Incredible but true: how the climate is reshaping global economic prospects!
In the current economic landscape, the reality of climate change is putting traditional economic models to the test. Economists, in anticipation of the upcoming climate discussions in Dubai, are reevaluating their estimates on the impact of global warming on the global economy. However, there is growing skepticism about the validity of these models in fully capturing the extent of climate damages, suggesting that they could provide a pretext for political inaction.
Record temperatures, droughts, floods, and wildfires have caused billions of dollars in damages this year, exacerbating the situation beyond the limits set by the 2015 Paris Agreement. Despite this, some economic models, criticized for their implausibility, conclude that global warming by the end of the century will cause less damage to the global economy than COVID-19 or will have a lesser impact on global stocks than the 2007-2009 financial crisis.
Nobel laureate in economics, William Nordhaus, sparked controversy in 2018 with a model that predicted warming of over 3°C by 2100 as the optimal result of climate policies from an economic perspective. These models have also been cited by the Trump administration to justify less restrictive environmental policies.
Many policymakers acknowledge the limitations of these models. Isabel Schnabel, a member of the executive board of the European Central Bank, stated that they may underestimate the impact. Others criticize the entire approach as flawed.
The criticisms focus on “integrated assessment models” (IAMs) used by economists to draw conclusions on everything from production losses to financial risk or carbon market pricing. These models are based on general equilibrium theory, but climate change, unlike other shocks, is a persistent phenomenon, which raises doubts about the validity of the underlying assumption.
Another issue is the use of a “quadratic function” to calculate GDP losses, which ignores other potentially more suitable methods to capture rapid changes. This choice tends to downplay the impact, especially if the planet reaches environmental tipping points.
IAMs produce very different results depending on their specific design and included variables, making interpretation difficult. For example, the 2023 update of Nordhaus’ model estimates damages at 3.1% of global GDP with 3°C warming, while the model used by the Network for Greening the Financial System (NGFS) predicts an 8% output loss by 2050.
Critics like Professor Steve Keen of University College London argue that these models need to be tested against common sense and current climate science. The Financial Stability Board (FSB) and NGFS are working to help authorities better understand the risks, but there are those, like Nicholas Stern of the LSE/Grantham Research Institute, who argue that these models are inherently too narrow to grasp the extreme risks of climate change.
Philipponnat of Finance Watch suggests that the European Union, which sees itself as a leader on climate matters, could adopt a broader approach with a climate risk study scheduled for 2025.