ISM University of Management and Economics

GROUP PROJECT

How may climate change affect economic growth in the long run? What policymakers have
to consider while imposing climate-related policies? Based on academic literature show some
hypothetical scenarios how transition policies may affect economic growth over time.

Jokūbas Ostrauskas,

Vėjūnė Žvigaitė,

Jegor Janočkin,

Elina Šatova,

Evita Koženevskytė

BUSINESS MANAGEMENT AND MARKETING

Macroeconomics
Climate change is currently regarded as one of the most serious dangers to economic
stability. Every year, natural disasters cause human suffering as well as significant economic
and environmental harm. The most significant economic impact of climate change is that it
might wipe out up to 18% of global GDP by 2050 if global temperatures rise by 3.2°C.
Global warming will largely have an impact on economic growth through property and
infrastructure damage, decreased productivity, mass migration, and security threats.1

In this paper, we are going to cover what policymakers have to consider while imposing
climate-related policies, show hypothetical scenarios, and discuss how climate change affects
world economic growth in the long run. 

Climate change necessitates a collaborative effort by governments, businesses, shareholders, and

individuals to adapt and execute mitigation measures. Delayed efforts to reduce carbon dioxide or
short-lived climate pollutant emissions will have serious, potentially permanent, repercussions for
global warming, higher sea levels, food security, and public health. Given that carbon pollution is
the main cause of climate change, any policy solution must successfully target lower carbon
emissions. Government action is essential to reorient resource allocation since free markets fail to
incorporate and price the negative outcome of global warming. 
 
Without public policy aimed at changing private sector action, economies risk polluting to the
point when it is too late for the environment to recover, and the economic repercussions are
catastrophic. Intergovernmental treaties involving all major economies will be the most effective
in combating climate change. Without a coordinated policy response, the efforts of a few
countries attempting to cut carbon emissions will fall short of what is required to have a
substantial influence on a global scale.
 
The first approach is to reduce the dangers of climate change by decarbonizing the world's energy
supply through a rapid energy transition. Biofuels, hydrogen, and clean energy can help
accelerate decarbonization while also reducing demand through energy efficiency measures.
Subsidies may be offered by governments to green energy providers to encourage innovation and
lower the cost of energy from these industries.
 
The Bank of England decided to commit to researching the financial system risks if climate
policy is successful in limiting global temperature increases. It follows on from statements made
by Mark Carney at a World Bank seminar in 2014 about the prospect that the bulk of confirmed
coal, oil, and gas reserves would be judged "unburnable" if temperature increases were confined
to 2°C. Economists agree that an internationally recognized market-based solution is essential to
effectively reduce carbon dioxide emissions. 
 
Carbon pricing is one of the most often discussed policies. Putting a price on each tone of CO2
emitted or issuing tradable permits that authorize a certain level of CO2 emissions, is thought to
be an effective way to counteract global warming. Economically, this internalizes the negative
externality, i.e., polluting carbon emissions associated with burning fossil fuels (in other words,
assures that the company/entity generating the carbon dioxide pays for the social costs).
Nonetheless, this strategy raises a slew of issues, the majority of which revolve with defining
optimal emission limits, price, and implementation strategies. It also requires global recognition
to function correctly. Since a carbon price of $100 per tonne is expected to be required by 2030,
1
https://www.ccacoalition.org/en/content/why-we-need-act-now
few countries are willing to make their economies less competitive on a global scale by
instituting carbon pricing.
 
Covington and Thamotheram (2015) present an alternate way in their second paper that places
the duty for initiating change on shareholders. Recognizing that directors of fossil fuel businesses
are evaluated and compensated based on short-term value creation goals, shareholders might use
voting rights to place a higher emphasis on accomplishing long-term goals. One such goal might
be to reduce CO2 emissions. Directors would be measured and compensated for fulfilling these
targets if they set goals commensurate with reducing emissions. A scheme like this might shift
capital spending away from fossil fuel exploration and toward the construction of clean energy
initiatives. Covington and Thamotheram (2015) correctly point out that this proposal relies on
sufficiently high carbon pricing or low emission ceilings to make the transition economically
viable. Meanwhile, investors concerned about the impact of climate change and the possibility of
writing down carbon-based assets will vote with their feet. 23
 

