Journal Issue

World Economic Outlook: Experts Examine Costs to Global Economy of Climate Change

International Monetary Fund. External Relations Dept.
Published Date:
December 2007
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Most scientists agree that the global temperature is rising as a result of man-made emissions of greenhouse gases and that the Earth’s climate is changing.

This can lead to, among other things, a rise in sea levels; increased frequency or intensity of heat waves, droughts, hurricanes, and floods; and a loss of biodiversity.

The physical and biological consequences of climate change and, hence, their economic costs, are uncertain, but are likely to vary across regions.

Although the direct impact of climate change is expected to be felt slowly, the steps that governments, businesses, and individuals take to mitigate, or adapt to, climate change can have immediate economic and financial consequences. The analytical and policy challenges posed by climate change were discussed at a workshop organized by the IMF’s Research Department on September 20.

Small, poor, resource-dependent economies are likely to be most affected by climate change.

Economic costs

All participants in the workshop underscored the high degree of uncertainty surrounding estimates of the economic costs of climate change. John Reilly (Massachusetts Institute of Technology) noted that although most available models suggest that the aggregate economic costs of climate change are likely to be small, these estimates represent a central tendency that summarizes the gamut of scenarios ranging from relatively favorable to catastrophic effects of climate change (see chart); policymakers may be particularly concerned about the tails of the distribution.

Low-impact estimates also disguise significant differences across countries: small, poor, resource-dependent economies are likely to be most affected by climate change. Robert Shackleton (Congressional Budget Office) and Francisco de la Chesnaye (Environmental Protection Agency) echoed these views, pointing out that the effects of climate change on economic growth, trade, financial flows, and migration depend on how physical and biological systems respond to rising temperatures and on how well countries adapt to climate change and cope with the institutional and social stresses climate change is likely to pose.

Mitigating climate change

In discussing the challenge of designing policies that would provide incentives for countries to participate in an international agreement on mitigating climate change, Warwick McKibbin (Australian National University) argued that these policies must be robust to uncertainty.

If an economy grows faster than originally anticipated, for example, its abatement costs will rise, making the original targets under a quantity-based scheme (cap and trade) hard to achieve and weakening the country’s incentives to participate in an international cap-and-trade agreement.

The increase in costs would be considerably smaller under a price-based scheme (a carbon tax) or a hybrid scheme that converts a quantity-based scheme into a price-based plan using a safety valve if abatement costs rise above a certain threshold.

William Pizer (Resources for the Future) underscored, among other things, the importance of international competitiveness in the context of designing sustainable international agreements. He pointed out that, for the business sector in countries considering joining an international agreement, the critical issue is whether it would remain competitive with producers from nonparticipating countries.

Calculating the costs

The results of different studies assessing the macroeconomic effects of climate change span a wide range of possible costs.

(average per capita GDP losses; percent of world GDP)

Source: IMF, World Economic Outlook October 2007, Appendix 1.2.

Nicholas Stern (London School of Economics) stressed that although advanced economies need to take the lead in mitigation, the participation of developing economies is crucial. He advocated working toward an international agreement that would combine strong individual emissions targets for developed countries with trading schemes open to developing countries. These issues are likely to remain high on the international policy agenda in the coming years, as countries debate the future of the Kyoto agreement, which is set to expire in 2012.

IMF’s role

The IMF is not a center of expertise on the scientific aspects of climate change, but it is building its capacity to assess the macro-economic implications of climate change and policies to abate it. This is part of the IMF’s strategic effort to understand the long-term challenges to the global economy, which could help form a basis for its policy advice to member countries and for contributing to the international efforts to deal with these challenges.

A considerable amount of work on climate change issues is already under way at the IMF in coordination with its sister organization, the World Bank. This work comprises, among other things, an appendix in the October 2007 World Economic Outlook that summarizes the state of knowledge and policy debate on the key economic aspects of climate change.

Natalia Tamirisa

IMF Research Department

The Climate Change Challenge

The average global temperature increased by about 0.7°C between 1906 and 2005, and existing greenhouse gases are expected to cause a further substantive temperature increase in the coming decades. The Nobel Peace Prize-winning Intergovernmental Panel on Climate Change projects that—without any policy response—emissions will lead to average global temperature increases of between 1.1°C and 6.4°C by 2100. The greatest increases in temperature are projected for the northern parts of North America, Europe, and Asia, with smaller—but still sizable—increases in tropical areas.

A number of other climatic effects are expected. The global pattern of rainfall, for example, is likely to change, with many already dry areas expected to become even drier. And there are further possible effects on rainfall in many tropical zones as well as on seasonal patterns, potentially affecting the sustainability of large human populations and critical natural resources. Flood risk is projected to increase through more intense rainfall and sea-level rise. In addition, the frequency and/or severity of extreme weather events, including hurricanes, floods, heat waves, and droughts, are expected to increase, most seriously in Africa, Asia, and the Caribbean.

Beyond these effects, there may be “tipping points” that, if passed, would result in more dramatic and irreversible climate effects. These include the potential for rapid glacial melting, reversal of the Gulf Stream, and large-scale tundra thawing in Canada, China, and Russia.

Policy responses

Although views differ on the appropriate extent and urgency, there is broad consensus on the need for some action to reduce the high economic risks posed by expected levels of warming in “business as usual” projections. The question of quite how much policy intervention would be desirable has generated a lively debate, reflecting the different assessments of the relative costs and benefits of action and inaction.

A core challenge is to reach agreement among major emitting countries on the implementation of polices to limit future greenhouse gas emissions. Initial steps toward international cooperation—most notably, the Kyoto Protocol—have had only limited success. The United States was assigned an emissions reduction under the Protocol but did not ratify the Protocol and is therefore not committed to it. And several ratifying countries are currently some way from achieving their commitments.

Some efforts to limit emissions currently undertaken by parties not bound by the Kyoto Protocol, notably Australia and the United States, have supported the development and diffusion of new technologies designed to promote energy efficiency. In addition, some countries have made efforts to reform energy pricing and reduce deforestation to increase energy security and reduce local air pollution. In each case, there have been important co-benefits in constraining the growth of greenhouse gas emissions.

These efforts, along with a range of wider international frameworks and processes that are being developed, should help reduce greenhouse gas emissions. But they will need to be extended significantly in breadth, depth, and efficiency, while paying due regard to the need for equitable sharing of the burden, to meet this challenge.

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