Putting a cost on investing in mitigating climate change

Economists continue to model the costs of investment to reduce global greenhouse gas emissions and the different routes these cuts could take to avoid dangerous climate change. The Paris Agreement on climate change set a target of staying within 2°C of warming, but this will require investment to cut emissions swiftly and sharply – the question is, how much could that cost?

In its review of the latest scientific evidence, Working Group III of the Intergovernmental Panel on Climate Change concluded that ensuring greenhouse gas concentrations do not exceed a level that would offer a 66 per cent chance of avoiding global warming of more than 2ºC would mean losses in global consumption of 1–4% in 2030, 2–6% in 2050 and 3–11% in 2100. These wide-ranging estimates depend on many assumptions, which are openly acknowledged in the report.

These costs look quite small when compared with the strong underlying growth that the global economy is likely to experience. Cost estimates ultimately depend on the assumptions made about the availability and costs of different emission abatement technologies, scale and pace of emission cuts required and the timescales considered in the models.

Savings from the co-benefits of reducing emissions

A recent report by the New Climate Economy (PDF) estimated that the co-benefits of climate action – those in addition to reducing greenhouse gas emissions – in many cases swamp the costs of reducing emissions. A study found that in China pollution by fine particulate matter (PM 2.5) could be linked to 1.23 million premature deaths in 2010 (median estimate) – or, put in monetary terms, damages equivalent to 9.7–13.2% of China’s GDP. The health damages caused by local air pollution alone are larger than the estimated cost of decarbonisation. Globally, model results for 2030 suggest that health benefits from reduced ozone and exposure to PM 2.5 pollution could be as large as 5 per cent of global GDP. Gains from reduced congestion, less waste and inefficiency, innovation spill-overs, energy security and fiscal reform from carbon pricing, further offset the costs of emissions reductions.

Different forms of emissions reductions have different costs

Some regions and sectors are better placed to make cost-effective cuts than others. For example, replacing inefficient technologies in developing countries with the more efficient ones that are currently available in developed countries is a cheaper option than having developed countries upgrade to best-in-class technologies. At the costly end of the spectrum, investment in carbon capture and storage from coal-fired power stations in regions far from CO2 storage sites might be expensive, but it is necessary to reduce carbon pollution.

Models are still highly dependent on assumptions about low-carbon technological progress during this century. Some economists suggest cost estimates may overstate the true long-term costs of action to cut emissions because they cannot yet capture future advancements in technologies (and thus falling costs), and new innovations developed over time. It is possible that, after years of investment, alternative energy sources could be significantly cheaper than extracting fossil fuels from ever more challenging and marginal locations. In fact, the costs of some low-carbon technologies have already fallen more than expected, challenging the price competitiveness of fossil fuels, even without subsidies. For example, in large parts of the United States, Africa, Latin America, India, Australia, and China, solar photovoltaic technology already offers a cheaper form of electricity generation than conventional fossil fuels in certain conditions.

The extent to which these costs fall further may depend on the policy commitment to developing and deploying these technologies. Market policies to level the playing field between high- and low-carbon technologies include removing subsidies for fossil fuels (estimated at $260 billion globally in 2016), or imposing a carbon price. In places, renewable technologies are already cheaper than fossil fuels that face a carbon price.

Modelling, uncertainty and the problem caused by delaying action

Estimating near-term costs is arguably easier; the longer the time frame considered, typically the higher the investment cost estimates, given the difficulty in making long-term predictions about the future cost of technologies or the climate policies that might be implemented by the end of the century.

The reality is that the world is not fully rational and fully optimal when it comes to climate policy decision-making. Providing a clear policy direction (PDF) can help build investor confidence and encourage research and development and innovation, which may bring costs down in the long run, but this is not where we are yet.

Nevertheless, the majority of studies (PDF) agree that delaying action increases the costs of reducing emissions. In order to stabilise the stock of greenhouse gases in the atmosphere, the flow of emissions will have to fall faster, from a higher baseline, for every year that action is delayed. Delaying cuts to greenhouse gas emissions will make it more expensive, as well as increasing the risks of serious climate impacts, as set out in the IPCC’s assessment.

Economic growth with declining emissions

The Global Commission on the Economy and Climate concludes (PDF) ‘that all countries at all levels of income now have the opportunity to build lasting economic growth at the same time as reducing the immense risks of climate change’. In the UK, for example, GDP has grown more than 65% since 1990 while emissions from production declined by 41% to the end of 2016 (although emissions from consumption have continued to rise). Globally, carbon dioxide emissions from energy-related activities have remained stable since 2013 while the economy has grown. By proactively steering the transition towards sustainable, low-carbon economic development, policymakers can increase the chances that the energy technology mix in the future will be both low-cost and low-carbon.

This FAQ updates a version written by Dimitri Zenghelis in 2014.

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