Climate and the Economy

By Gordon Noble MRSV
Institute for Sustainable Futures, University of Technology Sydney (UTS)

“I've heard that there is a new version of Trivial Pursuit… it's called the economist's edition. In this one, there are 100 questions, 3,000 answers.”¹

Economics – the “dismal science”² – is renowned for its differences of opinion. The challenge for economics today is whether economists as a profession will be able to reach consensus on how to manage climate change.

The good news on that front is that a new economics field is quietly emerging: climate economics.

Calculating the costs of climate change

In November 2023, the UK’s Royal Society produced the report, “New horizons for understanding economic consequences of climate change”, following a two-day discussion that the Society held earlier that year.

The report was led by eminent economist, Lord Nicholas Stern. Lord Stern’s work included a landmark study, “The Economics of Climate Change: The Stern Review”, which was produced back in October 2006. At that time, The Stern Review argued that there was still time to avoid the worst impacts of climate change - if strong action was taken immediately.

Almost twenty years after the Stern Review’s publication, its simple conclusion still holds true: the benefits of strong and early action far outweigh the economic costs of not acting.

With input from over 70 economists, the Royal Society’s 2023 report was blunt about the way economists are considering climate change impacts, stating “many economic assessments do not adequately reflect the scientific evidence of current and future climate change. As a consequence, economic assessments can often lead to misleading portrayals of the possible economic consequences of climate change.”³

The report’s themes, which are briefly discussed, represents a blueprint on changes the economics profession can make to incorporate climate change into economic assessments.

1. Challenges estimating economic impacts of climate change

Whilst economists have made some progress in better understanding and modelling the interactions between climate change and the economy, there are problems with current approaches to economic assessments of climate change. Overall, many economic analyses and models do not factor in all the latest scientific evidence of current and future climate change.

2. Earth system tipping points

Earth system tipping points are thresholds where a small change can alter the state or development of a system, resulting in the acceleration, irreversibly, or inevitability of serious impacts. The report argues that if economic assessments of climate change do not consider these tipping points, then they underestimate the magnitude of their impacts.

Consequently, decision-makers may therefore not adequately consider them in their climate response strategies, despite their significance for both mitigation and adaptation.

3. Economic impacts of extreme events

A limitation of many economic models is that they either exclude entire climate-induced hazards such as flooding, wildfires, and extreme heat, or consider them in a limited fashion. Economic models may also fail to capture the costs of increases in uncertainty, as well as broader impacts of risk changes on behaviour and the economy.

4. Economic effects on non-marketed goods

Climate change, nature, human health, and the economy are fundamentally connected. By excluding nature and health from economic assessments, it underestimates the economic impacts of climate change, and the co-benefits of mitigation and adaptation action.

This can result in unreliable estimates, which affects the ability of decision-makers to take appropriate action to address climate change.

5. Ethical issues within current approaches

The economic analysis of climate change is sometimes presented as being “free of values”. However, economists have to make decisions on which data to include or exclude, and make assumptions about the weights to place on different impacts, on different people, and at different points in time.

Economic assessments that estimate the economic impacts of climate change typically only consider the consequences of climate change on human welfare, expressed through the consumption of goods and services. This is a narrow lens through which to consider the entire consequences of climate change.

6. Population displacement, migration, and violent conflict

Population displacement can occur in response to natural disasters, including extreme weather events such as floods, droughts, and storms. It can also exacerbate factors, such as political unrest, that can lead to conflict.

Population displacement, migration, and violent conflict are inadequately represented in current assessments of the economic impacts of climate change.

7. Interweaving mitigation, adaptation, and development

Current approaches to analysing and modelling the economic impacts of climate change are overly focused on a ‘top-down’ global perspective, and neglect ‘bottom-up’ regional and local perspectives.

By too often focusing on global scale, and not including more localised, granular data, economic assessments can fail to provide the information required to support successful local adaptation and development policies.

‍Where to for Australia?

There are moments in time when small actions can have large impacts. Australia collectively has many decisions to make that will influence the pathway we take to decarbonize. We also have many decisions to make on how we manage climate change impacts that are already upon us. The reality is that these decisions are economic. The decisions that are made today will impact allocation of capital across the economy, and ultimately influence the jobs that are created and lost.

The challenge is that we have a very narrow window to get things right. If we get things wrong, then we will lose our chance to keep climate warming under 2 °C, with the potential of +3 °C warming.

The Royal Society’s report argued that “enhanced interdisciplinary collaboration between physical scientists, economists, and other social scientists can overcome the long-term disconnect that has existed between these disciplines in the context of climate change.”³

This is true for Australia. Many of the investment decisions on decarbonization depend on a depth of knowledge of science, with examples including hydrogen as a fuel, biotechnologies based on algae technologies, and battery technologies.

There is a need to urgently create bridges between science and finance. The dismal science of economics may offer us a pathway, and the Royal Society has demonstrated that an organisation advocating for science can play a leadership role in the process. They brought the UK’s leading economists to the table to understand and address the way that economics can contribute to addressing climate impacts, and the resulting report is a model for interdisciplinary collaboration on climate change.

There is an opportunity for Australian economists to follow the Royal Society’s lead, and convene to consider how we ensure our own economic models, which underpin many decisions in our economy, are fit for purpose for a new climate era.

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Gordon Noble is a Research Director at the Institute for Sustainable Futures, University of Technology Sydney.

References:

1. Reagan, R. (1985, October 15). Remarks at a Fundraising Dinner for Senator Robert W. Kasten, Jr., in Milwaukee, Wisconsin. reaganlibrary.gov/archives/speech/remarks-fundraising-dinner-senator-robert-w-kasten-jr-milwaukee-wisconsin
2. Carden, A. (2022, November 20). Why Is Economics Called the “Dismal Science”? Forbes. forbes.com/sites/artcarden/2022/11/20/why-is-economics-called-the-dismal-science
   
3. New horizons for understanding economic consequences of climate change A summary report. (2023). The Royal Society. royalsociety.org/-/media/policy/Publications/2023/climate-change-economics-conference-report.pdf

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