals while preserving and expanding the gains from trade.

## Trade Policy and Adaptation: Keep Borders Open

Both theory and empirics suggest the best way for trade policy to help is to keep the borders open, for a simple and compelling reason: trade reduces the welfare costs of adaptation. This happens through at least four channels: respecialization, growth, resilience, and access to technology (WTO 2023).

The mechanics behind these channels are quite intuitive. Opportunity to trade and respecialize allows low-latitude countries, which are losing comparative advantage in agriculture, to source food from the high-latitude areas while shifting their specialization toward services or manufacturing (Gouel and Laborde 2021). Trade-induced growth, in turn, gives countries more resources to pay for adaptation costs.

The resilience channel relates to risk-sharing possibilities not found in national markets. Concentrating production at home undermines supply chain resilience, as it increases country-specific risks to all sort of shocks, including climate change (Baldwin and Evenett 2020).

Finally, the technology channel is about having access to the least costly and most effective adaptation technologies, be they heat-tolerant seeds, weather-resilient housing and infrastructure, or more accurate and affordable meteorological forecasting (WTO 2023).

The technological argument is behind the so-called environmental goods (EG) initiatives, first launched as part of the Doha Round (2001) and followed by other negotiations at the Asia-Pacific Economic Cooperation (APEC 2012) and the WTO (the 2014 plurilateral Environmental Goods Agreement). The main objective is to lower tariffs on goods that can be instrumental to meeting environmental goals.<fnref n="12" />

<footnote n="12">¹² https://www.wto.org/english/tratop_e/envir_e/ega_e.htm. Currently, only Costa Rica figures among the Latin American and Caribbean participants in the WTO negotiations. APEC countries agreed in 2012 to reduce EG-applied tariff rates (on fifty-four goods) to 5 percent or less by the end of 2015.</footnote>
One caveat is that discretionary lower protection for EGs amounts to a tax on their home production. Since tariffs on these goods will be lower, investing in their production will be less profitable, pushing investment to more protected sectors. This may carry long-term welfare costs, as producing EGs often involves increasing returns, driven by a combination of fast technological change and high demand. The current race among the world's biggest economies—discussed in more detail later—to protect and subsidize their EGs underlines the importance of these considerations.

Despite such caveats, most Latin American and Caribbean countries, by accident or design, already have EG tariffs (according to the APEC definition) that are lower than the all-goods average (see Figure 11.6). The main issue seems to be that, in most cases, they are still significantly higher—particularly in Argentina, Brazil, and Venezuela—than those in developed countries.

## Trade Policy and Mitigation: Real and False Tradeoffs

Unlike adaptation, mitigation may involve clear tradeoffs between trade and climate policies. Since the scale and composition effects of trade may

<figure><img src="image_102.png" /><figcaption>**Figure 11.6.** Average Applied Tariffs on Environmental Goods by Country, 2019</figcaption></figure>

Source: IDB staff calculations, based on World Integrated Trade Solution (WITS) data.

Note: Environmental goods as defined by APEC (2012). Tariffs are simple averages.
eventually lead to higher emissions, countries must contend with reducing their carbon footprints while preserving welfare gains from trade.

This challenge is made particularly daunting by two aggravating circumstances: first, the urgency of raising carbon prices to keep global temperatures below catastrophic levels; and, second, the realization that a first-best, cooperative solution that would tax emissions at their primary source is, for political economy reasons, beyond reach.<fnref n="13" />

The interaction of these circumstances means that governments must operate in an environment where a myriad of uncoordinated climate initiatives exists at the multilateral, preferential, and unilateral levels, some of which resort to trade-related climate measures as a second-best climate tool. Trade-related climate measures are part of a larger group of trade-related environmental measures and notifications,<fnref n="14" /> some of which, as shown in Figure 11.7, have gained significant ground in the past decade. The

<figure><img src="image_103.png" /><figcaption>**Figure 11.7.** Numbers of Environment-Related Notifications and Measures, 2009–21</figcaption></figure>

Source: IDB staff calculations, based on data from the WTO Environmental Database.

Note: For a definition of the terms "environment-related measures" and "environment-related notifications," see footnote 14.

<footnote n="13">13 See, for example, Timilsina (2022) for the advantages of a carbon tax and its political economy challenges.</footnote>

<footnote n="14">14 "Measures" are environment-related trade policies reported under the WTO Trade Policy Review Mechanism (TPRM). All WTO members' trade policies are reviewed,</footnote>
share of WTO notifications that were environmental went from 8.1 percent
in 1997 to a peak of 19 percent in 2021.

The Multilateral Challenge

The multilateral challenge refers to self-imposed, supply-side constraints that have second-order impacts on trade. These constraints arise in the context of multilateral environmental agreements (MEAs), the most prominent of which are the voluntary country pledges to curb GHG emissions—the “nationally determined contributions” (NDCs) of the Paris Agreement. Most Latin American and Caribbean countries have committed to reach net zero emissions by 2050 and halt deforestation by 2030, commitments that will require a combination of heavy taxation of fossil fuels and strict control of changes in land use.<fnref n="15" />

The severity of the measures needed can be gauged by the fact most
of the region's countries do not have carbon taxes or equivalent emissions
trading schemes (ETSs), and many spend more than 1 percent of their GDPs
on fossil subsidies (Mesquita Moreira and Dolabella 2024). These create a
price gap between the actual and the estimated global social cost of carbon
of approximately US$61 to US$122 per ton of CO2e (World Bank 2023).

Closing this carbon price gap is likely to cause major disruptions to com-
parative advantages, particularly to exporters in such emission-intensive
sectors as agriculture and fossil fuels (Solano-Rodriguez et al. 2019; Welsby
et al. 2021). But while some export opportunities are likely to be destroyed,
others will arise. More expensive fossil fuels will speed up the transition
to cleaner and sustainable energy. The considerable endowment of wind,
solar, and hydropower of Latin America and the Caribbean, as well as of min-
erals critical for the electrification of transportation, provide plenty of export
growth opportunities, ranging from energy to mining to energy-intensive
manufacturing (IEA 2023c).

Figure 11.8 offers a glimpse of these export opportunities for the so-
called energy-intensive trade-exposed industries (EITEs), which account
for most of the global emissions in manufacturing, for selected coun-
tries in the region.<fnref n="16" /> The figure shows rough estimates of each country's

the frequency of each country's review varying according to its share of world trade. "Notifications" are environment-related trade measures that WTO members are required to report across all WTO agreements; examples include the Subsidies and Countervailing Measures (ACMs), the Technical Barriers to Trade (TBTs), and the Application of Sanitary and Phytosanitary Measures (SPSs). See WTO (2023) for details.

<footnote n="15">15 See Cárdenas and Orozco (2023), IEA (2023c), and https://t.ly/qq23M.</footnote>

<footnote n="16">¹⁶ Fischer and Fox (2018) provide a detailed list of EITEs as defined by the American Clean Energy and Security (ACES) Act of 2009.</footnote>
<figure><img src="image_104.png" /><figcaption>**Figure 11.8.** Relative Carbon Efficiency for Countries by Sector</figcaption></figure>

(continued on next page)
<caption>Figure 11.8. Relative Carbon Efficiency for Countries by Sector (continued)</caption>

D. Nonmetallic minerals

<figure><img src="image_105.png" /></figure>

E. Petroleum and coke

<figure><img src="image_106.png" /></figure>

F. Paper and paper products

<figure><img src="image_107.png" /></figure>

Source: Mesquita Moreira and Dolabella (2024) from 2014 GTAP 10-MRIO.

Note: Relative carbon emission efficiency (eff) is the log difference of the inverse of foreign (p) and domestic (c) total (direct plus indirect) emission intensities (ei) (CO₂e units per U.S. dollar of output) in good g times 100. Formally,

$$eff_{cg} = \ln\left(\frac{1}{ei_{cg}}\right) - \ln\left(\frac{1}{ei_{pg}}\right).$$

Foreign emission intensities are the partners' trade-weighted averages. A GHG emission efficiency of 20 percent means domestic production generates 20 percent more dollars' worth of goods per unit of CO₂e than the country's trade partners.
"carbon" comparative advantages vis-à-vis its trade partners.<fnref n="17" /> A positive number means the country has a comparative advantage—meaning it can generate more dollars' worth of goods per unit of CO₂—relative to trading partners in that specific EITE. All countries except for Trinidad and Tobago have a comparative advantage, and therefore export opportunities, in at least one EITE.

## Preferential Channels

At the preferential level, "environmental chapters" in trade agreements have been the weapon of choice. They have been on the rise since the early 2000s, particularly among North-South variants (Berger et al. 2020). Among agreements currently notified to the WTO, 97 percent include at least one environmental provision, while 18 percent have provisions that refer explicitly to climate change (WTO 2023).

Latin America and the Caribbean has been pioneering this trend, with the 1994 North Atlantic Free Trade Agreement (NAFTA) the first to include environmental provisions in a side agreement (CRS 2023). Since then, these provisions have evolved to become entire chapters of trade agreements, with enforceable mechanisms. The latest iterations are the 2018 United States–Mexico–Canada (USMCA) and the (yet-to-be-approved) 2019 EU–Mercosur agreements, both with environment chapters focused on enforcing national environmental laws and MEAs with dispute settlement mechanisms.<fnref n="18" />

Despite the growing popularity of environmental provisions in preferential trade agreements, their effectiveness is still an open question. To be sure, some preliminary evidence suggests they have had a positive impact in addressing ozone-depleting substances (Lundberg, Szmurlo, and Abman 2023) and deforestation (Abman, Lundberg, and Ruta 2021). More research, though, is needed for definitive conclusions, particularly regarding the latest crop of North-South agreements.

## Unilateral Initiatives

Unilateral initiatives have often been motivated by concerns among developed countries about pollution havens or carbon leakage (see Box 11.1). In theory, this is a legitimate concern for both environmental and competitive

<footnote n="17">¹⁷ Estimates of carbon comparative advantage consider direct (production) and indirect (input) emissions from suppliers at home and abroad.</footnote>

<footnote n="18">¹⁸ For the USMCA, see https://crsreports.congress.gov/product/pdf/R/R44981/14. For the EU-MSUR preferential trade agreement, see https://tinyurl.com/44avh8kc.</footnote>
reasons, but the priority accorded this issue does not seem to be justified
by empirical evidence. In Latin America and the Caribbean (see Figure 11.5)
and elsewhere, the composition effects of trade on emissions—driven
either by comparative advantages or carbon leakage—tend to be small
and are dwarfed by scale and technique effects (Copeland, Shapiro, and
Taylor 2022).

Empirical fundamentals aside, the more benign unilateral initiatives
have been dominated by trade-related climate measures directly address-
ing the carbon content of the goods. They range from carbon border tariffs
to private sustainability labeling schemes to public environmental stan-
dards. There is good and bad news about this trend. The bad news is that
the climate impacts of these measures, either locally or globally, tend to be
limited (Devarajan et al. 2022). This is not surprising since, as discussed ear-
lier, the share of overall GHG emissions attributable to trade, in the region
and elsewhere (see Figure 11.2), is not above 30 percent in most cases.

The good news is that this is a more promising approach to reconciling
trade and climate goals than such coercive measures as Nordhaus's climate
club (Nordhaus 2015, 2020). The "club" involves a group of "likeminded," large
economies implementing a uniform carbon tax, coupled with a punitive flat
import tax for nonmembers. Variations of this were discussed at the Group
of Seven (G7) summit in 2022 and in talks between the European Union
(EU) and the United States on steel and aluminum.<fnref n="19" /> Despite its potential for
greater climate impacts than the measures addressing the carbon content
of goods (Farrokhi and Lashkaripour 2024), the arbitrariness of a punitive
tax with no direct relationship to the emissions from goods poses a signifi-
cant risk to the rules-based multilateral trade system, already threatened by
intense geopolitical pressures.

Among the trade-related climate measures that directly address the
carbon content of goods, four stand out: carbon border taxes, sustainability
standards and regulations, production subsidies and quantitative restric-
tions, and “dirty” tariffs.

**Carbon border taxes.** Of the four measures, carbon border taxes are the most prominent. They consist of a tax on imports known as a border carbon adjustment or carbon border adjustment mechanism (CBAM). The idea is to make sure the carbon content of imported goods bears the same tax as that of the goods produced at home. The tax is defined as the product of the carbon price charged at home (set by a general carbon tax or the price

<footnote n="19">¹⁹ For the G7 proposal, see https://shorturl.at/djuCQ. For the United States–EU talks, see https://shorturl.at/lmEW6.</footnote>
of allowances of an emission trading system, or ETS) and the emission intensity of the good (the amount of emissions embedded in a unit of output). Although it has been discussed in a few countries, including the United States and the United Kingdom, only the EU has so far approved such a scheme.<fnref n="20" />

Implementation challenges to border carbon adjustments range from administrative costs (Böhringer et al. 2022) to potential conflicts with WTO nondiscrimination rules (Bacchus 2021) to adverse effects on welfare in developing countries (Bekkers and Cariola 2022). Efforts to address these challenges tend to undermine the ability of the adjustments to curb leakages and global emissions.<fnref n="21" /> Nevertheless, the border carbon adjustment is likely here to stay. What does that mean for Latin America and the Caribbean?

The main concern is the impact of the tax on EITE exports and an ensuing decline in the terms of trade as prices adjust to accommodate the higher costs. A prolific literature uses computable general equilibrium models (CGEs) to study this impact, but most studies provide little detail at the country level, particularly for Latin America and the Caribbean. The few exceptions point to modest effects on trade, welfare, and emissions, except for a few more heavily affected sectors in some countries. Devarajan et al. (2022), for instance, use a global CGE to simulate a scenario in which high-income countries impose a CO₂ tax of US$75 and an equivalent border carbon adjustment on EITE goods. In this scenario, the region would suffer welfare and export losses of 0.2 percent and 0.8 percent, respectively. The impact on emissions is not reported for the region, but the global fall would be a modest 7.2 percent. The results do not change significantly if the same taxes are applied to all goods.

A couple of other studies look in more detail at the expected impact of the upcoming implementation of the EU CBAM, which at least initially will be limited to EITE goods.<fnref n="22" /> These results also generally suggest modest impacts for the region, which, as shown in Table 11.1, might be explained by three factors: the relatively small share of EITE exports for most countries; the limited share of those exports going to the EU; and the relatively small contribution

<footnote n="20">²⁰ For the proposals of the EU, United States, and United Kingdom, see, respectively, https://shorturl.at/hTX07; https://shorturl.at/xyKS2; and https://shorturl.at/DKNO8.</footnote>

<footnote n="21">²¹ Bellora and Fontagne (2021), for example, show that a fully implemented version of the EU CBAM, with carbon prices high enough to be consistent with the Paris Agreement's pledges, would reduce global emissions between 0.6 and 1 percent.</footnote>

<footnote n="22">²² According to the latest regulation approved by the European Parliament, the target sectors are electricity, iron and steel, refinery goods, cement, aluminum, organic basic chemicals, hydrogen, and fertilizers. Refinery goods and organic basic chemicals, though, are exempted from the initial implementation, set to start in 2026. The so-called scope 2 emissions (emissions of electricity used in the production process) will eventually be included in the calculations but not in the first stage for most goods (see https://shorturl.at/hTX07).</footnote>
of these goods to overall emissions. Trinidad and Tobago and Venezuela are the most notable exceptions. Another consideration is the region's carbon comparative advantages, as discussed earlier, in some of these goods.

