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IMFSurvey Magazine: IMF Research

WORLD ECONOMIC OUTLOOK

Climate Change and the Global Economy

By Natalia Tamirisa
IMF Research Department

November 6, 2007

  • Uncertainty surrounds estimates of costs associated with climate change
  • Mitigating climate change can have immediate economic consequences
  • IMF building capacity to assess macroeconomic implications

Most scientists agree that the global temperature is rising as a result of man-made emissions of greenhouse gases, and that the earth's climate is changing.

While the physical and biological consequences of climate change are uncertain, it can lead to a rise in sea levels, increased frequency or intensity of heat waves, droughts, hurricanes, floods, and a loss of biodiversity.

Estimates of the macroeconomic effects of climate change at different levels of warming span a wide range of possible economic costs—ranging from negligible (even positive at low levels of warming) to a 10 percent reduction in world GDP for average global warming of 6 degrees Celsius.

While the corresponding economic costs are unclear, they are also likely to vary across regions. And, although the direct impact of climate change is expected to be felt slowly, the steps that governments, businesses, and individuals take to mitigate, or adapt to, climate change can have immediate economic and financial consequences. At a September workshop organized by the IMF's Research Department, participants discussed how climate change is likely to affect the global economy and debated policies that can help mitigate the adverse effects of climate change at a minimum cost.

Economic costs

All participants in the workshop underscored the high degree of uncertainty surrounding estimates of the economic costs of climate change. John Reilly (Massachusetts Institute of Technology) noted that although most available models suggest that aggregate economic costs of climate change are likely to be small, these estimates represent a central tendency that summarizes the gamut of scenarios ranging from relatively favorable to catastrophic effects of climate change; policymakers may be particularly concerned about the tails of the distribution.

Low-impact estimates also disguise significant differences across countries: small, poor, resource-dependent economies are likely to be most affected by climate change. Robert Shackleton (Congressional Budget Office) and Francisco de la Chesnaye (Environmental Protection Agency) echoed these views, pointing out that the effects of climate change on economic growth, trade, financial flows, and migration depend on how physical and biological systems respond to rising temperatures and how well countries adapt to climate change and cope with institutional and social stresses it is likely to pose.

Mitigating climate change

In discussing the challenge of designing policies that would provide incentives for countries to participate in an international agreement on mitigating climate change, Warwick McKibbin (Australian National University) argued these policies must be robust to uncertainty. If an economy grows faster than originally anticipated, for example, its abatement costs would rise, making the original targets under a quantity-based scheme (cap and trade) hard to achieve and weakening incentives for participation in an international cap-and-trade agreement.

The increase in costs would be considerably smaller under a price-based scheme (a carbon tax), or a "hybrid" scheme that converts a quantity-based scheme into a price-based plan using a safety valve if abatement costs rise above a certain threshold.

William Pizer (Resources for the Future) underscored, among other things, the importance of international competitiveness in the context of designing sustainable international agreements. He pointed out that, for the business sector in countries considering joining an international agreement, the critical issue is whether it would remain competitive with producers from non-participating countries.

Nicholas Stern (London School of Economics) stressed that, while advanced economies need to take the lead in mitigation, the participation of developing economies was crucial. He advocated working toward an international agreement that would combine strong individual emissions targets for developed countries with trading schemes open to developing countries. These issues are likely to remain high on the international policy agenda in the coming years, as countries debate the future of the Kyoto agreement, set to expire in 2012.

IMF's role

The IMF is not a center of expertise on the scientific aspects of climate change, but it is building its capacity to assess the macroeconomic implications of climate change and policies to abate it. This is part of the IMF's strategic effort to understand the long-term challenges to the global economy, which could help form a basis for its policy advice to member countries and for contributing to the international efforts to deal with these challenges.

A considerable amount of work on climate change issues is already under way at the IMF in coordination with its sister organization, the World Bank. This work comprises, among other things, an appendix in the October 2007 World Economic Outlook (WEO), which summarizes the state of knowledge and policy debate on the key economic aspects of climate change (see related article).


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