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Economic impact of climate change

Updated Monday, 13th February 2006

If the world's climate changes what does that mean for the economic future of the planet?

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When we talk about the economic impact of an event or a process, we normally mean ‘putting a monetary value on its costs and benefits’. There is good reason for this approach in that economists often advise governments on how best to spend money. Will the benefits outweigh the costs? That question requires a common unit of measurement and it tends to be what is being spent – money.

From this perspective estimating the economic impact of climate change is linked to the question: how much should we pay to abate climate change? The answer depends on how much it will cost us to do so and what the costs will be if we do nothing. The benefits of climate change abatement are the costs of climate change that will thereby be avoided. The analysis of the costs and benefits of climate change abatement has been very influential but it is controversial and may fail to reflect accurately the full economic impact of climate change.

The standard approach

Assessing the economic impact of climate change is fraught with great uncertainty even before using any specifically economic methodologies. What assumptions do you make about how severe and rapid climate change is going to be? There is a broad range of predictions of greenhouse gas emissions and then a further range of predictions about the physical effects of a given rate of emissions.

Most studies of the economic impact of climate change assume a doubling of carbon dioxide emissions and calculate the costs of its expected physical effects. They estimate that the costs of climate change will be 1-2 per cent of world gross domestic product (GDP), that is, the monetary value of world output of goods and services.

Much of this research has been undertaken by American economists assessing the impact of climate change on the US economy. Their results have been extrapolated to other economies to arrive at that estimate of its economic impact on the global economy.

That climate change could cost the world 1-2% of its output may not seem a very serious problem. But most industrial economies grow at about 2.5% a year, so if this estimate is even approximately correct, climate change comes close to stopping economic growth.

Most people in industrial economies are better off in terms of material possessions than their parents were 20 or 30 years ago. It is widely taken for granted that future generations will be better off again. Climate change will upset that comfortable assumption.

Problems with the standard approach

There are major difficulties with this approach to evaluating the economic impact of climate change. These are particularly damaging when trying to extend it to low income countries.

How do you quantify non-market effects?

In industrial nations the existence of market prices makes it easy to quantify many of the economic effects of climate change. For example, if agricultural land is lost to rising sea levels, we can refer to its previous market value to calculate the cost of its loss.

But even in industrial nations many of the effects of climate change are not marketable. The flooded land might have had cultural value for its beautiful landscape. If the agricultural land was owned by a community where land tenure is traditional and where there is no market for land, flooding will prevent farmers from making a living.

Can you put a price on animal or plant life?

Another problem arises when you try to assess the damage inflicted on ecosystems over and above their value as resources for economic activities. Monetary values have been put on the loss of biodiversity through species extinction. However, if animal and plant species are thought to possess intrinsic value or dignity that ought to be respected, their degradation is a loss that cannot easily be evaluated.

How do you evaluate long term effects?

For most people £100 is worth more today than £100 next year because there is a degree of uncertainty about what might happen between now and next year. They would prefer to spend £100 rather than postpone consumption to an uncertain future. This insight underlies the idea that the expected future costs, and benefits, of an event or activity should be discounted or reduced in value.

Many economic impacts of climate change are not expected to occur until decades into the future and economists therefore reduce their costs. There is no agreement about the appropriate rate of discount to use. You could argue that using any discount rate is unfair to future generations.

How much is human life worth?

For many people in poorer countries the impact of climate change will be much more severe than the lack of continually rising living standards. Climate change will cause the deaths of many people. How should we weigh these deaths against the sacrifices that will have to be made to lessen climate change?

The standard economic approach measures the value of a human life in financial terms. A person’s expected lifetime earnings provides an estimate of the monetary value of their life. But this means that the lives of people in rich industrial nations are worth much more than those of people in poorer countries. For some researchers this is reason enough to find another way of evaluating the economic impact of climate change.

Another approach

An alternative approach is the ‘capabilities approach’ initiated by Nobel prize winning economist Amartya Sen. This has already been influential in shaping the way international organisations assess human progress. What matters for this approach is not a constantly increasing material standard of living, but the degree to which people are able to do things that most people would regard as valuable. In the context of human development, life expectancy, literacy rates and gender inequality as well as income have emerged as central concerns.

Using this approach to estimate the economic impact of climate change involves considering evidence about different aspects of human well-being directly, without converting every dimension of human well-being a financial equivalent. Some basic capabilities (for example being able to be adequately nourished or live in a clean and safe shelter) are directly dependent upon ecosystems for supplies of food, building materials and fuel. These ecosystems are vulnerable to climate change.

So people living in low income countries that are heavily reliant on agriculture and forestry will lose basic capabilities as the climate changes. Inhabitants of low lying coastal areas or small islands vulnerable to flooding will also lose these important opportunities. Similarly, as arid zones become deserts, the people who live there will lose out. The populations of such areas will become environmental refugees.

Major cities such as London, New York, Sydney and Shanghai could also be at risk of flooding. The rise in oil prices in the immediate aftermath of Hurricane Katrina, which destroyed oil facilities near New Orleans, illustrates the economic impact that storm surges could have on low lying cities. It is possible that climate change may make hurricanes more severe.

Regional impact assessments suggest that desertification already threatens many millions of people in developing countries with the loss of capability to support themselves. It is estimated that there could be 80 million refugees from flooding caused by sea level rise, while 50 million people are already under pressure from desertification to migrate to overcrowded cities with uncertain employment prospects.

The cost of lessening climate change

The question that drives the standard approach to estimating the economic impact of climate change is how the costs of that impact compare with the costs of reducing climate change. Against a loss of 1-2% of world GDP from climate change, the costs of abatement are estimated to be 1-3% of GDP, which seemingly calls into question the wisdom of climate change abatement as a strategy. However, both estimates are subject to deep uncertainty.

In any case, from a capabilities perspective weighing the financial costs of climate change against those of its abatement is not a sound basis for policy decisions. The economic impact of climate change is a humanitarian disaster or sets of disasters stretching many years into the foreseeable future. The magnitude of these disasters can only be understood in terms of widespread loss of life and loss of capabilities among survivors. It is not clear that anything is added to an appreciation of the scale of the problem by trying to place monetary valuations on these impacts.

Estimating the economic impact of climate change ultimately rests on an ethical judgement. On one side we have moderate disturbance to the upward trend of comfortable living standards for industrial countries. Weighed against this is the loss of usable land, and the consequent loss of life and basic capabilities, for millions of people in low income countries. It is a matter of evaluating inconvenience for mainly rich populations against catastrophic loss and upheaval for millions of people whose normal standard of living is already much lower.

Further reading

American Heat: Ethical Problems with the United States’ Response to Global Warming
DA Brown, published by Rowman and Littlefield

Global Warming: The Complete Briefing
J Houghton, published by Cambridge University Press


UNEP Climate Change - a central source for substantive work and information resources regarding climate change

Intergovernmental Panel on Climate Change - established by WMO and UNEP to assess scientific, technical and socio- economic information relevant for the understanding of climate change

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