The most comprehensive of these studies is from the United Nations Conference on Trade and Development (UNCTAD 2021). It estimates that a CO₂ price of US$88 per ton (roughly the current EU ETS price), applied to both

<table><caption>**Table 11.1.** Latin American and Caribbean Exposure to EU CBAM, 2022</caption><thead><tr><th>Countries</th><th>(a) EITE share of exports</th><th>(b) EU share of EITE exports</th><th>(c) EITE share of CO₂ emissions</th></tr></thead><tbody><tr><td>Mexico</td><td>1.9%</td><td>0.2%</td><td>15%</td></tr><tr><td>Brazil</td><td>4.4%</td><td>2.1%</td><td>22%</td></tr><tr><td>Chile</td><td>1.2%</td><td>2.3%</td><td>6%</td></tr><tr><td>Argentina</td><td>2.1%</td><td>0.1%</td><td>12%</td></tr><tr><td>Peru</td><td>0.7%</td><td>0.0%</td><td>17%</td></tr><tr><td>Colombia</td><td>0.8%</td><td>0.3%</td><td>15%</td></tr><tr><td>Ecuador</td><td>0.8%</td><td>0.0%</td><td>7%</td></tr><tr><td>Costa Rica</td><td>2.5%</td><td>0.4%</td><td>9%</td></tr><tr><td>Guatemala</td><td>3.7%</td><td>0.0%</td><td>26%</td></tr><tr><td>Dominican Republic</td><td>2.8%</td><td>0.2%</td><td>13%</td></tr><tr><td>Bolivia</td><td>0.4%</td><td>0.0%</td><td>10%</td></tr><tr><td>Paraguay</td><td>0.2%</td><td>0.0%</td><td>12%</td></tr><tr><td>Uruguay</td><td>0.7%</td><td>0.0%</td><td>7%</td></tr><tr><td>Trinidad and Tobago</td><td>32.7%</td><td>21.9%</td><td>47%</td></tr><tr><td>Honduras</td><td>3.4%</td><td>0.0%</td><td>13%</td></tr><tr><td>Nicaragua</td><td>0.3%</td><td>0.0%</td><td>11%</td></tr><tr><td>Panama</td><td>0.6%</td><td>0.1%</td><td>5%</td></tr><tr><td>El Salvador</td><td>4.2%</td><td>0.1%</td><td>9%</td></tr><tr><td>Venezuela</td><td>16.2%</td><td>13.3%</td><td>18%</td></tr><tr><td>Jamaica</td><td>0.3%</td><td>0.0%</td><td>10%</td></tr></tbody></table>

Source: IDB staff calculations, based on World Integrated Trade Solution (WITS) and GTAP data.

Note: EITE sectors include chemicals and fertilizers, other nonmetallic mineral products, iron and steel, and nonferrous metals. Column (a) shows the share of EITE sectors in the countries' overall exports. Column (b) is the share of the countries' EITE exports to the EU. Column (c) is the share of the EITE sectors in the countries' overall GHG emissions, not including land use and forestry.
direct and indirect emissions,<fnref n="23" /> would impose an ad valorem equivalent tariff on EITE exports that ranges from 0.6 percent (on pulp and paper from Peru) to 22 percent (on cement from Mexico).<fnref n="24" /> These surcharges would lead to marginal reductions in emissions for economies such as Brazil, Mexico, and Central America (0.7 percent, 0.2 percent, and 0.01 percent, respectively) and marginal increases for the rest of the region. These changes are associated with modest EITE export losses, led by Brazil (2.8 percent), Argentina (2.3 percent), Mexico (1.1 percent), and Central America (1 percent). The rest of the region has modest gains, led by Peru (2 percent). Income losses or gains tend to follow the same patterns and order of magnitude.<fnref n="25" />

So, what should governments do? This is an area in which more research is needed. Considering the estimated impacts, however—and that a global cooperative solution is not on the table—it does not seem to be in the governments’ best interest to be fully opposed to border carbon adjustments, for three good reasons: First, in this world of the second-best solution—that is, where the trade-related climate measures are a reality that no country can avoid—border carbon adjustments are significantly less trade distorting than other coercive alternatives. Second, one cannot dispute the logic behind the carbon leakage/pollution haven argument. Countries in Latin America and the Caribbean are likely to face the same carbon leakage challenges seen in the high-income countries as they seek to fulfill their NDC pledges. Finally, given the region’s generally clean energy matrix, border carbon adjustments might eventually favor its EITE exports, particularly if indirect electricity emissions are included.

Rather than opposing border carbon adjustments, the governments should concentrate on negotiating common accounting methods for measuring embodied emissions. This is an agenda that goes beyond CBAMs and is relevant for other types of unilateral trade-related climate measures, such as sustainability standards and regulations, which are discussed next.

**Sustainability standards and regulations.** This is a trend that took off first in the voluntary private market and is now moving toward mandatory public regulations. Estimates of the number of private “voluntary sustainability standards” (VSSs) range from 264 to 455; they cover 195 countries and are

<footnote n="23">²³ Indirect emissions are those coming from electricity generation.</footnote>

<footnote n="24">²⁴ The model assumes that the sectors on which the CBA is imposed are electricity and the energy-intensive industries, including cement and glass, steel, aluminum, paper, petroleum and coal products, and chemicals and fertilizers.</footnote>

<footnote n="25">²⁵ See also Perdana, Vielle, and Oliveira (2023), examining the impact of the EU CBAM on Brazil. The study simulates a policy scenario for 2040, with EU ETS CO₂ prices reaching US$140, assumed to be consistent with the EU NDC pledges. In this scenario, and including indirect emissions from electricity, the effects are more significant; EITE exports and welfare drop by 22.5 percent and 0.9 percent, respectively.</footnote>
concentrated mostly in the OECD and the agricultural sector.<fnref n="26" /> Among these standards, those related to GHG emissions account for a small but growing share.<fnref n="27" /> Latin America and the Caribbean has been an active participant, with VSS uptake for some agricultural products proportionally higher than in other parts of the world (see Figure 11.9).

<figure><img src="image_108.png" /><figcaption>**Figure 11.9.** Voluntary Sustainability Standards Uptake in Selected Agricultural Commodities, 2021</figcaption></figure>

Source: Dolabella and Saeteros, forthcoming, with data from the Research Institute of Organic Agriculture (FIBL) and the International Trade Centre (ITC).

Note: These graphs consider the minimum total area certified—that is, the coverage of the most widespread VSS per product country year.

<footnote n="26">26 See https://standardsmap.org/trends and Elamin and Fernández de Cordóba (2020).</footnote>

<footnote n="27">27 The Ecolabel index lists 31 standards that are related to carbon emissions, of a total of 455 such standards; see http://www.ecolabelindex.com/ecolabels/.</footnote>
Public initiatives have been following suit. Approximately half of the environment-related measures taken in 1999–2022 put up sanitary and phytosanitary<fnref n="28" /> and technical barriers to trade.<fnref n="29" /> The most prominent, with explicit mitigation objectives, is the EU 2023 regulation on deforestation-free products. EUDR, which entered fully into force in December 2024, mandates extensive due diligence along the value chain for all operators and traders dealing in certain products derived from cattle, cocoa, coffee, oil palm, rubber, soya, and wood.<fnref n="30" /> A cursory look at the trade data (see Figure 11.10)

<figure><img src="image_109.png" /><figcaption>**Figure 11.10.** Latin American and Caribbean Exposure to the EUDR</figcaption></figure>

Source: IDB staff calculations, based on World Integrated Trade Solution (WITS) and GTAP data.

<footnote n="28">28 Sanitary and phytosanitary barriers are types of trade restrictions used by countries to protect human, animal, or plant life and health from risks arising from the spread of diseases, pests, or contaminants.</footnote>

<footnote n="29">29 Technical barriers to trade (TBTs) refer to regulations, standards, testing, and certification procedures applied by countries to imported and domestically produced goods.</footnote>

<footnote n="30">30 Exporters will have to be able to prove that goods do not originate from deforested land or contribute to forest degradation. These obligations kicked in for large operators on December 30, 2024, after an 18-month transition period, and for small operators on June 29, 2025, following a transition of up to 24 months; https://rb.gy/nxyoj. A similar initiative—the Forest Act—was proposed in the U.S. Senate in 2021 and recently revised (https://www.schatz.senate.gov/imo/media/doc/forest_act bill_text.pdf). Unlike EUDR, it covers only illegally deforested land. See Conte Grand, Schulz-Antipa, and Rozenberg (2023) for a discussion.</footnote>
reveals the most EUDR-exposed countries in the region (those that are sig-
nificantly dependent on the exports of targeted goods, in general, and to the
European market, in particular); they are led by Honduras (dealing in coffee)
and members of the Southern Common Market (MERCOSUR, dealing in soy,
cattle, wood, and coffee).

Even before the recent iterations, these trends in sustainability stan-
dards and regulations were a cause for trade concerns in the region, which
is seen as particularly exposed because of the importance of its agricultural
exports and its land use emissions and for the long distances to its main
markets (Herreros 2011; Bouzas 2011).

Neither the theory nor the worldwide evidence on the environmental and trade outcomes of these standards and regulations allow for definitive conclusions, however. On the environment, most of the estimated impacts of sustainability standards are either positive or statistically insignificant, depending on the context (Blackman and Rivera 2011; Traldi 2021; UNFSS 2022). Findings are particularly scarce on GHG emission outcomes (Liu, Wang, and Su 2016), except for studies on land use and deforestation, whose results show a similar mixed pattern (UNFSS 2022).

The same uncertainty arises from studies specific to Latin America and the Caribbean. Ruben, Fort, and Zúñiga-Arias (2009), for instance, find that the adoption of fair trade certification for bananas and coffee in Costa Rica and Peru had a mixed impact on environmental practices. Blackman and Naranjo (2012) and Ibanez and Blackman (2016), on the other hand, estimate that organic certification improved coffee growers' environmental performance in Costa Rica and Colombia, respectively. On deforestation, Rueda, Thomas, and Lambin (2015) find that certified coffee farms in Colombia have increased the amount of tree cover on their plots relative to noncertified counterparts. Rana and Sills (2024) also find some curbing of deforestation in the Brazilian Amazon as a result of voluntary forest management certification from the Forest Stewardship Council, while Blackman, Goff, and Planter (2018) find no significant impact of FSC certification on deforestation in Mexico.

Blyde and Ramirez (2022) offer more general, if indirect, evidence of how trade partners' sustainability standards and regulations can affect environmental outcomes at home. Using a panel of firm-level data from Chile, they find that an increase of 10 percentage points in the share of exports to high-income countries—which generally have more stringent environmental policies—is associated with an average 16 percent reduction in CO₂ emission intensity.<fnref n="31" />

<footnote n="31">³¹ The OECD Environmental Policy Stringent index for the average OECD country in 2020 was twice as high as for a sample of large emerging countries (https://stats.oecd.org/Index.aspx?DataSetCode=EPS).</footnote>
On trade, the impacts of sustainability standards and regulations depend on the balance between trade-destroying and trade-creating effects. The former is about compliance costs, which work as an entry barrier, particularly to small and medium exporters in developing countries. The latter has to do with the positive effect of compliance on productivity, markups, and quality gains (real or perceived), which could help firms break into new, environmentally conscious, markets (Fiorini et al. 2020; Dolabella 2020; UNCTAD 2023).

As with the environment, the available global evidence does not allow for generalizations (Elamin and Fernández de Cordába 2020). The little evidence available for Latin America and the Caribbean relates to voluntary standards, and it tends to support trade-creating effects. Blyde (2022), using firm-level data from Ecuador, finds that holding an ISO 14001 environmental certification increases a firm's likelihood of becoming an exporter by 4 percent but does not find an impact on the firm's exports. The results suggest certification is most useful to reduce information asymmetries, reducing entry barriers to export.<fnref n="32" />

Dolabella and Saeteros (forthcoming) find positive and significant trade impacts from private voluntary sustainability standards. They run a structural gravity model with country-level information on trade, certified harvested area, and production for twelve voluntary sustainability standards and eight agricultural commodities in 2013–21. They find that a 1 percentage point increase in the share of the certified harvested area increases exports of certified products by an average 1.88 percent. Their findings suggest that trade gains are larger for lower-income exporters trading with high-income destinations, with voluntary sustainability standards playing an important role in reducing information asymmetries. For instance, when the exports are from Latin America and the Caribbean and the destination is a high-income country, the positive impact shows a slight increase to 1.97 percent.

Finally, Dragusanu, Nunn, and Montero (2022) look at the effects of the fair trade certification of coffee on producers and households in Costa Rica (1999–2014). They find certification associated with higher prices and revenues for both domestic sales and exports, although with stronger effects for the former.

Overall, these results should allay the worst fears of trade-destroying effects of sustainability standards and regulations, while offering some mixed hope for better environmental outcomes. It is also true, however, that more research is needed, particularly on the latest crop of mandatory public

<footnote n="32">³² Introduced in 1996, the ISO (International Organization for Standardization) 14001 is a voluntary standard to reduce environmental footprints through an environmental management system.</footnote>
environmental regulations, such as the EU 2023 regulation on deforestation-free products. Governments can't afford to wait, though. What can they do?

As in the case of border carbon adjustments, one can hardly dismiss sustainability standards and regulations as protectionist ploys. These measures can be useful for countries in the region to meet environmental goals. They put pressure on exporters to use more sustainable techniques, magnifying the positive “technique” effect of trade (Box 11.1). The challenge is how to maximize this effect while minimizing the negative impact on exports that comes from higher compliance costs.

The United Nations Forum on Sustainability Standards offers recommendations that include public financial and technical support for certification, adoption of national standards, and mutual recognition agreements (UNFSS 2022). These have a better chance of success if they are implemented in tandem. To understand why, take, for instance, public support. Which of a multitude of actors, operating in different markets, each with its own, often opaque, proprietary methodology, is to be supported?

The development of public, national, or regionwide standards would help governments and firms make more informed choices, while providing complementary, low-cost alternatives to local firms.33 National standards, however, can only be effective—at least from an international trade perspective—if they adhere to widely recognized international standards, such as those developed by the International Organization for Standardization.34

The adherence of national standards to international standards is also a prerequisite for countries to explore, for instance, mutual recognition agreements—the least demanding form of harmonization.35 Such agreements recognize “the technical competence of specific conformity assessment bodies in the export country to perform conformity assessment at the expected level of the import country” (Brito, Kauffmann, and Pelkmans 2016). As an IDB report shows (Blyde, forthcoming), this sort of negotiation can have a significant positive effect on bilateral trade.

**Production subsidies and other trade-distorting measures.** A review of unilateral trade-related climate measures would not be complete without

<footnote n="33">33 The problem of multiple methodologies is recognized, for instance, by the EU, which recently launched an initiative to regulate the private market of emission standards (https://rb.gy/k2t7t).</footnote>

<footnote n="34">34 https://www.iso.org/obp/ui/#iso:std:iso:14067:ed-1:v1:en.</footnote>

<footnote n="35">35 Mutual recognition agreements are international agreements between two or more countries, or between regional trade blocs, whose parties agree to recognize each other's conformity assessments—procedures that demonstrate whether a product, service, process, or system meets specified requirements usually related to quality, safety, and performance standards.</footnote>
mentioning a whole range of assorted measures, like subsidies and quantitative restrictions, that are trade (and investment) distorting but marketed as necessary to meet broad climate or environmental goals. Nearly 47 percent of the environment-related measures taken in 1999–2022 were subsidies (for example, grants, direct payments, tax concessions, concessionary loans) and quantitative restrictions (bans or prohibitions, export and import licenses), most likely in violation of WTO rules. This is probably just the tip of the iceberg, because information on subsidies is uneven across countries and incomplete (see IMF et al. 2022).

The energy transition was the main justification used for 33 percent of subsidies that were notified to the WTO between 1999 and 2022. Exports of critical minerals linked to the transition have been particularly affected by the policies. The OECD estimates that, in 2017–19, approximately 10 percent of the world exports of critical minerals were under at least one type of export restriction (Przemysław and Legendre 2023).

What is particularly worrying is the prominent role in this trend of the largest world economies. China led the way with its Made in China 2025 plan launched in 2015, which targeted clean power and transportation equipment, among other sectors.<fnref n="36" /> This was followed more recently by the United States’ 2022 Inflation Reduction Act and the EU’s 2023 Green Deal Industrial Plan, both of which also target key manufacturing goods for the energy transition.<fnref n="37" />

While the commitment of these governments to reducing emissions is very much welcome, the choice of discriminatory policies is more likely to hinder than help mitigation. Subsidies for the consumption of clean energy and goods can be an economically sound, even if second-best, option to curb emissions. Subsidies for local production, however, are clearly not, particularly when they are combined with local content requirements and trade-related investment measures—the latter of which condition the access of local markets to foreign direct investment and technology transfers.