Empirical finding

To determine how economies might be affected by the continuing consequences of climate

change under alternative temperature increase scenarios, the Swiss Re Institute conducted a
stress test. With time, the effects of climate-related natural disasters become more severe,
which can cause significant losses in production and income. For instance, crop failures can
be caused by heat stress, while increasing sea levels result in the loss of land that could have
been effectively employed. Rising temperatures would have a particularly negative impact on
developing economies in equatorial areas. According to one of the latest press releases of the
Swiss Re Institute on climate issues, major economies should lose roughly 10% of GDP in 30
years.
By 2050, according to Thierry Léger, Group Chief Underwriting Officer and Chairman of
Swiss Re Institute, there will be about 10 billion people on the planet, particularly in the areas
most affected by climate change. He believes that people should make an effort to reduce
risks and achieve net-zero goals. Equally, as demonstrated by our most recent biodiversity
index, nature and ecosystem services have enormous economic value but are also seriously
threatened. Therefore, in order to maintain a strong economy and a sustainable future,
humans must address both climate change and biodiversity loss as a global community.
Various scenarios' anticipated effects on the world's GDP by 2050 in comparison to a world
without climate change include the following numbers. If no mitigation measures are done,
global warming will grow by 3.2°C; if some are taken, it will rise by 2.6°C; if further action
is taken, it will rise by 2°C; and if the Paris Agreement targets are fulfilled, it will rise by less
than 2°C.
 
Let's imagine how policymakers should act toward solving climate issues.
According to Baer M., et al. (2021) policymakers can utilize a range of potential strategies to
promote a decrease in greenhouse gas emissions. Emission charges, financial rewards for
reducing pollution, emission caps, tradable emissions allowances, and performance standards
are alternatives. Additionally, policymakers can choose whether to apply a specific

2
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2551478
3
whole page https://prod.schroders.com/de/SysGlobalAssets/digital/us/pdfs/the-impact-of-climate-
change.pdf
instrument to commodities or services that cause pollution rather than directly to emissions.
This method of reducing emissions—following all applicable laws and attempting to
eliminate emissions—is ineffective for a number of reasons.
 
By directing credit allocation toward low-carbon activities, policy motives can be promoted
to slow down climate change. Assuring the stability of the financial system in the face of
climate-related concerns can also be sensible. Policy instruments can also be educational,
increasing the amount of climate-related data that financial actors have access to as well as
giving them clear definitions, guidelines, and tools.
Policy instruments may also be incentive-based in order to add (financial) incentives and
raise the appeal of low-carbon initiatives to financial actors. Additionally, they can be
quantity-based to set explicit quantitative limits on financial flows.
What decision-makers can do is encourage a worldwide alliance to stop the Paris
Agreement's violation. As a result, the EU must raise its climate ambitions to a 65% decrease
in emissions by 2030. It must make clear what is already being done in order to pressure
other developed nations to follow.

Assessing the impact of climate change is, at best, a challenging task since there is
uncertainty regarding both the level of predicted global warming and the consequent impact
on world activity. As the earth heats, there will undoubtedly be some advantages as well as
consequences. There's also the mystery of how technology innovation may react and perhaps
change the course of global warming. Any assessment must therefore include a very long-run
perspective, well beyond what is often employed by financial market players. However,
increased knowledge of the issue means that there is a growing need for a perspective from
shareholders who are concerned about how the firms they own damage the environment,
concerned about the impact of climate change on the value stream of those companies, or
combination of both.
 
Climate change will almost certainly have a detrimental long-term influence on economic
growth. Global warming will largely have an impact on economic growth through property
and infrastructure damage, decreased productivity, mass migration, and security risks.
Hurricane Sandy, which flooded much of New York in 2012, is an excellent example of the
economic devastation that such extreme weather disasters may cause. Extreme weather
events are predicted to become more severe and frequent as a result of global warming,
resulting in property and infrastructure damage. Rising sea levels are expected to affect
economic production by interfering with enterprises and causing damage to people's houses.
 
We can illustrate the expected influence of climate change on output using a production
function (Figure 1). If we suppose that less capital stock is obtainable as a result of climate
change damage, the world economy's productive capacity will shrink. As a result, the global
production function would trend downward as each unit of labor generates less output.
Decreased labor productivity may result from factors other than a lower amount of capital
assets. Higher global temperatures may have an impact on food security, encourage the
spread of infectious illnesses, and impede outdoor workers. These variables are likely to
increase incapacity and social discontent, reducing both effectiveness (productivity) and the
number of workers available to create output.
Through a supply and demand model, this impact may also be described as a supply shock
(Figure 2). Global warming is anticipated to reduce supply at any given price, causing the
supply curve to move backward (from S1 to S2). As seen in the picture, this will result in
lesser production (Y2) and, as discussed in the following section, a higher price (P2). 
 
