How will acting on climate change affect the economy?

Avoiding climate change risks and their damages requires creating a zero-carbon economic and societal transformation. This involves developing and rolling out both new inventions and existing zero-carbon technologies such as renewable energy generators like wind and solar; batteries for energy storage and electric vehicles to replace petrol and diesel vehicles; businesses and homes switching away from fossil-fuel based energy sources; and people making different choices about what they buy and how they live.

The most important financial benefits of these actions come from avoiding the disastrous effect that the impacts of climate change would have on our society. Limiting increases in the frequency and intensity of flooding, heatwaves, wildfires and other extreme weather events can help avoid the otherwise major costs of adaptation to these impacts - the UK winter floods in 2013-14, which resulted from heavy rainfall that was made more likely by climate change, cost the economy £450 million in insured losses alone, for example^[1].

To understand the full economic impact acting on climate change, however, economists also look at the multiple gains and benefits that come from creating a zero-carbon society, beyond limiting the risks presented by climate change.

The economic costs of acting on climate change

Many of the changes needed to achieve a zero-carbon society will create an initial cost to sectors of the economy. High-carbon companies are likely to lose competitiveness in the transition, as infrastructure for the zero-carbon economy is built and policy incentives are rolled out.

In the UK, the Committee on Climate Change (CCC) suggests that reaching net zero emissions by 2050 would cost less than 1% of GDP every year through to 2050^[2]. For comparison, the UK’s military defence budget is currently about 2% of GDP each year^[3].

At a global level, the Intergovernmental Panel on Climate Change (IPCC) reports that limiting warming to 2°C would reduce the growth rate of per capita global consumption by around 0.06 percentage points annually, compared with growth in a hypothetical world with no climate change^[4]. On the other hand, the Organisation for Economic Co-operation and Development (OECD) argues that tackling climate change as part of a transition that also involves structural reform and fiscal initiatives could add 1% to GDP in G20 countries by 2021, and 2.8% by 2050^[5].

The large differences between these figures shows why it is so difficult to make long-term predictions about the costs of acting on climate change, and why any projection is always uncertain. Ultimately, the future is not a given and how exactly costs play out will depend on the decisions and investments made today and over the entire zero-carbon transition.

It is clear, however, that for the UK, the costs will be lower and the benefits higher, if the country proactively acts to tackle climate change^[6]. It is also clear that the costs of many zero-carbon technologies, such as solar energy, wind power and batteries, have reduced significantly over the past few years, making the transition cheaper^[7].

Costs without benefits is only half the story

Many calculations of the economic costs of tackling climate change do not account for the economic benefits that will also come from taking action. This means they only tell one part of the story, as the benefits of tackling climate change will likely outweigh the costs^[8].

Some of these benefits will come from positive effects on our health. Phasing out the burning of fossil fuels will bring down air pollution levels and switching to diets with less red meat and more plants make for healthier diets. Enabling changes like these will lead to healthier people and cost savings for healthcare systems like the National Health Service^[9].

Benefits also include avoiding the cost of damage caused by climate change and extreme weather events. The Organisation for Economic Co-operation and Development (OECD) suggests that if economic benefits of avoiding climate damages, such as increased flooding, droughts and extreme weather events, are also taken into account, taking action on climate change alongside pro-growth policies could add almost 5% to GDP in G20 countries by 2050^[10].

Transitioning to a zero-carbon society will also lead to new economic and industrial opportunities. As bringing down greenhouse gas emissions becomes the norm, businesses will compete to offer new, low-carbon technologies, goods and services such as offshore wind power, high-capacity batteries and advisory services for low-emissions urban planning. Companies that are successful in establishing this advantage early on, can access the new market opportunities that come from the need to reduce emissions in other sectors or in other countries. This can bring new benefits to the economy.  

Countries like the UK, which are good at many areas of innovation, can benefit especially from the fact that a zero-carbon economy relies on new technological developments, bringing new industrial opportunities when supportive policies are in place. In the UK, zero- and low-carbon goods and services already represent one of the fastest-growing parts of the economy. In 2017, businesses active in the low-carbon and renewable energy economy employed 396,200 people and had a direct and indirect combined turnover of £79.6bn, an increase of 8.2% compared with the previous year and growing faster than the whole of the UK business economy, which grew 5.6% over the same period^[11],[12].

The financial costs and benefits of achieving net-zero emissions will be distributed in different ways across different parts of the economy and among consumers. When making decisions about how to fund the United Kingdom’s transition to net-zero emissions by 2050, policymakers will need to consider how to avoid costs falling unfairly on vulnerable consumers and households^[1].

