Economics of climate change

The economics of climate change concerns the economic aspects of climate change; this can inform policies that governments might consider in response.

A number of factors make this and the politics of climate change a difficult problem: it is a long-term, intergenerational problem; benefits and costs are distributed unequally both within and across countries; and both the scientific consensus and public opinion on climate change need to be taken into account.

Effects of climate change may last a long time, such as sea level rise which will not be reversed for thousands of years. The long time scales and uncertainty associated with global warming have led analysts to develop “scenarios” of future environmental, social and economic changes. These scenarios can help governments understand the potential consequences of their decisions.

One of the responses to the uncertainties of global warming is to adopt a strategy of sequential decision making. This strategy recognizes that decisions on global warming need to be made with incomplete information, and that decisions in the near term will have potentially long-term impacts. Governments may use risk management as part of their policy response to global warming. For instance, a risk-based approach can be applied to climate impacts which are difficult to quantify in economic terms, e.g., the impacts of global warming on indigenous peoples.

Analysts have assessed global warming in relation to sustainable development. Sustainable development considers how future generations might be affected by the actions of the current generation. In some areas, policies designed to address global warming may contribute positively towards other development objectives, for example abolishing fossil fuel subsidies would reduce air pollution and thus save lives. Direct global fossil fuel subsidies reached $319 billion in 2017, and $5.2 trillion when indirect costs such as air pollution are priced in. In other areas, the cost of global warming policies may divert resources away from other socially and environmentally beneficial investments (the opportunity costs of climate change policy).

To achieve deep reductions in greenhouse gases and slow global warming, the financial system and the world’s economies will have to adapt.




One of the economic aspects of climate change is producing scenarios of future economic development. Future economic developments can, for example, affect how vulnerable society is to future climate change, what the future impacts of climate change might be, as well as the level of future GHG emissions.


Global futures scenarios and emissions scenarios


“Global futures” scenarios can be thought of as stories of possible futures. They allow for the description of factors which are difficult to quantify but are important in affecting future GHG emissions. The IPCC Third Assessment Report includes an assessment of 124 global futures scenarios. These scenarios project a wide range of possible futures. Some are pessimistic, for example, 5 scenarios project the future breakdown of human society.  Others are optimistic, for example, in 5 other scenarios, future advances in technology solve most or all of humanity’s problems. Most scenarios project increasing damage to the natural environment, but many scenarios also project this trend to reverse in the long-term.

In the scenarios,  no strong patterns in the relationship between economic activity and GHG emissions were found. By itself, this is not proof of causation, and is only reflective of the scenarios that were assessed.

In the assessed scenarios, economic growth is compatible with increasing or decreasing GHG emissions. In the latter case, emissions growth is mediated by increased energy efficiency, shifts to non- fossil energy sources, and/or shifts to a post-industrial (service-based) economy. However, in a study completed with several countries in 2022, a positive relationship was defined between renewable energy and economic growth. Most scenarios projecting rising GHGs also project low levels of government intervention in the economy. Scenarios projecting falling GHGs generally have high levels of government intervention in the economy.

In scenarios designed to project future GHG emissions, economic projections, for example changes in future income levels, will often necessarily be combined with other projections that affect emissions, for example nationalism. Since these future changes are highly uncertain, one approach is that of scenario analysis. In scenario analysis, scenarios are developed that are based on differing assumptions of future development patterns. An example of this are the shared socioeconomic pathways produced by the Intergovernmental Panel on Climate Change (IPCC). These project a wide range of possible future emissions levels.

Some analysts have developed scenarios that project a continuation of current policies into the future. These scenarios are sometimes called “business-as-usual” scenarios.

Experts who work on scenarios tend to prefer the term “projections” to “forecasts” or “predictions”.  This distinction is made to emphasize the point that probabilities are not assigned to the scenarios, and that future emissions depend on decisions made both now and into the future.

Another approach is that of uncertainty analysis, where analysts attempt to estimate the probability of future changes in emission levels.


Economic impacts


The economic impacts of climate change vary geographically and are difficult to forecast exactly. Researchers have warned that current economic forecasts may seriously underestimate the effects of climate change, and point to the need for new models that give a more accurate picture of potential damages. Nevertheless, one 2018 study found that potential global economic gains if countries implement mitigation strategies to comply with the 2 °C target set at the Paris Agreement are in the vicinity of US$17 trillion per year up to 2100 compared to a very high emission scenario.

