The price of ecological breakdown

Calculating climate costs

Not so long ago, prevailing work on the macroeconomics of climate change contended that – while set to fiscally devastate low-income countries near the equator – many cooler, wealthier nations will escape the financial fallout and even profit from warmer climes.

By 2017, influential studies had fed into an International Monetary Fund global report showing countries such as Canada and Sweden gaining in per capita outputs if temperatures rise as predicted. However, a Cambridge economist and his team wasn’t buying it.

“The idea that rich, temperate nations are economically immune to climate change and could see their prosperity surge as a result… it just seemed so implausible,” says Dr Kamiar Mohaddes, an Associate Professor at Cambridge Judge Business School and Fellow in Economics at King's College.

“It’s not solely about a number on the thermometer. It’s the deviation from climate conditions to which countries are accustomed that determines income loss, whether that’s cold snaps, heat waves, droughts, floods or natural disasters.”

Mohaddes and colleagues crunched the numbers using data from 174 countries going back sixty years to calculate the link between temperature change and income levels.

They modelled the world’s economies under business-as-usual emissions, as well as a scenario in which humanity “gets its act together” and holds to the Paris Agreement.

The study, which found that all countries – rich or poor, hot or cold – will suffer economically under the current emissions trajectory, showed the US losing 10.5% of its GDP, and Canada over 13%, by the end of this century.

Published as a working paper in 2019, the research underpinned much of a 2021 letter to the Chair of the Federal Reserve, signed by twenty-five members of the United States Congress, calling for the incorporation of climate risk into monetary policy.

This year the research has been updated and expanded in a new working paper using the latest data from the Intergovernmental Panel on Climate Change (IPCC). Results indicate that without significant mitigation and adaptation efforts, global GDP could decline by up to 24% by 2100 if fossil fuel pollution continues unabated.  

Aiming data-driven analyses at those who influence business and policy is at the heart of a new initiative, climaTRACES lab, established this year by Mohaddes and his fellow former Cambridge Gates Scholar Dr Ramit Debnath, who recently conducted research on how lethal heatwaves will hold back India’s economic development.  

ClimaTRACES was launched in May, on the same day that former US vice-president and legendary environmental campaigner Al Gore spoke at King’s College. Gore argued that research at universities focuses on technological solutions to the climate crisis, but there is little research into the “formation of political will” for action.

“Al Gore highlighted the very gap climaTRACES sets out to address,” says Mohaddes. “We want to work out how policy makers and businesses can best understand the cost of climate change and biodiversity loss. We need to take these communities with us through the right communications, and the right policy and product design.”

One of the first research projects from climaTRACES is in collaboration with the Boston Consulting Group (BCG), one of the world’s “big three” management consulting firms.

The new report suggests that an upfront investment of less than 2% of global GDP in additional efforts to prevent global warming will limit the temperature increase to under 2°C, avoiding the loss of an estimated 11% to 13% of cumulative GDP by 2100.

“Our work estimates the cost of inaction in the short-term will be 10% to 15% of lost global GDP by the end of the century – wiping out many trillions of dollars of wealth,” says Mohaddes. “Hesitating to incur the upfront costs of climate mitigation has truly enormous economic implications down the line.”

Working with the private sector will be a focus for climaTRACES. “An organisation like BCG has the machinery to take this research to its client base, to the key players in services, manufacturing and agriculture,” says Mohaddes.

“Our work will be to generate the data and help shape the messages needed to address the climate crisis.”

Nature of debt

Century’s end can feel distant for a private sector preoccupied with the next quarterly report, and policymakers dealing with constant shocks hitting their economies.

Mohaddes worked with colleagues from the University’s Bennett Institute for Public Policy to show how ecological damage will affect national finances much sooner in the form of sovereign credit ratings.

The economists used artificial intelligence to simulate the effects of climate change on Standard and Poor’s credit ratings for 108 countries by 2030, as well as decades into the future.

The first “climate smart” credit ratings suggested that – if nothing is done to curb emissions – up to 63 nations could be downgraded by over a notch on average by the end of this decade, with countries such as Germany and Sweden dropping three notches, and the US and Canada falling two notches.  

The multinational bank Standard Chartered now use the research in their modelling for sovereign default probabilities.

