Economics of climate change: the economical debt?


Climate change has many dimensions: physical, social, political and also economical. Mitigation is a challenge to our economies. Waiting is not longer an option. We tend to associate climate change with phenomena such as typhoons, floods or droughts. But it has economic implications too and the purpose of this article is to look at some of these.

The economic analysis of climate change took a new departure after the publication of the Stern Report (2006). The Stern Report’s main conclusion is that the benefits of strong, early action on climate change were much greater than the costs of not acting. According to the Report, without action, the overall costs of climate change will be equivalent to losing at least 5% of global gross domestic product (GDP) each year, now and into the foreseeable future. It could increase this to 20% of GDP or more, also indefinitely, in case of heavier impacts. The Report proposes that one percent of global GDP per annum is required to be invested to avoid the worst effects of climate change. In 2008, Stern increased the estimate for the annual cost of achieving stabilisation to 2% of GDP as climate change was taking place much faster than expected.

The effects of climate change are called in economics “externalities”. Economic agents seek profit from their activity, or the satisfaction of needs, but sometimes it causes unwanted effects: pollution, depletion of natural resources that are not any more available for future generations, or the accumulation of harmful gases for the global temperature of the planet. In the case of climate change, the difficulty of establishing the direct causality of the impacts is less visible than other environmental problems such as pollution or depletion of natural resources.

A key issue in economics and climate change is the cost of mitigation. The emission of greenhouse gases -and their accumulation in the atmosphere- is the vector of human intervention on climate change. Mitigation is the basic human activity to reverse –or to limit- climate change. There are two basic indicators to measure the level of risk.

First is the increase on the global average temperature, it is estimated that it should be kept in the range of 2 to 4 °C. Increases on average temperature above 4 °C make it very difficult to forecast the impacts but clearly puts them into the category of major disasters.

The second indicator is the number of particles of CO2 per million present in the steam, the upper safety limit for atmospheric CO2 is 350 parts per million (ppm). This is to say that any economic analysis will always be aware of these indicators and will try to suggest action under these limits.

If these are the physical indicators that warn us of the severity of the impacts of climate change, it is also interesting to identify those economic sectors that have a greater impact on the emission of greenhouse gases. The first one is power generation (41%); transport (19%); industry (19%); buildings (13%) and other (8%). This distribution also helps us to understand better where to put the efforts.

The economic analytical tool most frequently applied is the cost benefit analysis (CBA). For this we need the calculation of damages, the calculating of costs and to assign a discount rate. But it is not so obvious this kind of analysis, as there is significant uncertainty about the damage. Also the risk that losses can be much higher than anticipated, and how to give a monetary value to losses that are irreversible (biodiversity). Not only damage, but the costs are also difficult to estimate.

The costs of mitigation depend on the moment the policy is implemented. The longer it takes to initiate actions it will be more expensive, but probably there will be better technology that could reduce the costs; also the price allocated to the carbon, which as it has been seen in the trading mechanisms already in place, if the price is unrealistic it doesn’t provide relevant information and it prevents from transactions. International cooperation is also important because the more countries are involved the easier it will be to achieve the objectives to limit emissions. Finally the very objectives of concentration of CO2, the more ambitious they are, the most expensive to be achieve. The rate of discount also has implications; according the period of discount –and we are talking about long periods- it can lead to very different conclusions.

The cost-benefit analysis shows the efforts of economics for guiding action on climate change. Besides the cost of mitigation the economics of climate change have to deal with topics as the cost of adaptation, an open question as it is impossible today to foresee the extent of adaptation required to preserve life on earth.

Another issue is the transfer of resources to the less developed countries, the “ecological debt” that Pope Francis recognises in his encyclical “Laudato si”; this transfer of resources both to finance efforts on mitigation and to share technology. How to fund all these operations is the other side of the picture, ad hoc taxes seems inevitable. The private and public collaboration is indispensable, but finally the only realistic option is the development of an economy capable of moving towards more sustainable production and consumption.

Jose Ignacio Garcia, SJ