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Economic Research: For The U.S. Economy, Climate Change Is A Case Of Pay Now--Or Pay More Later

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Economic Research: For The U.S. Economy, Climate Change Is A Case Of Pay Now--Or Pay More Later

The scientific consensus on global climate change is now essentially unanimous: It's clearly occurring, and humans--through industry, transportation, agriculture, and other activities--are producing increasingly large quantities of the greenhouse gases that contribute to global warming. Less clear, however, are the potential economic consequences, regardless of whether we try to mitigate or reverse what has already happened, or simply deal with the results down the road.

Nonetheless, the accumulation of greenhouse gases in the atmosphere, if allowed to continue unabated, will have extensive and costly impacts on regional climates and economies throughout the world. To be sure, there will be some winners to go along with the many losers, under any scenario, but the overall economic effect will be starkly negative--even for large countries, such as the U.S., which seem set to fare better than small, less-developed nations.

In their 2000 study "Warming the World," Yale University economics professor William Nordhaus and research associate Joseph Boyer estimated that, assuming an average global temperature rise of about 11 degrees Fahrenheit by the end of the century (a notably dire scenario, granted), the resulting damages--including estimates of nonmarket damages, along with costs associated with catastrophic outcomes--could add up to about 5% of U.S. economic output and, with substantially larger losses in a number of other countries, a decline of about 10% of global GDP.

In line with this forecast, Standard & Poor's Ratings Services puts the cost to the world's largest economy of doing nothing to be between 2.2% and 5.2% of GDP by 2100.

At the same time, if we act aggressively to both adapt to the changing climate and to mitigate future effects, we can significantly reduce our exposure to the worst economic risks. Naturally, the cost of doing so would also likely be quite large, as it would entail substantial reductions in our carbon footprint--or at least a sharp slowing of its growth. For the U.S., which is responsible for almost one-fifth of global emissions, this represents a long row to hoe.

Here, we should note that the terms "climate change" and "global warming" are generally used synonymously, mostly because the consequences that climate scientists expect are primarily the result of higher temperatures--with the knock-on effect of rising sea levels, which, in turn, will threaten coastal areas, for example. Whatever the terminology, there is little question that carbon emissions will continue to increase for the foreseeable future, especially with China and India--the two largest countries by population, with a collective 36% of the world's people--entering energy-intensive phases of their economic development. And this is true even if the U.S.--the third-most-populous country, with about 4.4% of the world's inhabitants--sharply curtails its contribution to climate change.

However, it's unlikely that carbon emissions could continue to increase at the current pace. Global population growth is slowing (although this is hardly an efficient way to stem climate change), and the once-breakneck rate of China's economic expansion is easing. Additionally, greater public awareness and political willingness to confront the challenges of climate change will likely have some effect.

That said, it seems safe to say that troubling events could soon outpace our actions, a position forcefully articulated in the study "Risky Business – The Economic Risks of Climate Change in the United States," published in June by a group co-chaired by former New York Mayor Michael Bloomberg, former U.S. Treasury Secretary Henry Paulson, and Thomas Steyer, founder of the hedge fund Farallon Capital Management LLC. The report concluded that climate change is already causing significant harm and posited that such calamitous effects will almost certainly be far more severe in the future to the agricultural, energy, and coastal-property sectors, as well as to public health and labor productivity, more generally.

No "Average" Effects

A major hurdle in assessing any potential damage is that talking about average temperature rises or aggregate economic effects is inelegant and incomplete. Simply put, the U.S. is too diverse--geographically, socially, and economically--to allow for a simple average. Much of the impact of climate change will be regional, making it all the more difficult to ascribe a headline number to what it will cost us as a country. To paraphrase Mr. Steyer, having one's head in the freezer and feet in the oven doesn't mean the "average" room temperature is all that comfortable.

In the U.S. Southeast, for example, 36% of residents live in counties along the coast, and one-third of GDP comes from those counties, according to "Risky Business." Clearly, if significant coastal acreage were to be swallowed by the sea, there would be an outsize effect on the economies of that region, through the loss of arable land, the disappearance of tourist areas, and the destruction of property. In the Northeast, rising sea levels--and the possibility of storm surges that could make Sandy seem small by comparison--would threaten infrastructure that is already in desperate need of refurbishment (see "U.S. Infrastructure Investment: A Chance To Reap More Than We Sow," published May 5, 2014, on RatingsDirect). In the Pacific Northwest, meanwhile, more frequent wildfires could hurt the region's economically important forest-products industry.

Nor will we need to wait long to see some effects. Coastal cities in the East could face what amounts to pre-storm damage, with companies deciding that maintaining offices in New York or Boston, for example, isn't worth the risk of having to shutter their buildings at the approach of another storm--or having to shoulder increased insurance premiums to do so.

