IPCC report: the macroeconomic impacts of climate action and inaction

The IPCC report has issued a code red, calling for immediate climate policy action. But what are the macroeconomic consequences of climate policy inaction, or action? Economist Zsófi Kőműves unpacks this question, using analysis from Cambridge Econometric’s Sustainable Investment modelling work.

The new IPCC 6th Assessment Report (AR6) is a code red for humanity says UN Secretary-General António Guterres. The report summarises the physical evidence on climate change, concluding that human activity is warming the earth. The physical impacts of climate change have already caused devastation, and they continue to get stronger.

This report focuses on the climate science only but reads as a loud wake-up call to reduce and eventually eliminate greenhouse gas emissions. The technologies to reduce emissions mostly exist but scaling them up can only be achieved through strong and sustained commitment. We need policy leaders to make difficult choices and people to change their consumption habits.

With COP26 coming up, it’s time to take concrete action.

What is the cost of inaction?

Substantial reduction of emissions and reaching net zero by 2070 could slow down warming leading to below 2°C by 2100. This pace of warming is expected to mitigate climate damages substantially. How much would inaction and missing the 2°C target hurt?

Cambridge Econometrics has quantified the potential economic costs of higher global temperature pathways. We use the E3ME model’s GDP trajectories consistent with a business-as-usual (BAU) scenario with 4°C warming and a well-below 2°C scenario. In our estimates, we rely on global damage function parameters from Burke and Tanutama (2019) and country-level temperature aberrations.

Business-as-usual growth could lead to high physical damages even in the medium term

  • We estimate that global physical damages in the BAU scenario can reach up to 7.5% of the projected GDP by 2050 and stay below 4.5% in a well-below 2°C scenario, with large country-level variations.
  • These numbers mean alarmingly high damages even in a couple of decades, but due to the exponential shape of the damage function, losses can grow by up to 65% and 30% of GDP by 2100 in the two scenarios, respectively.

 

Average Physical Climate Damages in 2050, % of GDP

Source: Cambridge Econometrics, own calculation

  • These large damage estimates are still likely to understate the true losses, since our method is based on the observed relationship between temperature and economic output, and we focus only on the impacts of gradual warming on productivity.
  • They do not account for tipping points or other unprecedented changes in the climate system.
  • Given the high uncertainty around increasing climate sensitivity in the future and carbon-cycle feedbacks it is near impossible to get accurate estimates.
  • Natural factors are not the only uncertainty to account for. Escalating climate impacts could bring disruption of value chains, trade, and geopolitical crises as well.

Even without precise estimates, this indicative analysis sends a stark warning to investors, and policy makers.

What is the cost of climate action?

While international organisations and the EU recognise the importance of speeding up climate action, individual governments often hesitantly push that agenda. Fearing high short-term investment costs, job losses and the unpopularity of high energy bills, their action is slow.

Cambridge Econometrics’ modelling using E3ME, a global macroeconomic model designed for policy simulation, show that these fears are often unjustified.

Transition policies can kick-start the economy

Results from a Paris compliant well-below 2°C scenario show that investments into a capital intense green economy can increase economic prosperity. A large part of these investments will be private and would need the support of the financial sector.

Our modelling finds that low-carbon transition has net positive global impacts and can increase global GDP by about 1.3% by 2050. Countries investing in low-carbon technologies could realise even greater benefits while fossil fuel exporters lose in a global transition.

Average Transition Impacts in 2050, 2°C Compared to 4°C Scenario, % of GDP

Source: Cambridge Econometrics, own calculation

  • The building of low-carbon infrastructure, retro-fitting buildings and electrifying transport creates new jobs.
  • Our modelling shows that by using spare capacity in the economy, the transition could boost employment, incomes, and consumption.
  • When low-carbon technologies scale up, their costs fall substantially, which can bring down electricity prices compared to a carbon-intense BAU case.
  • The cost of renewables has already fallen beyond most expectations, making these projections increasingly plausible, when coupled with storage and grid-balancing technologies.
  • Fossil fuel importer countries further benefit from improving trade balance.
  • Fossil fuel exporting countries face stronger challenges in adapting their production and workforce to the demands of the low-carbon economy. They only benefit if manage to join the forming green value chains.

Green growth

The climate modelling of the IPCC report shows that we are facing an unprecedented climate crisis unless we act now.

Economic modelling shows that this does not need to come at a net cost but can create an opportunity to grow at a global scale.

It is time to find and enable the financing of the transition, as our work on green recovery shows that with the right tools, climate action could help in preventing climate damages and also to kick-start the economy.

This article has shown a high-level analysis, but we can model detailed sector and country level impacts across several indicators.

Click here for more information on our Sustainable Investment service and stay tuned for the model update with our strategic partner Ortec Finance, due to be released later this year.

Zsófi Kőműves Economist zsk@camecon.com

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