Climate Policies, Labor Markets, and Macroeconomic Outcomes in Emerging Economies

We study the labor market and macroeconomic effects of introducing a carbon tax in the energy sector in emerging economies (EMEs) by building a framework with equilibrium unemployment and firm entry that incorporates key elements of the distinct employment and firm structure of EMEs. Our model also endogenizes the adoption of green energy-production technologies—a core element of policy discussions regarding the transition to a low-carbon economy. Using EME data to calibrate the model, we find that a carbon tax fosters greater green technology adoption and increases the share of green energy used, but leads to lower salaried firm creation and formal employment, greater self-employment, and higher unemployment. As a result, the tax generates consumption, output, and welfare losses. Endogenous green technology adoption plays a key role in limiting these losses: absent this margin, a carbon tax generates output and welfare losses that are almost three times greater for the same reduction in emissions, with carbon-tax-induced changes in the composition of employment playing a key role in shaping these losses. Finally, we show that a carbon tax coupled with a plausible reduction in the costs of becoming a formal firm can offset the adverse labor market and macroeconomic effects of the tax and generate a transition to a lower-carbon economy with minimal economic costs