The International Monetary Fund says that the economic costs of addressing climate change—one of the world's greatest collective action problems—can be contained by putting in place well-designed policies that are implemented across many countries.
An analytic chapter in the IMF's April 2008 World Economic Outlook (full report will be published on Wed, April 9th), entitled Climate Change and the Global Economy, examines the macroeconomic and financial consequences of policies aimed at mitigating climate change. It finds that putting a price on emissions of greenhouse gases that contribute to climate change would have an adverse effect on productivity and economic growth. Saving and investment, capital flows, and exchange rates are also likely to be affected.
The policies required to reduce emissions by 60 percent from 2002 would leave the global economy about 2.6 percent smaller than it otherwise would be in 2040, the IMF projected. Even so, the global economy would grow to about 2.3 times its current size between 2007 and 2040, the IMF said.
"There are significant risks from climate change; damages could be severe," saidIMF economist Natalia Tamirisa. "The costs of mitigation could be moderate provided that policies are well designed."
To minimize the costs of mitigation policies, it would be critical to aim at a long-term and credible policy framework that is flexible enough to adjust to emerging information and changing economic conditions. Also, the policies need to be implemented as broadly as possible, while ensuring that costs are equitably distributed across countries.
Simon Johnson, Economic Counsellor and Director of Research at the IMF said at a press conference in Washington DC on Thursday that the IMF staff analysis points to some lessons as to how such policies could be more effective and efficient.
First, carbon pricing policies need to be long term and credible. Policies need to establish a time horizon for steadily rising carbon prices that people and businesses believe. Higher carbon prices would then induce the required shifts in investment and consumption away from emission-intensive products and technologies. And gradual price increases starting early and from a low level would minimize the cost of adjustment. A framework for multilateral action should induce all groups of economies, advanced, emerging market, and developing, to start pricing their emissions.
"Any policy framework that does not include large and fast-growing economies such as Brazil, China, India, and Russia, in some fashion would be costly and politically difficult. That is because during the next 50 years, 70 percent of emissions are projected to come from emerging and developing economies," Johnson said.
Johnson also said that carbon pricing policies should also aim at establishing a common world price for emissions. This would ensure that emissions reduction occur where it is least costly to do so. If carbon prices are not equalized across countries, the global cost of mitigation policies will be at least 50 percent higher. Carbon pricing policies should be sufficiently flexible to accommodate the business cycle. During periods of high demand it would be more costly for firms to reduce emissions and the opposite will be true when demand is low. Abatement costs will be lower if firms are allowed to vary their emissions over the cycle while still targeting a given level of emissions reductions over the medium term. Unlike carbon taxes, schemes for trading emission permits, also known as cap and trade, could prove restrictive in periods of high growth unless they incorporate elements that help control price volatility, so-called hybrid policies.
"Finally, the costs of mitigation need to be distributed equitably on a global basis. Transfers under cap and trade schemes need to account for how easily different countries could reduce emissions," Johnson said. "A scheme generating a flow of transfers toward emerging and developing countries would reduce the costs of carbon pricing policies for them and would encourage their participation. However, such flows may also put an upward pressure on exchange rates in the recipient countries leading to symptoms of the so-called Dutch disease problem. It will be important to put in place supporting policies that could help to address these issues," he added.
Finance & Development on climate change
The March 2008 issue of the IMF's quarterly magazine Finance & Development tries to further the debate on the effects of climate change, warning that farm production will fall dramatically—especially in developing countries—if steps are not taken to curb carbon emissions. Other articles in the magazine on this theme argue that policies to reduce greenhouse gas emissions need not hobble economies, that financial markets can help address climate change, that fiscal instruments can help countries adapt, and that the problems of climate change and sustainable development could be solved together.
Climate Change and the Economy
Climate change can be addressed without either hurting macroeconomic stability and growth or putting an undue burden on the countries least able to bear the costs of policies. If policies are well designed, their economic costs should be manageable.
Global Warming and Agriculture
William R. Cline
If steps are not taken to curb carbon emissions, agricultural productivity could fall dramatically, especially in developing countries. It is therefore strongly in these countries' own interest that they participate actively in international emissions abatement programs.
Paying for Climate Change
Benjamin Jones, Michael Keen, and Jon Strand
Governments must manage the incentives for households and firms to counter and adapt to climate change. The role of fiscal instruments is central—indeed, indispensable—for both mitigating and adapting to climate change.
The Greening of Markets
Recognizing how financial markets will react to climate change initiatives, and how they can best promote mitigation and adaptation, will become crucial to shaping future policy and minimizing its costs.
Rising Temperatures, Rising Risks
Although climate change and sustainable development are complex, interlinked problems that pose a challenge to humanity, they could be solved together by integrating adaptation and mitigation response measures into the broader rubric of sustainable development strategies.
Finfacts Climate Change Reports