Meanwhile, across the country, the demand for more power generation--mainly for air conditioning--would strain a system already struggling to keep pace with demand. And even if power providers were able to construct and maintain plants sufficient to meet the country's needs, there would clearly be significant costs involved. Costs that, naturally, would ultimately be borne by consumers.

A surge in the number of Americans--the elderly, in particular--who would require medical attention because of extreme heat could burden the U.S. health care system, which, it's worth mentioning, has gone through its share of well-documented cost- and care-related issues in recent years.

At the same time, while it seems reasonable to expect that farmers and agricultural companies will be hard hit by climate change, U.S. food producers are among the most prepared to face these challenges, through such efforts as the development and refinement of drought-resistant crops. And each region will be affected differently. While many areas of the South could suffer water shortages and heat so extreme that crop yields would shrink significantly, some Northern regions may enjoy longer growing seasons as the number of frigid days declines, which could be a boon to their local economies.

Insurers, too, have much at stake, given the likelihood of additional claims, especially along the U.S. coastline. In anticipation of this, many companies have been preparing to address the effects of climate change, and, ultimately, we expect that they would fare well by passing along any increased costs to consumers in the form of higher premiums (perhaps, in some cases, becoming more profitable, as recent ratios of premiums-to-payouts demonstrate).

Additionally, in what is surely a sign that the science of climate change has reached a consensus, even global oil companies are doing what they can to prepare. Perhaps counterintuitively, much of this means an increase the exploration and production of oil and natural gas, with the rampant and accelerating melting of Arctic ice allowing greater access to trapped fossil fuels. (Here, we should note that the U.S. is one of just five countries with a claim to the Arctic--and all the oil and gas it contains--along with Canada, Russia, Denmark, and Norway.)

Winners And Losers

This naturally leads to a discussion of potential winners and losers.

On a global scale, Greenland, for example, could shake off three centuries of Danish rule and achieve full independence if the revenues it expects to generate from an increase in arable land (as well as a significantly longer growing season), a surge in fishing hauls (as stocks move north in search of colder water), and a jump in tourism (as the morbidly curious flock to see global warming in action) come to fruition.

And not only would Greenland become independent and self-reliant, but it could soon become a fairly wealthy nation. In fact, Greenland is so rich in oil--as well as other commodities, minerals, and precious metals--that the U.S. once tried to buy the island from Denmark in the mid-1940s, for what would have been the bargain sum of $100 million--the equivalent of $1.2 billion in today's money (or about what the so-called oil supermajors collectively earn in a week). Greenland would also become the world's most water-rich country, on a per capita basis, surpassing Iceland.

Greenland wouldn't necessarily be the only--or even primary--beneficiary of the northward creep of desirable farmland. Russia and Canada, the two largest countries in the world by land mass, could benefit in a major way.

Of course, Greenland's emergence as a wealthy nation wouldn't come problem-free, given that the melt rate of the country's ice cap has been increasing 7% a year since 1996, according to the 2014 book "Windfall – The Booming Business of Global Warming" by journalist McKenzie Funk. In fact, Greenland's ice cap is so large--covering about four-fifths of the island nation--that if it were to melt entirely, global sea levels would rise more than 20 feet. In the U.S., Miami and New Orleans would effectively disappear, and much of lower Manhattan would be underwater. Around the world, an astounding number of island nations would disappear completely, forcing their entire populations to flee.

To be sure, those may represent worst-case scenarios. But the effects of glacial depletion are already being felt around the world. The aforementioned economic development of China and India comes as the countries worry about waning water supplies, with the Himalayan glaciers on which they rely continuing to shrink rapidly. Similarly, a number of large ice caps in the central and southern Andes are receding, threatening populations in Argentina and Chile, which depend on water supplies and the hydroelectric power that glacier-fed rivers provide.

That's the thing about assessing the winners and losers of climate change: It's a zero-sum game, at best. For every flourishing Greenland there is a disappearing Maldives. For every day added to the growing season in the U.S.'s Northern Plains, there's a day of drought that eats into crop yields further south. For every shipping lane now accessible because of warming waters, there's a food shortage in a developing nation.

Standard & Poor's looked at the direct costs to the U.S. if nothing changes. In this scenario, with global warming on an average estimated trajectory of a 5-degree Fahrenheit rise by 2100, we could see, once a decade, all regions impacted by climate change to varying degrees. Here, direct losses could add up to more or less a loss of 2.2% of economic output by 2100 in real terms. Assuming a once-in-a-50-year Katrina-like event puts an upper limit to our scenario, with a direct loss between 2.2% and 5.2% to economic output by 2100.

Of course, the full economic impact is fraught with hidden costs as well. If incorporated in our scenario, costs would be even larger. Besides the replacement value of infrastructure, there are real costs of rerouting traffic, workdays and productivity lost, provision of temporary shelter and supplies, potential relocation and retraining costs, among others. Likewise, climate change adds an extra layer of uncertainty and risk, which imposes new costs on the insurance, banking, and investment industries, and complicates business planning processes, particularly in the agricultural and manufacturing sectors, as well as public works projects.