Production subsidies coupled with local content requirements are trade-discriminatory measures that go against the principle of comparative advantage. They delay and raise the costs of mitigation while causing havoc in the multilateral trade system, and they can only be rationalized as part of a growing geopolitical rivalry, in which the world’s largest economies compete

<footnote n="36">³⁶ See https://isdp.eu/content/uploads/2018/06/Made-in-China-Backgrounder.pdf and Cai and Wang (2023).</footnote>

<footnote n="37">³⁷ https://www.epa.gov/green-power-markets/summary-inflation-reduction-act-provisions-related-renewable-energy; https://commission.europa.eu/strategy-and-policy/priorities-2019-2024/european-green-deal/green-deal-industrial-plan_en.</footnote>
to capture the energy transition's growth opportunities at the expense of
everybody else. Saving the planet risks becoming an afterthought.

What can governments in Latin America and the Caribbean do? Should they join the race, adopting their own brand of discriminatory policies? The limited available data reveal that at least some are already leaning in this direction. The region accounts for approximately 13 percent of the environment-related measures tallied by the WTO in 1999–2022. There are, though, strong reasons to be cautious.

The strongest is pure survival instinct. As discussed earlier, the region stands to be one of most affected by climate change. It clearly has no interest in delaying mitigation by artificially increasing the price of critical equipment and technology on uncertain, long-term, infant industry arguments. John Maynard Keyes's quip about death in the long run could not be more appropriate than in this case.

Coming close to survival instincts as a reason for caution is the uncomfortable reality that the region cannot compete on subsidies with the likes of the Chinese, EU, or U.S. treasuries. This restriction became even more constraining after the COVID-19 pandemic, with most governments facing daunting fiscal challenges (Galindo and Nuguer 2023). In such an environment, the opportunity cost of engaging in industrial policy becomes almost impossible to bear. Should government cut, for instance, social spending to support firms and sectors?

Finally, governments cannot ignore Latin America and the Caribbean's checkered record with industrial policy, particularly in the mining sector, where, as mentioned earlier, the region has strong comparative and competitive advantages it can leverage in the energy transition.<fnref n="38" /> Overambitious local content requirements and export bans to develop local value chains, which do not consider institutional limitations or their impact for the economy as whole, can easily be turned into another costly missed opportunity.<fnref n="39" /> Before mimicking discriminatory policies, governments should probably consider other, significantly less risky and more promising, alternatives. Improving, for instance, their regulatory, infrastructure, and human capital fundamentals, which continue to fall behind those of their main competitors, is a much safer choice. No amount of subsidies can compensate for these shortcomings.

It is also important to consider leveraging and expanding the region's
already wide network of preferential trade agreements. This could, first,

<footnote n="38">³⁸ For a good illustration of the risks involved, see the discussion of Brazil's recent industrial policy endeavors in Frischtak and Mesquita Moreira (2015).</footnote>

<footnote n="39">³⁹ See Ing and Grossman (2024) for the pros and cons of local content requirements.</footnote>
neutralize the impact of discriminatory policies and, second, ensure coun-
tries have enough market access to exploit scale economies associated
with clean technologies. The case of Mexico, whose USMCA membership
has granted it access to the benefits of the U.S. Inflation Reduction Act for
electric vehicles, demonstrates the tangible economic advantages that can
arise from participating in preferential trade agreements.<fnref n="40" />

A third relevant tool to address this challenge is to resort selectively to trade defense measures. As part of the WTO Agreement on Subsidies and Countervailing Measures, countries have every right to respond to illegal subsidies by taxing imports of the targeted goods.<fnref n="41" /> But, particularly in the case of environmental goods, there is a strong case for being selective. Their urgently needed broad adaptation and mitigation benefits might more than offset illegal competition concerns. The way to ensure that is to use the “public interest test,” a mechanism already used by such economies as Canada, the EU, and, more recently, Brazil.<fnref n="42" /> It means applying a rigorous and independent evaluation of costs and benefits to the whole economy— not just to the targeted sector—before implementing any sanctions.

**Dirty tariffs.** Countries' import tariffs can have a tangible impact on trade emissions by changing resource allocation across sectors and partners that have different GHG emission intensities. If, for instance, governments grant lower tariffs to emission-intensive goods, they are implicitly subsidizing trade in “dirty” goods. Unfortunately, that is what frequently happens; policymakers usually favor granting lower tariffs for raw materials and intermediate goods, which tend to have higher emission intensities than final goods (Shapiro 2021), then analyze their causes and consequences. In most countries, import tariffs and nontariff barriers are substantially lower on dirty than on clean industries, where an industry's “dirtiness” is defined as its carbon dioxide (CO₂). The policy solution is a tariff reform that removes the bias by bringing all tariffs to the same level—an initiative that could be carried out unilaterally, without necessarily violating WTO principles. The reform would not only purge the “dirty” subsidy but would remove the tariff distortions on relative prices, improving resource allocation, as well.

A recent IDB study (Mesquita Moreira and Dolabella 2024) tests the rel-
evance of this insight for the region. It finds that, in approximately half of the
20 countries in the sample, tariffs are negatively correlated with the emis-
sion intensities of the goods, confirming the presence of trade emission

<footnote n="40">⁴⁰ See, for example, Attinasi, Boeckelmann, and Meunier (2023).</footnote>

<footnote n="41">⁴¹ https://www.wto.org/english/tratop_e/scm_e/subs_e.htm.</footnote>

<footnote n="42">⁴² Kotsiubska 2011 and Naidin 2019.</footnote>
subsidies (see Figure 11.11). MERCOSUR countries have the highest subsidies, ranging from approximately US$10 per ton of CO2 equivalent in Argentina and Brazil to US$7 in Paraguay and Uruguay. The other half of the sample countries have either a positive correlation—that is, an implied tax on emissions—or no correlation at all. Colombia, with a tax of US$9, leads the countries with taxes on emissions. As mentioned earlier, recent estimates of the social cost of CO2 range from US$61 to US$122 per ton.

It seems fair to argue that the region's trade policies are either pushing countries in the wrong direction or making only a modest contribution to closing the gap between the private and social costs of carbon. What can be done? The most promising option would be to converge to a uniform

<figure><img src="image_110.png" /><figcaption>**Figure 11.11.** Covariances of Applied Tariffs and Goods Emission Intensities</figcaption></figure>

Source: Mesquita Moreira and Dolabella 2024.

Note: The figure shows the results for the following regression: The lefthand variable is applied tariffs, and the righthand variable is total emission intensities (CO₂e per U.S. dollar of output). Observations are at the sector-partner level. Estimates were made for each country. Emission intensities that were greater than the 95th percentile were replaced by this 95th percentile value. The blue bars represent the 95 percent confidence interval, calculated with robust standard errors.
most-favored-nation (MFN) tariff around the OECD mean (4.4 percent), which would be consistent with the countries' obligations under preferential trade agreements and would avoid the efficiency costs of raising tariffs on dirty goods. It is important, though, to keep expectations in check. Shapiro's (2021) general equilibrium result for a similar reform, for instance, is a modest 3.4 percent drop in Brazil's and Mexico's emissions.

## The Captain's Log

After all is said and done, it is worth writing down a few takeaways related to the main question of this chapter: how can the region mitigate its trade carbon footprint, reduce its adaptation costs, and respond to "green" protectionism abroad while preserving and expanding its gains from trade? The points made above can be summarized as follows.

**Trying times are ahead for the adaptation of trade in Latin America and the Caribbean.** That is the information coming from both anecdotal evidence and prospective exercises. The reasons are clear. With most of the region in low-latitude tropical areas, the damage imposed by rising temperatures to its infrastructure and productivity is likely to be among the highest in the world. Agriculture is likely to be hit the hardest.

**The carbon footprint of the region's trade is too big to be ignored but too small for a panacea.** The effectiveness of trade policy as an environmental policy depends largely on the size of the trade's carbon footprint. Accounting for 19.8 percent to 26.5 percent of the region's emissions—a range that could be higher if land use were considered—the footprint is large enough to matter but too small to suggest trade policy can do the job alone.

**Trade policy toward adaptation should keep the borders open.** The case for trade and adaptation is very straightforward: There are no tradeoffs here. Opportunity to trade allows countries to specialize and have access to sustainable technology, softening the blow of climate change. Trade-induced growth, in turn, give countries more resources to pay for adaptation costs.

**Trade policy toward mitigation should focus on the carbon content.** With a global cooperative solution—which would tax emissions at their primary source—beyond reach, tradeoffs between mitigation and trade goals are inevitable. The tradeoffs can themselves be mitigated, however, if the policy tools target the carbon content of goods and services. Other coercive
measures, such as carbon clubs with arbitrary punitive tariffs, can cause serious trade distortions and put the multilateral trade system at risk.

**Multilateral environmental agreement and preferential trade agreement commitments will bring higher carbon prices and shifting comparative advantages.** Meeting Latin American and Caribbean countries' stringent emission commitments will require a combination of heavy taxation on fossil fuels and strict control of land use. This is likely to disrupt comparative advantages in emission-intensive sectors, such as agriculture and fossil fuels. While some trade opportunities will be destroyed, others will arise. The region's considerable endowment of clean energy and critical minerals suggests plenty of new opportunities in energy, mining, and energy-intensive manufacturing.

**Unilateral carbon taxes and sustainability standards and regulations are here to stay.** In this second-best world, they are a reality countries can hardly avoid and significantly less trade distorting than other coercive alternatives. The region will most likely have to use them to fulfill their emission pledges. More importantly, the region's generally cleaner energy matrix means these measures may favor its energy-intensive, trade-exposed exports. Rather than opposing them, the focus should be on negotiating common accounting methods, either in preferential trade agreements or multilaterally.

**With respect to climate-related production subsidies and other trade-distorting measures, widespread mimicking and retaliation are against the region's interests.** While the pervasiveness of these measures threatens the region's comparative advantages in the energy transition, governments should be cautious about adopting their own brand of discriminatory policies, for at least three strong reasons: First, the region's survival instinct dictates it has no interest in delaying mitigation by artificially increasing the price of vital equipment and technology. Second, the region cannot compete in subsidies with the largest economies. And, third, the region's own checkered record with industrial policy makes the viability of these policies dubious at best.

**Before resorting to trade-distorting measures, consider more promising alternatives.** Latin America and the Caribbean should start with the obvious: Improve regulatory, infrastructure, and human capital fundamentals, and eliminate fossil fuel subsidies. Policymakers should consider leveraging and expanding the region's already extensive network of preferential trade agreements to neutralize discriminatory policies and expand market access
to clean goods and services; they should resort selectively to trade defense
measures based on the criterion of public interest; and they should consider
a tariff reform that would eliminate the bias toward trade in dirty goods.

In short, the story of climate change and trade in Latin America and the
Caribbean need not be a narrative of tight tradeoffs. There is plenty of room
to pursue adaptation and mitigation objectives while preserving the gains
from trade. All it takes is a careful review of the data and their implications.
Knee-jerk policy reactions, driven by a complex political economy, can be a
major setback for the region's much-valued goal of sustainable economic
growth.
# Filling the Finance Gap: What Multilateral Development Banks Can Do

<figure><img src="image_111.png" /></figure>

At just over US$1 trillion, annual climate finance flows fall far short of the US$10 trillion required. Market and government failures—such as inefficient regulations, weak policy frameworks, high costs in emerging economies, and underdeveloped domestic financial markets—hinder the scaling up of climate investments. Multilateral development banks can blend concessional and private finance, enhance regulatory environments, and facilitate innovative instruments like green bonds. Crucially, technical assistance, though modest in cost, unlocks larger investments by improving project design, enabling market standards, and supporting policy reforms that attract public and private financing.

In the past decade, momentum has been growing for climate finance, with financial flows increasingly supporting adaptation or mitigation goals. Current investment levels still fall significantly short of estimated needs, however. Although global flows of climate finance tripled between 2011–12 and 2021–22, from an estimated US$364 billion to about US$1.3 trillion per year, annual spending on climate solutions needs to amount to around US$10 trillion if the worst impacts of climate change are to be avoided (CPI 2023).

The good news is that, while the climate financing shortfall is large, analysis based on data from the World Bank and Statista indicates it represents less than 10 percent of global gross domestic product (GDP) and less than 10 percent of the total value of assets managed by investment companies globally. This suggests resources in global financial markets could be sufficient to finance climate goals if some investments were reoriented.

Nonetheless, a number of barriers hinder investments in climate solutions. Capital is scarce and expensive in emerging markets and in countries where levels of climate vulnerability and risk are high. In addition, mitigation and adaptation projects can be expensive to identify and design. Domestic
financial markets are also still incipient in developing countries—for instance, in terms of the available financial instruments (CPI 2022). Finally, market and government failures discourage investment in climate projects (Chapter 9).

The magnitude of the climate finance gap, together with limited public resources and high levels of public debt in emerging and developing countries, means that scaling up private spending will be essential. At 4.8 percent per year, however, growth in climate finance from the private sector has been slower than in the public sector (9.6 percent) in the past decade (CPI 2022). Greater efforts, therefore, must be made to mobilize private sector investment.

The public sector has a big role to play in these efforts. Both public and private spending decisions, for instance, are shaped by governments' strategies and regulations. While multilateral development banks (MDBs) can provide only a fraction of the total funding needed, they can support governments and corporations in designing climate plans, enacting policy reforms to encourage private investment, and building the capacity of public agencies and private companies to select and design climate projects. MDBs can also help developing countries get access to grants and blend concessional funds and commercial debt to enhance the risk-return profiles of climate projects (Prasad et al. 2022; NGFS 2023).

Both public and private lenders can use special investment vehicles to ensure companies and governments spend on climate change goals. With green bonds,<fnref n="1" /> for instance, the issuer guarantees it will use all proceeds to finance or refinance projects that support these goals. A cumulative US$2.6 trillion worth of green bonds was issued globally between 2019 and mid-2023 (CBI 2023d).

Achieving climate goals requires not only increasing total financial flows but also making sure different climate solutions are funded simultaneously across multiple sectors. Between 2011 and 2020, almost 70 percent of tracked climate mitigation finance went to renewable energy investments. Spending on other solutions, such as energy efficiency, low-carbon agriculture, and clean industry, needs to be increased.

Indeed, a combination of financial support from governments, supportive regulations, and improvements in technology have made renewable energy an attractive investment for the private sector, while investment in other sectors remains hindered by technical, commercial, and regulatory barriers (Chapter 9).

<footnote n="1">¹ The term “green bond” is sometimes used as a synonym for “climate bond.” In most contexts, though, “climate,” “green,” and “sustainable” finance refer to different but nested concepts. Green finance is broader than climate finance; it includes climate finance and finance that funds projects with other environmental benefits, such as biodiversity protection or pollution reduction. Sustainable finance covers green finance and investments that support social, economic, and governance goals.</footnote>
A lack of appropriate business models slows, for instance, the electrification of road transportation, while high investment costs stand in the way of developing new low-carbon buildings (CPI 2022). Progress could be facilitated by lifting barriers to enable spending in these emission reduction solutions.

Scaling up investment in adaptation is also crucial. Adaptation finance that has been tracked has been growing faster than mitigation finance (with annual growth rates at 16.7 percent versus 6 percent in the past decade; CPI 2022), but it still represents the smaller portion of reported climate finance. Part of the reason is that mitigation finance is far easier to measure. Nonetheless, there is room to include more adaptation components in new projects.

The rest of this chapter provides a deeper analysis of climate finance flows in Latin America and the Caribbean, examines the different actors supporting climate investments, and explores the different financial instruments they can use to channel and attract further capital.

## The Lay of the Climate Finance Land

The United Nations Framework Convention on Climate Change (UNFCCC) recognizes that developed countries, which have, historically, been responsible for more than half of greenhouse gas emissions, should provide financial assistance to poorer, more vulnerable countries. In accordance with this principle, developed countries pledged to meet a target of US$100 billion per year in financing for climate mitigation and adaptation in developing countries by 2020.

## Official Support to Climate Change

Developed countries provide climate aid through three main channels. They endow multilateral climate funds (Box 12.1); they instruct bilateral development agencies, such as the French Development Agency or the German Kreditanstalt fuer Wiederaufbau (KfW), to spend more on climate solutions; and they vote, through their shares in the boards of multilateral development banks, for the banks to finance more projects with climate benefits.

