Economic analysis of climate change
Economic analysis of climate change is about using economic tools and models to calculate the magnitude and distribution of damages caused by climate change. It can also give guidance for the best policies for mitigation and adaptation to climate change from an economic perspective. There are many economic models and frameworks. For example, in a cost–benefit analysis, the trade offs between climate change impacts, adaptation, and mitigation are made explicit. For this kind of analysis, integrated assessment models (IAMs) are useful. Those models link main features of society and economy with the biosphere and atmosphere into one modelling framework.[2] The total economic impacts from climate change are difficult to estimate. In general, they increase the more the global surface temperature increases (see climate change scenarios).[3]
Most types of climate change effects are associated with an economic cost.[4]: 936–941 Many of the effects have impacts that are linked to market transactions and therefore are directly affect GDP. However, there are also non-market impacts which are harder to translate into economic costs. These include the impacts of climate change on human health, biomes and ecosystem services. Economic analysis of climate change is challenging as climate change is a long-term problem. Furthermore, there is still a lot of uncertainty about the exact impacts of climate change and the associated damages to be expected. Future policy responses and socioeconomic development are also uncertain.
Economic analysis also looks at the economics of climate change mitigation and the cost of climate adaptation. Mitigation costs will vary according to how and when emissions are cut. Early, well-planned action will minimize the costs.[5] Globally, the benefits of keeping warming under 2 °C exceed the costs.[6] Cost estimates for mitigation for specific regions depend on the quantity of emissions allowed for that region in future, as well as the timing of interventions.[7]: 90 Economists estimate the cost of climate change mitigation at between 1% and 2% of GDP.[8] The costs of planning, preparing for, facilitating and implementing adaptation are also difficult to estimate, depending on different factors. Across all developing countries, they have been estimated to be about USD 215 billion per year up to 2030, and are expected to be higher in the following years.[9]: 35–36
Economic analysis of climate change is an umbrella term for a range of investigations into the economic costs around the effects of climate change, and for preventing or softening those effects. These investigations can serve any of the following purposes:[10]: 2495
The economic impacts of climate change also include any mitigation (for example, limiting the global average temperature below 2 °C) or adaption (for example, building flood defences) employed by nations or groups of nations, which might infer economic consequences.[11][12][13] They also take into account that some regions or sectors benefit from low levels of warming, for example through lower energy demand or agricultural advantages in some markets.[10]: 2496 [14]: 11
There are wider policy (and policy coherence) considerations of interest. For example, in some areas, policies designed to mitigate climate change may contribute positively towards other sustainable development objectives, such as abolishing fossil fuel subsidies which would reduce air pollution and thus save lives.[15][16][17] Direct global fossil fuel subsidies reached $319 billion in 2017, and $5.2 trillion when indirect costs such as air pollution are priced in.[18] In other areas, the cost of climate change mitigation may divert resources away from other socially and environmentally beneficial investments (the opportunity costs of climate change policy).[15][16]
Challenges and debates[edit]
Utility of aggregated assessment[edit]
There are a number of benefits of using aggregated assessments to measure economic impacts of climate change.[4]: 954 They allow impacts to be directly compared between different regions and times. Impacts can be compared with other environmental problems and also with the costs of avoiding those impacts. A problem of aggregated analyses is that they often reduce different types of impacts into a small number of indicators. It can be argued that some impacts are not well-suited to this, e.g., the monetization of mortality and loss of species diversity. On the other hand, where there are monetary costs of avoiding impacts, it may not be possible to avoid monetary valuation of those impacts.[134]: 364
Efficiency and equity[edit]
No consensus exists on who should bear the burden of adaptation and mitigation costs.[72]: 29 Several different arguments have been made over how to spread the costs and benefits of taxes or systems based on emissions trading.
One approach considers the problem from the perspective of who benefits most from the public good. This approach is sensitive to the fact that different preferences exist between different income classes. The public good is viewed in a similar way as a private good, where those who use the public good must pay for it. Some people will benefit more from the public good than others, thus creating inequalities in the absence of benefit taxes. A difficulty with public goods is determining who exactly benefits from the public good, although some estimates of the distribution of the costs and benefits of global warming have been made – see above. Additionally, this approach does not provide guidance as to how the surplus of benefits from climate policy should be shared.
