Economics of Climate Change

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Economics of Climate Change


The economics of climate change refers to the study of the economic costs and benefits of climate change, along with the economic impact of actions aimed at limiting its effects.

Participants in the climate change debate—from government to non-governmental organizations (NGOs) to academia—have increasingly used economic assessments to determine the costs of addressing climate change.

In recent years, influential economic analyses, such as the 2006Stern Review, have influenced the climate debate and shifted climate change policy by countering assertions that greener technologies are too expensive. Increasing support among economists for action to mitigate possible causes of climate change is especially significant given the public perception—particularly in the United States and many developing nations—that the main arguments against action are economic (i.e., that the costs of effective policies would be too large, or that delay is economically justifiable).

Historical Background and Scientific Foundations

The field of climate change economics has evolved in tandem with increased scientific knowledge of climate

change itself. In February 1997, 2,500 U.S. economists, including eight Nobel laureates, signed the “Economists' Statement on Climate Change”—a short, three-point document acknowledging human impact on Earth's climate, and the “environmental, economic, social, and geopolitical risks” justifying preventative measures. There were many counteractive policies, it said, “for which the total benefits outweigh the total costs.” And that “the most efficient approach to slowing climate change is through market-based policies.” This can be the starting point for the modern study of the economics of climate change: the majority of studies and reports published since then have concerned themselves with finding the most monetarily efficient way of mitigating global warming.

Not all scientists and economists are agreed that positive mitigation action is the best way forward. However, in 2004, Danish academic Bjørn Lomborg, who later wrote Cool It: The Skeptical Environmentalist's Guide to Global Warming (2007), founded the Copenhagen Consensus, a project in which a panel of economists established priorities for advancing global welfare using the theory of welfare economics. Welfare economics is the study of how best to distribute economic product among competing claimants. The experts ranked 17 global challenges—from climate change to water sanitation—in order of priority. The panel ranked lowest the three projects addressing climate change.

Opponents of the Kyoto Protocol have used economic arguments to bolster claims that Kyoto implementation would be too expensive or harm economic growth. At a July 2002 hearing on U.S. climate change policy under the President George W. Bush administration, James L. Connaughton, the chairman of the Council on Environmental Quality, testified that implementing the Kyoto Protocol would reduce U.S. economic output by “up to$400 billion” in 2010. His estimate was similar to a $397 billion estimate that appeared in a 1998 report by the Energy Information Administration (EIA), an independent statistical and analytical agency within the U.S. Department of Energy. The figures projected conflicted with the results of a number of other studies, however.

Initially most economics research on climate change employed simple cost-benefit analyses framed by two key questions: What are the potential costs of cutting greenhouse-gas emissions? Can such reductions be achieved without sacrificing economic output? In other words: do the costs of climate change prevention outweigh its possible benefits, or vice-versa? Published in October 2006 by the British government, the Stern Review on the Economics of Climate Change—a 700-page report authored by economist and Cambridge University Fellow Sir Nicholas Stern—also asked a third question: what are the economic costs if we do nothing? The report's answers, which mentioned that inaction on climate change issues could lead to environmental devastation and long-term economic crisis, attracted international attention for the report.

The Stern Review estimated that without international action to counteract climate change “the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year…If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more.” Stern contrasted this with the economic cost of taking action to reduce climate change—around 1% of global GDP. He wrote of the necessity of taking prompt action:

The investment that takes place in the next 10–20 years will have a profound effect on the climate in the second half of this century and in the next. Our actions now and over the coming decades could create risks of major disruption to economic and social activity, on a scale similar to those associated with the great wars and the economic depression of the first half of the twentieth century. And it will be difficult or impossible to reverse these changes.

At the core of Stern's recommendations was the necessity to stabilize greenhouse-gas levels in the atmosphere between 450 and 550 parts per million (ppm) CO2 equivalent (CO2e). The current level is 430ppm CO2e and according to Stern is rising at more than 2ppm each year. In order to achieve this, emissions would need to be reduced by at least 25% from current levels by 2050. In the long term, Stern recommended that annual emissions be brought down to more than 80% below current levels, while acknowledging that such action represented a major challenge.

Stern put forward a three-point plan for action. First, implement a regulatory system through which carbon could be taxed and traded. Second, foster government support for the development and the deployment of low carbon technologies. Third, educate the public and policymakers about climate change and increase individual responsibility. Stern further asserted that action by individual countries was insufficient and that addressing climate change requires a sustained, cooperative international response.

