The Macroeconomic Impact of Climate Change

The Macroeconomic Impact of Climate Change: Global vs. Local Temperature Adrien Bilal & Diego R. Känzig – May 2024

“According to estimates from the study, the macroeconomic damages of climate change are six times greater than previously thought. We exploit the natural variability of global temperature and rely on time-series deviations. A 1°C increase in global temperature leads to a 12% decline in global GDP. Global temperature shocks are much more strongly correlated with extreme climate events than the country-level temperature shocks typically used in the panel literature, which explains why our estimate is significantly larger. We use reduced-form evidence to estimate structural damage functions in a standard neoclassical growth model. Our results suggest a social cost of carbon of $1,056 per ton. (May 2024). (Update: By November 2024, this value has already reached $1,367 per ton. …etc.) A standard warming scenario results in a 31% welfare loss in present value terms. Both are orders of magnitude larger than previous estimates and imply that unilateral carbon abatement policies are cost-effective for large countries like the United States.” – this is the summary of a new research finding with the following details.

New Analysis Finds Economic Impact of Global Warming 6 Times Greater Than Expected

In 2018, William Nordhaus was awarded the Nobel Prize in Economics for his research, which showed that a 1°C increase in global average temperature would lead to a 1-3% decline in global economic output. Since then, this has been the conventional view on the economic impacts of global warming, but a new study by Adrien Bilal of Harvard University and Diego Känzig of Northwestern University reaches a very different conclusion.

In their research paper titled “The Macroeconomic Impact of Climate Change”, published in May 2024: Global vs. Local Temperature, they conclude that the economic impact of global warming is six times greater than what Nordhaus claimed. In the introduction, the authors explain: “We reach this conclusion in two steps. First, we rely on a time-series local projection approach to estimate the impact of global temperature shocks on gross domestic product (GDP).”

“This approach exploits the natural variability of global average temperature—the fluctuation source closest to climate change—which we show is a much stronger predictor of extreme climate events than country-level temperature. We find that a 1°C increase in global temperature reduces world GDP by 12% at its peak. Second, we use our reduced-form results to estimate structural damage functions in a simple neoclassical growth model. We find that climate change results in a 31% present-value welfare loss and a social cost of carbon of $1,056 per ton.”

The Massive Economic Impact of Global Warming

The Neue Zürcher Zeitung, a Swiss German-language daily newspaper founded in 1780, is known for its detailed reporting on international affairs. In an article about the economic research conducted by Bilal and Känzig, it writes that the long-term effects of global warming on the economy would be enormous—comparable to the Great Depression of the 1930s. However, that was only a temporary event (although those affected did not feel it as such), while climate change will have an impact for centuries.

The Swiss-born Känzig told the NZZ: “When we first saw the result, we were shocked.” He and his co-author, Adrien Bilal, reviewed the research and repeatedly tested the model they used. But in the end, they were convinced of their results, which are particularly surprising from an economic perspective. “On the other hand, the result is very much in line with climate science research,” said Känzig. “When we talk to climate scientists, they paint a much more dramatic picture” than what William Nordhaus presented six years ago.

Where does this discrepancy between previous research and the new study come from? After all, the difference is quite staggering. Känzig and Bilal noticed that previous economic model calculations used country-specific weather data to draw conclusions about economic impacts. However, this analysis ignores the fact that climate change is a global phenomenon. Country-specific data, for example, do not include ocean temperatures, even though they greatly influence how storms develop before moving inland.

Comprehensive Analysis

The general conclusion of the study is that extreme weather events such as heatwaves, heavy rainfall, or high wind speeds will increase more than previously assumed by the economic models used. The more heatwaves there are, the more productivity declines, not only for outdoor workers but also for office workers. Events such as power outages are also more likely to occur. Another new approach of the study is that it analyzes not only the damages caused by declining productivity but also capital losses. “Rainfall, floods, or storms will cause significant damage to infrastructure,” says Känzig. Roads, power lines, and other infrastructure will be destroyed.

This latest research shows that since the potential damages are so large, investing in climate protection is much more worthwhile than previously thought. Climate activists believe that this new research could lead to a rethinking of international climate policy—for example, in terms of investments in climate-friendly technologies aimed at mitigating the extent of global warming.

Känzig also hopes for this. “Climate is a topic that is very close to my heart,” he says. At the beginning of his career, he completed internships at the Swiss National Bank and the Bank of England. He actually wanted to research monetary policy, “but then I realized that given the enormous importance of climate change, too little economic research is being done on the topic,” he said.

Reaction to “The Research”

Since the publication of the study, there has been broad agreement in the economic and scientific communities, but criticisms have also been voiced. Some argue that the calculations used in the latest model do not take into account the fact that the world is adapting to climate change. Känzig says this is a valid objection. “But today, no one can say how much the world will actually invest in adaptation measures.”

Others criticize that the results are too optimistic because the analysis does not account for so-called tipping points—events where an ecosystem collapses due to warming—which would have catastrophic consequences. Känzig said he remains convinced that the economic damages caused by climate change have been significantly underestimated so far and that every new insight, such as this new study, serves to inform people about the severity of the impending climate crisis resulting from global warming.

Conclusions on Global Warming and the Economy

In the conclusion of their research, the authors write:

“In this study, we show that the impact of climate change on economic activity is significant. By exploiting the natural climate variability of global average temperature, we obtain time-series estimates that are representative of the general effects of global warming. We find that a 1°C increase in global temperature persistently reduces global GDP, with a peak loss of 12%. This large effect is due to the surge in extreme climate events.”

“In contrast, the local temperature shocks used in the traditional panel literature lead to minimal increases in extreme events and much smaller economic impacts. Our results collectively imply a social cost of carbon (SCC) of $1,056/tCO2 and a 31% welfare loss under a moderate warming scenario. These impacts are comparable to fighting a major war on home soil forever (emphasis added). Our results not only show that climate change poses a serious threat to the global economy but also have significant implications for carbon abatement policies. Many carbon abatement interventions cost between $27 and $95 per ton of CO2 reduced. The traditional SCC value ($151/tCO2) implies that these policies are only cost-effective if governments internalize the benefits for the entire world, as captured by the SCC. However, a government that internalizes only domestic benefits evaluates the benefits of mitigation using the domestic cost of carbon (DCC).”

“The DCC is always lower than the SCC because the damages to a single country are smaller than the damages to the entire world. For example, traditional estimates based on local shocks suggest that the U.S. DCC is $30/tCO2, making unilateral abatement prohibitively expensive. However, our new estimates suggest that the U.S. DCC will be $211/tCO2, greatly exceeding policy costs. In this case, unilateral carbon abatement policies are cost-effective for the United States.”

The Lesson

Mark Z. Jacobson is a professor of civil and environmental engineering and director of the Atmosphere/Energy Program at Stanford University. He knows a thing or two about global warming and how to take action to mitigate its effects. He is also a good friend of CleanTechnica, having written numerous articles for our small community on the edge of the internet. I asked Professor Jacobson what he thought about this latest economic research, and he replied: “This study adds to a growing list of studies suggesting that the social cost of carbon and the economic damages from climate change are much higher than previously thought.”

Oceans cover nearly two-thirds of our planet. Ignoring the effects of warmer ocean water due to global warming simply leads to unrealistic results. People may argue with Bilal and Känzig’s conclusions—is the social cost of carbon over a thousand dollars per ton, or just $574.22? Such questions are like asking how many angels can dance on the head of a pin. The primary value of the study is that when examining the economic impact of global warming, we must consider the entire Earth, not just the landmasses. For this alone, they deserve a Nobel Prize.

Source: CleanTechnica