Stopping emissions requires a shift in both public and private spending. The government will need to create policies that incentivise people to spend their money differently, such as by switching to decarbonised heating in their homes and transport options like electric vehicles. At the same time, shifts in public spending and new financial incentives are needed to drive the development of innovative zero-carbon technologies, increase energy efficiency in buildings, change farming practices and create a clean energy system.

Current government policies support investment in renewable power through direct subsidies, which are funded through household and business energy bills, and through additional charges on electricity generated from fossil fuels. Economists expect the prices of electricity and heating to rise during the 2020s, until the needed infrastructure to supply clean energy for electricity and heat is entirely built and operational^[2].

Currently, however, higher electricity and gas prices from subsidising zero-carbon technologies is outweighed by savings made through improvements to energy efficiency. The total annual electricity and gas bill for a UK household fell £115 in real terms between 2008 and 2016, a trend which could continue through the 2020s as households further balance higher gas and electricity prices with greater savings from more efficient energy use^[3].

The Committee on Climate Change suggests that future costs to households of switching to clean energy in the home, particularly for heating, are also likely to be offset by falling costs elsewhere. For example, the shift to electric vehicles will lead to lower transport costs for households, as electric vehicles are likely to become cheaper to drive than petrol or diesel vehicles in the mid-2020s. Falling costs of renewable power between 2030 and 2050 are also expected to make the average electricity bill cheaper than it is today^[4].

Despite these benefits, economists suggest that the transition to a zero-carbon society, particularly if funded by household energy bills, could be ‘regressive’ because poorer households tend to spend a higher proportion of their income on energy costs; and so decarbonisation imposes a greater proportional burden on them than on wealthy households^[5],[6].

Policies such as carbon taxes and emissions trading systems follow the ‘polluter pays’ principle and put a price on the carbon emissions from households and businesses. Although making polluters pay seems fair, these policies also hit low-income households harder.  Fortunately, it is possible to address this issue through rebate schemes that pay back at least some of the collected revenues to poorer households.

Such schemes could potentially work either through the current benefit system, providing support to lower-income households to improve poorly insulated homes, or through a new ‘carbon dividend’ for every household that would return revenues to each household, often benefiting those on lower incomes^[7].

Economic models help us analyse pathways to a zero-carbon future. They are used to test how the economy could respond to different future circumstances, and how existing or possible future technologies could help meet targets to reduce greenhouse gas emissions in different sectors. This helps us compare the costs of different policies to reduce emissions, and the risks and uncertainties that come with each option. However, economic models also have limitations which are important to keep in mind when interpreting their results. 

Economic models currently are sometimes used to guide policy decisions about climate change. The most common type used are Integrated Assessment Models. These attempt to capture how economic and societal choices, and technological developments, could interact with the climate system and natural world. However, because models often predict the future based on knowledge about the past, calculations of what it could cost to reduce emissions are always just one version of a possible future, based on very specific assumptions. 

Economic models have been criticised for badly representing real-world technology development. They often fail to take account of the process of disruptive technological change and as a result tend to underestimate the rate at which costs can fall. For example, the rate and pace of cost reductions for solar energy were underestimated by models, as government subsidies and the response to them have driven widespread deployment. Solar photovoltaics are now well placed to outcompete new coal power plants as a source of power almost everywhere in the world^[1]. This makes it much cheaper to cut emissions from electricity generation than models predicted it would be by now.

Economic models can also struggle to incorporate the major future risks of dangerous climate change, as these are hard to quantify and capture^[2]. Many models do not include the economic implications of reaching a level of global warming that would create irreversible global changes, such as collapse of ecosystems, melting of entire ice sheets and extreme heat events. By not modelling these risks, our predictions of the possible economic impacts of climate change excludes some of the events that represent the greatest threat to human livelihoods, development and economic growth.

What economic models do tell us is that the longer we wait, and the less coherently we manage the transition to a zero-carbon society, the higher the costs are likely to be^[3]. Estimates of the costs of acting on climate change are also only one part of the equation, but when combined with analysis of the benefits of acting on climate change, they become useful parts of the toolkit for understanding our options for action. Models can also help us think about the implications of taking action at different timescales, when to introduce policy measures in different sectors and which policies are effective it at the lowest possible cost.

Adapting to the impacts and risks of living in a changed climate is an essential part of tackling climate change. However, in no way does it replace the need to urgently reduce emissions as well. In fact, the rate and speed of emissions reductions determines how effectively we can adapt to the impacts of climate change. If emissions do not decrease, it will be much harder, perhaps even impossible, to adapt as the impacts will arrive more quickly and at a more rapidly increasing scale.

