Economics and climate change: the complexity of transition
The COP26 gathering of last November left in the background the economic implications of dramatically transforming the entire production and consumption systems, on which the current life of mankind relies.
The 26th annual UN Climate Change Conference – formally Conference of the Parties meeting – that closed in Glasgow on November 12, 2021 – registered little disagreement on the issue of global temperature increase and its anthropogenic nature. Yet, understanding and managing the crucial interrelationship between the economy and the environment is vital for the success of any environmental and emission abatement policy. Complexity and transition are the keywords.
What we know
Some firm points must be considered to evaluate the depth of the issues at stake and how complex – not just “difficult”, but truly “complex” – they are:
First, the fundamental role of human activity on climate change has been confirmed by the three-decade effort of the UN Intergovernmental Panel on Climate Change (IPCC) that produces studies and scenarios, bringing together experts in all hard sciences relevant to climate change. Scientists who disagree with the results of the IPCC are definitely a minority.
According to the 2018 IPCC report “Observed global mean surface temperature over 2006–2015 was 0.87°C (…) higher than the average over the 1850–1900 period”.
At the COP26 meeting, the initially proposed roadmap to contain the temperature increase to 1.5°C by 2100 included a goal of zero net CO2 emissions by 2050, with an intermediate step of halving emissions by 2030.
Secondly, the window for limiting global warming to 1.5°C is rapidly closing. According to Global Temperature Trend Monitor, the existing carbon budget – the amount of CO2 that can be emitted leaving the world with a 50% chance to contain global warming within 1.5°C compared to preindustrial levels – is a total of 500 gigatonnes (GtCO2), and global carbon emissions in 2021 alone have been 39.4 GtCO2 . Equally concerning is that projected emissions from electricity-generating infrastructure already in place exceed the remaining carbon budget.
Thirdly, the dissolution of CO2 and other greenhouse gases occurs over very long periods of time (many decades or even centuries) and therefore the level of greenhouse gases present in the atmosphere today will not be reduced by 2100 through the reduction of future emissions. The objective “net zero emissions” is therefore to avoid further accumulation of greenhouse gases that over time would lead to further increases in temperature. The problem is unequivocally global since the movement of greenhouse gases knows no boundaries. However, for reasons related to the economic and social sustainability of the objectives, some key countries such as China, India and Russia opposed those objectives and the final road map was significantly watered down. A key aim of the climate negotiations at COP26 was the notion of keeping 1.5°C alive. While the emission reductions promised at Glasgow fell shy of that figure, countries were asked to return to COP27 with improved pledges to cut further.
The fourth point is that two approaches (or a combination of the two) can be considered for containing temperature increases: mitigation and adaptation. Mitigation refers to all actions that can result in a reduction of net emissions; adaptation refers to all actions whose objectives is to minimize the impact of the “symptoms” of climate change (for example, bulkheads along coastlines, atmospheric CO2 capture, etc.). There is no single solution, meaning that the goal of temperature containment can be achieved through a basically infinite combination of very different timings and approaches, with a strong level of interdependence between the levers that can be used, whether technological, policy induced, change of population habits or other. Put differently, the fight against global warming is an inherently “complex” problem, meaning that there are interactions that cannot be simplified and are potentially random (in the sense that their ex-ante controllability is highly uncertain if not impossible).
The fifth and final point is that the reduction of emissions involves a radical restructuring of the entire production and consumption systems as we know them today, both in advanced and emerging or developing countries, a configuration that is at the boundary of what is economically and politically feasible. This restructuring in turn will require a long transition period (probably several decades) during which economic activity, as well as household and business incomes, will be negatively affected. During the transition, disequilibria in the demand/supply curves of the production system will be high and increasing, mostly showing up in higher inflation rates and overall lower level of employment. Such problematic impacts will prevail until the full costs of embracing new technologies and new energy sources will remain higher than those on which the current production system is based – and despite the positive economic impact that planned investments to combat climate change will have. The balance of economic and financial opportunities and risks will remain tilted to the downside, whereas the “number of decades” to absorb the impact of the transition will depend on the successful adoption of the proper technologies and policies.