The environmental costs of climate change, Stern argued, would be felt first by the least-developed nations and developing countries, many of whom had contributed least to greenhouse-gas levels. Stern argued that developing countries should not be required to bear the full costs of stabilizing greenhouse-gas levels alone.

Stern acknowledged that climate change prevention could cause some mild to moderate market losses. However, he noted that some of those initial losses would be offset by growth in the development and production of green technologies. Entire new markets will be created in low-carbon energy technologies and other low-carbon goods and services worth hundreds of billions of dollars each year. “Changes in energy technologies and in the structure of economies have created opportunities to decouple growth from greenhouse gas emissions,” argued Stern, adding that “tackling climate change is the pro-growth strategy for the longer term.”


CARBON TAX: Mandatory fee charged for the emission of a given quantity of CO2 or some other greenhouse gas. Under a carbon taxation scheme, polluters who emit greenhouse gases must pay costs that are directly proportional to their emissions. The purpose of a carbon tax is to reduce greenhouse emissions. Carbon taxation is the main alternative to emissions trading.

CARBON TRADING: Buying and selling of carbon credits, abstract instruments (like money) that each represent the right to emit 1 ton of carbon dioxide or an equivalent amount of other greenhouse gases. Carbon trading presently takes place under the European Union Emission Trading Scheme and the Chicago Climate Exchange.

ECONOMISTS' STATEMENT ON CLIMATE CHANGE: A statement endorsed by over 2,500 economists including eight Nobel Prize winners: the economists stated that “global climate change carries with it significant environmental, economic, social, and geopolitical risks, and that preventive steps are justified.” They also empasized that preventive steps would not necessarily be harmful to economies and might in fact “improve productivity in the long run.”

GREENHOUSE GASES: Gases that cause Earth to retain more thermal energy by absorbing infrared light emitted by Earth's surface. The most important greenhouse gases are water vapor, carbon dioxide, methane, nitrous oxide, and various artificial chemicals such as chlorofluorocarbons. All but the latter are naturally occurring, but human activity over the last several centuries has significantly increased the amounts of carbon dioxide, methane, and nitrous oxide in Earth's atmosphere, causing global warming and global climate change.

STERN REVIEW: The Stern Review on the Economics of Climate Change, a controversial report commissioned by the government of the United Kingdom and written by British economist Nicholas Stern (1946–). The Stern Review predicted that climate change, if not mitigated, will eventually severely damage world economic growth, causing disruptions comparable to those of the world wars and Great Depression of the twentieth century.

Stern marked the onset of a new consensus amongst economists regarding climate change. The International Monetary Fund's October 2007World Economic Outlook concluded that the economic impacts of climate change were potentially substantial, and could include a number of wide-ranging effects. These ranged from a direct negative impact on output and productivity from long-term temperature change, particularly for agriculture, fisheries, and tourism; to costs from sea-level rise and increased flooding. It also highlighted many of the concerns mentioned by Stern, such as the increased risk of widespread migration and conflict; weakened tax bases; and increasing national debt burdens. Positive effects were also mentioned, such as long-term environmental health, natural resource protection, and the “double dividend” promised by mitigation schemes.

Impacts and Issues

No economic paper can predict the future. Behind each analysis is an economic model with its own set of assumptions, its own definitions of how the economy works, and its own data sets. As such, it remains endlessly open to interpretation and counter argument.

The United States has been accused by a majority of environmental organizations of using worst-case scenarios to support its decision to reject the Kyoto Protocol. An oft-quoted figure—provided by the White House Council on Environmental Quality—of a $400 billion cost for Kyoto implementation is at odds with figures cited in other studies. A 1997 study by the Council of Economic Advisors (CEA) found that the U.S. costs of implementing the Kyoto Protocol could be as little as $7– 12 billion, depending on the extent of international emissions trading allowed and the participation of developing countries. The estimate of the White House Council on Environmental Quality assumed that all reductions would be achieved domestically, while the CEA estimate allowed for the purchase of emissions reductions from other nations. Both reports used different growth rates. Neither methodology used was incorrect, rather its subjective elements left room for interpretation. Therefore, the different types of models produced different types of cost estimates for implementing the Kyoto Protocol.

The methodology of the Stern Report came under scrutiny when it was published in 2006. One of the most renowned experts on the economics of climate change, Richard Tol, produced a detailed critique of the report, which he concluded was “alarmist and incompetent.” Tol wrote that Stern used only the most pessimistic impact studies and had no real cost-benefit analysis. Tol concluded that “unsound analyses like the Stern Report only provide fodder for those skeptical of climate change and climate policy.” This skepticism was mirrored by several other interest groups and individuals. For example, OPEC, the Organization of Petroleum Exporting Countries, called the Stern Report misguided and stated that the scenarios used by Stern had little scientific or economic basis.