As a result of global warming, the supply and demand diagram above indicates not just a
decrease in output, but also a rise in the general price level. This brings us to the possibility of
global warming's inflationary consequences on the global economy.
There is also an opportunity cost to think about. The previous analysis is based on a ceteris
paribus argument, which holds that the world's population will not respond to climate change.
To reduce the consequences of climate change, it is likely that preventative measures such as
flood defenses will be implemented over time. While this may decrease long-term economic
effects, it is probable that this measure will have a short-term economic cost as resources are
diverted away from more productive applications.

INFLIATION IS MORE LIKELY TO RISE SHORTAGES EMERGE

 ·       Higher global cost of food will almost certainly reduce consumer income. However,
if the amount of warming continues to rise food price inflation is expected to rise.
·       Rising inflation may also appear as a reduction in land availability. The rise in
global temperatures may someday create some areas of the planet uninhabitable,
resulting in mass migration.
 
ENERGY COSTS TO INCREASE IN THE TRANSITION TO RENEWABLES

·       Higher energy prices are also expected to push up inflation. As our climate gets
more harsh, we are expected to require more energy to both cool and heat our working
and home surroundings during the summer and to heat them during the harsher
winters. 
·       Not only will energy demand vary, but supply may also decrease as the efficiency of
current power plants is harmed by increasing temperatures. Government policy
initiatives to support a shift to green energy may lead to energy inflation in the short-
to medium-term by taxing fossil fuel-derived power.

Climate change functions

Since the early 1990s, a series of studies have both confirmed and rejected the evaluation of
the financial impact of climate change on the world's GDP. Covington and Thamotheram's
(2015) study is predicated on so-called "climate damage functions," which assess the
economic risk caused by global warming. According to Wade, K., & Jennings, M. (2016)
"Economic climate damage is defined as the fractional loss in annual economic output at a
given level of warming compared to the output in the same economy with no warming." 

Predictions of global warming damage differ based on the existence of a critical point
beyond which damages accelerate.

The "N-damages" climate damage function, called after its creator Nordhaus W. (2013), is
the weakest alarm of the three functions of climate damage and is extensively employed by
economists. Under this function, environmental damage would be progressive, so that no
critical point would be reached and the global population would have the longest time to
minimise any harmful effects of climate change. It can be observed that by the moment in
which the world will be 4°C warmer, the yearly economic output would be only 4% lower
than it would have been in the absence of global warming.

The "W-damages" function was developed by Weitzman M. L. (2012), who forecasts that by
the time a temperature rise of 4°C is reached, 9% of yearly economic production will be
sacrificed relative to a background with no temperature increase. Under this situation,
industries such as insurance, agriculture, and forestry that are globally sensitive to climate
change danger are expected to be impacted.

The last climate damage function, "DS-damages," called after Dietz S. and Stern N. (2014),
represents the worst case in which the worldwide economy will suffer significant losses
rising temperatures. Under this scenario, after warming reaches 4°C, annual economic
production will be reduced by 50 % relative to a zero-warming scenario. Dietz and Stern
predict a warming of around 3.5°C by 2100 to provide context.

A summary of the data

The analysis by Mendelsohn, R., Morrison, W., Schlesinger, M. E., and Andronova, N. G.
(2000) estimates that warming of 2°C would occur by 2060, with agriculture suffering the
most damage. The OECD economies will benefit from climate change, while the world as a
whole will suffer. Individual country damages do not necessarily correspond to continental
statistics.

According to the next study by Mendelsohn, R., Schlesinger, M., and Williams, L. (2000),
market effect costs will differ from nation to nation worldwide. Warming is anticipated to
benefit rising nations, whereas poor nations would likely suffer losses. However, impacts of
temperatures beyond 2°C are likely to reduce advantages and raise harm.

The basis for calculations is inaction. Taking into account a broader spectrum of risks and
consequences increases costs to at least 20% of GDP. By the mid-century, based on simple
forecasts, the annual cost of extreme weather could reach between 0.5 and 1 percent of the
global GDP. (Stern, 2005)
The last analysis by the IPCC, Fifth Assessment (2014), reveals that when damage
predictions accelerate beyond 3°C of warming, there are significant disparities between
countries. It is estimated that delaying mitigation actions beyond those now in place until
2030 will significantly disrupt the shift to low long-term emissions standards.

