The economics of climate change

There follows a first attempt by me to discuss the economics of climate change. It is from the 2 October issue of Fund Strategy magazine. I intend to return to this topic in the near future.

The consensus that cutting carbon emissions is the only way to tackle climate change is almost universal. Even the few who were sceptical about the need for a low-carbon economy are dwindling in number.

Several fund management groups have already discussed the possibility of specialist firms benefiting from the development of new technology to mitigate climate change.

However, the costs of mitigation, which could affect huge swathes of the economy, have received little attention. To assess the overall economic and investment impact of curbing emissions of carbon dioxide it is necessary to balance these factors against each other. It should not be assumed automatically that mitigation is the only way of tackling climate change, let alone the best.

The consensus in favour of mitigation is certainly striking. Many have long favoured such a strategy, but now almost everybody does.

Under Arnold Schwarzenegger, its Republican governor, California has recently become the first American state to legislate curbs on greenhouse gas emissions. Shortly afterwards the state announced it was suing six of the world’s largest carmakers for their responsibility for global warming.

Meanwhile, Rupert Murdoch, long known as a sceptic on climate change, has announced that News Corporation is to go carbon neutral. This outlook is already being reflected in his newspapers, including articles in the Sun such as “going green can be so, so sexy” and “we’re on the erode to hell”.

Richard Branson, long a target for environmentalists because of his involvement with airlines, has tried to clean up his image with the announcement of a $3bn (£1.6bn) investment in alternative energy over the next decade. He has also called on the global aviation industry to cooperate to help tackle climate change. Although some environmentalists are sceptical of these moves, they do raise the possibility of heavy investment in alternative energy.

In Britain the government is stepping up its pro-mitigation initiative still further. As David Miliband, the environment secretary, told last week’s Labour Party conference: “Today I propose we adopt a new goal as a country: to aim to live as a nation within the limits that the environment can tolerate – One Planet Living.”

Companies are coming under pressure to live to share Miliband’s planet. The new company law, which should be enacted soon, will make it a statutory duty for directors of quoted companies to take into account environmental factors when making decisions. Businesses have countered that such a requirement will increase the regulatory burden they have to bear.

Margaret Hodge, the industry minister, reportedly signalled that the process could go even further at a Labour Party fringe meeting where she argued that private companies too should have such an environmental obligation. Although in a later statement Alistair Darling, the trade and industry secretary, denied this was the government’s intention.

Even before the introduction of such legislation most large British companies seem to be moving towards mitigation. According to a survey of FTSE 350 companies by Investec published in July, more than three quarters of respondents claim to measure their emissions and two thirds report on them. More than half are trying to cut emissions.

Under such circumstances those funds that invest in environmental technology could benefit. Those that specialise in this area include the Impax Environmental Markets investment trust and Merrill Lynch New Energy Technology. There are also numerous specialist open-ended environmental funds.

However, despite the overwhelming consensus in favour of mitigation, and the opportunities that could flow from its implementation, it is important to remember it has costs. For many sceptics the costs could be exorbitant. For example, fossil fuels are still by far the cheapest and most efficient form of energy in many cases, and are likely to remain so for a long time. So forcing people to switch to other forms of energy could slow growth or even cause an economic reversal. If the litigation against carmakers is successful, the impact on global growth could be even greater.

Those who suffer most as a result of mitigation are likely to be the developing countries. At present even China, with its rapidly industrialising economy, is responsible for far less greenhouse gas emissions per person than America or the European Union (see bar chart).

If China reaches the level of emissions per head of the EU or Japan, let alone America, the total level of emissions would increase enormously. But that could be the price necessary to raise China out of poverty. The sceptics would argue it is not up to rich Westerners to deny the Chinese, or the rest of the global poor, the benefits of affluence.

The mainstream counter-argument to this stance takes several forms. Some contend that it would be relatively quick and easy to switch to low-carbon technologies. If that is true the economic costs would be lower. At the Labour Party conference Gordon Brown proposed a $20bn global fund to help the poorer countries develop alternative energy sources.

Despite this apparently optimistic talk of new technology many are, more or less explicitly, arguing that economic development needs to be curtailed. That was certainly the implication of Miliband’s “One Planet Living” remark at the Labour Party conference. The idea is that Third World development should be limited – or made “sustainable” – and Westerners should curb their living standards too. Understandably, such talk is not popular with the general public.

It is hoped that the Treasury’s Stern Review on the economics of climate change, due to report soon, will help answer these questions. But the discussion paper already published on its website . is decidedly skimpy on how much mitigation is likely to cost: “For all countries, understanding the costs of mitigation will be critical. Existing estimates vary considerably.

“One important factor in the variation of these estimates is the assumption made about the nature of technological progress, specifically whether innovation can be stimulated by policy. If policies to reduce emissions are assumed to accelerate the development of these technologies, then the costs of mitigation will look much lower than if technological development is assumed to happen exogenously.”

Of course many environmentalists would argue that whatever the economic costs of mitigation it should be implemented. In their view the planet is facing such a serious threat that an immediate switch to a low-carbon economy is essential.

However, even if such environmentalists are right on the science – and there is debate about whether we are facing a catastrophic scenario as opposed to just a serious one – there are other ways to deal with climate change.

The most widely discussed alternative is adaptation, which involves such measures as constructing better flood defences, building at or above current sea levels and developing new crops. Indeed, the preliminary papers on the Stern Review point out that in any case adaptation will be necessary as the climate is set to warm whatever happens.

A more ambitious approach is what could be called geo-engineering or weather modification. For example, Paul Crutzen, a Nobel laureate in chemistry, has raised the possibility of injecting sulphur into the atmosphere to promote cooling. Others have suggested putting trillions of lenses into orbit to divert some of the sun’s rays. Although such initiatives may appear like science fiction, it does not mean they cannot play an important role in the future.
< br />The answers to these questions will have a substantial bearing on future economic and investment prospects. For the more optimistic proponents of mitigation there can be a smooth transition to a low-carbon economy without significant economics costs.

For the more pessimistic advocates of mitigation such a strategy is vital to save the planet, to the extent that the economic costs are unimportant. Such pessimists see austerity as a necessary part of the response to global warming.

For the sceptics a strategy based on mitigation is generally seen as bearing high economic costs. It could stunt development in the Third World and undermine economies in the West. They advocate alternative strategies such as adaptation and even geo-engineering as the best way to tackle the threat posed by climate change.

The outcome of this debate is likely to have enormous consequences. At present the proponents of mitigation are overwhelmingly in the ascendant, but it does not necessarily follow that they are right.