Macroeconomic Policies and the Costs of Climate Change

Alejandro Nadal (also available in Portuguese)

Stabilizing concentrations of greenhouse gasses (GHG) in the atmosphere, and adapting to the impact of climate change, have significant economic costs. Can these costs be met under the macroeconomic policy posture currently embraced by most countries? This is an important question given the massive scale of resources that are involved in a sustained time horizon.

In spite of the global economic and financial crisis, most advanced capitalist countries still adopt a view of macroeconomic polices dominated by the overarching objectives of price stability and fiscal discipline. In fact, this is what is guiding today the policy response to the crisis in Europe and the United States. In the developing world, the picture is a bit more complicated, but it is fair to say that most countries still define their macroeconomic priorities in terms that closely resemble the dogmas of neoliberalism.

Total costs of climate change are classified into three components: mitigation (reducing GHG emissions), adaptation (attenuating the damages caused by climate change) and residual costs. The last term comprises costs that are unavoidable, regardless of efforts in the previous two components of total cost.

How these costs are estimated is surrounded by great uncertainty. This is of course normal under the present circumstances. Any estimate will have to rely on scenarios concerning levels of the most important GHG in the atmosphere, the impact on mean global temperatures, rising sea levels, the desired trajectory for reducing emissions, and other important variables that make the exercise of producing estimates a daunting task.

Take the costs of adaptation in developing countries. Although most developing countries have not contributed significantly to the accumulation of GHG in the atmosphere, they will nevertheless have to incur  significant adaptation costs in order to take the edge off the impacts of climate change. The World Bank developed a methodology that first considers current investments in sensitive areas and then adds the cost of “climate proofing” them. This leads to underestimating the levels of investment that are required because the actual levels of investment in many “sensitive” areas (certainly in infrastructure) are already very low. The study commissioned by UNFCCC suffers from this same methodological bias and calculates total annual funding requirements by developing countries in 2030 in the range of $27–66 billion. After close examination, a team at the International Institute for Environment and Development (IIED) concluded these figures underestimated the investments needed to prevent catastrophic damage from climate change by a factor of between 2 and 3 for most of the sectors included in the UNFCCC study.

Returning to our initial question, is fiscal policy in developing countries ready to meet this challenge? It will be very difficult if the dogmas of fiscal discipline and the need to systematically generate a primary surplus are not abandoned. This creed has led to chronic underinvestment in areas that are intimately related to climate change vulnerability (health, housing, infrastructure). This has been the legacy of decades of fiscal discipline.

One way ahead is to increase fiscal revenues through progressive taxation schemes. (Because poverty is intimately related to vulnerability, regressive taxation needs to be avoided.) Of course, imposing higher taxes on high-income strata and duties on financial transactions are promising hunting grounds that need to be considered. This of course requires a fundamental change in the mindset in the ministries of finance of the developing world.

Mitigation involves economy-wide structural transformations that imply a shift away from big carbon footprints and greater reliance on renewable sources of energy. This is associated with significant changes in investment patterns as industry, transportation, construction, manufacturing and the energy sector transform their base of capital goods and equipment. The same UNFCCC study estimates that by 2030 developing countries will require $495 billion to address mitigation costs in key sectors (including energy, industry, transportation and construction).

In some of these sectors, public sector enterprises will have to play a critical role, and this also needs a change in fiscal policy priorities. In other cases, mitigation will call for large-scale private sector investments as technological trajectories change. The neoliberal macroeconomic policy package is ill prepared to meet the challenge of this structural transformation. In the past three decades, gross capital formation in developing countries has slowed down, in part due to the high cost of credit associated with restrictive monetary policies obsessed by price stability. In addition, investment patterns have been distorted due to attractive opportunities opened by speculation. Rethinking monetary and credit policies, as well as financial re-regulation are urgently needed to meet the challenges posed by mitigation objectives.

The magnitude of costs and the nature of the problem at hand clearly point towards the reconsideration of the neoliberal macroeconomic policy package.