Trading in a new climate: How mitigation policies are reshaping global trade dynamics

Faced with the urgency of climate change, many countries are embracing policies to tackle it. However, these policies are not only reshaping the landscape of global trade flows but also risking further fragmentation and inequality.  One challenge concerns the consequences for low-income countries that rely on export-led growth and especially their Small and Medium-sized Enterprises (SMEs) part of global supply chains. To successfully navigate this challenge and promote a just and inclusive transition to a greener world, bold policies are needed that foster coordination and incentivize firms to decarbonize. 

The impact of recent climate mitigation policies on emission reduction commitments  

The large number of climate mitigation policies — including net zero goals, supply chain due diligence obligations and green subsidies — is significantly reshaping global trade flows. For example, the European Union's Carbon Border Adjustment Mechanism (CBAM) is penalizing high-carbon content exports to the European Union (EU) to encourage cleaner production and meet its own climate ambitions. The EU Corporate Sustainability Reporting Directive will require around 50,000 large companies and listed SMEs in the EU to report their environmental and social impacts, including through their supply chains. Several countries are using green subsidies at the risk of distorting market access to firms from other countries producing green products. These policies are a game-changer in the global trade landscape.

Reshaping global trade flows: Risks for SMEs and low-income countries

The shift towards more binding social and environmental regulation will reshape global supply chains, which are critical to development and job creation. However, countries that fail to decarbonize production processes risk losing trade to greener counterparts. World Bank research shows that climate change mitigation policies can disproportionately affect low- and middle-income countries, leading to a decline in their trade compared to high-income economies.  This poses a significant challenge for job security in affected sectors.ⁱ

The Bank’s new CBAM Exposure Index (Figure 1) shows for instance that Zimbabwe is the most vulnerable country, largely because of its sizeable exports of high carbon-emissions intensive ferroalloys to the EU. In Mozambique, almost 20 percent of the country’s exports fall under CBAM, impacting the economy, especially with 97 percent of aluminum exports going to the EU.

Source: Maliszewska, M., Chepeliev, M, Fischer C. and Jung, E. (2023) How developing countries can measure exposure to the EU’s carbon border adjustment mechanism. https://www.worldbank.org/en/data/interactive/2023/06/15/relative-cbam-exposure-index

Note: The relative CBAM exposure index is measured by multiplying the export share by the difference between the exporter’s emissions intensity and the EU average emissions intensity for the CBAM product, scaled by the assumed CBAM price ($100 per ton). This index identifies countries with an excess of carbon emissions to the EU average. In the figure, green signifies cleaner than the EU average while red expresses more carbon intensive than the EU average. For the relative CBAM exposure index, the threshold is zero. Negative (green) index indicates relatively clean exporters may gain competitiveness in the EU market, while positive (red) indicates countries that may lose export competitiveness. See: https://www.worldbank.org/en/topic/trade/brief/technical-note-for-the-cbam-exposure-index

Disproportionate impact on SMEs: Compliance challenges and risk of exclusion from global supply chains

Multinational enterprises (MNEs) are under increasing pressure from consumers, investors, and regulators, to enhance sustainability requirements for their products. While this is a positive development, it comes with compliance costs.  A recent survey found that 78 percent of MNEs would exclude suppliers endangering their carbon transition plans by 2025.

SMEs, particularly in developing countries, bear a higher burden of compliance due to their limited resources. Failure to comply with these requirements can result in exclusion from global supply chains and trade. For example, the new EU Regulation on deforestation-free products may hinder the access of small-holder farmers producing cocoa, coffee, and palm oil from countries like Côte D’Ivoire, Ethiopia, and Honduras.

What is needed for a just and inclusive transition to a greener world?

To ensure a just and inclusive transition to a greener world, it is crucial to implement better coordinated policies with compliance requirements that are manageable for the green transition of SMEs.  This can be achieved through environmentally friendly trade practices, lowering barriers to trade in the goods, services, and technology that help with adaptation and mitigation.

Additionally, global collaboration is essential to harmonize regulations and introduce mutual recognition agreements to avoid duplication. Enhancing institutional capacity in carbon standards, measurement, and verification, along with compliance to private initiatives, is also vital. For example, in Georgia, less than half of businesses monitor energy consumption and only 3 to 5 percent monitor emissions.

Mobilizing support to address the technical and financial needs for firms affected by mitigation policies is critical to ensure compliance, promote sustainable practices and facilitate the adoption of green technology. For example, in South-East Asia, 79% of SMEs surveyed acknowledged the need to acquire new technical skills to effectively deal with climate change and leverage existing climate mitigation opportunities.

Increased global cooperation, technical and financial assistance are necessary to safeguard the continued access and participation of SMEs in global value chains.  This is what the World Bank is supporting in Brazil, Türkiye, and Kenya.

Takeaways

The challenges posed by climate mitigation policies require careful navigation to achieve a just and inclusive transition to a greener world. By implementing bold policies that foster coordination, incentivize decarbonization, and support SMEs, we can promote sustainable practices and facilitate the adoption of green technology.  Increased global cooperation, technical assistance, and financial support are essential to ensure the continued access and participation of SMEs in global value chains, safeguarding future inclusive growth. Together, we can navigate these challenges and create a more sustainable and equitable world.