Some of the Bennett Institute-led team went on to produce the first biodiversity-adjusted sovereign credit ratings, to show how destruction of natural habitats could affect public finances.

Again, the findings were stark. Loss of plant and animal species may already be set to cause major sovereign downgrades, with China and Indonesia on course to drop two notches, perhaps as early as 2030.

Beyond its intrinsic – and incalculable – worth, biodiversity provides fundamental natural services: from basic sustenance through fish stocks or insects that pollinate crops, to soil regeneration, and water and climate regulation.

According to Bennett Institute research, if parts of the planet see “partial ecosystems collapses” of fisheries, tropical timber production and wild pollination, as simulated by the World Bank, then over half the 26 nations featured in the study face downgrades.

All these predicted sovereign credit downgrades would increase the annual interest payment on debt by billions of dollars a year and put many developing nations at severe risk of default – in effect, bankruptcy.

Biodiversity economics

The total absence of the essential ecosystem services in national balance sheets is not only a major blind spot of economic risk – it has served to intensify exploitation of the natural world. It’s a hole in the discipline many believe we can no longer afford.

Over a forty-year career at Cambridge’s Faculty of Economics, Prof Sir Partha Dasgupta has led the way in developing economic models that include nature and human wellbeing – going beyond the Gross Domestic Product metrics that have dominated since the last world war.

GDP ignores everything that ecosystems provide – from raw materials to clean air. Dasgupta argues that GDP is not fit for purpose, as it is based on a “faulty application” that does not include “our most precious asset”: nature.

He is joined in this assessment by other Cambridge economists including Prof Dame Diane Coyle, Co-Director of the Bennett Institute, where the ‘Wealth Economy’ project has worked on ways to measure assets required for sustainable prosperity.

“GDP tots up the value of stuff and services produced by a given country to provide a single number used to rank national economies,” says Coyle. “A focus on GDP without proper regard for environmental degradation or inequality has been a disaster for global ecosystems.”

The UK Treasury commissioned a report on the economics of biodiversity led by Dasgupta, published in 2021. The landmark 600-page review called for urgent increases to global supplies of “natural assets”: from the expansion of Protected Areas to policies that reduce damaging consumption such as meat-heavy diets.

Currently, nations are judged to have thriving economies when their biological assets are being severely eroded. Estimates show that between 1992 and 2014, produced capital per person doubled, but the stock of natural capital per person declined by nearly 40%.

The report recommended new metrics for economic success, with the injection of natural capital into national accounting as a critical first step. Dasgupta was among the Cambridge academics to help the United Nations launch their updated ‘Ecosystems Accounting’ framework.

There is also a need for “supra-national” economic systems to preserve the biosphere, the report argued, such as payments to countries in a position to protect irreplaceable habitats – tropical rainforests, for example – and charges for the use of ecosystems outside national borders e.g. fishing and freight traffic on open oceans.  

When accepting the BBVA award for Economics, Finance and Management earlier this year, Dasgupta pointed out that oceans are vital public goods treated as free goods. “All the billions of dollars of merchandise shipped across the oceans, polluting them, yet no one pays any rent,” he said.

An international tax on ocean-harming activities, from sea-bed mining to cruise ships, could help alleviate pressure on marine ecosystems. Dasgupta proposes establishing a new institution – perhaps linked to the World Bank, for example – to collect this ocean rent.

Revenue could then be used to compensate the countries that house rainforests, in order to stop the deforestation contributing to species loss and climate change. “It's a self-financing proposition that solves two problems in one go.”

Good growth

As highlighted in Dasgupta’s Review, the UN estimates we use natural assets equivalent to 1.6 Earths to maintain our current living standards. A fixation with GDP growth has taken a devastating ecological toll, and some now argue for a dramatic scaling back of production to decarbonise our economies.

“Economic growth lifted millions out of poverty, but it’s true that growth in rich nations has been tied with greenhouse gas emissions and environmental destruction,” says economist Dr Alessio Terzi from the University’s Department of Politics and International Studies. “I wanted to understand if reversing growth is really the answer.”

Terzi went back through the centuries to examine how economic expansion is “interwoven with the human quest for well-being and self-determination”. He set out to look “beyond the slogans” at the potential systems that restrict economic growth.

“Capitalism will always rekindle growth, but that’s part of why it’s such an efficient machine for fostering innovation, which we need develop and deploy new clean-energy technologies. Degrowth means slowing this innovation down.”