Global losses reveal rapidly rising costs due to extreme weather events since the 1970s.  Socio-economic factors have contributed to the observed trend of global losses, such as population growth and increased wealth. Part of the growth is also related to regional climatic factors, e.g., changes in precipitation and flooding events. It is difficult to quantify the relative impact of socio-economic factors and climate change on the observed trend. The trend does, however, suggest increasing vulnerability of social systems to climate change.

A 2019 modelling study found that climate change had contributed towards global economic inequality. Wealthy countries in colder regions had either felt little overall economic impact from climate change, or possibly benefited, whereas poor hotter countries very likely grew less than if global warming had not occurred. Part of this observation stems from the fact that greenhouse gas emissions stem mainly from high-income countries while low-income countries are affected by it negatively.

The total economic impacts from climate change are difficult to estimate, but increase for higher temperature changes. For instance, total damages are estimated to be 90% less if global warming is limited to 1.5 °C compared to 3.66 °C, a warming level chosen to represent no mitigation. One study found a 3.5% reduction in global GDP by the end of the century if warming is limited to 3 °C, excluding the potential effect of tipping points. Another study noted that global economic impact is underestimated by a factor of two to eight when tipping points are excluded from consideration. In the Oxford Economics high emission scenario, a temperature rise of 2 degrees by the year 2050 would reduce global GDP by 2.5% – 7.5%. By the year 2100 in this case, the temperature would rise by 4 degrees, which could reduce the global GDP by 30% in the worst case.

Studies in 2019 suggest that economic damages due to climate change have been underestimated, and may be severe, with the probability of disastrous tail-risk events being nontrivial. Carbon-intensive industries and investors are expected to experience a significant increase in stranded assets with a potential ripple affect throughout the world economy.


Adaptation and mitigation


The distribution of benefits from adaptation and mitigation policies are different in terms of damages avoided. Adaptation activities mainly benefit those who implement them, while mitigation benefits others who may not have made mitigation investments. Mitigation can therefore be viewed as a global public good, while adaptation is either a private good in the case of autonomous adaptation, or a national or regional public good in the case of public sector policies. Climate change mitigation consist of human actions to reduce greenhouse gas emissions or to enhance carbon sinks that absorb greenhouse gases from the atmosphere.


Cost estimates for mitigation


Mitigation cost estimates depend on the baseline (in this case, a reference scenario that the alternative scenario is compared with), the way costs are modelled, and assumptions about future government policy. Cost estimates for mitigation for specific regions are dependent on the quantity of emissions “allowed” for that region in future, as well as the timing of interventions.

Mitigation costs will vary according to how and when emissions are cut: early, well-planned action will minimise the costs. Globally, the benefits of keeping warming under 2 °C exceed the costs.

Many economists estimate the cost of climate change mitigation at between 1% and 2% of GDP. One 2018 estimate stated that temperature increase can be limited to 1.5 °C for 1.7 trillion dollars a year.  According to this study, a global investment of approximately $1.7 trillion per year would have been needed to keep global warming below 1.5°C. Whereas this is a large sum, it is still far less than the subsidies governments provided to the ailing fossil fuel industry, estimated at more than $5 trillion per year by the International Monetary Fund. However by the end of 2022 many thought limiting to 1.5°C politically impossible.

The economic repercussions of mitigation vary widely across regions and households, depending on policy design and level of international cooperation. Delayed global cooperation increases policy costs across regions, especially in those that are relatively carbon intensive at present. Pathways with uniform carbon values show higher mitigation costs in more carbon-intensive regions, in fossil-fuels exporting regions and in poorer regions. Aggregate quantifications expressed in GDP or monetary terms undervalue the economic effects on households in poorer countries; the actual effects on welfare and well-being are comparatively larger.

Cost–benefit analysis may be unsuitable for analysing climate change mitigation as a whole but still useful for analysing the difference between a 1.5 °C target and 2 °C. One way of estimating the cost of reducing emissions is by considering the likely costs of potential technological and output changes. Policy makers can compare the marginal abatement costs of different methods to assess the cost and amount of possible abatement over time. The marginal abatement costs of the various measures will differ by country, by sector, and over time.


Paying for an international public good


Economists generally agree on the following two principles:

  • For the purposes of analysis, it is possible to separate equity from efficiency. This implies that all emitters, regardless of whether they are rich or poor, should pay the full social costs of their actions. From this perspective, corrective (Pigouvian) taxes should be applied uniformly (see carbon tax#Economic theory). It has been suggested that countries over the average per person emissions be carbon taxed and the funds raised given to countries under the average.
  • It is inappropriate to redress all equity issues through climate change policies. However, climate change itself should not aggravate existing inequalities between different regions.

