So what exactly do we mean by the economics of climate change? The world’s climate has already changed measurably in response to accumulating greenhouse gas (GHG) emissions. These changes as well as projected future disruptions have prompted intense research into the nature of the problem and potential policy solutions.
Considerable uncertainties surround the extent of future climate change and the importance of such change’s biophysical impacts. Notwithstanding the delays, climate scientists have reached a strong consensus that in the absence of measures to reduce GHG emissions significantly, climate changes will be substantial, with long-lasting effects on many of Earth’s physical and biological systems. The estimates of these impacts are significant. Moreover, there are significant risks associated with low probability but potentially catastrophic outcomes. Although a focus on median results warrants efforts to reduce emissions of GHGs, economists argue that the uncertainties and associated risks justify more aggressive policy action than otherwise would be warranted. Apart from this, there are also some significant impact on the economy this climate change brings known as “Economics of Climate Change”
Economics of climate change
The economics of climate change refers to the economic aspects of climate change; this helps inform governments’ policies in response. Several factors make this and the politics of climate change a difficult problem: it is a long-term, intergenerational problem, benefits and costs are distributed unequally both within and across countries, and both scientific and public opinions need to be taken into account.
One of the most important greenhouse gases is carbon dioxide (CO2). Around 20% of carbon dioxide emitted due to human activities, can remain in the atmosphere for many thousands of years. The long time scales and uncertainty associated with global warming have led analysts to develop “scenarios” of future environmental, social and economic changes. These scenarios can help governments understand the potential consequences of their decisions.
Climate change impacts include the loss of biodiversity, sea-level rise, increased frequency and severity of some extreme weather events, and acidification of the oceans. Economists have attempted to quantify these impacts in monetary terms, but these assessments can be controversial. The two primary policy responses to global warming are to reduce greenhouse gas emissions (climate change mitigation) and to adapt to the impacts of global warming (e.g., by building levees in response to sea-level rise).
Given these uncertainties, some economists have attempted to analyse the economics of climate change in the context of cost-benefit analysis. Others have criticised this approach to put a monetary valuation on issues with social, political, and ecological implications that go far beyond dollar value. Cost-Benefit Studies of Global Climate Change Without policy intervention, carbon emissions in a business-as-usual scenario would be expected to continue to rise. However, these projections are based on current trends without considering the impacts of future emissions reductions policies. Aggressive and immediate policy action is required to stabilise and reduce total CO2 emissions in the coming decades. This is the goal of the 2015 Paris Agreement. To understand the issues involved in reducing emissions, we need to look at such policy initiatives’ economic implications.
When economists perform a cost-benefit analysis of the economics of climate change, they weigh the consequences of the projected increase in carbon emissions versus the costs of current policy actions to stabilise or even reduce CO2 emissions. Decisive policy action to prevent climate change will bring benefits equal to the value of avoided damages. These benefits of preventing damage can also be referred to as avoided costs. The estimated benefits must then be compared to the costs of taking action. 18 Various economic studies have tried to evaluate the benefits and costs of policy action on climate change. Attempting to measure the costs of climate change in monetised terms, or as a percentage of GDP, poses several inherent problems. In general, these studies can only capture climate change effects insofar as they impact economic production, or create non-market impacts expressed in monetary terms. Some economy sectors are potentially vulnerable to climate change impacts, including farming, forestry and fishing, coastal real estate, and transportation. But these comprise only about 10% of GDP. Other significant areas, such as manufacturing, services, and finance, are only lightly affected by climate change.31 Thus, an estimate of GDP impacts may tend to omit some of the most potent ecological effects of climate change.
The Cons of Cost- Benefit Analysis
Cost-benefit analysis can also be controversial since it puts a dollar figure on the value of human health and life. Most studies follow a common cost-benefit practice of assigning a value of about $8 ̶ 11 million to life, based on reviews of the amounts that people are willing to pay to avoid life-threatening risk, or are willing to accept (e.g., in extra salary for dangerous jobs) to undertake such risks. But lower human life values tend to be assigned in developing nations since the methodology for determining the value of a “statistical life” depends on monetary measures such as incomes and contingent valuation. Since many of the most severe impacts of climate change will be experienced in developing nations, this economic valuation bias raises both analytical and moral issues.
One estimate of the costs of meeting the Paris agreement target of no more than two °C temperature increase is that it would require about 1.5% of world income (about the equivalent of one year’s growth in real revenue). But this is under best-case assumptions of international cooperation. Under less favourable assumptions, costs are estimated to rise to above 4% of global GDP. 35 Similarly, the meta-analysis referred to above finds that prices could vary from 3.4% of global GDP under worst-case assumptions to an increase in global GDP of 3.9% using best-case assumptions.
Policy Responses to Climate Change
Adaptation and Mitigation Policy responses to climate change can be broadly classified into two categories: adaptive measures to deal with the consequences of climate change and mitigation, or preventive measures, intended to lower the magnitude or timing of climate change.
Adaptive measures include:
• Construction of dikes and seawalls to protect against rising seas and extreme weather events such as floods and hurricanes.
• Shifting cultivation patterns in agriculture to adapt to changing weather conditions.
• Creating institutions that can mobilise the needed human, material, and financial resources to respond to climate-related disasters. Mitigation measures include:
• Reducing greenhouse gas emissions by meeting energy demands from sources with lower greenhouse gas emissions (e.g., switching from coal to wind energy for electricity).
• Reducing greenhouse gas emissions by increasing energy efficiency.
• Enhancing natural carbon sinks.
Carbon sinks are areas where carbon may be stored; natural sinks include soils and forests. Human intervention can either reduce or expand these sinks through forest management and agricultural practices. Forests recycle carbon dioxide (CO2) into oxygen; preserving forested areas and expanding reforestation can significantly affect net CO2 emissions. Soils are also vast carbon repositories, with three times more carbon stored in soils than in the atmosphere. Restoring degraded soils could capture large quantities of CO2. Economic analysis can provide policy guidance for nearly any particular preventive or adaptive measure. As seen above, the cost-benefit analysis can present a basis for evaluating whether a policy should be implemented. However, as discussed previously, economists disagree about the appropriate assumptions and methodologies for cost-benefit analyses of climate change. A less controversial conclusion from economics of Climate Change theory is that we should apply cost-effectiveness analysis in considering which policies to adopt. The use of cost-effectiveness analysis avoids many of the complications associated with a cost-benefit research. While cost-benefit study attempts to offer a basis for deciding upon policy goals, cost-effectiveness analysis accepts a plan as given by society and uses economic techniques to determine the most efficient way to reach that goal.
An effective response to the climate change problem requires much more sweeping action globally than anything so far achieved. Economic policy instruments that have the power to alter patterns of energy use, industrial development, and income distribution are essential to any plan for mitigating or adapting to climate change. Evidence of climate change impacts is already evident, and the issue will become more pressing as greenhouse gas accumulation continues and costs of damages and climate adaptation rise.