According to the latest estimate from the Organisation for Economic Co-operation and Development (OECD), Latin America and the Caribbean received US$12.5 billion in climate aid in 2020, or 17 percent of the global amount that year.<fnref n="2" /> Globally, developed countries provided US$90 billion in climate aid

<footnote n="2">² For comparison, the region hosts about 10 percent of the population of the developing world, generates 16 percent of its GDP, and, depending on the definition used, is home to between 4 and 8 percent of the global population living in poverty (Kofi Tetteh Baah et al. 2023).</footnote>
Box 12.1. Multilateral Climate Funds

One way developed countries provide climate aid to developing countries is through multilateral climate funds. The Green Climate Fund (GCF), for instance, was created in 2009 specifically to serve the goals of the UNFCCC; it is committed to spending on mitigation and adaptation in equal amounts. Similarly, while the Global Environmental Facility (GEF), established in 1991, serves the goals of the UNFCCC, it has a broader mandate that also covers the goals of other UN conventions on biodiversity and desertification. These funds do not disburse money directly to selected projects. Instead, they work through accredited intermediaries, which typically include multilateral, bilateral, and national development banks.

Other multilateral funds are endowed by developed countries to provide climate finance but operate independently from the UNFCCC. The largest one in the region is the Clean Technology Fund (CTF), an MDB-administered fund focused on low-carbon technology. Not all funds are endowed by developed countries, however. While Germany and Norway have contributed to the Amazon Fund, for instance, it is funded mainly by the national oil company Petrobras and the government of Brazil. It provides grants to reduce deforestation and promote conservation in the Amazon rainforest.

Together, the GCF, CTF, Amazon Fund, and GEFs provided 77 percent of the resources received by Latin America and the Caribbean from multilateral climate funds between 2003 and 2020 (Figure B12.1.1). Multilateral funds deliver a small share of climate finance in the region—they approved US$556 million in 2020 (Watson, Schalatek, and Evéquoz 2023). This small number, however, masks the fact that these funds tend to rely on a relatively larger share of grants and subsidized loans than other providers of climate finance do.

<figure><img src="image_112.png" /><figcaption>**Figure B12.1.1.** Multilateral Funds Supporting Latin America and Caribbean, 2003–20</figcaption></figure>

Source: IDB staff based, on Watson and Schalatek (2021).
<figure><img src="image_113.png" /><figcaption>**Figure 12.1.** The Sector Distribution of Climate-Related Overseas Development Assistance, 2021</figcaption></figure>

Source: IDB staff, based on OECD data.

Note: The unspecified category (18 percent of climate finance) primarily comprises confidential private sector projects that cannot be further disaggregated. The figure shows raw financial flows. Contrary to what OECD (2023) does, it does not discount financing from multilateral institutions to reflect that some of their shares are held by Latin American and Caribbean actors.

to developing countries in 2021 (OECD 2023). While the latest data have not yet been fully processed, preliminary findings indicate the US$100 billion target was reached, albeit two years late, in 2022 (OECD 2024a).<fnref n="3" />

In 2021, development partners financed projects with climate benefits in a variety of sectors (Figure 12.1), some of which, such as energy and transportation, were more likely to contribute to mitigation, while others, such as general environmental protection, agriculture, forestry, and fishing, were

<footnote n="3">³ Importantly, when computing these figures, the OECD discounts financial flows from multilateral development banks and multilateral funds to take into account that only some of the finance provided by multilateral institutions is attributable to developed countries. If the Inter-American Development Bank, for instance, lends US$100 million to Colombia to finance renewable energy deployment (a loan that would be counted 100 percent as climate mitigation finance), the OECD only counts about US$74 million. Since the IDB receives financial contributions from both developed and developing countries, the OECD estimates that about US$26 million of that loan represents a financial flow between developing countries.</footnote>
<figure><img src="image_114.png" /><figcaption>**Figure 12.2.** Geographical Distribution of Climate-Related Overseas Development Assistance, 2021</figcaption></figure>

Source: IDB staff, based on OECD (2023) data.

Note: Values at the top of each bar represent the ratio of climate-related finance to the regional GDP in 2021. Values within each bar sum to 100 percent for each region.

more likely to contribute to adaptation. While most projects focused on a specific sector, such as energy (accounting for 12 percent of climate finance) or transportation (10 percent), almost a third comprised projects strengthening the capacity of government and civil society, projects with multisector purposes, and projects targeted to environmental protection in general.

When expressed as a percentage of its GDP, the Caribbean receives the most climate finance from development partners (Figure 12.2). In 2021 it received 0.93 percent of its GDP, more than the Andean countries (0.62 percent), Central America (0.24 percent), or the Southern Cone (0.16 percent).<fnref n="4" /> The countries in the region that receive the most climate aid as a share of GDP are Honduras, Nicaragua, and Costa Rica, while Brazil, Mexico, and Suriname receive the least. The Caribbean is also the only region where most climate finance is tagged for adaptation—but, importantly, adaptation and

<footnote n="4">⁴ The Caribbean group is composed of the following: Antigua and Barbuda, the Bahamas, Barbados, Belize, Cuba, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Suriname, and Trinidad and Tobago. The Andean region comprises Bolivia, Colombia, Ecuador, Peru, and Venezuela. The Central America group includes Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, and Panama, and the Southern Cone group consists of Argentina, Brazil, Chile, Paraguay, and Uruguay.</footnote>
Box 12.2. Apples to Oranges: Measuring Adaptation and Mitigation Finance

In Latin America and the Caribbean, most climate finance is reported as mitigation. Direct comparisons between mitigation and adaptation finance is complicated, however, by the differing approaches to counting them.

Mitigation finance tracking relies on a standardized list of approved activities, such as investments in renewable energy or electric vehicles (IDB et al. 2023). All projects in the list are automatically counted as mitigation finance, regardless of the objectives of the project. Most renewable energy projects, for instance, are financed by private corporations interested in selling electricity at a profit. The full cost of these projects is counted as climate mitigation finance by third parties who compile global databases of renewable power investment (CPI 2023).

In contrast, there is no closed list of what constitutes adaptation. For an investment to count as adaptation finance, investors have to demonstrate they have identified a climate risk, state an intention to reduce the risk, and present a detailed budget that shows what fraction of the cost corresponds to adaptation (Larsen, Brandon, and Carter 2022). This means many adaptation projects may not be declared as such, and, among those that are, only a portion of their cost counts toward adaptation.

Finally, there is no widely used process to count adaptation finance from governments and the private sector (CPI 2023). Most of the available data come from development banks that track and report adaptation finance in their operations, while most governments, commercial banks, firms, and individuals simply do not count or report it. Surveys and mandatory disclosure could remedy this and enhance adaptation finance tracking.

mitigation finance are counted very differently and cannot be directly compared (Box 12.2).

Are development partners financing more mitigation projects in countries with high emissions and more adaptation in those more vulnerable to climate change? Figures 12.3 and 12.4 examine these relationships.

As the figures show, almost no correlation exists between mitigation investments and emission intensity. In fact, many factors influence the decisions by development partners to spend on mitigation in a given country. Take the Clean Development Mechanism (CDM), a UNFCCC rule that allows developed countries to earn credits to meet their emission reduction targets by investing in reduction projects in developing countries. Familiarity factors, such as a colonial history, bilateral trade, and bilateral aid, strongly influence CDM project location (Dolšak and Crandall 2013). And while Halimanjaya (2015) finds that countries with higher CO₂ intensity and larger carbon sinks
<figure><img src="image_115.png" /><figcaption>**Figure 12.3.** Relationship between GHG Emissions and Mitigation Finance, 2013–20</figcaption></figure>

Source: IDB staff, based on Climate Watch and OECD data.

Note: The vertical axis shows the average ratio of mitigation finance to GDP between 2013 and 2020. The horizontal axis shows the average ratio of emissions to GDP in the same period. Both variables are expressed on a logarithmic scale. All Kyoto GHGs are included (CH$_4$, CO$_2$, N$_2$O, and F gases). Green markers correspond to Latin American and Caribbean countries. The Bahamas, Barbados, Trinidad and Tobago, and Venezuela are not included due to data issues. The regression line in Panel A has a slope of -0.04 and an R-squared of 0.008, while the slope of the regression line in Panel B is 0.03 with an R-squared of 0.02. These values should not be interpreted as a causal relationship but, rather, as a correlation between the variables of interest.

tend to receive more climate mitigation finance from development partners, so do countries with lower GDP per capita and better governance.

On the other hand, although countries with higher climate vulnerability (as measured by the ND-GAIN index; Chen et al. 2023) tend to receive more
<figure><img src="image_116.png" /><figcaption>**Figure 12.4.** Relationship between Countries' Vulnerability Index and Adaptation Finance, 2013–20</figcaption></figure>

Source: IDB staff, based on ND GAIN Index and OECD data.

Note: The vertical axis shows the average ratio of adaptation finance to GDP between 2013 and 2020 on a logarithmic scale. The horizontal axis reports the vulnerability index, which comes already normalized by ND GAIN. Blue markers correspond to Latin American and Caribbean countries. Averages for Chile and Uruguay include data up to 2017. Barbados, the Bahamas, the Grenadines, Saint Vincent, Trinidad and Tobago, and Venezuela are not included due to data issues. The regression line in Panel A has a slope of 2.6 and an R-squared of 0.24, while the slope of the regression line in Panel B is 1.7 with an R-squared of 0.03. These values should not be interpreted as a causal relationship but, rather, as a correlation between the variables of interest.

adaptation finance, this, like mitigation finance, also depends on other factors. In Malawi, the areas most in need receive relatively little adaptation finance, which tends to go instead to areas where donors are already active and places are able to absorb capital (Barrett 2014). In Sub-Saharan Africa,
adaptation finance tends to depend on the democratic characteristics of the recipient country and on a prevailing donor-recipient relationship, with vulnerability not being a factor (Robertsen, Francken, and Molenaers 2015). Most recently, Han and Cheng (2023) found that the likelihood of a country's receiving climate change-related financial aid, for both mitigation and adaptation, was significantly enhanced by its having submitted climate plans to the UNFCCC, the quality of its budget, and the quality of its public administration.

In Latin America and the Caribbean, the level of political stability and the degree of development of the credit market are the strongest predictors of how much climate finance a country receives from multilateral development banks (Lisazo, Meirovich, and Yañez-Pagans, forthcoming). Climate risk and GHG emissions are not significant determinants after controlling for other factors.<fnref n="5" /> In contrast, bilateral climate aid does seem to be targeted toward vulnerable countries and countries with higher capacity to invest in adaptation actions, as measured by NDGAIN (Chen et al. 2023).

## Climate Finance Beyond Official Support

The US$100 billion per year that developed countries have pledged toward climate action will necessarily fall short of financing all the actions entailed by the goals of the Paris Agreement. There are many different estimates, but all agree that the needs are far higher. The Climate Policy Initiative, for instance, estimates that around US$10 trillion is needed per year to reach a global net-zero, climate-resilient economy by 2050 (CPI 2023). In Latin America and the Caribbean, Galindo Paliza, Hoffmann, and Vogt-Schilb (2022) find that US$470 billion to US$1,300 billion is needed per year.

The good news is that reaching climate goals does not necessarily require additional investments; climate action is often about spending differently rather than spending more (Galindo Paliza, Hoffmann, and Vogt-Schilb 2022). Building a new road farther from the coast, for example, to avoid flooding as a result of sea-level rise can be cheaper than building the same road by the beach and then spending more to build protection. In addition, some types of spending can reach several development goals at the same time. Since, for instance, the poorest households are often the most vulnerable to climate change (Chapter 3; Chapter 14),

<footnote n="5">⁵ Regressions were estimated using total climate finance per unit of GDP as the outcome variable and controlling for country and year fixed effects, GDP per capita, domestic credit to the private sector, annual GDP growth, political stability, regulatory quality, voice and accountability, innovation, GHG emissions per unit of GDP, and an estimate of the disaster risk in each country.</footnote>
spending on social protection can both reduce poverty and improve resilience (Hallegatte et al. 2016).

In addition, development partners are not the only ones that spend on climate action. In every country, domestic governments, firms, and households do, as well. This is demonstrated by the Climate Policy Initiative, which compiles data from development partners, similar to those used in the previous section, and surveys national development banks and public and private banks to calculate their climate spending (CPI 2023). CPI also reviews comprehensive databases of projects in key climate mitigation sectors, such as renewable energy and electric vehicles, to assess public and private spending on these activities. Importantly, these databases contain few if any activities that would qualify as adaptation to climate change (see also Box 12.2).

In Latin America and the Caribbean, CPI recorded US$52 billion in climate finance, on average, in 2021 and 2022 (CPI 2023), of which public and private sources provided about the same amount (Figure 12.5). On the public sector side, 39 percent of total climate finance came from multilateral and bilateral development banks. Governments, national development finance institutions, and the resources of state-owned banks accounted for 10 percent and multilateral climate funds for just 1 percent. On the private sector side, corporations were the leading source (27 percent), followed by

<figure><img src="image_117.png" /><figcaption>**Figure 12.5.** Average Climate Finance Flows in Latin America and the Caribbean, by Provider, Financial Instrument, and Use, 2021–22</figcaption></figure>

Source: IDB staff, based on information publicly available from the Climate Policy Initiative.

Note: DFI stands for Development Finance Institution.
commercial financial institutions, such as banks (14 percent) and house-
holds or individuals (9 percent).

A broad set of financial instruments supports climate finance in the region (Figure 12.5). Debt is the most used, accounting for 59 percent of total climate investments. The largest fraction of total climate finance (31 per- cent) comes from project-level market-rate debt—that is, loans taken by a firm to fund a specific project; an example would be a utility taking a loan from a commercial bank to fund a solar panel project. Another 22 per- cent of projects are financed by low-cost project debt. These are loans at below-market rates, often provided by development banks. Coming third (comprising 6 percent) is debt under the balance sheet—that is, market- rate loans taken by companies not attached to a particular project. Equity finances 36 percent of climate investments in the region; examples might include a household using its savings to buy an electric vehicle or a cor- poration using funds raised through the sale of stock shares to renovate the buildings it uses. Finally, grants, such as subsidies from governments or multilateral funds, account for 4 percent of total climate finance.

How MDBs Can Step It Up

While multilateral development banks currently provide only about a third of total climate finance flows in the region, they can play a big role in help- ing bridge the climate financing gap.

Perhaps the most obvious way they can contribute to meeting climate goals is by directly financing projects that help reduce emissions or build resilience to climate change. A key advantage they hold over market alternatives is the lower-cost financing they provide (Prizzon, Josten, and Gyuzalyan 2022). In addition to using their own funds, MDBs can help countries get access to multilateral climate funds (Box 12.1). They can also combine different financing sources, such as grants from international donors and loans from their own capital, to lower financing costs further.

Redirecting Public and Private Sector Spending

Fundamentally, the climate financing gap greatly exceeds the finan-
cial capacity of multilateral development banks. MDBs lend between
US$40 billion and US$45 billion a year to Latin American and Caribbean
countries, ten to thirty times less than total climate spending needs (Galindo
Paliza, Hoffmann, and Vogt-Schilb 2022). Part of the solution could be to
expand their scope and lending power, as called for by the Bridgetown Ini-
tiative (Box 12.3). But even as MDBs have been able to mobilize growing
Box 12.3. The Bridgetown Initiative

The Bridgetown Initiative is an ambitious plan proposed by the prime min-
ister of Barbados, Mia Mottley, to reform the global financial system so it can
better address the challenges faced by developing countries, particularly in
the context of climate change and mounting debt crises. The initiative seeks
to transform how financial support is provided to developing countries, espe-
cially those subject to severe climate-related impacts.

The following are among the key proposals, as set forth in a 2023
communiqué issued by the United Nations:

* Provide immediate liquidity support including rechanneling at least $100 billion of unused Special Drawing Rights through the IMF and multilateral development banks.

* Restore debt sustainability today and in the long term and support countries in restructuring their debt with long-term low interest rates.

* Dramatically increase official sector development lending to reach $500 billion annual stimulus for investment in the SDGs (SDG Stimulus).

* Mobilize more than $1.5 trillion per year of private sector investment in the green transformation.

* Transform the governance of international financial institutions to make them more representative, equitable and inclusive.

* Create an international trade system that supports global green and just transformations.

