Climate change and the Economy

• Author: Natalia Tamirisa
• Position: Deputy Division Chief in the IMF's Research Department
• Pages: 18-22

Page 18

Policies to reduce the emission of greenhouse gases need not hobble the economy

ADDRESSING climate change and the economic damage it will likely bring presents policymakers with a dilemma. The benefits of policy action are uncertain and would accrue largely to future generations, whereas the costs of policies run the risk of being more immediate and extensive. At the same time, the costs of inaction are irreversible, potentially catastrophic, and likely to hit poorer countries harder than developed ones. Moreover, even if the greenhouse gas (GhG) emissions that accumulate in the atmosphere and warm the climate stopped immediately, temperatures would rise for some decades because of the emissions already accumulated.

For these reasons, economic policymakers increasingly recognize that policies will have to be adopted both to mitigate global warming, by slowing and ultimately reversing the growth of GhG emissions, and to adapt to the effects of the emissions that have already occurred and will occur in the coming decades. And they agree that mitigation policies in particular can have rapid and wide-ranging consequences.

To shed light on how mitigation policies would affect countries' economies, the IMF recently undertook a study comparing alternative policy designs-taxes on GhG emissions, emissions permit trading, and hybrid schemes combining elements of both policies. the encouraging news is that the analysis shows that climate change can be addressed without either hurting macroeconomic stability and growth or putting an undue burden on the countries least able to bear the costs of policies. In other words, if policies are well designed, their economic costs should be manageable.

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Potential economic damage

Business-as-usual scenarios imply a sizable risk that the global climate will change dramatically by the end of the century. the Intergovernmental Panel on Climate Change (IPCC, 2007) projects that, in the absence of emissions control policies, global temperatures will increase by 2.8°C on average by 2100 (with best-guess increases ranging from 1.8°C to 4°C across scenarios from the Special Report on Emissions Scenarios). the probability of higher temperature increases is not negligible. Nicholas Stern (2008) points out that if business-as-usual concentrations of GhG stabilize at or above 750 parts per million (ppm) in CO2-equivalent terms by the end of the century, as implied by the latest IPCC scenarios, there is at least a 50 percent chance that global temperatures will increase by more than 5°C, with potentially disastrous consequences for the planet.

A wide range of uncertainty surrounds any estimate of economic damage from climate change. the Stern Review estimates that the loss in GDP per capita by 2200 under his baseline scenario (with relatively high emissions and including market and nonmarket impacts and catastrophic risk) ranges from about 3 percent to 35 percent (90 percent confidence interval), with a central estimate of 15 percent (see Chart 1, panel 1). Uncertainty about damage from climate change stems from several sources. First, scientific knowledge about the physical and ecological processes underlying climate change is a work in progress. For example, it is unclear how rapidly GhGs will accumulate in the atmosphere, how sensitive climate and biological systems will be to increases in the concentration of those gases, and where the "tipping points" are, beyond which catastrophic climate events-such as the melting of the west Antarctic ice sheet or permafrost, a change in monsoon patterns, or a reversal of the Atlantic thermohaline Circulation-would occur. Second, it is difficult to estimate how well people will be able to adapt to new climate conditions. And third, it is difficult to put a current value on damage that would be incurred by future generations.

Moreover, the low estimates of global damage mask a large variation across countries (see Chart 1, panel 2). Climate change will be felt earlier and much more acutely by less developed countries, at least in relation to the size of their economies. Such economies depend more on climate-sensitive sectors (such as agriculture, forestry, fishing, and tourism), have less healthy populations that are more vulnerable to changes in the environment, and offer fewer public services, which also tend to be of lower quality. the regions that are likely to be hurt the most by climate change include Africa, south and southeast Asia, and Latin America. India and Europe are exposed to catastrophic risk from a change in monsoon patterns and the reversal of the Atlantic thermohaline Circulation, respectively. In contrast, China, North America, advanced Asian countries, and transition economies (especially Russia) are less vulnerable and may even benefit at low degrees of warming (for example, from better crop yields).

Facilitating adaptation

Of course, societies have historically shown an ability to adapt to changing environmental conditions, and individuals and firms can be expected to adjust their behavior-for example, by planting more drought-resistant crops and moving away from coastal areas exposed to increased flooding and hurricanes. But governments will also have to get involved because of possible market failures (individual firms and households unable to incorporate the...