The Economics of Climate Change

The economics of climate change are tricky, but not necessarily dismal. With few exceptions, we who buy fossil fuels and emit greenhouse gases aren’t paying a price that reflects the costs imposed by that pollution. Because the effects are global and persist for hundreds and thousands of years, most of us will see very little of the negative consequences that have already been set in motion.

Barring major interventions, global emissions of greenhouse gases are bound to increase dramatically in the years ahead due, in part, to world population growth and the increasing incomes of people in developing countries, which allow them access to refrigeration, motor bikes, and other opportunities to emit greenhouse gases. Options for curtailing greenhouse emissions include:

1. marketing campaigns to convince people that the moral thing to do is stop emitting greenhouse gases because of the harm resulting for people and living things all over the globe in decades and centuries ahead;
2. laws and regulations that limit how much can be emitted; and
3. laws and regulations that require purchasers of greenhouse-gas-producing fuels and technology to bear the cost of the negative effects. These give us economic incentives to reduce these emissions. Examples include cap and trade regulations and carbon taxes, which can be offset by reductions in other taxes. [Note1]

Since the beginning of the industrial revolution in the nineteenth century, the world has heavily invested in greenhouse-gas-emitting infrastructure. Transforming our world with new technology that keeps greenhouse gas emissions at safe levels is estimated to require $45 trillion of investment between now and 2030. [Note 2] If we wait to tackle this problem, the cost of making this transformation will rise dramatically. The President’s Council of Economic Advisors estimated that to meet the internationally agreed upon level that would limit global warming to no more than two degrees Celsius would cost about 40 percent more if we wait a decade to act. [Note 3] Moreover, the additional cost of trying to redress the increased effects of climate change, such as severe heat waves, droughts, flooding, extinction of many species, and sea level rise, would be astounding.

Is fighting climate change worth $45 trillion? Probably not, from the perspective of a corporate leader, who in the absence of a cap and trade system or carbon tax is thinking about the costs the corporation will face, not all the long run costs. If their business plan focuses on the period between now and their retirement, it’s too short sighted to be worth that level of investment. Under a cap and trade system or with a carbon tax that imposes a substantial share of the cost of avoiding the harmful effects from greenhouse gas emissions, the investment may well become worthwhile. It’s even more financially sensible if you have a business plan focused on the long run and you don’t discount the enormous cost of lives lost and damage far in the future.

How can such investments be financed? By governments, businesses, families, and individuals. The gross world product (GWP) was about $75 trillion in 2012. Assuming it doesn’t increase between now and 2030, investing $45 trillion between 2015 and 2030 would require an average of $2.8 trillion a year—3.8 percent of GWP. If the world economy grows at a 3 percent annual rate (after adjusting for inflation), the $45 trillion dollar investment would represent an average of 2.7 percent of GWP each year. [Note 4] We could start by eliminating government subsidies for the fossil fuel industry, estimated by the IMF to be $1.9 trillion annually. [Note 5] The IPCC estimates that making the investment needed to avoid warming above two degrees Celsius could reduce the annual growth rate in global consumption by 0.04 to 0.14 percentage points. [Note 6] Others conclude that it would not affect consumption. [Note 7] These estimates do not, however, take into account the enormous benefits of reducing climate change. If we work together, this is doable. For the sake of posterity and the biosphere, let’s just do it.

 Notes