From an Economics Perspective, do the Benefits Outweigh the Costs of Fighting Climate Change?
Guilty about their contributions to climate change, the world saw 195 countries pledge to play their part and deal with their greenhouse gas (GHG) emissions in the 2015 Paris Agreement. The goal is to keep the increase in global average temperature to well below 2°C, recognising the catastrophic effects of climate change on GDP growth, development and health. This essay will therefore examine the different climate change policies and evaluate their economic costs and benefits in relation to the time horizon.
Following the Agreement, many countries are set on slashing greenhouse gas (GHG) emissions rates and transitioning to a low-carbon economy, i.e. one that is based on clean energy rather than fossil fuels, which could bring about major shifts in the labour market. This involves phasing out fossil fuel subsidies and supporting the renewables industry instead. In the short term, there will be job losses in carbon-intensive sectors and new jobs in low-carbon sectors (for example, to run a wind farm), but the net effect could be job creation as low-carbon technologies tend to be more labour intensive (Kammen et al., 2004). It is important to note however, that the higher job creation rate reflects the fact that green energy is not yet ‘cost-effective’, meaning that more labour is used up to produce a given amount of output, assuming that capital stock is fixed in the short run. Another caveat is that laid-off workers may not immediately find a new job in the renewables sector as they have different skillsets to what is required. This may give rise to structural unemployment, which the government may need to address by spending more on public training programmes on green jobs. Furthermore, Babiker and Eckhaus (2006) found that this increased unemployment could decrease GNP in the first ten years. This, along with the minimal immediate effect on climate change, alludes to the costs of fighting climate change slightly overweighing the benefits in the short run.
In the longer term, this transition will unleash a wave of innovations as profit-seeking firms exploit carbon opportunities. Over time, the need to adopt new green technology will create a wave of further innovations as firms adjust their processes and adapt the technology to their specific requirements, generating further job opportunities. In other words, mitigation policies will trigger extensive structural adjustment in a process called ‘creative destruction’, whereby technical change and innovation drive job growth, productivity gains and subsequently, economic growth. At the same time, this additional technological change leads to declines in abatement costs, i.e. the cost incurred to firms when reducing emissions. It may therefore moderate the overall economic impact of climate change policy. Plenty of evidence suggests that whilst climate change mitigation technology may be expensive at first, the averaging of costs over a longer time horizon and the potential accumulation of economies of scale mean that green energy will be cheaper and more sustainable than fossil fuels (Fankhauser et al., 2008). Moreover, in the long run, it has the potential to create more jobs across a number of sectors including, but not limited to, the construction, manufacturing, transport, energy, engineering, insurance and consultancy sectors. Of course, the extensive benefits from cleaner air would be reduced healthcare costs, but also decreased premature deaths and increased productivity.
But what of fighting climate change in less developed economies? It is no secret that climate change has adverse effects on poverty and inequality, and these effects are exacerbated by the vicious cycle of poverty linked to health, education and livestock. Initial inequality causes disadvantaged groups to be more exposed and susceptible to the damage caused by climate change, and less able to cope with it due to their poor access to resources. Consequently, these groups suffer disproportionately which results in greater subsequent inequality. As such, combatting climate change requires policymakers to take into account poverty and inequality issues. From an economics perspective, carbon pricing is the sine qua non of climate policy. One way to establish a carbon price is to levy a carbon tax on the distribution, sale or use of fossil fuels, which increases their cost and encourages users to switch to more environmentally friendly energy. Although this raises tax revenues, carbon taxes are regressive by nature, meaning those on low incomes will bear the brunt of the burden, and thus lead to a deadweight loss in economic welfare. Poorer countries tend to have larger shares of energy costs and lower shares of labour costs, making their productivity more vulnerable to energy price hikes and as a result, lower economic growth. Further, financing costs are typically higher in developing countries as interest rates tend to be higher and access to capital more difficult. Consequently, a carbon tax will increase fuel prices but not necessarily lead to investment in low-carbon technologies due to higher average capital costs (Schmidt, 2014).
