Climate Change, the Environment and the Work of the IMF
It is now generally recognized that climate change poses potentially severe macroeconomic, fiscal and financial challenges, particularly in many low-income countries. It could lead to sizeable reductions in output and productivity, particularly in agriculture, fisheries, and tourism, and brings a low (although unknown) risk of catastrophic events. Efforts to mitigate climate change-reducing its extent by cutting back greenhouse gas emissions-will impose costs, and so too will adapting to the effects that remain. |
The Fund aims to contribute to understanding and dealing with the macroeconomic, fiscal, and financial challenges of climate change. This is in line with its comparative advantage, expertise, and mandate. In the broader context of international economic policy, the Fund is not taking a lead in the work on climate change but is working with the organizations that do-especially the United Nations and the World Bank. Given resource constraints, the Fund's activities in the area of climate change are largely demand-driven, focused on providing advice to member countries where climate change can have a significant impact on economic and financial stability. It also aims to promote understanding of the difficult issues of fiscal policy cooperation and design, likely to arise in negotiating a successor to the Kyoto Protocol.
The macroeconomic challenges from climate change
Climate change is in many respects a uniquely difficult economic problem. It arises from a global externality-emitters of greenhouse gases do not bear all the damage they cause, and that damage is the same wherever the emission is made. There is a strong intertemporal mismatch between the (early) costs of action to limit its extent and the (later) benefits from doing so. There are pervasive uncertainties and ireversibilities, including the risk-with a low but unknown probability-of catastrophic events. And there are large differences in how countries will be affected, and in the extent of their contribution to the atmospheric concentrations that cause global warming.
Two recent publications illustrate the contribution that the IMF can make in understanding and coming to terms with the macroeconomic policy challenges that climate change poses.
A chapter in the Spring 2008 World Economic Outlook, on climate change and the global economy sets out the macroeconomic challenges posed by climate change and policies to address the problem. It emphasizes that policies to mitigate climate change can have potentially rapid and wide ranging macroeconomic consequences. Putting a price on emissions of greenhouse gases would affect countries' economic growth, saving and investment levels, capital flows, and exchange rates. Yet the chapter also reports simulation results that show how these costs can be minimized if policies are well designed. In particular, policies should be long-term and credible, yet flexible enough to be able to adjust to emerging information and changing economic conditions; and implemented as broadly as possible, while being managed so as to ensure an equitable distribution of costs.
A policy paper prepared for the Executive Board of the IMF deals in more detail with the fiscal implications of climate change. These take many forms. Climate change will directly affect tax bases and public spending needs, but beyond this there is also a more purposeful role for government tax and spending policies. To mitigate climate change-that is, reducing its extent by cutting emissions-fiscal instruments (emissions taxes, or cap-and-trade schemes to limit emission) can ensure that the full environmental cost is borne by all emitters of greenhouse gases. Underlying fiscal policy for mitigation is the basic principle that any emitter of greenhouse gases should face the marginal cost to the entire world society of doing so. While this is a simple principle, it raises formidable conceptual and implementation problems, requiring worldwide efforts and solutions. Public expenditure on adaptation-learning to live with changing climatic conditions-may also be required to reduce societies' risk exposure through better infrastructure, coastal protection, education, health and water services, and meet other challenges of changing climate. Such expenditure is expected to rise as climate change progresses and could reach more than US$100 billion annually, by 2030 or earlier.
Climate change has implications for financial markets to, with innovative instruments-such as catastrophe bonds and weather derivatives-providing a way to manage climate-related risks. These too are discussed in the WEO chapter and policy paper, and also in an article in the March 2008 issue of Finance & Development, which contains several articles on macroeconomic aspects of climate change.
Other environmental work in the IMF
Though it has come to dominate the policy agenda, climate change is not the only environmental issue of potential macroeconomic significance. Others may include local pollution, which can be addressed through environmental tax policy; forest and other renewable resource management involving resource tax and concession policies; and the appropriate structure of environmental tax systems. Some of these issues may interact with climate policy issues (such as when reduced deforestation also leads to lower carbon emissions, and when less local pollution is associated with less burning of fossil fuels); but to some degree they are also stand-alone issues which, when they become significant to macroeconomic performance, warrant IMF attention.