Economic analysis of climate change
Economic analysis of climate change uses economic tools and models to calculate the scale and distribution of damages caused by climate change. It can also give guidance for the best policies for mitigation and adaptation to climate change from an economic perspective. There are many economic models and frameworks. For example, in a cost–benefit analysis, the trade offs between climate change impacts, adaptation, and mitigation are made explicit. For this kind of analysis, integrated assessment models are useful. Those models link main features of society and economy with the biosphere and atmosphere into one modelling framework.
In general, climate damages increase the more the global surface temperature increases. Many effects of climate change are linked to market transactions and therefore directly affect metrics like GDP or inflation. For instance, climate change can drive inflation in food via heat and droughts, but also drives up overall inflation. There are also non-market impacts which are harder to translate into economic costs. These include the impacts of climate change on human health, biomes and ecosystem services.
Economic analysis also looks at the economics of climate change mitigation and the cost of climate adaptation. Mitigation costs will vary according to how and when emissions are cut. Early, well-planned action will minimize the costs. Globally, the benefits and co-benefits of keeping warming under 2 °C exceed the costs. Cost estimates for mitigation for specific regions depend on the quantity of emissions allowed for that region in future, as well as the timing of policies. Economists estimate the incremental cost of climate change mitigation at less than 1% of GDP. Across all developing countries, adaptation costs have been estimated to be about USD 215 billion per year up to 2030, and are expected to be higher after.
Purposes
Economic analysis of climate change investigates the economic impacts of the effects of climate change, the costs and benefits of preventing climate change, and the cost of adapting to a changing climate. These analyses can focus on:- Global aggregate economic costs of climate change
- Sectoral or regional economic costs of climate change
- Economic costs and benefits of implementing climate change mitigation and adaptation strategies
- Estimating the projected impacts to society per additional metric tonne of carbon emissions
- informing policy decisions, interntionally or nationally
In some areas, policies designed to mitigate climate change may contribute towards other sustainable development objectives, such as abolishing fossil fuel subsidies which would reduce air pollution and thus save lives. Direct global fossil fuel subsidies reached $319 billion in 2017, and $5.2 trillion when indirect costs such as air pollution are priced in. In other areas, the cost of climate change mitigation might divert resources away from other socially and environmentally beneficial investments.
Types of economic models
Many economic tools are employed to understand the economic aspects around impacts of climate change, climate change mitigation and adaptation. Several approaches exist. Econometric models are used to estimate the impacts of weather and climate on economic variables, either globally or for a specific sector. Structural economic models look at market and non-market impacts affecting the whole economy through its inputs and outputs. Process models simulate physical, chemical and biological processes under climate change, and the economic effects.Process-based models
Structural models
Computable general equilibrium models
Aggregate cost-benefit models
are also used to make aggregate estimates of the costs of climate change. These models balance the economic implications of mitigation and climate damages to identify the pathway of emissions reductions that will maximize total economic welfare. In other words, the trade-offs between climate change impacts, adaptation, and mitigation are made explicit. The costs of each policy and the outcomes modelled are converted into monetary estimates.The models incorporate aspects of the natural, social, and economic sciences in a highly aggregated way. Compared to other climate-economy models, they do not have the structural detail necessary to model interactions with energy systems, land-use etc. and their economic implications.