What Incentive To Stop It?

In this light, it's pertinent to ask what incentives the countries--as well as industries and companies--that could benefit most have to counter climate change. The short, sad answer is that there seems to be little, given the upfront costs of doing so.

There's almost no question that rich, Western nations will suffer much less than poorer ones. Evidence of this emerged during the international food-price crisis of 2008. In March of that year, average wheat prices around the world more than doubled from a year earlier, rice prices soared 74%, and the cost of corn rose by almost one-third, according to the Institute for Food and Development Policy (the think tank also known as Food First). In the U.S., this resulted in the relatively mild move by discount retailers such as Sam's Club and Costco to limit the amount of bulk rice customers could buy. In many parts of the developing world, it kicked off rioting, political and economic instability, and a scarcity of affordable dietary staples.

Granted, the causes of that crisis can't all be directly tied to global warming. But severe droughts in many grain-producing nations, along with rising oil prices--which added to the costs of agricultural production and transportation--were major contributing factors.

Nonetheless, the U.N.'s Food and Agriculture Organization says there is more than enough food in the world to feed everyone--about half as much more than is needed--and that food production is growing faster than the global population. While this may ease some concerns about the possibility for a Malthusian catastrophe of pandemic famine and disease, it demonstrates that the knock-on effects of climate change can be as problematic as the direct impact--especially for poorer nations, but also for large, developed economies such as the U.S.

In fact, climate change will likely be far worse than a break-even prospect for the U.S. And this likelihood moves the discussion from a hypothetical one about potential winners and losers to a very real one about Washington's policy response.

Former Treasury Secretary Robert Rubin, a member of the committee that published "Risky Business," has said the cost of doing nothing to address climate change is, over the long term, far greater than the cost of action. In an opinion piece in the Washington Post in July, Mr. Rubin said that "future federal spending to deal with climate change is likely to be enormous" and suggested that this "should be included in fiscal projections, whether in existing estimates or in additional estimates."

"If nothing is done to prevent climate-related crises, the federal government will be forced to deal with them later — from property losses to public health crises to emergency aid," Mr. Rubin wrote. "To cover those costs, we will have to increase the deficit; raise taxes; or significantly cut spending on defense, our social safety net, and public investment including infrastructure, education and basic research."

Of course, achieving the sorts of reductions in greenhouse gases that would have a material effect could mean a transformation of the U.S. economy from one that runs on fossil fuels to one that increasingly relies on nuclear and renewable fuels--and this would come at some short-term cost to the economy, depending on the level of reductions and on the particular measures employed.

To take just one example, studies show that, under the cap-and-trade system proposed in the American Clean Energy and Security Act [ACESA] of 2009 (passed by the House and defeated in the Senate), a 50% reduction in emissions by 2050 could be achieved at a cost of a year or two of GDP growth in the period.

The Congressional Budget Office (CBO) concluded that ACESA would have trimmed about 0.25%-0.75% from U.S. real GDP in 2020, and 1%-3.5% in 2050. The CBO said this damping of economic growth would result from shifts in production, investment, and employment away from industries involved in the production of carbon-based energy and energy-intensive goods and services; declining productivity and increased prices for domestic goods as energy costs rose, leading to a competitive disadvantage relative to international competitors--as well as reduced net inflows of capital from abroad; and a reduction in the labor supply and workers' real wages (a primary concern for many).

However, the cost estimates didn't factor in the potential economic benefits of averting or mitigating climate change. And while the CBO concluded that the net effects of restricting emissions--adding back in the boost to GDP of addressing global warming--would still likely be negative in the next few decades, most of the benefits would accrue in the second half of the 21st century and beyond. Additionally, such remediation policy isn't a jobs issue, as it would likely create as many jobs as a drop in productivity would eliminate.

Along similar lines, a study by researchers at the Massachusetts Institute of Technology, published in August in the journal Nature Climate Change, estimated that the value of health benefits Americans would reap from cleaner air could dwarf the costs of U.S. policies regarding carbon emissions--by more than 10 times.

Not A Question Of "If" We Will Pay--But "When"

Allowing for significant vocal dissension, Standard & Poor's takes it as fact that global warming is happening, and that humans are contributing to it. In this light, our approach is to assess the economic costs that climate change will carry.

It seems clear to us that there will be significant costs involved, whether we take stapes now to tackle the problem or simply deal with the consequences as they come--with costs of the latter likely to significantly outstrip the former. Whether or not bearing the brunt of upfront expenses is preferable is a determination we leave for others to debate. We merely point out that they will be much smaller than the price we would pay for inaction.

Writer: Joe Maguire

Credit Market Services:Beth Ann Bovino, U.S. Chief Economist, New York (1) 212-438-1652;
bethann.bovino@standardandpoors.com
Satyam Panday, U.S. Economist, New York (212) 438-6009;
satyam.panday@standardandpoors.com

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