16 May 2007 - 11:55
  • News Code: 104811

The planet"s environment is going through an epochal upheaval in weather patterns. A key question from Standard & Poor"s Ratings Services" point of view is, “What might that mean for economic growth?”

It"s a particularly difficult question, considering that the relevant time frame is over decades, not years, and that most of the burden of damage and remediation will fall on future generations. Economists usually analyze choices made by individuals based on their own preferences. We"re not as good at comparing the welfare of the present generation with the well-being of those to come or at weighing costs incurred by developed countries against damage to the environment of poorer nations -- or, for that matter, at predicting how much people will sacrifice today to help their grandchildren. To quote the famed economist Joan Robinson, "What has posterity ever done for me?"


Clearly, the costs of controlling carbon emissions remain highly uncertain, primarily because of the technological variables. Analysts are still guessing the costs of substituting nonfossil-fuel energy sources for oil and how much conservation can cut energy demand. Still, as the technologies become better defined, the range for the cost estimates is narrowing, and now at least some reasonable projections are becoming available. A stern assessment


Perhaps the most comprehensive look at the economics of climate change comes from the British Treasury in a report published in January known as the Stern Review. It cites a likely cost of global warming at about 1% of world gross domestic product by 2050, but the range of possible outcomes mentioned is wide, from a loss of 1% to a gain of 5%.


At the low end, production would actually increase because the savings in energy costs would more than offset the expense of switching from fossil fuels. At the high end, it may prove more expensive to eliminate fossil fuels than expected (see BusinessWeek.com, 4/19/07, "Rx for Earth: Sooner Not Later").


Of course, the costs of doing nothing are potentially much higher, although equally uncertain. The Stern Review"s estimate of the most likely cost of inaction is 5% of world GDP, but the range is up to 20%. The more catastrophe-minded would put the worst case at 100%, wiping out civilization -- or at least economic output -- as we know it.


And it"s clear that even though the costs will be steep for Europe, North America, and East Asia, the heaviest burden will be borne by countries that can least afford it -- the poor nations in equatorial regions.


Even though the ultimate solutions are as yet unknown, a consensus is emerging that climate change needs to be addressed, as the recent UN Framework Convention on Climate Change suggests. How expensive remediation will be is unclear, in large part because the technology is still being developed. Measuring the costs is also complicated by how investments in the national income accounts get treated.


The Stern Review"s cost estimate of 1% of world GDP by 2050 is certainly a manageable figure. For the U.S., that"s less than the cost of the Iraq war and similar to the estimates for increased security to fight terrorism after September 11. The expenses for extra security and global-warming remediation, however, are to a large extent an insurance policy against much greater future costs. Windmill windfall


GDP is really a poor measure of the impact, since the statistical estimates will differ depending on how the costs are incurred. Expenditures by the government or as capital investment by firms will generally add to GDP, while costs incurred by individuals and corporations as ongoing expenses, such as higher energy or other operating costs, will not. The correct measure is cost of remediation as a percentage of GDP, not change in GDP caused by remediation.


Look at it this way: Replacing a power plant with a windmill farm will add to GDP, since building windmills amounts to an investment. The country, however, will still have the same energy output. On the other hand, if a power generator uses sequestration of carbon dioxide, the costs incurred would probably not count as additions to GDP, just as a rise in the expense of operating the power plant. The costs might be the same in either example, and the results might be the same. But the accountants would treat them differently.


Regarding economic impact, remediation is not a jobs issue. The impact will be felt in slower growth in real incomes -- not in higher unemployment. Simply put, the remediation process will create as many jobs as the lower productivity growth will lose. There"s no reason for the costs of global warming to raise unemployment.


International competitiveness, though, could be a problem if all countries don"t adopt similarly tight energy policies. If the U.S. does so while other major emissions producers do not, the U.S. costs of production will rise relative to those of other countries and current trade imbalances could be exacerbated. Exchange-rate moves could solve that imbalance, but as we have seen recently, the adjustment can be difficult, especially if other countries don"t allow their exchange rates to adjust. The trade imbalance will be solved eventually, and countries that try to stop the adjustment may find themselves later losing money on foreign exchange movements. Note that Europe and Japan, which have adopted tighter carbon restrictions, are running trade surpluses, while the U.S. is in deficit. ----------------- Checking carbon footprint


Further down the road, a company"s carbon footprint might even become a consideration in the ratings process. Depending on how a company pursues remediation, emitting carbon may become more expensive, giving an advantage to those that are more efficient. Remediation will create an additional business risk that must be managed.


The global climate is changing. What"s uncertain is how severe the damage will be, how much it"s part of a natural cycle vs. manmade, and how expensive it will be to fix. But the room for argument is narrowing. The damage will be severe, and it could be disastrous.


Human use of fossil fuels is a significant part of the problem. But even if humans aren"t the primary cause, we have to fix the problem. While much uncertainty surrounds the cost, it"ll clearly be significant but not impossible to bear -- and almost certainly less costly than not fixing the problem.


The fundamental issue remains intergenerational: How much are we willing to spend now to insure our grandchildren against environmental disaster? How much are developed countries willing to spend to ward off problems for emerging economies? Here"s one certainty: The longer the world waits, the more expensive and less believable the solution.



News Code 104811

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