Head of Global Economics
BofA Global Research
A hot take on climate change
Much has been written on climate change and mitigation efforts, but we believe it is a good time to separate the news from the noise and look at the impacts that are already becoming visible. Climate change is not just an abstract problem for the next generation. It is already impacting the global economy in several ways.
Any discussion of the economics of climate change should start and end with the fact that it is the ultimate example of "externalities"—private activities that create public costs. Indeed, climate change is the ultimate externality because activity in one place impacts the whole world. The fact that climate change is global in nature and that so much of the benefit of actions accrues to everyone else has some powerful implications.
Unlike other technology "races", climate mitigation is more cooperative than competitive. When countries like the U.S. and China "compete" to develop new technologies, two points of conflict often tend to arise – a fight for market share and a fight for geopolitical superiority. By contrast, countries that develop efficient climate mitigation technologies have a strong incentive to share the benefits. If they hoard the technology, the impact on their own climate will be much smaller.
Perhaps the most depressing consensus out of the climate change literature is that even if everyone cooperates globally, the earth will continue to warm as there are lags in the link between greenhouse gases and global warming. Even under the best of outcomes – with every country hitting aggressive mid-century goals – the policy shift will mitigate, not stop, the problem. Hence in our view climate events will be a rising downside risk, of varying intensity, under almost any plausible scenario. This shows how important it is to also find ways to mitigate the impact of climate events.
In our view, both press reports and many of the studies of climate change focus on the wrong side of the economy – the impact on aggregate demand rather than on productive capacity. By the time serious climate mitigation efforts are underway the global economy, and particularly the U.S. economy, will likely be close to full employment. Hence staffing up the industry means drawing workers out of the rest of the economy. At the same time, building up green energy infrastructure will require more than a doubling of investment in the sector, from roughly 2% of GDP now to a 4.5% average over the 2020-30 period.
Meanwhile, we think climate mitigation is likely to slow the supply side of the economy, particularly in the ramping up phase. Big structural changes in the economy tend to create big transitional challenges. Workers need to move from one sector to another, some industries will boom while others shrink, and as regulations and taxes increase, capital that had been invested in producing and using dirty energy will rapidly become obsolete. All of this means lower trend growth during the transition from a dirty to a green economy.
The payoff comes in the very long-run. Most important, there will be a lot fewer climate events if global warming is mitigated. Perhaps the biggest benefit of containing climate change – for which it may already be too late – is avoiding major migration out of the worst-impacted regions. In addition, while replacing dirty capital with clean capital is inefficient in the short run, high investment in new technologies could create significant productivity gains over time.
Turning to current policy, we see progress as painfully slow. Indeed, some policies continue to worsen rather than help the problem. In many instances there is a conflict between helping the poor and helping the environment. For example, countries spend more than $400bn per year subsidizing mainly oil, but also gas and electricity consumption.
There is also some evidence that climate change and mitigation have played a role in the recent rise in energy prices. Given the regulatory outlook, investment in dirty energy capacity is likely to be low and depend on high prices. Green energy is not ramping up fast enough to fill the gap. Changes in wind and rain patterns seem to have affected the supply of wind and hydro power. And China has imposed curbs on emissions from power plants, causing electricity shortages. All of this underscores the importance of getting the transition right. Some economists view carbon taxes as one of the most efficient ways to encourage a more natural transition.
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