Source: UN 2023.

resources to finance projects with climate goals—US$9.8 billion in 2021, up
from US$6.7 billion in 2020 (IDB et al. 2023)—direct investment will likely
never be enough.

MDBs can use their limited funds to help countries redirect public
and private spending toward climate solutions. To help enable developing
countries to spend on climate needs, MDBs can mobilize their recognized
comparative advantages by providing policy advice and technical assis-
tance, carrying out research, and convening different actors toward a
common goal (Prizzon, Josten, and Gyuzalyan 2022).

In the public sphere, a key goal should be to help governments inte-
grate climate objectives into strategic planning. MDBs can assist in
designing policies that promote decarbonization and climate adaptation
as development goals (Jaramillo and Saavedra 2021). For example, they
can help governments develop long-term climate strategies and update
their nationally determined contributions (NDCs) in line with the Paris
Agreement, providing technical assistance and incentives through policy-
based loans (Jaramillo et al. 2023).

MDBs can also strengthen climate governance by helping countries clarify roles across sectors and government levels to meet long-term climate targets. Many governments lack preparation in this area (Jaramillo et al. 2024). MDBs can assist in establishing climate coordination agencies and integrating climate offices into relevant ministries (Mosqueira and Alessandro 2023).

Additionally, MDBs can create an environment for climate action by
addressing barriers like inadequate infrastructure or regulation (Chapter 9).
They can support reforms in public procurement or permitting processes
to encourage investments in clean energy or electric buses. MDBs can also
mitigate first-mover risks in climate projects by offering financial solutions,
such as loans with favorable terms (Smallridge 2017), or by helping govern-
ments set up revolving funds for climate projects.

Finally, MDBs can help public and private sectors incorporate climate
change into project design and selection (Delgado et al. 2023), using tools
like risk assessments, project evaluation, and climate-resilient procure-
ment guidelines to address adaptation needs, such as drought or heatwave
mitigation.

Despite the importance of redirecting public and private flows to
achieve climate targets, an IDB analysis finds that few MDBs do so. Only
about 20 percent of climate finance from MDBs goes toward redirecting
investment by improving climate strategy, developing climate policy, or
supporting project design at the pre-investment stage. Around 80 percent
goes to financing climate solutions directly, using either their own funds or
leveraging multilateral funds (Figure 12.6).

Helping Governments Plan

How should MDBs prioritize their actions to help governments finance
climate solutions? One option is to rely on country-led *climate finance
strategies*, a framework that starts by quantifying the investments required
to achieve climate-related objectives and then identifies domestic and
international resources, from both the public and private sectors, to finance
them (Jaramillo et al. 2024).

A key action will often be to help countries design their financial strate-
gies, which, presently, only five countries in Latin America and the Caribbean
have (Jaramillo et al. 2024). Worse, while all countries in the region have
presented NDCs, only eight have also presented long-term climate strat-
egies (LTSs; see Chapter 9), and only six have climate change investment
plans that make explicit what investments can be undertaken to advance
<figure><img src="image_118.png" /><figcaption>**Figure 12.6.** Type of Support Provided by Multilateral Development Banks, 2022</figcaption></figure>

Source: IDB staff based on data from IDB et al. (2022).

the goals in either document. The first step to financing climate action is to
define specific actions consistent with long-term goals.

MDBs can also help countries estimate the costs and benefits of cli-
mate investments. While ministries of finance in the region agree that
estimating the cost of meeting NDCs is important, only a few have done so
(Jaramillo et al. 2024). A detailed sector-by-sector cost analysis would help
identify funding sources. Policymaking should prioritize interventions that
offer development benefits, yet many studies focus solely on gross costs.
The experience from developed economies is that LTSs and NDCs can be
better aligned with other sustainable development objectives.

MDBs can help governments introduce new instruments and processes throughout the budget cycle to ensure public spending is consistent with climate goals. The region has made progress in identifying public spending on climate change. But for this information to be useful, it needs to be connected with the existing budget management systems and with national climate goals (Pizarro et al. 2022).
MDBs should also strengthen the knowledge base and promote col-
laboration among countries. While none of the region's climate finance
strategies have undergone impact evaluations (Jaramillo et al. 2024), coun-
tries benefit from cooperation, such as through the Regional Climate
Change Platform of Economy and Finance Ministries. This collaborative
effort enhances knowledge exchange, accelerates learning, and strength-
ens institutional capacities.

Finally, the climate finance strategies governments design should seek to enable private spending, too. MDBs can inform financial strategies by measuring the risks and returns for investors of new technologies, diagnosing whether existing regulatory environments facilitate or hinder business models, and supporting consultation processes with all stakeholders.

Financing the Private Sector

As well as working with governments, multilateral development banks
engage directly with businesses and corporations, using loans and techni-
cal cooperation with firms (see below) to help increase the private financing
of climate solutions.

The most obvious function of MDBs is to make resources available to
finance the upfront cost of different projects. In addition to lending money
from their own capital, MDBs can use a variety of financial instruments for
this purpose (Ehlers et al. 2022).

**Structured finance vehicles** are legal entities created to manage the issuance of complex financial instruments. One example is a green bond fund that was created by the International Finance Corporation (IFC), part of the World Bank Group, and Amundi, Europe's largest asset manager. The fund pooled green bonds issued by financial institutions in various emerging and developing economies, and IFC purchased a first-loss equity tranche of this fund (which means IFC's capital would be the first to be lost if the fund did not perform well). This reduced the credit risk of other investors and encouraged pension funds to invest.

**Blended finance** combines cheap official development assistance money with more expensive private resources. This can help reduce the risk of infrastructure investments or other complex projects. IDB Invest, for instance, the private sector arm of the Inter-American Development Bank Group, used blended finance to support the first four wind and solar projects in Uruguay from 2014 to 2016. In 2020, commercial banks and institutional investors entered into the scheme by refinancing the projects at more attractive prices, demonstrating how an MDB's initial intervention could result in a change in risk and movement in the market.
**Outcome-based sustainable debt instruments**, such as sustainability-linked bonds, help firms or governments align with sustainability targets, such as GHG emission reductions. MDBs may provide support in the design and issuance of these instruments, participate as issuers themselves, or provide debt instruments for the private sector to invest in projects that meet the targets. IDB Invest, for example, worked with Bancolombia on the issuance of the first sustainability-linked bond by a bank in the region. More specifically, it led the design, conceptualization, and identification of the project's key performance indicators (KPIs).

## Providing Technical Assistance

What support can MDBs offer the private sector, other than providing financing? As a first step to answering this question, an IDB Invest study analyzes its own current practice. It finds that, between 2016 and 2022, 69 percent of climate finance investments included a technical assistance component.<fnref n="6" /> Of these, 30 percent were targeted to financial intermediaries that developed green financial products, while 70 percent were allocated to clients in the real economy—for instance, infrastructure, energy, agribusiness, manufacturing, or tourism companies. In terms of when during the project cycle the technical assistance was provided, 27 percent of cases involved preparation work prior to MDBs' engaging in a financial operation with the company, while in 73 percent of cases assistance was offered with structuring a financing operation.

The analysis shows that technical assistance targeted to the private sector can fall into one of three categories:

* *Increasing the supply of climate projects*, by supporting pre-investment activities to accelerate the planning and design of private sector projects, increase companies' internal capacities regarding climate, or define sound business models

* *Supporting market development*, by supporting the design of first-of-their-kind projects that create demonstration effects, as well as developing standards and taxonomies for greater transparency and more efficient resource allocation in certain markets

* *Attracting private investors*, by reducing the risk of certain investments, supporting the structuring of blended finance

<footnote n="6">⁶ During this timeframe, IDB Invest supported more than 300 clients with technical assistance while investing over US$7 billion in climate finance toward mitigation and adaptation projects across companies, financial institutions, and infrastructure and energy sectors.</footnote>
operations, or facilitating the acquisition of data or knowledge to guide investors' decisions

The three categories are not mutually exclusive. A project that has, for instance, benefited from technical assistance to improve a business model can also be the first of its kind in a specific market and require blended finance.

As shown in Table 12.1, most technical assistance provided to mobilize private capital has been devoted to increasing the supply of climate projects (83 percent), followed by market development (31 percent) and investor attraction (12 percent). Within each of these categories, different activities have been deployed with varying levels of importance or intensity. To increase the supply of climate projects, for example, technical assistance has involved producing studies that help reduce the perceived risks of certain projects (51 percent), support the preparation of specific projects (30 percent), or build a company's climate-related capacities (19 percent).

The IDB Invest analysis shows the important role of technical assistance in supporting and scaling up private climate investments. The support provided is diverse and sophisticated, which shows that there is more than one set of solutions, and that a combination of actions is needed to mobilize private capital. As no rigorous evidence is yet available on the effectiveness of these instruments or how the results obtained compare with each other, further research is needed on this front.

## Green Debt Markets

Private firms and governments both use bonds to finance their investments. Green bonds, which are issued specifically to finance or refinance projects

<table><caption>**Table 12.1.** Types of Technical Assistance Provided to Mobilize Private Capital</caption><thead><tr><th>Supply of climate projects (83%)</th><th>Market development (31%)</th><th>Attracting investors (12%)</th></tr></thead><tbody><tr><td>Increasing climate-related capabilities of companies:<br><strong>19%</strong></td><td>Design first of their kind projects:<br><strong>42%</strong></td><td>Structuring of blended finance operations:<br><strong>71%</strong></td></tr><tr><td>Developing studies to reduce project uncertainty:<br><strong>51%</strong></td><td>Develop market standards and taxonomies:<br><strong>58%</strong></td><td>Data and knowledge products for investors:<br><strong>29%</strong></td></tr><tr><td>Project preparation:<br><strong>30%</strong></td><td></td><td></td></tr></tbody></table>

*Source:* IDB staff, based on IDB Invest portfolio data.

*Note:* Percentages in each of the three levels do not add up to 100 percent, as one technical assistance project could contribute at more than one level.
that support climate or other environmental goals, will thus become more and more common (Ehlers et al. 2022). Between 2007 and 2020, the issuance of green bonds globally nearly doubled every year, reaching a cumulative US$1 trillion (CBI 2023a).

While MDBs have played a key role in creating green bond markets at the global level,<fnref n="7" /> the private sector has fueled this market in recent years. In 2022, large companies issued 54 percent of global green bonds (CBI 2023c). Since green bonds have emerged in countries with better-developed domestic capital markets and access to international bond markets (Stevenson 2023), countries willing to use them should focus on developing and strengthening local markets, as well as improving investor confidence in environmentally friendly projects. MDBs can facilitate this, especially in small economies (ECLAC 2017).

Although the subject of this chapter is climate finance, the data available on thematic bonds are not granular enough to distinguish between those that have supported only climate investments and those that support a broader set of investments with environmental benefits. That said, the data suggest that, in Latin America and the Caribbean, most of these funds have financed climate mitigation projects. Between 2014 and 2022, 53 percent of cumulative issuances supported the financing of renewable energy projects, 23 percent efficient transportation, and 10 percent land use (for instance, investment in low-carbon agriculture; CBI 2023b).

## Green Bonds in the Region

Between 2014 and 2022, the issuance of green bonds in Latin America and the Caribbean accounted for less than 2 percent of those issued globally (CBI 2023b). The region issued US$3 billion in 2022, while Europe issued US$229 billion and Asia-Pacific countries US$133 billion.

Green bonds issuance in the region was initially driven by the private sector. The first bond was issued in 2014 by Energía Eólica, a Peruvian company, to finance the construction of two wind farms (CBI 2019). Twelve countries issued green bonds between 2014 and 2021, with issuance peaking in mid-2021. Brazil, Chile, and Mexico have been among the top issuers (Figure 12.7). Green bonds have mostly targeted the energy sector (52 percent of the cumulative total issuance so far), followed by transportation (23 percent), land use and forest management (10 percent), and green buildings (6 percent; CBI 2023b).

<footnote n="7">⁷ The first green bond was issued in 2007 by the European Investment Bank (EIB), and the World Bank issued its first green bond in 2008.</footnote>
<figure><img src="image_119.png" /><figcaption>**Figure 12.7.** Green Bonds Issuance, by Country and Year</figcaption></figure>

Source: IDB staff, based on CBI (2023b).

Sovereign green bonds—those issued by national governments—have taken longer to materialize. As of 2021, Chile and Colombia were the only countries to have issued these bonds.

Since 2020, the annual issuance of green bonds in Latin America and the Caribbean has been diminishing, showing that the regional focus is shifting from funding purely environmental projects toward broader projects that also address social and sustainability issues. By 2022, green bonds accounted for 13 percent of the annual issuance of thematic bonds, with sustainability bonds (which include green and social categories) comprising 51 percent and social bonds 12 percent (see Figure 12.8). The COVID-19 pandemic was behind the increased issuance of social bonds, which were key to financing relief packages (CBI 2021).

A new type of bond comprises 23 percent of issuance: sustainability-linked bonds. With these, the issuer defines targets in advance, such as producing 35 percent of its energy from renewable sources by 2035. At maturity, the issuer pays penalties to bond holders if the target has not been met (or, equivalently, bondholders pay the issuer if the target has been met). These bonds became popular in 2020 after the International Capital Market Association published guidelines on how to issue them (Núñez Reyes, Veloso, and Da Silva 2022).
<figure><img src="image_120.png" /><figcaption>**Figure 12.8.** Thematic Bond Issuances by Theme</figcaption></figure>

Source: IDB staff, based on CBI (2023b).

Despite the decrease in green bonds, sustainability and sustainability-linked bonds are also funding projects that have climate benefits. In addition, new types of bonds have emerged, such as transition bonds, which are connected to debt coming from entities operating in the hard-to-abate sectors, such as metals and mining.<fnref n="8" /> Up to 2022, transition bonds originating from the region amounted to 1 percent of the thematic bond volume, or US$770 million (CBI 2023b). Finally, innovative schemes encourage the issuance of infrastructure bonds by private companies, as in the case of incentivized bonds in Brazil (Box 12.4).

## The Premium in Greenium?

The term “greenium”—a portmanteau combining “green” and “premium”—refers to the pricing advantage sustainable or green bonds may enjoy over conventional bonds. This is reflected in a negative premium in the yield difference between green and equivalent non-green bonds with

<footnote n="8">⁸ A transition bond has use of proceeds earmarked for activities that are not low- or zero-emission (that is, not green), but have a short- or long-term role to play in decarbonizing an activity or supporting an issuer in its transition to Paris Agreement alignment.</footnote>
Box 12.4. Incentivized Infrastructure Bonds

In 2011, the government of Brazil became the first in the region to introduce a framework for the issuance of infrastructure bonds by private companies to promote the development of long-term private capital markets and strengthen financing for infrastructure projects. These novel instruments, known as incentivized bonds, offer income tax exemptions conditioned on using funds to finance infrastructure expenditures. Incentivized bonds have a minimum duration at issuance of four years, are denominated in Brazilian Reais, and are primarily indexed to the Extended Consumer Price Index (IPCA). They also evidence moderate spreads over Brazilian Treasury bonds of similar duration.

Since the first issuance in 2012, Brazil's infrastructure bond market has become a significant source of financing for infrastructure projects, with a relatively low default rate—attributed to guarantees from sponsors and collateralization of receivables—and potential for further expansion. Despite its success, however, no other countries in the region have adopted similar approaches. Since the lower default risk of local currency bonds can be attractive to investors, the countries might consider emulating Brazil's approach to financing climate change-related infrastructure projects and match the currency of revenues from those projects, especially in sectors like transportation, water, and telecommunications.

Source: Borensztein, Cavallo, and Pereira Dos Santos 2022.

similar characteristics, such as maturity, issuer credit quality, and liquidity. A greenium may arise from such factors as growing environmental awareness among investors and higher demand for sustainable or green bonds; supportive government policies; or the scarcity of green investment opportunities. As the market for green investments evolves, the dynamics of supply and demand will continue to influence the magnitude of the greenium (Bachelet, Becchetti, and Manfredonia 2019; Ghosal, forthcoming).

