Climate policies, labour markets and macroeconomic outcomes in emerging economies

Summary

Focus

We study the labour market and macroeconomic effects of implementing a carbon tax and related climate policies in the energy sector in emerging market economies (EMEs). We build a macro model that captures the distinct structure of employment and firms in EMEs, with emphasis on the prevalence of self-employment. Calibrating the model to a representative EME, we analyse how a carbon tax on polluting energy production affects the labour market and macroeconomic activity in the long run and along the transition to a setting with lower polluting carbon emissions.

Contribution

EMEs face unique challenges due to their distinct employment and firm structure compared with advanced economies, making it crucial to assess the broader impact of climate policies in these economies. We provide insights into how carbon taxes can reshape the domestic production structure of EMEs, highlighting the role of green technology adoption and the potential economic trade-offs EMEs face when considering climate policies. Policymakers can use these insights to design more effective economic policies that balance economic growth with a reduction in carbon emissions.

Findings

Our analysis delivers four main insights. First, a carbon tax promotes the adoption of green technologies and increases the share of green energy but also results in higher energy prices. This leads to less creation of formal salaried firms, higher self-employment and more labour participation and unemployment. The reallocation of labour away from salaried firms and into self-employment, coupled with the rise in energy prices, ultimately leads to long-term output and welfare losses. Second, the ability of energy producers to adopt green technologies significantly limits the adverse effects of the carbon tax. Third, the carbon tax-led increase in self-employment, a central component of EME labour markets, exacerbates the output and welfare losses from the tax compared with an environment where self-employment is not a viable employment option. Fourth, a joint policy that raises the carbon tax on polluting energy production and reduces the cost of firm formality can effectively mitigate the negative labour market and macroeconomic effects of a carbon tax, thereby leading to a smoother transition to a lower-carbon economy with minimal economic costs.

Abstract

We study the labour market and macroeconomic effects of a carbon tax in the energy sector in emerging economies. We build a search and matching macro model with pollution externalities from energy production, endogenous green-technology adoption, and salaried-firm entry that incorporates two key elements of the employment and firm structure of these economies: salaried labor and firm informality and self-employment. Calibrating the model to emerging-economy data, we show that a carbon tax increases green-technology adoption and the share of green energy, but also leads to higher energy prices. As a result, the tax reduces salaried firm creation, the number of formal firms, and formal employment, and leads to an increase in self-employment, labor participation, and unemployment - a response that generates long run output and welfare losses. Green-technology adoption limits while self-employment exacerbates the quantitative magnitude of these losses. A joint policy that combines a carbon tax with a reduction in the cost of firm formality can offset the adverse effects of the tax and generate a transition to a lower-carbon economy with minimal economic costs.

JEL Classification: E20, E24, E61, H23, J46, J64, O44, Q52, Q55

Keywords: environmental and fiscal policy, carbon tax, endogenous firm creation, green technology adoption, search frictions, unemployment and labour force participation, informality and self-employment, emerging economies