Statistical (econometric) methods
A third modelling approach uses empirical, statistical methods to investigate how the economy is affected by weather variation. This approach can identify effects of temperature, rainfall, drought and storms on agriculture, energy demand, industry and other economic activity. Panel data of weather variation over time and space, e.g. from ground station observations or gridded data is aggregated for economic analysis to investigate effects on national economies. These studies show that for example, hot years are linked to lower income growth in poor countries, and low rainfall is linked to reduced incomes in Africa. Other econometric studies show that there are negative impacts of hotter temperatures on agricultural output, on labour productivity and in outdoor industries such as mining and forestry. The analyses are used to estimate the costs of climate change in the future.Analytical frameworks
Cost–benefit analysis
Standard cost–benefit analysis has been applied to the problem of climate change. In a CBA framework, the negative and positive impacts associated with a given action are converted into monetary estimates. This is also referred to as a monetized cost–benefit framework. Various types of model can provide information for CBA, including energy-economy-environment models that study energy systems and their transitions. Some of these models may include a physical model of the climate. Computable General Equilibrium structural models investigate effects of policies on economic growth, trade, employment, and public revenues. However, most CBA analyses are produced using aggregate integrated assessment models. These aggregate-type IAMs are particularly designed for doing CBA of climate change.The CBA framework requires the valuation of costs and benefits using willingness to pay or willingness to accept compensation as a measure of value, and a criterion for accepting or rejecting proposals:
For, in CBA where WTP/WTA is used, climate change impacts are aggregated into a monetary value, with environmental impacts converted into consumption equivalents, and risk accounted for using certainty equivalents. Values over time are then discounted to produce their equivalent present values. The valuation of costs and benefits of climate change can be controversial because some climate change impacts are difficult to assign a value to, e.g., ecosystems and human health.
For, the standard criterion is the Kaldor–Hicks compensation principle. According to the compensation principle, so long as those benefiting from a particular project compensate the losers, and there is still something left over, then the result is an unambiguous gain in welfare. If there are no mechanisms allowing compensation to be paid, then it is necessary to assign weights to particular individuals. One of the mechanisms for compensation is impossible for this problem: mitigation might benefit future generations at the expense of current generations, but there is no way that future generations can compensate current generations for the costs of mitigation. On the other hand, should future generations bear most of the costs of climate change, compensation to them would not be possible.
CBA has several strengths: it offers an internally consistent and global comprehensive analysis of impacts. Furthermore, sensitivity analysis allows critical assumptions in CBA analysis to be changed. This can identify areas where the value of information is highest and where additional research might have the highest payoffs. However, there are many uncertainties that affect cost–benefit analysis, for example, sector- and country-specific damage functions.
Damage functions
Damage functions play an important role in estimating the costs associated with potential damages caused by climate-related hazards. They quantify the relationship between the intensity of the hazard, other factors such as the vulnerability of the system, and the resulting damages. For example, damage functions have been developed for sea level rise, agricultural productivity, or heat effects on labour productivity.Cost-effectiveness analysis
is preferable to CBA when the benefits of impacts, adaptation and mitigation are difficult to estimate in monetary terms. A CEA can be used to compare different policy options for achieving a well-defined goal. This goal is usually expressed as the amount of GHG emissions reduction in the analysis of mitigation measures. For adaptation measures, there is no common goal or metric for the economic benefits. Adaptation involves responding to different types of risks in different sectors and local contexts. For example, the goal might be the reduction of land area in hectares at risk to sea level rise.CEA involves the costing of each option, providing a cost per unit of effectiveness. For example, cost per tonne of GHG reduced. This allows the ranking of policy options. This ranking can help decision-maker to understand which are the most cost-effective options, i.e. those that deliver high benefits for low costs. CEA can be used for minimising net costs for achieving pre-defined policy targets, such as meeting an emissions reduction target for a given sector.
CEA, like CBA, is a type of decision analysis method. Many of these methods work well when different stakeholders work together on a problem to understand and manage risks. For example, by discussing how well certain options might work in the real world. Or by helping in measuring the costs and benefits as part of a CEA.
Some authors have focused on a disaggregated analysis of climate change impacts. "Disaggregated" refers to the choice to assess impacts in a variety of indicators or units, e.g., changes in agricultural yields and loss of biodiversity. By contrast, monetized CBA converts all impacts into a common unit, which is used to assess changes in social welfare.
File:2021 Carbon dioxide emissions per person versus GDP per person - scatter plot.svg|thumb|Scaling the effect of wealth to the national level: richer countries emit more per person than poorer countries. Emissions are roughly proportional to GDP per person, though the rate of increase diminishes with an average GDP/pp of about $10,000.