In his book ‘Growth for Good’, Terzi concluded that trying to reorient market capitalism is better than aiming for a radical economic transformation that could “take years of soul searching… years we don't have by the way, because 2050 is tomorrow”.

As a thought experiment, Terzi used two decades of data from the IMF and Global Carbon Project to calculate that – while far from Net Zero – the current trajectory of decarbonisation could see CO2 emissions fall 48% by mid-century.

However, to almost halve carbon emissions through decreased economic output, global GDP would need to shrink 5% every year. By way of comparison, the worldwide COVID-19 lockdowns of 2020 shrank GDP by 2.7%.

Harnessing capitalism does not mean relying on free markets. A new age of green technologies must learn lessons of previous industrial revolutions, says Terzi, which saw governments invest in infrastructure – from rail to waterways – and lend money to early manufacturers.

“Take cars,” says Terzi. “Expensive and prone to failure at first, it wasn’t clear they would be more efficient than horse carriages. Innovations such as assembly lines reduced costs, but government bans were also used to speed the transition from horses to cars in cities. Bans on sales of fossil-fuelled cars are just the current-day equivalent.”

Echoing Dasgupta, Terzi's recent working paper argues for international collaboration across wealth divides as a fast-track to decarbonisation. “For example, bilateral or regional partnerships in which poorer nations can provide green minerals to richer nations in exchange for investment in sustainable infrastructure.”

Cleantech competition

Technological turning points always see winners and losers, however. Governments are interested in how to increase the chance that their countries and companies end up on the ‘winning’ end.

Building an evidence base for the types of cleantech and green industrial policy that boost competitiveness is a focus for Laura Diaz Anadon, Professor of Climate Change Policy at Cambridge and Director of the Centre for Environment, Energy and Natural Resource Governance (CEENRG).

Among other work in this space, Anadon co-led one of the first studies on the forces behind government funding of energy research in the 21st century. Public energy ‘Research, Development, and Demonstration’ (RD&D) in the OECD countries plus China and India grew from just under $10 billion in 2000 to over $25bn in the late 2010s.

An analysis of official reports showed RD&D increases in many Western economies – from post-2008 US investments to the EU Green Deal – were often justified by policy makers pointing to competitive threats from China, which grew cleantech spending at double-digit rates almost every year between 2003 and 2014.

“RD&D for onshore wind increased in a number of other big economies when Chinese firms entered the market,” says Anadon. “However, shippable cleantech such as solar PV suffered from the intense Chinese investment that eliminated other market players.”

Anadon was a lead author on the Innovation chapter in the IPCC’s 2022 ‘Mitigation of Climate Change’ 6th Assessment Report, which called for the rapid rollout of policies that generate “demand pull”: stimulating the creation and expansion of markets and industries for emissions-reducing technologies.

To understand this "demand pull" in large economies, Anadon and her Cambridge colleague Dr Cristina Peñasco conducted a major analysis of low-carbon policies, and compared how they perform in areas such as cost and competitiveness.

All the data was poured into an interactive online tool that allows users to explore evidence around carbon-reduction policies from across the globe.

“New technologies that are not yet competitive can be pulled into markets using government policy, and over time the cost comes down through refined manufacturing and the business models that get developed,” says Anadon.

“Consumers become comfortable with the tech, and we get to the point we are at today with things like electric vehicles and solar panels, where in some parts of the world it is now cheaper than fossil fuel incumbents.”

While Anadon points out that such improvements in cleantech were “not foreseen by deterministic models or experts”, she argues that a new generation of economic modelling – incorporating far more detailed data from global regions, sectors and technologies – can catalyse the energy transition.

Further work from Anadon and CEENRG shows many policies that spur renewable growth in OECD countries do not have the same effect in low- and middle-income countries, where “international finance, lower cost of capital, and institutional change" are all needed to facilitate energy transitions.

Anadon is also Vice-Chair and Founding Member of the European Scientific Advisory Board on Climate Change (ESABCC), created by the European Climate Law in 2021.

In a report last year the ESABCC called for a new 2040 target for EU-wide emissions reductions of at least 90% relative to 1990 levels, a recommendation supported by President of the EU Commission, Ursula Von der Leyen.