Climate Change Climate Economics;
The impact of climate change on economic growth
Climate change can reshape natural ecosystems, threatening life on Earth physiologically, but also economically. By analysing the economic impact of global warming, we can understand why this is a risk we cannot afford to take.
Massimo Tavoni, Full Professor of Climate Change Economics, School of Management Politecnico di Milano, and Director of the European Institute on Economics and the Environment
Climate change will have a profound impact on both ecosystems and human beings. Some of these kinds of impact are not quantifiable from an economic point of view because they have consequences such as the extinction of ecosystems and species. Others have been quantified, especially those which have an impact on production factors such as labour, capital and natural resources. Climate economists have been dealing with this problem for several years now, but to date, estimates regarding economic impact remain a very bountiful research topic, the depths of which have not yet been plumbed.
Recently, alternative methods have been developed to estimate the economic impact of the climate starting from historical empirical data. This approach analyses how temperature changes over the past 40 years have influenced the economic growth of every country in the world, taking into account their institutional, technological and climatic differences. This retrospective assessment has revealed a non-linear relationship between temperature and economic growth: for cold countries (i.e. those below an ‘ideal’ temperature), an increase in temperature could benefit the economy and lead to additional growth. For warm countries, however, it appears to lead to diminished economic growth, more significant in scale the warmer the country is.
By applying these estimates to different future global warming scenarios, we can observe some extremely significant economic losses. For example, for global temperature increases of 3°C – a very likely outcome given current emission trends – these estimates predict losses of World GDP of between 15 and 60%. It is important to bear in mind that these studies – as they extrapolate the information of the past in a future with a different climate – do not include factors such as rising sea levels, ocean acidification, etc.: factors that would, on the whole, increase the economic damage to the climate. As a counterpoint to this, an increased level of adaptability could limit damage. The latest IPCC report on 1.5°C has shown that limiting global warming to 1.5°C instead of 2°C would save 1.5-2.0% of the world’s gross domestic product (GDP) by halfway through the century and 3.5% of GDP by the end of the century. Based on a 3% discount rate, this corresponds to $8.1-11.6 trillion and $38.5 trillion in damage avoided by the middle and end of the century, respectively.
As shown in the Figure below, the impacts of global warming on economic growth are not felt the same way around the world. Both today and in the future, economic losses will mostly be concentrated in hot countries, where further warming leads to strong economic decline. Hot countries are also, on the whole, poorer than cold ones. As a result, climate change will not just slow global economic growth, but also exacerbate global inequalities, actually hitting the countries which have contributed the least to manmade climate change the hardest. This is likely to be the source of strong international tensions.
Figure 1. Projected economic impacts of climate change. Source: Burke et. Al, Nature, 2015.
We can attempt to break down the direct and indirect economic impacts of climate change into their relevant sectors. An OECD study (Dellink et al. 2019) assessed a wide range of impacts: changes in crop yields, loss of land and capital due to rising sea levels, changes in fisheries’ catches, damage to capital caused by hurricanes, changes in labour productivity and changes in healthcare costs from diseases and thermal stress, changes in tourism flows and changes in the demand for energy for cooling and heating. The results show that damages are expected to increase twice as fast as global economic activity – the impacts on productivity in both labour and agriculture have the most severe negative economic consequences. The damage caused by rising sea levels will grow faster after the middle of the century. The damage to energy and tourism is very small from a global perspective, as the benefits in some regions outweigh the damage in others. Climate damage caused by hurricanes can have significant effects on local communities, but macroeconomic consequences are expected to be relatively small. In line with the studies listed above, the net economic consequences are expected to be particularly serious in Africa and Asia, where regional economies are vulnerable to a range of different climate impacts.
Given this worrisome outlook, what actions should companies, governments and citizens be taking? Economists agree that pricing carbon is a fundamental tool for discouraging fossil fuels and incentivising green innovation. Staying below 2°C would require putting a price of about 50 Euros/tCO2 on CO2 globally. This seems politically challenging, especially in fast-growing economies which rely heavily on fossil-generated energy. Complementary policies such as incentives for green innovation, as well as behavioural change measures by consumers, could help to kickstart the low carbon transition. We now have the technology to achieve this transformation at reasonably low societal costs, if it is well-designed. It is a question of political capital and public acceptance. Regions such as Europe have a unique opportunity to use this green momentum to restructure their economies and favour a more sustainable and inclusive model.