When we speak about the resilience of economies to climate change, we have more than one angle to consider. One is in relation to adaptation and improving resilience to climate damage. Another is in relation to mitigation and reducing the magnitude of climate change. Success in either requires an ability to weather the transition to net zero with minimum economic damage.
The key to this is evaluating resilience within a framework of macroeconomics, which considers the effect of policies and actions on the economy as a whole as measured by GDP, rather than considering actions in individual sectors one at a time. From a macroeconomic view, gains or losses in one economic sector may be compensated for or exacerbated by gains or losses in other sectors. So we could see how changes in one sector as a result of climate change or as a result of the trajectory to net zero causes changes in many other sectors.
Macroeconomic evaluations are built on input-output methods that follow the flow of money in an economy. The same models can be tweaked to follow the flow of embodied carbon dioxide. That flow is both ‘upstream’ where sector B buys supplies from sector A, and ‘downstream’ where sector B sells products to sector C.
Calculating resilience
Economic resilience has five components that need evaluating:
- Resilience against direct losses, such as production capacity in factories following flooding.
- Resilience against damage to infrastructure that is crucial for economic activity. For example, climate damage to a transport system or insufficient energy during a transition to renewables that prevents goods from being shipped.
- Resilience against upstream losses due to impacts on supplier sectors in the value chain.
- Resilience against downstream losses due to impacts on sectors that buy the products or services of another sector.
- The allocation of resources for recovery after an extreme weather event.
A resilient economy is one in which all five of these components are improved by strategies that protect the assets of the production system of that economy and the infrastructure elements on which those assets rely.
That could involve keeping the structure of the economyi constant while investing in protecting production and infrastructure against climate damage. Or it could mean changing that structure so that only components of production that are resilient to climate damage form the basis of GDP. This structural change might be either deliberate or a consequence of climate damage itself.ii
Applying risk-cost-benefit to climate adaptation
Important insights can be gained by using either a quantitative or qualitative process to evaluate resilience within a macroeconomic system. Economic resilience is then understood in the language of risk-cost-benefit, a language with which businesses are already well versed.
For example, estimate the scale and probability of threats to each part of the production system, identify adaptation strategies to reduce vulnerability to those threats, evaluate the investment costs of those strategies and compare them against costs if vulnerability is not reduced, and create and implement public and private policy cases for such investments.
When evaluations are made from a macroeconomic rather than microeconomic perspective, three key lessons become clear. The first is that climate losses in GDP are largely through damage to upstream and downstream links and public sector infrastructure, rather than to a given sector directly.
However, while some sectors experience losses, others – such as construction – experience gains due to the need for repairs. Only a macroeconomic perspective allows for a full understanding of the total impact of adaptation on economic performance.
The second is that the potential costs of investing in climate resilience are often significantly less than the potential losses caused by climate damage. However, note the word ‘potential’ here. The science of climate change and the impact of extreme weather on economic activity are often significantly uncertain. Therefore, decisionmakers might consider these uncertainties too large to warrant the costs of adaptation. Hence the central role of networks in increasing our knowledge of climate science and threat assessments.
The third is that losses to GDP are strongly affected by how resources are allocated to support recovery.iii If the private sector is left unsupported in that recovery, it will generally wait for demand for its products and services to return before investing in repairs. Whereas if resources are made available from the public sector for repairs that are not driven by a return of demand, both the recovery period and total loss of GDP are reduced significantly.
The transition trepidation
When it comes the question of whether an economy will stay the same, increase, or decrease due to the transition to net zero, part of the answer depends on the kind of macroeconomic model used.
Dynamic macroeconomic models suggest that GDP will either remain the same or increase slightly as a result of decarbonising an economy. Recent studiesiv attribute this to these models identifying previously unused economic resources that can be unlocked by the net zero transition, creating opportunities for growth. However, to reach this conclusion, we need to look at the whole transition period and not simply the before and after picture.
Looking at the whole transition period reveals the potential of that transition to cause economic instability, with winners and losers in that event. The winners during a transition period could be the emerging green economic sectors, as long as they survive (as we know, startups become profitable once economies of scale are reached but are at risk in the interim due to lack of access to resources for growth). The losers would be the high carbon sectors, such as oil extraction and processing and the upstream and downstream industries that support them.
The economy could be damaged if the transition to lower carbon sectors moves at a slower pace than the demise of high carbon sectors. For example, punitive policies such as carbon taxes might collapse high carbon industries but do not provide support for the emergence of their low carbon replacements. In that case, existing economic activity would be starved by a lack of access to resources while the green sectors mature.
Winners and losers can also be entire countries, divided between those whose economies can make a transition easily and those who cannot transition in time to avoid damage. So transitions to net zero are not only about climate policy but have serious implications for global economic justice.
Becoming resilient to instability
Solutions lie in making an economy resilient to the changes needed to transition to net zero. This means that climate policies need to focus less on optimising existing resources and more on stimulating resource creation, which involves public and private sector support for innovations and new technology investment across all stages of the research, development, demonstration, and deployment (RDDD) trajectory. RDDD processes can help technologies emerge that unlock additional resources, improve economic productivity, and reduce greenhouse gas emissions.
A resilient economy then is one where innovation flourishes by investment in research and support for the growth of SMEs to mature businesses, governments use green public procurement to accelerate the growth of supply chains for low carbon innovations, sectors can smoothly slot low carbon solutions into their production processes at a scale matched to the availability of those solutions, and the profitability of sectors does not rely heavily on high carbon assets that might become stranded during the transition.
Answers also lie in improving the global climate finance mechanism such as the UN’s Green Climate Fund, which enables capital and low carbon technology to flow from developed to developing economies so they can improve their economic performance while also reducing their carbon intensity. This, along with potentially forgiving past debt, ensures that developing economies are not the ‘losers’ in the transition to net zero, but rather are resilient enough to weather it.