A study produced by Vivid Economics, titled “Net Zero Financing Roadmaps” makes projections of the investment required, based on an International Energy Agency net zero emissions scenario and on assumptions about the carbon price and the relative costs from low versus high carbon technologies. It concludes that $125 trillion in investments is required over the next decade for the world to achieve net zero emissions by 2050. The study also suggests that over half of this figure could come from the corporate sector, as companies decarbonize their operations, funded by their own balance sheets, with the rest from financing operations. Whether this estimate is accurate or not, the order of magnitude of the financial investment required in the next nine years is appallingly huge.
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In this context, the task before policymakers, producers, financial investors and consumers is bone chilling. In failing to acknowledge that containing the temperature increase within 1.5°C may well be beyond our reach, policy makers are making pledges of future carbon abatement measures that are unlikely to ever be realized. As end result, tables may well turn, with voters no longer willing to support policies to combat global warming.
In fact, each of the policy choices being debated – such as, for example, abandoning coal and gas, returning to nuclear power, financing the purchase of electric cars, focusing on hydrogen, etc. – should be evaluated by taking into account the current social organization and the scarcity of both financial resources and skilled labor. Each of these choices would be very complicated when taken individually, but the puzzle becomes truly complex when looking at its multiple interdependencies.
The electrification challenge and the uncertainty factor
One example of such complexity is the electrification of the economic/production system, an inevitable long-term strategy that today looks inevitable. In order to achieve net zero emissions, the mix of energy sources for electricity generation should be radically revised in favor of renewable sources which are still very expensive when taking into account fixed investment costs to install them and then replace them at the end of their life cycle. Realistically the electrification strategy will require (globally) several decades – unless we accept a dramatic reduction in economic activity, especially in countries that today use mainly fossil sources for electricity generation – which not by chance are the lower income countries that opposed the initial COP26 roadmap. As a reference, the collapse in economic activity in 2020 due to the pandemic has reduced CO2 emissions by only 7-8%.
Even assuming that it would be possible (which in reality it is not) to switch the entire production of electricity from fossil fuels to renewables in a couple of decades, a strategy of electrification of the entire economic system – and therefore also of energy consumption – would also require a radical strengthening of the transport (within and across country boundaries) and of the distribution and storage of electricity, currently calibrated on far lower needs. Suffice it to think of the increase in electricity consumption due, for example, to home heating (today mostly gas-fired). And at the same time, electric vehicles would need infrastructure for charging cars, most of them in urban areas where a sufficient number of recharging stations would have to be installed.
Today the global car park is about 1.4 billion cars globally (of which more than 250 million are in Europe) and a systematic electrification strategy would have to create a high-power charging infrastructure. Given the size of such changes, it will be necessary to keep in mind the negative feedbacks: the construction and installation of charging stations or home chargers (dismantling and rebuilding practically all urban roads, reconverting most service stations, urban and not) as well as the adjustment for the transition to electric heating, and for all consumption to be “electrified” – with the result of largely increasing the emissions of CO2 in the transition period. In other words, such a massive infrastructural plan is bound to have a very large environmental footprint – even assuming it could be carried out by adopting today’s greenest technologies.
The electrification strategy is also interdependent with financial issues: to what extent can governments subsidize the sale of electric products without exceeding sustainable levels of deficit and debt? To what extent can private investors finance the necessary research and innovation in all technologies involved, among which more powerful battery and electricity storage? To what extent will consumers be ready to spend for electric products usage (cars in particular)? Electrification can only be successful if consumers accept to shift to electric products, an acceptance which in turn is only possible if technology and infrastructure make substantial progress: the major change in behavior implied by such consumer adaptation adds to the complexity of the choice and the risk taken by government through subsidies and by private players through investment.
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Additional aspects of “complexity” should also be considered when going forward on the path of electrification. The illustration of all the complexities of electrification would require an encyclopedia but a few examples are: first, there is increasing support for the choice of hydrogen on a large scale as a vector for energy use in various applications, both consumer and industrial. The production of hydrogen at the current and foreseeable state of technology requires large amounts of electricity (at least to produce “green” hydrogen), requiring further investment in renewable sources. The additional demand for electric power would require distribution structures to use it. Such hydrogen distribution structures would be totally different from those of an electric system, ultimately thwarting the efforts to revise the electric distribution network (the car charging stations mentioned above would become obsolete).