 
According to Mendelsohn (2013), the greatest threat to economic development from climate
change comes from rapid, intense, and ineffective mitigation initiatives ( mitigation means
reducing risk of loss from the occurrence of any undesirable events). The adaptation process
and mitigation will imply a temporary economic shift from consumption to investment, with
the assumption that the transitioning costs are insignificant in contrast to the cost of
inactivity. Stern (2006) predicts that the costs of mitigation will be around 1% of global GDP
per year by 2050. However, we believe that as the costs of mitigation grow, financial
restrictions will become more critical. Governments, for example, may be unable to raise the
funds required to construct appropriate defenses.
 
Climate change risks are already pushing insurance costs higher
 
·       Firms have already felt the impact of extreme weather events on revenues; from
unseasonal flooding in the UK to Hurricane Katrina in the US, insurance companies
have paid out to cover the expenses of extreme weather-related property damage.
2011 is considered to have been the most expensive year on record for extreme
weather events, with insured losses reaching more than $126 billion. Mark Carney,
Governor of the Bank of England, stated in a recent study report that climate change
is one of the top risks facing the insurance business.
·       Rising insurance costs contribute to inflation and prevent businesses and households
from settling in risky locations. According to this viewpoint, the consequences of
climate change are already being included into business choices and, as a result, are
influencing global activity. Insurance firms may even refuse to give insurance
coverage, providing a problem for governments that must either underwrite or
minimize the risk of loss.

Standard & Poor's research on the impact of climate change on sovereign risk ("country risk,"
is the danger that a government would default on its debt (sovereign debt) or other
commitments, supports the forecast that developing nations will be disproportionately
affected. It is also the risk associated with investing in a certain country or providing funding
to its administration. Recognizing climate change as a worldwide megatrend influencing
sovereign risk through economic, fiscal, and external performance, they discover that lower-
rated sovereigns tend to be the most vulnerable. They quantify sovereign vulnerability using
three criteria: the proportion of the population living in coastal areas less than five meters
above sea level, the proportion of national GDP spent on agriculture, and a country score
from the "vulnerability index." An indicator of this type examines how vulnerable a system is
to the negative impacts of climate change and how well it can cope with them. Based on these
metrics, we may interpret the results as an economy's sensitivity to climate change. Figure 4
depicts the results on a globe map. According to much of the economic research, many
developing countries look to be the most vulnerable to climate change all through the rest of
the century. (MAJORITY OF CONTRIES THAT ARE MOST VULNERABLE ARE IN
AFRICA AND INDONESIA, WHEREAS LEAST VULNERABLE COUNTRIES ARE IN
NORTH AMERICA AND EUROPE)

Monetary policy dilemma

 
Finally, analyze the monetary policy consequences of climate change. Climate change will
slow economic growth and raise inflation. From the viewpoint of monetary policy, such a
stagflationary environment would put the world's central banks in a tight spot: lower growth
will encourage demands to boost the economy, but such measures are most likely to increase
inflation. Monetary policy will be unable to compensate for the change in the supply curve,
and policy action will be limited to the measures mentioned above. Because of the long- time
horizon, we are unlikely to observe much of a noticeable influence until much later in the
couple of centuries.
 
CONCLUSION

·       Climate change will affect the global economy. Attempting to comprehend, much
alone quantify, these consequences is a particularly tough task fraught with
 inaccuracy. Despite that, we can make conclusions about how global warming will
affect many economic issues based on the information we have now. 
·       More harsh weather has the potential to restrict economic development by reducing
capital stock and supply of labor, and productivity levels will fall as the global
economy adjusts to higher temperatures. Inflation will increase as the cost of food,
energy, and insurance rises. As monetary policy attempts to fight the stagflationary
forces of climate change, it will be limited.
·       To prevent potential future costs, the general consensus, which is supported by an
increasing amount of research, is that we should act sooner rather than later. All
stakeholders must participate in order for mitigation policies to be successful. The
insurance business is already including some of these costs, but without a more
comprehensive and coordinated right policy response, the global economy is unlikely
to factor in one of the most significant negative externalities ever encountered. 
·       Recognizing that evaluating the impact of climate change on shareholder
investments is essential for creating a motive to act, we will attempt to include
impacts of global warming into extended long-run return predictions for various asset
classes.
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It takes two to dance: Institutional dynamics and climate-related financial policies -
ScienceDirect

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financial risk from global warming. Available at SSRN 2551478

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