Effective adaptation will help people, businesses, communities and countries cope with both the currently-happening and future impacts of climate change. Measures like flood protection and changes to land-use, as well as the ways we construct buildings, can help minimise damages to human livelihoods and the economy.

The sooner we roll out effective measures, the earlier we benefit from avoided damages. As global warming increases, the intensity and frequency of extreme weather events will grow and impact food security, nature, cities and jobs in more harmful ways^[1]. This means more adaptation is required, at greater cost, and can increase the risk of irreversible loss that it is impossible to adapt to, such as extinction of species and submergence of low-laying islands or cities due to sea level rise. 

Calculations of the exact future costs of adaptation produce a variety of results, as they depend strongly on the level of future greenhouse gas emissions and how the climate system will respond to them in different places, and whether they are effective. This makes accurately predicting the economic costs and benefits of adaptation very difficult. It is clear, however, that adaptation without efforts to stop climate change would prove extremely expensive.

The World Bank estimates the costs of adapting to 2°C of warming by 2050 might be $75–100 billion a year (£60-80 billion) for developing countries^[2]. However, these figures are almost certainly too low^[3]. The UN Environment Programme (UNEP) suggests that the cost of adapting to climate change in developing countries could reach between $280 and $500 billion (£217 - £388 billion) per year by 2050, with 2°C of warming^[4]. If warming increases beyond this level, the costs of adaptation would increase significantly as well.

Investing in adaptation is essential to limit the damages of climate change impacts on human society. However, any effective strategy to tackle climate change must both cut emissions to limit future warming and adapt to those impacts of climate change that cannot be avoided. The Global Commission on Adaptation states that even the most ambitious adaptation plans will not protect us against all the impacts of climate change. That is why lowering emissions is “the best form of adaptation”^[5].

Creating a zero-carbon, climate-resilient economy involves changing our buildings and our transport, energy and water systems. To achieve this, new investments in efficient and clean infrastructure - which is also resilient to climate change impacts - are crucial^[1],[2].

Total worldwide investments in infrastructure are set to double across the next twenty years as the world’s population increases, urbanisation continues and both developed and developing countries grow^[3],[4],[5]. China alone is expected to invest up to US$30 trillion in infrastructure by 2040, which would represent more than half of Asia’s currently identified needs and 30% of global investment^[6].

We need this infrastructure to be fit for a zero-carbon and climate-resilient world rather than locking us into a high-carbon economy. This involves investing in new sustainable infrastructure and retrofitting the old, alongside a rapid phase-out and halting of new investment in infrastructure that involves the unabated burning of fossil fuels, particularly coal power plants^[7],[8]. One study suggests that to meet the Paris Agreement target of keeping global warming to well below 2°C, total investments in low- and zero-carbon technologies would have to multiply by a factor of ten between 2016 and 2050^[9]. The pace at which coal power plants are closing would also have to be doubled immediately^[10].

Investment in zero-carbon infrastructure forms the structures we need to create a low-carbon economy, such as new transport systems that are designed for electric or hydrogen-powered vehicles. While this is not expected to be more costly than fossil-fuel based infrastructure in the long run, large upfront investments are required. Such investments also have broader benefits, beyond helping to avoid the impacts of climate change. Smart, clean and modern power networks reduce air pollution and waste and upgrading industrial processes to zero-carbon alternatives can their increase efficiency and lower production costs^[11].

Investments in zero-carbon infrastructure also present new opportunities for economic development and growth. With the costs of renewable energy technologies, such as solar panels and wind turbines, rapidly falling and global demand growing, countries that lead in developing zero-carbon infrastructure can benefit from the expansion of new markets across the world. Countries and financial institutions that do this will also avoid the economic risk of developing high-carbon infrastructure that ends up losing its value and becoming obsolete before investors have seen a return, what is known as a ‘stranded asset’^[12].

Sustainable infrastructure investment is also essential to make our cities, ecosystems and ways of life resilient to a more hostile climate, with more frequent and intense extreme weather events in many parts of the world^[13],[14]. As these events increase in severity, the risks of damage to infrastructure grows, which could cause harm to people and mean high costs from repairing and rebuilding.

A major flood or storm event, for example, can render large areas of a city uninhabitable until vital infrastructure for services like electricity and water networks are up and running again. This can cause extended financial losses for businesses and can have serious consequences for national economies^[15],[16]. Adapting our infrastructure to withstand those impacts of a changing climate that now cannot be avoided is essential to limit harmful impacts on both people and the economy; and it can lead to people’s greater well-being and sustained economic development as well^[17].