Nevertheless, the Stern Report attained widespread support of an unlikely coalition of climatologists, scientific bodies, NGOs, and economists. “It provides the vital missing link between global economics and the emerging and overwhelming evidence of human influence on climate change,” said Chris Huntingford of the Centre for Ecology and Hydrology. Martin Rees, president of the Royal Society, put the impact he hoped it would have in the following terms: “this should be a turning point in a debate which has pitted short term economic interests against long-term costs to the environment, society and the economy.”


“Government support through financial contributions, tax credits, standard setting and market creation is important for effective technology development, innovation and deployment. Transfer of technology to developing countries depends on enabling conditions and financing (high agreement, much evidence).”

“Public benefits of RD&D investments are bigger than the benefits captured by the private sector, justifying government support of RD&D.”

“Government funding in real absolute terms for most energy research programmes has been flat or declining for nearly two decades (even after the UNFCCC came into force) and is now about half of the 1980 level.”

“Governments have a crucial supportive role in providing appropriate enabling environment, such as, institutional, policy, legal and regulatory frameworks, to sustain investment flows and for effective technology transfer without which it may be difficult to achieve emission reductions at a significant scale. Mobilizing financing of incremental costs of low-carbon technologies is important. International technology agreements could strengthen the knowledge infrastructure.”

SOURCE:Metz, B., et al, eds. Climate Change 2007: Mitigation of Climate Change: Contribution of Working Group III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change. New York: Cambridge University Press, 2007.

The overwhelming message of the Stern Review was that it was time to move on from arguing about the existence of climate change to taking preventative action. The report's conclusions were that a rise in temperatures of 9–11°F (5–6°C) could trigger a global loss of economic wealth of up to 20%. What arguably separated the Stern Review from other major studies and articles on climate change, was not its basic hypothesis, but rather

its highly controversial appeal to the self-interest of developed countries. Citing financial disarray and possible economic collapse as well as the possibility of the developed world being flooded with climate change refugees, Stern put forth a financial choice to the world: spend 1% of your GDP now and avoid a potential loss of 20% later.

Upon the publication of the Stern Review, the British Chancellor of the Exchequer (prime minister as of June 2007) Gordon Brown, promised to expand carbon trading and legislate on carbon reductions, with an independent body to monitor progress and to push to reduce European-wide emissions by 30% by 2020 and over 60% by 2050. Although such pledges were welcomed by a majority of British environmentalists, Brown immediately also received criticism from the same sector for not going far enough. For example, many environmental advocates sought regulation of private car and airline emissions, higher taxes on large polluters, and increased investment in clean technologies.

European leaders reached a consensus to reduce greenhouse emissions by 60% by 2050. But the Stern Report also sought to persuade skeptical governments, particularly that of the United States, to undertake reforms. Stern traveled to Washington, D.C., to discuss his findings. He met with President George W. Bush, who called the report a “contribution to the body of knowledge on climate change,” but did not endorse a shift in current U.S. climate change policy. Eileen Claussen, the president of the Pew Center on Global Climate Change, suggested that the Stern Report would only belatedly have an impact in the United States. “We are at the beginning of a serious debate about what to do about climate change….[m]uch of the opposition will be over the costs, and Stern has been able to talk to the costs of inaction.”

See Also Environmental Policy; Stern Review; United States: Climate Policy.



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Giles, Jim. “How Much Will It Cost to Save the World?” Nature 444 (November 2, 2006): 6–7.

“A Global Call to Arms.” Nature 444 (November 2, 2006): 2.

“The Heat Is On: Survey—Climate Change.” Economist (September 7, 2006).

Sachs, Jeffrey. “Averting Disaster: At What Cost?” Nature Reports: Climate Change (June 7, 2007).

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Web Sites

“The Economists' Statement on Climate Change.” Redefining Progress: The Nature of Economics, 2001. <> (accessed December 7, 2007)

Shogren, Jason, and Michael Toman. “How Much limate Change Is Too Much? An Economics Perspective.” Climate Change Issues Brief, No. 25, September 2005. <> (accessed November 26, 2007).

Stern, Nicholas, et al. “The Stern Review of the Economics of Climate Change: Final Report.” HM Treasury (British government). < report.cfm> (accessed November 26, 2007).

Tol, Richard S. J. “The Stern Review of the Economics of Climate Change: A Comment.” <> (accessed November 26, 2007).

James Corbett

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Economics of Climate Change

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