A second approach has been suggested based on economics and the social welfare function. To calculate the social welfare function requires an aggregation of the impacts of climate change policies and climate change itself across all affected individuals. This calculation involves a number of complexities and controversial equity issues.[44]: 460
For example, the monetization of certain impacts on human health. There is also controversy over the issue of benefits affecting one individual offsetting negative impacts on another.[4] : 958 These issues to do with equity and aggregation cannot be fully resolved by economics.[135]: 87
On a utilitarian basis, which has traditionally been used in welfare economics, an argument can be made for richer countries taking on most of the burdens of mitigation.[136] However, another result is possible with a different modeling of impacts. If an approach is taken where the interests of poorer people have lower weighting, the result is that there is a much weaker argument in favour of mitigation action in rich countries. Valuing climate change impacts in poorer countries less than domestic climate change impacts (both in terms of policy and the impacts of climate change) would be consistent with observed spending in rich countries on foreign aid[137][138]: 229
A third approach looks at the problem from the perspective of who has contributed most to the problem. Because the industrialized countries have contributed more than two-thirds of the stock of human-induced GHGs in the atmosphere, this approach suggests that they should bear the largest share of the costs. This stock of emissions has been described as an "environmental debt".[139]: 167
In terms of efficiency, this view is not supported. This is because efficiency requires incentives to be forward-looking, and not retrospective.[72]: 29 The question of historical responsibility is a matter of ethics. It has been suggested that developed countries could address the issue by making side-payments to developing countries.[139]: 167
A 2019 modelling study found climate change had contributed towards global economic inequality. Wealthy countries in colder regions had either felt little overall economic impact from climate change, or possibly benefited, whereas poor hotter countries very likely grew less than if global warming had not occurred.[140] Part of this observation stems from the fact that greenhouse gas emissions come mainly from high-income countries, while low-income countries are affected by it negatively.[141] So, high-income countries are producing significant amounts of emissions, but the impacts are unequally threatening low-income countries, who do not have access to the resources to recover from such impacts. This further deepens the inequalities within the poor and the rich, hindering sustainability efforts. Impacts of climate change could even push millions of people into poverty.[142]
Insurance and markets[edit]
Traditional insurance works by transferring risk to those better able or more willing to bear risk, and also by the pooling of risk.[72]: 25 Since the risks of climate change are, to some extent, correlated, this reduces the effectiveness of pooling. However, there is reason to believe that different regions will be affected differently by climate change. This suggests that pooling might be effective. Since developing countries appear to be potentially most at risk from the effects of climate change, developed countries could provide insurance against these risks.[143]
Disease, rising seas, reduced crop yields, and other harms driven by climate change will likely have a major deleterious impact on the economy by 2050 unless the world sharply reduces greenhouse gas emissions in the near term, according to a number of studies, including a study by the Carbon Disclosure Project and a study by insurance giant Swiss Re. The Swiss Re assessment found that annual output by the world economy will be reduced by $23 trillion annually, unless greenhouse gas emissions are adequately mitigated. As a consequence, according to the Swiss Re study, climate change will impact how the insurance industry prices a variety of risks.[144][145][146]
Authors have pointed to several reasons why commercial insurance markets cannot adequately cover risks associated with climate change.[147]: 72 For example, there is no international market where individuals or countries can insure themselves against losses from climate change or related climate change policies.
Financial markets for risk
There are several options for how insurance could be used in responding to climate change.[147]: 72 One response could be to have binding agreements between countries. Countries suffering greater-than-average climate-related losses would be assisted by those suffering less-than-average losses. This would be a type of mutual insurance contract.
These two approaches would allow for a more efficient distribution of climate change risks. They would also allow for different beliefs over future climate outcomes. For example, it has been suggested that these markets might provide an objective test of the honesty of a particular country's beliefs over climate change. Countries that honestly believe that climate change presents little risk would be more prone to hold securities against these risks.
Underestimation of economic impacts[edit]
Studies in 2019 suggest that economic damages due to climate change have been underestimated, and may be severe, with the probability of disastrous tail-risk events.[148][149]
Tipping points are critical thresholds that, when crossed, lead to large, accelerating and often irreversible changes in the climate system. The science of tipping points is complex and there is great uncertainty as to how they might unfold.[150] Economic analyses often exclude the potential effect of tipping points. A 2018 study noted that the global economic impact is underestimated by a factor of two to eight, when tipping points are excluded from consideration.[99]
The Stern Review from 2006 for the British Government predicted that world GDP would be reduced by several percent due to climate related costs. However, their calculations may omit ecological effects that are difficult to quantify economically (such as human deaths or loss of biodiversity) or whose economic consequences will manifest slowly.[151] Therefore, their calculations may be an underestimate. The study has received both criticism and support from other economists (see Stern Review for more information).