Recent research finds a greenium fluctuating between 4 and 11 basis points (Caramichael and Rapp 2022; Benincasa et al. 2022; Ando et al. 2024). This means that if a normal bond costs 1.2 percent per year, a green bond might cost 1.13 percent. Greeniums depend on the issuer's transparency and credibility in communicating its environmental commitment, which helps mitigate risks of greenwashing. The issuer's reputation and the certifying agency's credibility are essential to establishing a greenium (Kapraun et al. 2021; Pietsch and Salakhova 2022). Additionally, Caramichael and Rapp (2022) have attributed the emergence of greeniums in bond markets since
2019 to the development of institutional frameworks that ensure genuine green investments.

Ramos and Vasa (forthcoming) suggest that in Latin America and the Caribbean, green bonds were less affected than conventional bonds during the COVID-19 pandemic; this can be ascribed to the long-term commitment of green investors. Furthermore, the concept of greenium extends beyond bond markets. Avellán et al. (forthcoming) explore the existence of a greenium in loan financing for infrastructure projects, particularly renewable energy. Their findings indicate a potential greenium in loan markets, as loans for renewable energy investments tend to have marginally lower interest rates than similar, nonrenewable projects.

## More Transparency, Less Greenwashing

Scaling up green finance requires reducing the incentives for greenwashing. If firms that are not green can pretend to be green easily (without incurring costs), green financial products have no signaling value to investors (Schmittmann and Gao 2022). Reducing greenwashing requires more guidelines, disclosures, fines for false information about green credentials and emissions, and effective validation and screening processes both before and after issuance. Progress is being made on these issues, but there is room for improvement.

Regulators can provide guidance through taxonomies—that is, classification systems that identify and define activities, assets, or investment projects with positive environmental impacts, based on established goals and criteria. Taxonomies can contribute to local market growth by establishing precise and consistent definitions for sustainable activities, which encourages investment and better tracking of sustainability financing flows. Given that the issuance of green bonds is more costly than conventional bonds as a result of reporting requirements, consultancy fees, and the need for external verification of green credentials, countries like Japan and Singapore have begun providing subsidies to issuers, accompanied by strong disclosure requirements, regulations, and screening to avoid greenwashing (Schmittmann and Gao 2022).

In the past few years, initiatives have emerged in Latin America and the Caribbean to support greater transparency in green bond markets. One of these has been the Green Bond Transparency Platform, launched in 2021, which provides investors with credible, comparable, and consistent information about green bonds. It also serves to provide a benchmark to best practice disclosure for issuers, investors, and regulators; and issuers can request external review through the platform. And, in July 2023,
ten international development institutions launched a Common Taxonomy Framework for Latin America and the Caribbean, to enhance comparability and ensure interoperability of sustainable finance taxonomies in the region (CBI 2023b).

## Much Progress, But More to Be Done

While the measurement of climate finance comes with many challenges, recent years have brought substantial progress in standardizing definitions and systematizing information. The available data highlight that climate finance is still well below the levels required to achieve climate change goals. In Latin America and the Caribbean, a broad set of actors is involved in deploying climate-beneficial investments, using a large set of financial instruments to attract and channel resources. More remains to be done, however, and more coordinated actions from public and private sector actors are urgently needed to increase climate finance flows.

Climate investments also need to cater to wider needs. Within mitigation finance, this means funding more solutions than just renewable energy. Channeling more concessional flows toward developing economies, particularly to the most vulnerable and those with the largest potential impacts, is also imperative. For this to be possible, more evidence is needed on the impacts achieved by these investments to guide the allocation of resources to the most cost-effective approaches.

This chapter has also discussed the important role MDBs can play in climate finance. On the one hand, they facilitate access to funds, both to governments and the private sector, to support climate investments. On the other, they are relevant in their role of supporting the public sector in better planning and designing climate investments and in providing incentive to the private sector to invest in climate change. MDBs can also use their capital in a smart way to crowd in private investors and create new markets, such as was the case for green bond markets.

MDBs are scaling up their ambition in terms of climate change targets and have devoted substantial resources to setting standardized methods for tracking climate finance. They also work directly with the private sector, helping corporations develop innovative financial instruments, such as structured vehicles that allocate the most risk to the actors most willing to take it, or green and sustainable bonds. For this progress to continue, more analysis is needed on the costs and benefits of these innovations. MDBs can be at the forefront of such efforts, and of others, to finance emission reduction and adaptation to the impacts of climate change.
# Cities: A Hot Spot in the Fight against Climate Change

Cities in Latin America and the Caribbean will experience the geophysical effects of climate change through increased flooding, heat islands, and changes in water security, along with socioeconomic effects. Informal settlements are particularly vulnerable, as they are often located in high-risk areas and have poor infrastructure services. Cities can adapt by improving the conditions in informal settlements through early warning systems, voluntary resettlements, and neighborhood upgrades. They can improve adaptation and mitigation more broadly by enacting building codes and zoning regulations, implementing policies that induce behavior change among residents, and providing urban green spaces. Finally, cities can drive progress through coalitions that exchange knowledge and best practices and increase coordination.

Cities are development engines. Those in Latin America and the Caribbean are home to most of the region's economic activity, critical infrastructure, cultural assets, and social and administrative institutions. More than 85 per cent of its population will be urban by 2050, the highest percentage among all developing-country regions (UN DESA 2019).

Efforts both to mitigate emissions and adapt to the effects of climate change need to center on cities. Globally, 70 percent of greenhouse gas (GHG) emissions are generated in cities (Mahendra et al. 2021), and most of the adverse climate change effects will be concentrated there. Because infrastructure has not kept up with the surge of new residents, rapid urbanization has increased vulnerability and exposure (Mahendra et al. 2021), making climate change events riskier.

The concerns and needs of cities traverse many sectors, some of which have been touched upon in other chapters of this book. These include health, education, mobility, and infrastructure (Chapters 3 and 7) and decarbonization (Chapters 8 and 9). This chapter deals with climate topics
inextricably and explicitly linked to cities that have not previously been covered. In particular, it discusses the impacts of climate change on cities, the policies available to cities to address the climate challenge, and how cities can lead the way in climate action by building strong coalitions to exchange knowledge, experiences, and good practices.

## Hotter, Wetter, More Vulnerable

While climate change has multifaceted adverse impacts that differ across geographies, it will present many cities with common challenges. The geo-physical phenomena, such as extreme heat, and socioeconomic trends, such as urban migration, that result from climate change will be especially challenging for cities in Latin America and the Caribbean.

## Geophysical Effects

The impacts of the geophysical effects of climate change summarized below—heat islands, floods and sea-level rise, and droughts—are specific to or concentrated in urban areas.

### Heat Islands

The rising incidence of extreme heat expected with climate change will be a particular concern in cities because of the urban heat island effect. Temperatures in cities are typically higher than in surrounding areas because roads, buildings, and other urban infrastructure absorb, retain, and reemit heat at a greater rate than the natural environment, while groups of tall buildings reduce ventilation and trap heat, and human activities that generate it are highly concentrated (U.S. Environmental Protection Agency 2023; Doblas-Reyes et al. 2021). In the eight largest cities in Latin America and the Caribbean, the urban heat island effect leads to temperatures that are 3°C to 8°C higher than those in surrounding areas (Sarricolea and Meseguer-Ruiz 2019). This effect is likely to intensify in the future with increasing urbanization and the higher-intensity heatwaves brought about by climate change (Doblas-Reyes et al. 2021). Under the worst scenario, South America's largest cities will see five to ten times more extremely hot days by 2050, with temperatures that used to occur less than twenty days a year occurring up to six months annually (Kephart et al. 2022).

Heatwaves reduce economic growth (see Chapter 2) and cause productivity loss, behavioral challenges, learning concerns, economic disruption, and health risks, including greater propagation of pathogens transmitted
by food, water, insects, or other animals (Chapter 3). The consequences of
high temperatures through heatwaves can be unevenly distributed across
the urban population, with particularly dire implications for elderly and child
populations (Dodman et al. 2022) and residents of informal settlements or
substandard housing units (Corburn and Sverdlik 2019).

Access to technologies such as air conditioning and cars helps residents
cope with higher temperatures but also illustrates that the burdens of cli-
mate change will be unequal within cities. Both air conditioning and travel
by private vehicle are likely to be cost prohibitive for many with low incomes
or in substandard housing.

Data from the International Monetary Fund show that the median retail
electricity price in the region increased from 2020 to 2022, and the region's
median retail electricity price in 2022 was the second highest across all
world regions (Black et al. 2023). Furthermore, both cars and air condition-
ing expel hot air as exhaust, worsening heat for those without access to
them (Dodman et al. 2022).

Rising Waters

Floods caused by heavy rains, sea-level rise, and land subsidence are among the most problematic aspects of climate change for cities. Globally, flooding is one of the most common extreme weather events (see Chapters 2 and 5), and outdated and poorly planned or unmaintained urban infrastructure makes cities particularly vulnerable to it. Impervious pavements and buildings, for example, block drainage, while waste collection systems left unattended can clog pipes, and wetlands that have been drained cannot function as barriers that store water (Boland et al. 2021; Talbot-Wright, Libertun de Duren, and Vogt-Schilb 2023). A lack of investment in drainage makes floods within informal settlements especially hazardous (Dodman et al. 2022).

The exposure of Latin America and the Caribbean to flooding is particularly
high because it is the region with the highest proportion of its metropolitan
population living near coasts (Talbot-Wright, Libertun de Duren, and Vogt-
Schilb 2023). Between 23 million and 29 million people reside within 10 meters
above sea level (McGranahan, Balk, and Anderson 2007), and research shows
that 96 million people across seventy major cities would benefit if watershed
conditions were improved using natural infrastructure (Tellman et al. 2018)—a
finding that implies those people are exposed to urban flooding.

The threat to cities and their inhabitants posed by flooding, excessive
precipitation, and sea-level rise takes many forms. Excessive precipitation
increases the risk of floods from the runoff and of landslides, which are espe-
cially hazardous for informal settlements on high slopes and in lowlands.
Flooding causes direct casualties (injuries and death), loss of critical public infrastructure in flood-prone areas, and loss of assets and economic activities, and it increases the incidence of waterborne diseases. Heavy rainfall in 2023, for example, triggered floods and landslides across the region that killed people, destroyed and damaged homes, displaced thousands, and resulted in economic losses (WMO 2024). Almost half (136) of the municipalities in Santa Catarina, Brazil, were affected by the rains and floods that year, with 89 declaring a state of emergency (WMO 2024). Coastal cities are additionally threatened by sea-level rise that increases the risk of flooding and storm surge damage. In fact, by midcentury, sea-level rise and storm surges could cost coastal cities US$1 trillion each year, affecting more than 800 million people (Mahendra et al. 2021).

## Water Security

Climate change also threatens cities' water security by increasing the risk of drought as temperatures rise, precipitation patterns shift, and sea-level rise brings more intrusion of saltwater into fresh groundwater in coastal aquifers (Kundzewicz et al. 2007). Cities in the region, such as Mexico City in Mexico and La Paz in Bolivia, already suffer from freshwater stress as a result of climate change (Talbot-Wright, Libertun de Duren, and Vogt-Schilb 2023), and expanding urban populations further increase the demand for freshwater in cities. Severe droughts can leave authorities with few choices to meet this demand. In 2023, for instance, authorities in Montevideo, Uruguay, resorted to tapping into unpotable brackish water sources (Tocar 2023). Furthermore, because the region relies heavily on hydropower, droughts can also reduce electricity generation from low-carbon sources; the results may include electricity shortages or increased air pollution from the use of fossil fuels to generate more (Eriksson et al. 2024).

## Socioeconomic Effects

Cities will also have to contend with socioeconomic challenges brought about by the effects of climate change outside of urban areas, as people resort to migration to urban areas to get away from them.

## The Great Escape...

In addition to being a driving force for international migration (Chapter 3), climate change increases domestic migration flows to urban areas, largely as a result of its adverse effects on livelihoods (Nawrotzki et al. 2016; Nawrotzki et al. 2017). Rural-urban migration is often accelerated by climate disasters
such as droughts. In Mexico, for instance, the odds of rural-urban migration increase by 3.6 percent with each additional month of drought (Nawrotzki et al. 2017). Similarly, when, in 1997-99, an area twice the size of Portugal in Northeast Brazil experienced one of the worst droughts of the century, the resulting loss of crops and livestock forced small farmers to migrate in search of other opportunities (Marengo et al. 2022). More destructive disasters can have even larger effects. Hurricane Mitch in 1998, for instance, prompted the relocation of 100,000 to 150,000 people in Central America.

... to Humble Dwellings

The influx of migrants into cities as a result of such climate events often leads to unplanned urban expansion (Busso and Chauvin 2023). Many settle in informal neighborhoods (Sandoval and Sarmiento 2020). These have three defining characteristics: their inhabitants have no security of tenure over the land or dwellings; they usually lack formal basic services and urban infrastructure; and the housing units do not comply with planning and building regulations (UN Habitat 2015). As a result, the inhabitants tend to be people who lack better housing options, including many low-income and socially vulnerable families. Households led by women, Indigenous people, Afro-descendants, and people with disabilities are overrepresented in these settlements (IDB 2020b). Globally, about 1.1 billion urban residents lived in informal neighborhoods in 2020 (UN Stats 2023). In Latin America and the Caribbean, they are a common part of the urban landscape, with more than a fifth of city residents living in them, including many migrants (IDB 2020b).

Households in informal settlements are frequently the most vulnerable to the effects of climate change (Thomas et al. 2019; Dodman et al. 2022), mostly because they are typically situated in at-risk areas (UN Habitat 2016). Many such settlements, for example, are built on large-slope terrains, on the tops of hills, or in river floodplains, making them particularly susceptible to landslides and flooding (Satterthwaite et al. 2018). From 2004 to 2013, 611 landslides were recorded in twenty-five countries in Latin America and the Caribbean, causing 11,631 deaths. The proportion of fatalities was much higher in poor and informal neighborhoods, which experienced 41 percent of the fatal landslide events but 81 percent of the deaths (Sepúlveda and Petley 2015). A 2016 study found that, in São Paulo, Brazil, 48 percent of landslides took place within 100 meters of informal settlements and 82 percent within 300 meters (Perez and Martins 2016). Informal neighborhoods are disproportionately affected by other climate-related risks, as well, including floods, fires (see Box 13.1), extreme heat, and heightened exposure to infectious diseases (Satterthwaite et al. 2018).
Box 13.1. Fires in Informal Settlements

Higher temperatures, drought, and rapid city growth increase the incidence of wildfires that affect urban areas (Talbot-Wright, Libertun de Duren, and Vogt-Schilb 2023; Boland et al. 2021). From 2015 to 2018, 152 out of 196 countries around the world saw a rise in the average annual number of days people were exposed to them in each country, compared to 2001–2004 (Watts et al. 2019). Wildfires cause deforestation, increase susceptibility to landslides, and disrupt air transportation by reducing visibility. In addition to the injuries and deaths they inflict directly, they can be harmful to health, exposing large numbers of people to particulate-matter air pollution that can lead to eye and respiratory illnesses (Ebi et al. 2008). In 2017, for example, when Chile suffered one of the most intense landscape fires registered on Earth in this century (Bowman et al. 2019), an estimated three-quarters of the country's population were exposed to air pollutants from wildfire smoke (De la Barrera et al. 2018).

Fires can start on the outskirts of cities and then spread across them, moving especially quickly through dwellings that are built close together in informal settlements. In fact, over 95 percent of deaths and injuries related to urban fires occur in low- and middle-income countries, and the risk of fire resulting in trauma, injury, or death is particularly high within informal settlements (Dodman et al. 2022; Rush et al. 2020), where populations are dense, housing materials are often flammable, access to safe power sources is unreliable or nonexistent, and, sometimes, fire services are unable to reach the sites that are burning (Rush et al. 2020). The case of Valparaiso, Chile, exemplifies this. In 2014, a large urban fire that originated in the wildland spread across the city through adjacent informal settlements as a result of the poor construction standards, meager infrastructure services, and flammable trash accumulated on empty lots in these areas (Reszka and Fuentes 2015).

The location-related vulnerabilities of informal settlements are further exacerbated by poor infrastructure or the lack of it (UN Habitat 2016). Overcrowded, unstable dwellings and limited access to basic services, such as water, sewage, waste disposal, and electricity, magnify the consequences of natural hazards; they also increase exposure to disease (Satterthwaite et al. 2018; Satterthwaite et al. 2020; Kim et al. 2022). Heavy rains, for instance, often lead to sewage overflows and to water running along the streets and into private houses (Libertun de Duren et al. 2021). Urban informal settlements are also disproportionately exposed to excessive heat by their dense populations and the use of building materials that hold more heat (Scott et al. 2017). Furthermore, climate change may accelerate the deterioration of already poor infrastructure.
## What Can Be Done?