Some early studies suggested that a uniform carbon tax would be a fair and efficient way of reducing emissions. A carbon tax is a Pigouvian tax, and taxes fuels based on their carbon content. A literature assessment by Banuri et al. summarized criticisms of such a system:

  • A carbon tax would impose different burdens on countries due to existing differences in tax structures, resource endowments, and development.
  • Most observers argue that such a tax would not be fair because of differences in historical emissions and current wealth.
  • A uniform carbon tax would not be Pareto efficient unless lump sum transfers were made between countries. Pareto efficiency requires that the carbon tax would not make any countries worse off than they would be without the tax Also, at least one country would need to be better off.

An alternative approach to having a Pigouvian tax is one based on property rights. A practical example of this would be a system of emissions trading, which is essentially a privatization of the atmosphere. The idea of using property rights in response to an externality was put forward by Ronald Coase in The Problem of Social Cost (1960). Coase’s model of social cost assumes a situation of equal bargaining power among participants and equal costs of making the bargain. Assigning property rights can be an efficient solution. This is based on the assumption that there are no bargaining/transaction costs involved in buying or selling these property rights, and that buyers and sellers have perfect information available when making their decisions.

If these assumptions are correct, efficiency is achieved regardless of how property rights are allocated. In the case of emissions trading, this suggests that equity and efficiency can be addressed separately: equity is taken care of in the allocation of emission permits, and efficiency is promoted by the market system. In reality, however, markets do not live up to the ideal conditions that are assumed in Coase’s model, with the result that there may be trade-offs between efficiency and equity.


Efficiency and equity


No consensus exists on who should bear the burden of adaptation and mitigation costs. Several different arguments have been made over how to spread the costs and benefits of taxes or systems based on emissions trading.

One approach considers the problem from the perspective of who benefits most from the public good. This approach is sensitive to the fact that different preferences exist between different income classes. The public good is viewed in a similar way as a private good, where those who use the public good must pay for it. Some people will benefit more from the public good than others, thus creating inequalities in the absence of benefit taxes. A difficulty with public goods is determining who exactly benefits from the public good, although some estimates of the distribution of the costs and benefits of global warming have been made – see above. Additionally, this approach does not provide guidance as to how the surplus of benefits from climate policy should be shared.

A second approach has been suggested based on economics and the social welfare function. To calculate the social welfare function requires an aggregation of the impacts of climate change policies and climate change itself across all affected individuals. This calculation involves a number of complexities and controversial equity issues. For example, the monetization of certain impacts on human health. There is also controversy over the issue of benefits affecting one individual offsetting negative impacts on another. These issues to do with equity and aggregation cannot be fully resolved by economics.

On a utilitarian basis, which has traditionally been used in welfare economics, an argument can be made for richer countries taking on most of the burdens of mitigation. However, another result is possible with a different modeling of impacts. If an approach is taken where the interests of poorer people have lower weighting, the result is that there is a much weaker argument in favour of mitigation action in rich countries. Valuing climate change impacts in poorer countries less than domestic climate change impacts (both in terms of policy and the impacts of climate change) would be consistent with observed spending in rich countries on foreign aid

In terms of the social welfare function, the different results depend on the elasticity of marginal utility. A declining marginal utility of consumption means that a poor person is judged to benefit more from increases in consumption relative to a richer person. A constant marginal utility of consumption does not make this distinction, and leads to the result that richer countries should mitigate less.

A third approach looks at the problem from the perspective of who has contributed most to the problem. Because the industrialized countries have contributed more than two-thirds of the stock of human-induced GHGs in the atmosphere, this approach suggests that they should bear the largest share of the costs. This stock of emissions has been described as an “environmental debt”. In terms of efficiency, this view is not supported. This is because efficiency requires incentives to be forward-looking, and not retrospective.  The question of historical responsibility is a matter of ethics. Munasinghe et al. suggested that developed countries could address the issue by making side-payments to developing countries.


Natural resources of India

Resources are classified as either biotic or abiotic on the basis of their origin. The Indian landmass contains a multitude of both types of resource and its economy.

Effects of climate change

The effects of climate change impact the physical environment, ecosystems and human societies.

Economic liberalisation in India

Refers to the series of policy changes aimed at opening up the country's economy to the world, with the objective of making it more market-oriented and service-driven.