Cross-Border Risks of a Global Economy in Mid-Transition

Abstract

A consistent analytical framework for the cross-border economic and financial risks associated with a world economy in this critical mid-transition period is needed. 3 The existing literature on the macroeconomic effects of climate mitigation policies often simplifies nation-level challenges and policy contexts with the goal of seeking simple narratives that apply at the global level (Riahi et al., 2022; Masson-Delmotte et al., 2018; Van Vuuren et al., 2020; Rogelj et al., 2018; Grubler et al., 2018). Developed as general basis scenarios of globally coordinated decision-making and cost-effective economic evolution, this literature sheds little light on the links between the transition and the structural transformation of the global economy. While a growing body of literature examines the cross-border effects of the physical impacts of climate change, we are unaware of any systematic analysis of the cross-border impacts of decarbonization in a mid-transition context. 4 The paper's three main contributions are as follows. First, we draw on a range of stylized facts to show that global decarbonization will very likely change the structure of international trade and capital flows. Second, we propose an analytical framework to analyze these effects that is based on a system dynamics approach. Third, we assess a subset of the likely impacts of global decarbonization that we outline, notably those on output and trade, under specific global decarbonization assumptions. Our analysis suggests that, among the world's largest economies, China, India and Japan are likely to benefit the most from the transition, while Russia, Saudi Arabia the U.S. could be negatively affected relative to a hypothetical baseline of baseline GDP growth. While this paper seeks to draw the attention of the research and policy communities to cross-border transition risks, it does not imply any minimization of the major opportunities associated with the transition-and the counterfactual of an absence of transition implies far greater risks than those we analyze here. Opportunities include economic growth, notably in the short run as low-carbon infrastructure is developed, as well as job creation, innovation, and many environmental and health co-benefits (see, e.g., Bhattacharya et al., 2021). A counterfactual "no (or failed) transition" scenario, where fossil production and consumption are not significantly reduced would imply a host of major cross-border risks, in particular those stemming from the economic and financial consequences of an accelerated deregulation and destabilization of the Earth system. The rest of this paper is organized as follows. Section 2 highlights several stylized facts that are relevant for assessing cross-border risks during the mid-transition period. Section 3 proposes a taxonomy of country-level cross-border risks. Section 4 analyzes potential cross-border impacts that result from shifting trade, energy, and employment patterns, quantifying some of them using the E3ME-FTT global macroeconomic model. Section 5 explores the potential international macroeconomic and financial spillovers that cross-border mid-2 As documented by Fressoz (2022), the concept of "energy transition" first appeared in 1967 in response to the threat of energy resource shortages, and in 1982 to make the case for the need to invest in nuclear energy as a contingency option to rapidly decarbonize the global energy system if a climate catastrophe were to appear likely. Geels and Turnheim (2022), meanwhile, use the term "transition" to refer to a technological transformation that may not necessarily be entirely driven by a climate goal, making use of a historical perspective looking at where transitions have occurred before and the conducing factors. Here, the mid-transition that we describe does not necessarily imply a sufficiently rapid decarbonization of the world economy to avoid climate change of 2°C or more. 3 The paper essentially abstracts from the macroeconomic effects of physical risks of climate change, including those that could adversely impact the global low-carbon transition. 4 See the recent study by Carter et al. (2021) for a conceptual framework for cross-border impacts of the physical effects of climate change. On cross-border impacts of physical climate change, see also Adams et al. argue that societal reactions to worsening physical climate impacts could create destructive dynamics whereby societies are increasingly distracted by the symptoms of the crisis, deepening its consequences and generating a doom loop.