The policies and strategies available to policymakers to address climate change—many of which have been discussed throughout this book—will be important in cities; these include building resilient infrastructure and strengthening social programs. This section presents policies and tools complementary to those mentioned in other chapters that cities can implement to reduce their emissions and adapt to climate change.

## Make Cities Greener

Green infrastructure or nature-based solutions are among the most effective alternatives to traditional grey infrastructure for cities. Green infrastructure works in harmony with ecological systems and considers surrounding ecosystems as a complement, rather than a menace, to the urban built environment (Muñoz Castillo and Crisman 2019). Urban green spaces, for example, play an important role in the lives of city residents, providing space for recreation and exercise, improving physical and mental health, and reducing air and noise pollution (WHO 2023a). They are also an important policy tool for adapting cities to climate change by reducing extreme heat and flooding, and they contribute to climate change mitigation by reducing GHG emissions (De la Sota et al. 2019; WHO 2023a).

Urban parks can substantially reduce ambient temperatures and mitigate the urban heat island effect by providing shade and through transpiration. It is estimated, for instance, that an optimally designed urban park of 2,500 square meters in Mexico City can reduce the temperature by 5.3°C (Barradas et al. 2022). The cooling effects extend beyond the park boundaries (Chang and Li 2014; Yan, Wu, and Dong 2018). A study in Beijing, China, for example, has found mean temperatures 0.6°C to 2.8°C lower inside a large park than in the surrounding area, with the cooling effects extending nearly 1.4 kilometers from the park boundaries (Yan, Wu, and Dong 2018). Another study in Beijing estimates that the cooling effects of urban green spaces could lead to energy savings of 0.6 kilowatt-hours per square meter of urban green space (Zhang et al. 2014).

Urban green spaces can also manage excessive rainfall and reduce stormwater runoff by infiltrating, redistributing, and storing stormwater (Berland et al. 2017). Curitiba, Brazil, has 60 square meters of green space per resident, which is five times the minimum recommended by the World Health Organization (Galarraga Gortázar 2023), and the city's large parks, particularly those along the Barigui River, help prevent flooding (European Commission et al. 2019).
In addition to parks, trees and green spaces can be incorporated into bike lanes, avenues, and roofs. The Green Corridors program in Medellín, Colombia, for example, transformed eighteen roads and twelve waterways into thirty green corridors, creating an interconnected system of greenery throughout the city (UN 2019). By its third year, the program had resulted in a 2°C drop in the city's average temperature, at a cost of US$6.50 per capita (Thomson 2024; C40 2019). Similarly, green roofs can provide crucial relief for those who do not have access to cooling, and they can reduce energy consumption for those who do. According to measurements taken during the Favela Green Roof pilot program in Rio de Janeiro, Brazil, homes with green roofs were up to 20°C cooler indoors during peak heat than those with traditional roofs (Oliver et al. 2021). Green roofs can also retain rainwater, which reduces runoff and flooding during periods of peak rainfall (Silva et al. 2023), and they can work together with other urban green spaces to reduce both indoor temperatures and ambient temperatures.

## Local Governments' Policy Toolbox: Zoning and Building Codes

Many of the challenges of climate change adaptation need to be addressed at the local level, making city governments critical players. While the jurisdictions and responsibilities of local governments vary from country to country, across most of Latin America and the Caribbean they have two key policy tools at their disposal: land use zoning and building codes or regulations.

## Where to Build

Zoning regulations govern the types of buildings and their permissible uses in particular areas of a city.

Zoning can be used to prevent sprawl and promote urban density, which facilitates adaptation along several dimensions (OECD 2012). While climate change can lead to scarcity and disruptions in the provision of infrastructure services, such as water, energy, and transportation (Cavallo, Powell, and Serebrisky 2020), density can take advantage of economies of scale to encourage their more efficient use (Glaeser 2012). More compact urbanization can also make cities more resilient to future waves of population relocation, as it reduces the cost of scaling up housing supply and the provision of public services (Libertun de Duren and Guerrero Compean 2016).

Zoning can also be used to help cities adapt to climate change by reducing exposure to climate-related hazards, such as coastal and inland flooding, landslides, and extreme heat. Cities around the world currently are adapting to surges in these hazards (Araos et al. 2016) by building protective
infrastructure, such as seawalls and flood barriers, and by investing in the resilience of existing transportation, water, and electricity infrastructure (Cavallo, Powell, and Serebrisky 2020; Hsiao 2023). These types of solutions can be costly, however, and are feasible for only a subset of cities, and for specific areas within those cities. Zoning provides an alternative by promoting development in areas that are less vulnerable to these risks and banning construction in at-risk areas with inadequate protective infrastructure (Boland et al. 2021). Barbados, for example, implemented a minimum coastal setback, stipulating that buildings cannot be constructed within 30 meters of the high-water mark (Mycoo 2006).

Zoning also provides a cascade of benefits that contribute to climate change mitigation. It can facilitate the implementation of nature-based solutions and green infrastructure (Dodman et al. 2022), such as the planting of trees on slopes or the development of urban parks on flood plains, that reduce GHG emissions and reduce vulnerability to extreme weather events. Zoning, can moreover, produce better infrastructure environments for walking and cycling (ibid.)—environmentally friendly forms of transportation that reduce GHG emissions. The Vital Neighborhoods project in Bogotá, Colombia, for instance, seeks to increase the public space dedicated to pedestrians by implementing an urban model known as the 15-minute city, which allows residents to satisfy most of their daily needs within a short walk or bike ride from home. The shift away from the use of private vehicles and the provision of more green spaces result in fewer GHG emissions and cleaner air. Additional benefits of using strategies like tactical urban planning and infrastructure interventions include greater dependence on sustainable means of transportation, the generation of new public spaces that encourage residents and visitors to meet and linger, and the reorganization of other areas dedicated to pedestrians (Vera, Uribe, and Del Castillo 2023).

## How to Build It

Cities can complement zoning regulations with building codes, which are also a powerful local policy tool. Building codes can effectively promote “greener” construction by mandating or providing incentive for the use of certain materials and insulation metrics, as well as bioclimatic designs for better adaptation to climate change. Buildings that ensure thermal comfort through passive cooling and minimize the use of air conditioning can reduce the hot air they expel, which can also help mitigate the urban heat island effect (Dodman et al. 2022; Salamanca et al. 2014). Although building according to green standards is ideal, it is not always an option. In those cases, retrofitting existing units is the next best choice (Dodman et al. 2022).
Like zoning, building codes can help mitigate the effects of climate change in many ways. The development and enforcement of regulations and standards for buildings and appliances that increase energy efficiency can reduce citywide GHG emissions (Mahendra et al. 2021). It is estimated, for example, that energy efficiency measures can reduce energy use by 50 to 90 percent in new buildings and 50 to 75 percent in existing ones (Westphal et al. 2017). Measures related to building codes in residential and commercial buildings, like the implementation of building energy codes, will account for an estimated 70 percent of the potential to reduce global urban-level GHG emissions in 2030 (ibid.).

Building codes, particularly those that regulate building height, can also be used to complement zoning in the promotion of agglomeration (Busso, Carrillo, and Chauvin 2023). In many cities in Latin America, buildings are shorter than they could be, which may be explained, at least in part, by regulations restricting their height (Jedwab, Barr, and Brueckner 2022). These regulations reduce agglomeration by encouraging cities to sprawl (Bertaud and Brueckner 2005). Changing or eliminating them could have the opposite effect.

## Sharpening the Tools

Although zoning and building codes are very effective policy tools, they have limitations. In Latin America and the Caribbean, their effectiveness is hindered by the significant percentage of land occupation and building construction that is informal. Moreover, while some regulations—such as requirements for regular audits and management standards—promote adaptation in both existing and new buildings, most affect only future development, leaving exposure to climate change effects high in the built stock and informal construction (Dodman et al. 2022; Talbot-Wright, Libertun de Duren, and Vogt-Schilb 2023). Although building codes and zoning may not have direct impacts in informal settlements, they may provide some indirect benefits for the populations residing in them. Decreased energy use can reduce local air pollution, leading to better respiratory health, while building codes that apply to commercial and municipal buildings (like schools, hospitals, or social housing) can benefit all city residents by making the places where they work or their children go to school safer and more comfortable (Westphal et al. 2017).

For these instruments to be and remain effective, they should be suited to local needs and adjusted as those needs evolve. Building codes must be tailored to the specific hazard patterns and risk levels of different locations within the city, and a streamlined process is needed to update these regulations dynamically as new knowledge is acquired, new technologies emerge, and climate-related risks evolve. One example of this flexible approach is
provided by Chile, which consistently revises its regulations for earthquake-
resistant construction. After the 2010 earthquake that triggered severe
tsunamis, for instance, the Chilean government updated the building codes,
enhancing the safety margin by mandating greater distances between
coastal buildings and the seafront (Cavallo, Powell, and Serebrisky 2020).

Protect Lives, and Make Them Better

Cities can implement a set of policies to address the unique challenges to climate action presented by informal settlements. One policy instrument available to local governments to support this purpose is the implementation of “slum upgrading” programs. These in situ interventions seek to enhance both the built environment and socioeconomic conditions of informal neighborhood inhabitants. They can include investments that facilitate adaptation, such as the construction of protective barriers, the use of more durable building materials and drainage systems, and improvements in connectivity, including the creation of evacuation routes (Núñez Collado and Wang 2020). Upgrading programs can also include strategies that mitigate climate change by introducing renewable and clean energy sources or making older equipment more energy efficient. This is exactly what happened in Chile in a project that upgraded houses in informal settlements and integrated solar panels with the capacity to provide for up to 70 percent of energy consumption, diminishing the need for traditional energy sources (ibid.). Enhancing the resilience of informal neighborhoods through these interventions both addresses climate change and improves the lives and safety of the most vulnerable urban populations.

A second, related policy instrument available to local governments when upgrading is not possible and hazards are imminent is resettlement of the populations at risk. Among the examples of such initiatives is “La Nueva Barquita” (the New Boat) project in Santo Domingo, Dominican Republic, which relocated households that were highly vulnerable to floods (Núñez Collado and Wang 2020), and the Moravia project in Medellín, which relocated families away from a neighborhood built in an open garbage dump (Montoya Restrepo et al. 2011). In many cases, however, the local population resists relocation, despite being aware of the risks (Nathan 2008; Smith et al. 2020). Additionally, resettled residents may find new housing unaffordable and return to slum conditions. Resettlement also distances residents from their workplaces and can erode essential community bonds and social networks (UN Habitat 2003).

Third, governments can provide and coordinate adaptation efforts in
informal settlements. Implementing well-designed public policies to adapt to
climate risks in a timely manner is important, as slow local government action
can lead dwellers of informal settlements to take adaptation into their own hands. In response to localized flooding in Bangkok, Thailand, for example, households in informal neighborhoods built flood walls around their properties. While these "autonomous adaptations" did result in less water coming into private houses, they also led to the retention of more water on street surfaces and in drainage infrastructure (Limthongsakul, Nitivattananon, and Arifwidodo 2017). This less than ideal outcome highlights the importance of adaptation policies led by governments. Such policies not only help improve public infrastructure but can minimize the potential negative externalities of individual adaptation efforts and reduce those that are maladaptive.

A final policy available to local policymakers is to deter the emergence of informal settlements in highly exposed areas by installing resilient public facilities, parks, or green infrastructure in these places, both to prevent rapid informal urban growth and reduce the likelihood of flooding and landslides there (Talbot-Wright, Libertun de Duren, and Vogt-Schilb 2023). These policies may provide other benefits, as well, generating projects that can improve the environment and the well-being of people by providing green spaces (parks or gardens; see the discussion of urban green spaces, above), recreational areas, and employment and education.

## Provide Knowledge for Power

Cities can use information and communications strategies to mitigate emissions and adapt to climate change impacts by encouraging citizens to change their behavior. Informational programs can, for instance, reduce the use of energy without requiring any investment by households. In one large-scale experiment, the U.S. company Opower (since acquired by the Oracle Corporation) sent reports to residential utility customers that included information on their home energy use, provided comparisons to usage by similar neighbors ("social comparisons"), and offered tips on using less energy (Allcott 2011; Allcott and Rogers 2014). The reports reduced electricity consumption in the households by 2 percent on average (Allcott 2011), and the effects were relatively persistent, decaying by only 10 to 20 percent a year after the reports had been sent for two years (Allcott and Rogers 2014). This type of information provision is cost effective, costing the utility just a few cents per kilowatt-hour of energy saved (Allcott and Mullainathan 2010), which is lower than the cost of saving energy through demand-side management (Arimura et al. 2012) and comparable to that of other energy efficiency programs (Friedrich et al. 2009). While some studies indicate that, in places with lower energy consumption than the United States, social comparison messaging is only cost effective when targeted
to high-use subgroups (Andor et al. 2020), similar encouraging results have been found elsewhere. In Sweden, for instance, using technology to display real-time social comparison messages reduced daily residential electricity use by 6.7 percent on average (Kažukauskas, Broberg, and Jaraitė 2021), and, in India, social comparison reports both reduced energy use and increased responsiveness to price changes (Sudarshan 2017).

Beyond social comparison, other types of communications, such as environmental or moral persuasion messages, can be effective in reducing residential energy use and emissions. In a randomized controlled trial across seventeen favelas in Rio de Janeiro, for example, environmental persuasion messages increased the probability of using LED light bulbs, which consume less energy than traditional incandescent ones, by 13 percent, on average (Toledo 2016). Similarly, in Valdivia, Chile, where wood is a major fuel for residential heating, informational signs on woodstoves that indicate the pollution emission levels associated with different settings have been found to lessen the amount of time households use their woodstoves on the most polluting settings and reduce residential pollution emissions by 11 percent (Ruiz-Tagle and Schueftan 2021). In some cases, environmental and health information communications more effectively reduce energy use than information about monetary savings (Asensio and Delmas 2015).

Prices can also be used to encourage reductions in energy use. In some cases, simply making households aware of the nonlinear pricing schedule to which they are subject can reduce consumption.<fnref n="1" /> In Puebla, Mexico, for example, electricity use was reduced by an intervention that informed households of the nonlinear pricing schedule for electricity and how the ways in which they used different appliances affected their bills, with the largest effects occurring among those with high consumption (Stojanovski et al. 2020). Another pricing strategy—real-time pricing—in which the cost of electricity to consumers varies dynamically with the marginal cost of supplying it can reduce or reallocate electricity use from peak to off-peak times. Combined with smart meters or digital displays that provide information on electricity prices during critical demand hours on critical demand days, real-time pricing information can also decrease energy consumption (Ito, Ida, and Tanaka 2018).

Behavioral changes can also play an important role when severe climate change hazards occur. Between 2015 and 2017, for example, Cape Town, South Africa, suffered three consecutive years of unprecedented below-average rainfalls, leading to water shortages and a water crisis. During 2017–18, the city introduced a campaign to reduce water consumption, encourage

<footnote n="1">¹ In nonlinear pricing, the price per unit of electricity is higher for an individual who has already consumed many units.</footnote>
residents to make behavioral changes, and avoid “day zero”—the day the city would run out of water. The program communicated the real possibility that “day zero” could happen and included a series of “nudges,” such as two-minute songs to sing in the shower, to prompt residents to change their behavior. The campaign was successful, with Cape Town able to reduce its water use by more than half from 2015 to 2018, including a significant decline in residential use. This success illustrates the importance of providing information in a way that empowers people to act promptly, according to the situation, and collaboratively (Boland et al. 2021; Birkmann et al. 2022).

While behavioral changes alone will not come close to meeting mitigation targets, they can induce voluntary reductions in the use of services at little cost. Furthermore, they can play an important role in adapting to climate change impacts. Governments and utilities can experiment with different information content, framing, and modes of communication to find the most effective communications for their contexts.