Do the negative economic implications mean that inaction would be ideal in developing countries? Far from it. According to the Stern Review (2006), the cost of inaction can be as high as the equivalent of losing at least 5% of global GDP each year, now and forever, whereas taking action to fight climate change will cost only around 1% of global GDP. Inaction is a slow death. Delaying would also be dangerous and much more costly. Khosla et al. (2017) suggest that the transfer of foreign low-carbon technology in developing countries such as India is urgent for meeting the dual objectives of development and climate change but warns that it will be costly at first. Through climate negotiations under the United Nations Framework Convention on Climate Change (UNFCCC), developed countries are to mobilise approximately US$100 billion by 2020 for climate change activities in emerging economies. However, due to the high costs and low sums governments are willing to set aside to help the developing countries to fight climate change, much of that funding will have to come from the private sector, particularly foreign direct investment (FDI) in developing countries. Historically, FDI has contributed to GHG emissions, for example when they transport goods and operate waste treatment facilities.
Despite its potential to aggravate climate change, FDI also offers potential to combat climate change by facilitating the transfer of clean technology. On that account, whether the benefits outweigh the costs of fighting climate change depends on whether governments succeed in concocting policies that prevent FDI from exacerbating climate change and maximising the contributions of capital markets towards mitigating it. If done correctly, FDI can bring the much-needed green technologies into these developing countries and subsequently, jobs, productivity and economic growth. This may have broad positive spill-over effects if infrastructure is improved as a result of FDI, incentives are provided for domestic entrepreneurs to invest, and tax revenues generated by FDI are used to fund education and training. From these, we can expect emissions rate to fall, poverty to alleviate and the income gap to narrow, as employment creation, flows of knowledge and ideas and enhanced domestic investment contribute to higher economic growth. Therefore, careful planning of FDI is crucial when tackling climate change in these countries, and tight regulation on high-carbon FDI necessary.
Ultimately, considering the serious economic and social impacts of climate change, there is no question that the world as a whole needs to act on it, fast. The question lies in which policies to implement in each country and region. As there are many market and government failures, climate mitigation will involve the combination of different instruments including carbon pricing, a shift of subsidies away from fossil fuels to the renewables industry, innovation policies, regulations and performance standards, policies to attract clean FDI in developing economies, and education and training. The balance between these instruments will depend on the stage of development of the economy, and the social and political acceptability of these instruments. Nevertheless, the most sustainable policy is to adopt low-carbon technologies and reduce dependency on non-renewables. Although the costs override the benefits in the short run due to the high initial capital costs and the rise in structural unemployment, a structural shift to a low-carbon economy makes millions of jobs possible from the necessary investment, and millions more saved if we take action. In contrast, taking no action would imply both a dead planet and no jobs.
Babiker, M. and Eckhaus, R.S. (2006), Unemployment Effects of Climate Policy, Report No. 137, MIT Joint Program on the Science and Policy of Global Change. [Online] Available at: https://globalchange.mit.edu
Fankhauser, S., Sehlleiler, F. and Stern, N. (2008) Climate Change, Innovation and Jobs. London School of Economics. [Online] Available at: http://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/02/climate-change-innovation-jobs.pdf.
Kammen, D., Kapadia, K. and Fripp, M. (2004) Report of the Renewable and Appropriate Energy Laboratory. Putting Renewables to Work: How Many Jobs Can the Clean Energy Industry Generate? [Online] Available at: http://rael.berkeley.edu/old_drupal/sites/default/files/very-old-site/renewables.jobs.2006.pdf.
Khosla, R., Sagar, A. and Mathur, A. (2017) Deploying Low‐Carbon Technologies in Developing Countries: A View from India's Buildings Sector. [Online] 149–162. Available at: https://doi.org/10.1002/eet.1750.
Schmidt, T. (2014) Low-carbon investment risks and de-risking. Nature Climate Change 4 [Online] 237–239. Available at: https://www.nature.com/articles/nclimate2112/#citeas
Stern, N. (2006) Grantham Research Institute on Climate Change and the Environment. The Stern Review on the Economics of Climate Change. [Online] Available at: http://mudancasclimaticas.cptec.inpe.br/~rmclima/pdfs/destaques/sternreview_report_complete.pdf.
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