Adapting to Climate Change: Pricing Right, Taxing Smart, and Acting Now

January 31, 2018

1. We recently have seen the IMF appearing to step up its work on climate change. Why now?

The Short Answer: This is our response to the threat climate change poses to our planet—and the growing demand from our membership and the international community to respond.

The IMF has been involved in the climate change work for several years. Our recent work reflects compelling evidence that adapting to climate change is one of the most important challenges facing economic policy makers worldwide. The IMF also has an obligation as a member of international community to address the doubts about climate change with fact-based analysis.

The Long Answer: the Fund’s core mandate is to ensure economic stability and resilience. Climate change could prove to be a destabilizing force for the global economy if it is not addressed.

The macroeconomic impact of climate change was illustrated by the especially damaging hurricane season last year in the Caribbean and the U.S. We certainly will see more frequent and more damaging such natural disasters in the future.

So, the key question is what we can do—and do better—in helping policymakers confront the challenges of climate change?

Two key areas of work are: mitigation, which includes helping countries meet their commitments under the Paris Agreement to reduce emissions; and adaptation, which focuses on building resilience to climate change. Our general message to our membership with regard to meeting the goals of the Paris agreement to contain emissions is to “price it right; tax it smart; and do it now.”

2. What are the main findings of your work on climate change? What risks does climate change have on the global economy?

We are deeply concerned about the link between climate change and macroeconomic performance. Global temperatures have increased at an unprecedented rate over the past 40 years, and significant additional warming could occur. All countries will be affected if we don’t reduce greenhouse gas emissions.

Most importantly, increases in global temperature have uneven macroeconomic effects for countries in different income groups. For example, we estimate that the average annual cost of natural disasters in low-income countries is equal to 2 percent of GDP. That is four times the impact on larger economies.

That calls for a clear focus on low income countries, including the small island economies.

Let’s examine this in terms of policies focused on adaptation and mitigation. For adaptation, we find that sound domestic policies and investment in specific strategies can help reduce the adverse consequences of weather shocks.

For example, in Grenada we have encouraged the government to save 40 percent of the revenue from its Citizenship by Investment Program as a buffer against future natural disasters. In addition, Grenada has included a hurricane clause to it debt agreements to defer debt payments if there is by a natural disaster.

For mitigation, our main finding is that carbon pricing is crucial in reducing emissions, and carbon taxes are more effective than other mitigation instruments. There are environmental benefits such as reduced air pollution, and increased government revenues.

3. How does the IMF help its membership in addressing the risks of climate change and which countries/regions are most affected?

We are helping countries through the core operations of the institution, with a focus on low-income countries. This work takes place on several fronts: macroeconomic analysis, policy advice, capacity development, and financial assistance.

We undertake macroeconomic analysis at the country, regional and global levels. The challenge is to understand how policy and environmental objectives interact. In this regard, I would highlight our October 2017 World Economic Outlook , which devotes a chapter to the implications of weather shocks for low-income countries.

We are assessing the emissions prices and other policies countries will need to meet their mitigation pledges. This assessment is key to developing carbon pricing measures and related policies.

We use our analysis to provide the practical policy advice so that countries can better respond to the challenges of climate change.

We tailor our capacity development work to help governments to implement these policies. This includes training and customized advice.

We provide financial assistance to assist the response to climate-related events. For example, during the 2015 Ebola crisis in West Africa, we established a Catastrophe Containment and Relief Trust. This facility provides debt relief to poor countries hit by natural disasters, thus freeing up resources to respond to a crisis.

In addition, beginning in December 2016, the amount that countries can borrow after a large natural disaster was nearly doubled. This will enhance the effectiveness of other forms of support.

4. More specifically, how do you see measures such as energy subsidy reform and carbon taxes addressing risks of climate change?

We see two ways to assess the costs associated with fossil fuels. The first is the failure to fully recover supply costs in subsidized user prices for energy. In 2015, this part of the subsidy amounted to $330 billion worldwide.

The second is a broader measure that also includes undercharging for environmental costs and for general consumer taxes. We estimate this cost at $5.3 trillion—equivalent to about 14 percent of global GDP in 2016.

The Fund takes the view that energy subsidies have negative economic and environmental effects. Several studies have shown that subsidies benefit the wealthiest households and reinforce income inequalities. They also encourage wasteful energy consumption. The IMF is playing its part with assessments of energy subsidies, emissions prices, and other policies.

5. How do you see the private sector role in financing or investing in infrastructure helping to address climate risks?

Addressing climate change can only be successful if there is a partnership among governments, international organizations, and the private sector. The role of business is critical in infrastructure development. The challenge is for countries to create projects that are attractive to investors. Our work in this area aims to create an enabling environment for this investment.

We have launched an infrastructure policy support initiative to help countries meet their infrastructure needs in a way that supports macroeconomic stability and is fiscally sustainable.

We also have developed a model that analyzes the macroeconomic effects of natural disasters. It helps to define the appropriate financing mix to build resilient infrastructure. This is being applied in our policy recommendations in several countries, including the Solomon Islands and the Maldives.

6. What are the future risks of climate change and what’s next for the IMF’s work in this regard?

The science is very clear about the future risks. In our work, we fully accept these scientific facts.

In terms of what’s next, our efforts are focused on developing tools to help countries to take measures to meet their mitigation commitments and to recognize the environmental, economic, and fiscal impact of those policies.

We are also starting to assess the interaction of climate risks and financial stability. For example, we have collaborated with the World Bank and UN Environment on the “roadmap” for green financing.

I would like to emphasize the Fund’s work with small island states—which are most vulnerable to climate change, but least equipped to build resilience.

To attract investors and donors, small islands will need to create a favorable macroeconomic and business environment. This includes assurances that investors will get a fair return and that money will be well spent. The Fund is advising through what we call the Climate Change Policy Assessments for island states.

These assessments take stock of countries’ mitigation and adaptation plans, risk-management strategies, and financing capabilities. They identify areas where countries need investment, policy changes, or capacity-building assistance. For example, we are working to create room in government budgets to enhance preparedness and resilience to natural disasters. This focuses mainly on mobilizing revenue, redirecting spending, and improving public financial management.

This type of assessment should be useful for investors, as it helps to signal which countries have a sustainable climate strategy. The Seychelles offers a model in this regard, linking mitigation and adaptation plans to financial support and risk-management. Their strategy includes financial innovations such as a “blue bonds” to protect marine resources, and debt-for-nature swaps that are attracting foreign investors.

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