In other words, choosing to use hydrogen on a large scale in final consumption (for example in vehicles) is a choice that is somehow alternative to a “pure” electrification strategy and should take into account the need to build two different distribution systems and both with expensive investment. Second, a large part of the components of electrical tools requires minerals and metals (many of which are defined as “rare earths”) whose extraction involves high CO2 emissions and is concentrated in a few countries (the main one being China) – which would undermine the security of energy supply of large countries where such resources are not available, including the EU27, the US, Japan and several other advanced countries. Third, in an electrified world, the problem of recycling and disposal of batteries and their components and/or nuclear waste remains open.
Complex policy choices
The list of issues to be solved depending on the policy choices and/or technologies to be adopted is unfortunately not exhausted in those listed above – which are indeed only a small subset. In fact, each production chain will have to make choices that will have repercussions on other production chains or on products destined to final consumption, repercussions whose overall impact will end up increasing emissions (and more generally the products’ footprint) and whose cost in terms of social, employment, income and economic growth should be evaluated on a case-by-case basis.
Once taking properly into account the complexity of the fight against climate change (that is, being realistic about it), it would not be impossible to carry out a conversion of the production system and consumption.
A careful evaluation of the objectives and timescales becomes essential – predictably much longer than what is currently envisaged, even in the final version of the COP26 meeting – with subsequent careful management of the transition to the new system. An excessively rapid transition to a “highly electrified” consumption system but not accompanied by an equally rapid transition to the use of renewables for the production of electricity would end up making the use of coal and/or other fossil sources inevitable. In short, the question to be asked is whether the goals set by the Paris and Glasgow agreements are technically and financially achievable and, above all, compatible with an economically and socially sustainable path, particularly for emerging countries but also for advanced countries.
The impact of the restructuring, mentioned in the fifth point above, on society and on everyone’s life is typically neglected in the political debate and by the media – consequently it is almost ignored in popular perception, with an unhealthy feedback on the political debate. The huge political support obtained by Greta Thunberg is a symptom and at the same time a cause of the superficiality with which the issues related to the objectively “complex” management of solutions are communicated.
The Glasgow conference reached some important agreements on specific objectives, including among others: an end to deforestation by 2030 (agreement signed by nearly one hundred countries, including Brazil); a pledge by India to achieve a net-zero emissions target by 2070, along with a commitment to increase renewable energy sources in the country’s energy mix by 50% by 2030; a commitment (“Glasgow Breakthroughs”) made by nearly 40 nations to give developing countries access to the innovation and tools they need to make the transition to zero carbon emissions feasible; a $8.5 billion grant by the US and European countries to help South Africa move away from coal, its main source of energy (the first concrete agreement of this type which could set an example for the future); nearly 100 countries agreed to reduce methane emissions by 30% by 2030 – methane is responsible for about one-third of the average global temperature increases since the Industrial Revolution according to the most recent findings of the IPCC.
However, it is also fair to ask: concretely, given the complexity of the issues, is enough being done to achieve the goals and the roadmap indicated by the IPCC and Paris Agreements? To answer this question, it is first necessary to identify which countries are the biggest emitters. This assessment is only apparently simple and depends on the parameters to be used: total level of emissions, emissions per capita, emissions in relation to income, historical trend or current values.
It is on this point that the large countries (US, EU, China, India, Brazil, Russia) have been arguing for many years now and the issue has become more strictly political. To simplify: are low-income countries right in arguing that it is unfair to be asked to curb their economic growth? If we add the (legitimate) Sino-Indian and even Russian resistance to the climate change skepticism of Brazilian President Jair Bolsonaro, we could see a front of emerging countries holding back on the stringent demands of developed ones. As several analysts have argued, the largest economies will have to provide the financial resources to somehow compensate the lower income ones. On this front, little progress seems to have come out of COP26.
In a nutshell, the complexity of the fight against climate change resides not only in the interdependence of technical issues and choices – it resides also and above all in the entanglement of economic, social, financial and geopolitical factors. An awful lot remains to be done – much more than most media, consumers and politicians like to think.
Note: the opinions expressed in this article do not necessarily represent the views of Oxford Economics.
