Energy transition and economic growth in low-income countries: the role of climate finance

Abstract Although prices for renewable energy technologies have recently declined, many low-income countries still face barriers to deployment. The energy supply for their growing economies largely originates from the burning of fossil fuels. To avoid accelerating global greenhouse gas emissions, it is crucial that low-income countries enter a low-carbon growth path through the large-scale deployment of renewable energy. This is particularly relevant in countries that import fossil energy resources from global markets, where renewable energy deployment could be a tool for achieving independence and economic development. It can be beneficial in the short-run, for low-income countries with limited access to finance to rely on existing energy infrastructure. However, investment in renewable energy provides a long-run solution to preventing carbon lock-in by expanding existing infrastructure, such as pipelines or refineries. Therefore, we develop a theoretical model for long-run economic growth in import-dependent low-income countries. To produce renewable energy, a country must either attract international climate finance funds or substitute for other investments in the domestic economy to build a renewable energy capital stock. The results imply that sufficient and stable access to climate finance funds to transition to renewable energy accelerates long-run economic growth and welfare. Conversely, when investments in the energy transition crowds-out investment from other productive sectors in the economy, financing the energy transition can lead to income losses between 15 and 20% in the short- to medium-run. However, the energy transition does stimulate economic growth and welfare with an optimal allocation of capital in the long run. Furthermore, insufficient access to climate finance leads to rebound effects, accelerating demand for fossil energy and carbon emissions.