## Give Warning

Increasing awareness of climate change and its risks is essential for cities and their inhabitants, helping to optimize response to disasters and emergencies and prevent catastrophic scenarios. This is where early warning systems come into play. They allow timely and orderly evacuations in climate emergencies and help households and authorities prepare for them (Dodman et al. 2022; Boland et al. 2021). Developing early warning systems can help citizens avoid the devastating effects of hurricanes, floods, landslides, and other climate-related disasters, protecting not only people's health but their assets (Boland et al. 2021). Just twenty-four hours' warning of a coming storm or heatwave can cut the ensuing damage by 30 percent, while spending US$800 million on such systems in developing countries would avert losses of US$3 billion to US$16 billion per year (Global Commission on Adaptation 2019).

Early warning systems are particularly important in informal settlements, where fatalities are concentrated. In 2022, a consortium of universities, nongovernmental organizations, and other organizations implemented a monitoring and early warning system in Medellín that used state-of-the-art technology for the early detection of landslides, along with an alert dissemination system that relied on local community involvement. Initially tested in the Bello Oriente informal settlement, the system provided precise hazard information at the household level, heightened community awareness of the risks, and improved readiness to respond to critical events (Gamperl et al. 2023).
Coordinate and Join Forces

High levels of urbanization in Latin America and the Caribbean have put the region's cities and their local governments at the forefront of efforts to respond to climate change. Individual cities can have significant impacts on climate change adaptation, since the challenges and solutions tend to vary from one location to another, and local governments control key policy tools, like building codes and zoning. When it comes to mitigation, however, local authorities acting individually have less leverage, because mitigation often requires coordinated efforts at a larger scale. Moreover, climate change mitigation is a public good, in the sense that everyone benefits from it, regardless of their contribution (Paavola 2011; Jenssen and Sippel 2011).

The coordination required by many policies to mitigate climate change and reduce disaster risks effectively at the metropolitan level extends across many types and levels of stakeholders. Many cities have weak metropolitan governance institutions and operate in an environment of institutional fragmentation, where it is unclear which actor is responsible for what in taking action. The forest management needed to reduce wildfire risks that affect a particular urban area, for instance, may depend on a different jurisdiction or a central government institution rather than the local urban planning authority (Boland et al. 2021). Evaluation of institutions to diagnose miscoordination and the creation of policy networks that address emerging interdependences are useful to overcome institutional fragmentation and clarify responsibilities (Dodman et al. 2022).

Coordination across cities is also a challenge. Many Latin American and Caribbean countries lack the institutional framework to coordinate decisions on land use, natural resources management, and infrastructure investments across metropolitan areas and with national institutions (IDB 2021b). The latter is particularly important because most cities in the region depend heavily on fiscal transfers and lack the financial autonomy to advance robust climate change agendas independently.

International organizations and national governments have deployed different initiatives to improve coordination among the different stakeholders within and across cities and between the cities and national governments. The United Nations' Local2030 initiative, for example, works to create hubs where local and regional government entities and their associations, national authorities, the business sector, community organizations, and other local players can come together, share effective practices, monitor progress, and coordinate actions for the advancement of the 2030 Sustainable Development Goals; these include the Paraná Hub in Brazil and the Cómo Vamos Hub in Colombia (Lobos Alva, Hernández, and Cárdenas 2021).
Because many cities around the world face similar challenges, they can exchange lessons learned beyond national borders. Steady progress has taken place in recent decades, and cities have played an important role. Since the early 1990s, when the ICLEI Local Governments for Sustainability network was launched, a number of international multicity initiatives have emerged with the explicit goal of promoting coordinated sustainability efforts. These include the C40 Cities Climate Leadership Group, the Carbon Neutral Cities Alliance (CNCA), the Global Covenant of Mayors for Climate and Energy, and the Rockefeller Foundation's 100 Resilient Cities, among others. Many cities in Latin America and the Caribbean are active in these networks, and urban leaders have remained highly visible in the international conversation on climate change. The city of Buenos Aires, Argentina, for instance, worked with the 100 Resilient Cities initiative to develop an integrated strategy for managing the risk of flooding that results from modification of and encroachment into riverine zones (UN Habitat 2022). As a result, many of the most effective agreements to promote sustainable practices are still being established by cities (Angelo and Wachsmuth 2020).

## Cities: Leaders in the Climate Change Challenge

Cities will continue to face numerous impacts of climate change. To ameliorate the effects on the well-being of urban residents in cities, policymakers can implement policies to improve conditions in informal settlements, encourage behavioral change among residents, and reduce the impacts of climate change and disasters through zoning, building codes, and green infrastructure. These policies can also contribute to climate change mitigation goals by reducing GHG emissions at the city level. Despite the challenges they face when managing climate change and designing and implementing policies to deal with its effects, cities can lead the way and accelerate climate action by building strong coalitions, which allow local governments and communities to coordinate and exchange knowledge, experiences, and good practices. As cities produce most of the economic activity and are home of most of the population, it is imperative that those in the region address climate change, allowing people to lead healthier, and more productive, lives.
<figure><img src="image_121.png" /></figure>

In public opinion surveys, residents of Latin America and the Caribbean express strong support for climate action. This support is affected by education, perceptions of fairness, perceptions of policy effectiveness, and climate change beliefs. Policy efforts are often hampered by perceptions that gains and costs are not equitably spread, together with competing interests. These barriers can be addressed through communication and engagement with citizens and whole-of-government approaches.

Citizens play an important role in addressing climate change. They can take numerous actions to reduce their carbon footprints voluntarily, such as biking instead of driving. The example they set can encourage others to undertake climate-friendly actions, as well. Meeting the challenge of climate change will require more than individual actions, however. The most effective changes will stem from ambitious government policies, the implementation of which requires support from citizens.

## Climate Change Policies: The Public Opinion Landscape

Painting an accurate picture of citizens' support for climate change policies is challenging. Most of the evidence comes from surveys. Self-reported support for policies in surveys, especially hypothetical ones that are not currently under consideration, may not align with actual voting behavior. Furthermore, individual climate change policies are often part of a policy bundle, which complicates the measurement of people's support. Still, surveys provide valuable information for assessing public opinion on climate policy.

Compared to residents of other parts of the world, those in Latin America and the Caribbean generally express strong support for climate change policies in surveys. A survey conducted in May and June of 2023
found 88 percent of respondents across thirteen countries in the region in favor of government measures requiring people to adopt climate-friendly behavior, as compared to 66 percent of European respondents (European Investment Bank 2023).<fnref n="1" />

The favorability of specific types of climate change policies is also often stronger in Latin America and the Caribbean than elsewhere in the world. In contrast to the 47 percent of respondents in Brazil and 55 percent of respondents in Mexico who approve of a carbon tax with cash transfers, the average level of support across twelve high-income countries is 37 percent (Dechezleprêtre et al. 2022). Similarly, in another survey, the average approval for subsidies for low-carbon technologies across four Latin American countries is 65 percent, which is higher than the European average of 59 percent (Dabla-Norris et al. 2023).

Support varies across types of climate change policies, as well. In comparisons of different mitigation policies, support for low-carbon technologies and green infrastructure tends to be stronger than for bans or emission regulations, the support for which in turn, tends to be stronger than for carbon taxes. Among Brazilian respondents, for example, 77 percent are in favor of a green infrastructure program, 60 percent a ban on combustion-engine cars, and 47 percent a carbon tax coupled with transfers to citizens (Dechezleprêtre et al. 2022). Similarly, 84 percent of Mexican respondents support a green infrastructure program, 67 percent a ban on combustion-engine cars, and 55 percent a carbon tax with transfers (Dechezleprêtre et al. 2022). A second survey conducted in Argentina, Brazil, Colombia, and Mexico shows a similar ranking. Across these four countries, 65 percent of respondents support subsidies for low-carbon technologies, 52 percent regulations that limit emissions, and 54 percent carbon pricing (Dabla-Norris et al. 2023).

As suggested above, however, support for these individual policies depends on the complete policy bundle, and combining them with complementary policies can substantially increase it. In Brazil, for example, 47 percent of respondents support a carbon tax with an equal transfer to all households, while 78 percent support one with revenue dedicated to funding environmental infrastructure (Dechezleprêtre et al. 2022). Similarly, in Mexico, of all the policy bundles based on a carbon tax, respondents are most in favor of a carbon tax with revenue devoted to funding environmental infrastructure (73 percent; Dechezleprêtre et al. 2022). Although it is

<footnote n="1">¹ The survey was conducted in the following countries: Argentina, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Mexico, Panama, Paraguay, Peru, and Uruguay.</footnote>
typically most economically efficient to use the revenue from carbon taxes to lower distortionary taxes (see Chapter 10), combining a carbon tax with funding for green infrastructure or technology typically receives greater approval (Dechezleprêtre et al. 2022).

## Garnering Support for Climate Action

To design effective policies, it is key to understand the primary drivers of citizens' support for climate action.

## Beliefs, Education, and Experience

People will not support policies to address problems they do not perceive as important and urgent. Seventy-three percent of respondents across seventeen Latin American countries and one Caribbean country stated in the 2017 Latinobarometer survey that climate change is an urgent problem that needs to be addressed immediately (see Figure 14.1). Similarly, LAPOP's 2016/17 AmericasBarometer survey conducted in 29 countries in the Americas found that most people in the region believe climate change will become a very serious problem in their country if nothing is done to reduce it. Agreement with this statement was highest in Mexico and Central America (81.5 percent), followed by South America (75.0 percent), and the Caribbean (66.7 percent) (Evans and Zenchmeister 2018).

Education affects climate change beliefs (Bergquist et al. 2022; Czarnek, Kossowska, and Szwed 2021). In Latin America and the Caribbean, beliefs that climate change is an urgent problem that needs to be addressed immediately are positively correlated with education levels (Figure 14.2).<fnref n="2" />

Evidence indicates that having more education causally increases support for addressing climate change. Angrist et al. (2024) examine changes in compulsory schooling laws to demonstrate that education shifts beliefs, behaviors, and policy preferences in favor of adaptation to and mitigation of climate change. Importantly, the effects of education on this range of outcomes demonstrates its potential to influence both individual behaviors and government policy related to climate change.

Survey experiments conducted in Latin America and beyond provide indirect evidence that targeted climate change education can be effective

<footnote n="2">² In contrast, there is little consistent evidence showing that other key demographics, such as income, gender, or age, are systematically and significantly correlated with climate change beliefs.</footnote>
<caption>**Figure 14.1.** Perceived Urgency of Climate Change</caption>

Survey respondents who view climate change as urgent and needing to be addressed

<figure><img src="image_122.png" /></figure>

Source: IDB staff calculations, based on Latinobarometro survey 2017.

in garnering support for climate policies (Dechezleprêtre et al. 2022 and Dabla-Norris et al. 2023). In particular, both intensive courses and pedagogical videos can affect beliefs and behaviors, increasing survey respondents' stated approval of public policies related to climate action (Cordero, Centeno and Todd 2020 and Dechezleprêtre et al. 2022).

In short, governments can expect that increasing educational attainment in the region in general will raise support for climate policies, and they
<caption>**Figure 14.2.** Perceived Urgency of Climate Change, by Education</caption>

Survey respondents who view climate change as urgent and needing to be addressed, by level of education

<figure><img src="image_123.png" /></figure>

Source: IDB staff calculations, based on Latinobarometro survey 2017.
Note: Weighted average among eighteen Latin American and Caribbean countries.

can accelerate this trend by integrating climate change specifically into curriculums and developing pedagogical tools for the public—something that remains uncommon in Latin America and the Caribbean. A recent study that examines official education plans specifically for climate change concepts finds that curriculums in only three of the sixteen countries in the region included in the study (19 percent) mention these concepts (UNESCO 2021).

People's acceptance of efforts to address climate change also tends to increase with experience with well-designed climate policies (Carattini et al. 2018; Schuitema, Steg, and Forward 2010; Jagers, Matti, and Nilsson 2017). While only 30 percent of people were in favor of El Salvador's 2011 gas subsidy reform at the start of implementation, for example, support grew to 65 percent over 18 months (Hallegatte et al. 2023). A converse finding—that disagreement typically fades with experience—suggests that the phasing in of carbon taxes or the gradual reduction of fossil fuel subsidies can help diminish resistance to them (Carattini, Carvalho, and Fankhauser 2018). Governments can even design climate policies with features, such as trial
periods, that provide an opportunity for citizens to gain experience with the policy. Such trial periods have been widely successful in increasing the favorability of, for example, congestion pricing, a fee on vehicles for entering busy roads (Gu et al. 2018). Furthermore, strategically sequencing climate policies by first implementing those with less benefit but high levels of citizen acceptance could help to build support for other, more efficacious climate policies over time (Hallegatte et al. 2023).

## Trust in Climate Policy

Perceived effectiveness is another important driver of citizen support for climate policies, as indicated by a large-scale survey covering twenty countries conducted in 2021 and 2022 (Dechezleprêtre et al. 2022).

Perceptions of the effectiveness of public policies more generally, but especially climate policies, may be intertwined with broader perceptions of the effectiveness of and trust in government. It is difficult for citizens to judge the environmental effectiveness of many climate policies, even after they are implemented. Many climate policies deliver the bulk of their benefits in the medium or longer terms, implying that citizens do not have evidence to update their beliefs about effectiveness in the short term. Without easily verifiable information, they may rely on these broader perceptions when forming their opinions of specific policies. In the United States, a large national sample survey showed the perceived efficacy of local governments as a driver of support for local adaptation policy (Harris and Howe 2023).

Another driver of support for climate policies is citizens' trust that their governments have the capacity and the will to implement them. In fact, political trust can be more important to garnering citizen support for mitigation policies than climate change beliefs. In one study of twenty-three European countries, those countries where political trust was greater—not those with greater climate change awareness or concern—were the ones in which support was strongest for policies for reducing carbon emissions.

Support for climate policies also depends in part on perceptions of cost effectiveness. Citizens tend to overestimate the costs of environmental policies and underestimate the benefits (Schuitema, Steg, and Forward 2010). Correcting misperceptions of the environmental and cost effectiveness of climate policies through information or experience could increase support for and acceptance of these policies.

Finally, in many cases, the effectiveness of climate policies depends on the cooperation and participation of the community, showing that trust in others, such as family, friends, neighbors, and even strangers, could also play a role in support for them.
## Social Norms and Higher-Order Beliefs

Carrying out many climate policies successfully requires collective action, meaning that their benefits are determined by the behavior of everyone. This fact brings into play social norms.

Attitudes about global warming, support for mitigation policies, and intentions to engage in voluntary climate behaviors are affected by information that emphasizes norms and scientific consensus around climate change (Bolsen, Leeper, and Shapiro 2014). Visible local social norms play an important role in, for example, individuals' adoption of solar panels and hybrid cars (Baranzini, Carattini, and Péclat 2017; Narayanan and Nair 2013). Solar panels that are installed on steep roofs and building facades, for instance, increase the adoption of solar panels more than panels that are less visible to passersby (Baranzini, Carattini, and Péclat 2017).

Governments can consider social norms when designing programs to promote more climate-friendly behaviors to increase their effectiveness. Public advertising and communication campaigns can inform citizens of local norms regarding climate change beliefs and others' support for climate change efforts. Governments can also consider offering larger subsidies for those visible, climate-friendly investments, such as solar panels, that will spur adoption by peers. When social norms are not readily visible, as in the case of energy usage, information can be provided to illuminate them. A series of experiments demonstrates that people respond to information comparing their energy usage to their neighbors', for example, and that these effects persist (Allcott and Rogers 2014).

Higher-order beliefs also play a key role in support for climate policies. A recent survey conducted in 125 countries around the world, including 19 in Latin America and the Caribbean, documented that individuals dramatically underestimate their fellow citizens' willingness to contribute to climate action (Andre et al. 2024). Correcting misperceptions about fellow citizens' support for climate policies and their adoption of behaviors to mitigate climate change could shift norms and pave the way for governments to embark on ambitious climate policies.

## Who Pays, Who Gains? The Perceived Fairness of Climate Policies

Also influencing support for climate policies are the perceived distributional implications and expected impacts of the policies on personal budgets. In a choice experiment conducted in Sweden that used hypothetical policy instruments, respondents preferred those with a progressive cost distribution (Brannlund and Persson 2012). Similarly, in a choice experiment in