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The Necessity of Climate Economics

Economics must recognize the central role of negative externalities in the growth process, and integrate the costs and benefits of environmental stewardship and climate action. By doing so, economists could make an enormous contribution to tackling global warming – the biggest challenge facing the world today.

SINGAPORE – The economics profession has failed to anticipate the rapidly escalating climate crisis, just like it missed the looming global financial crisis back in 2008. True, some influential economists are starting to add to the chorus of concern about the threat global warming poses to sustainable economic growth. But mainstream macroeconomic-growth models have yet to integrate the scientific evidence for climate change. They must do so urgently if governments are to take the crucial step of shifting to low-carbon growth paths.

The traditional macroeconomic models used by governments and their development partners, including multilateral lenders such as the International Monetary Fund and World Bank, underestimate or ignore climate effects in forecasting growth, even as some now mention the climate challenge. As a result, governments have many incentives to boost short-term growth and far fewer to invest in climate mitigation, which generally takes a long time to yield visible results.

To begin changing this perilous state of affairs, growth economics must factor in the failure of businesses and governments to tackle global warming. Fortunately, economists have the concepts to do this, in the form of so-called externalities. These spillover effects can be positive, as when a vaccination program provides secondary benefits to an entire community. But climate change involves negative externalities, because firms do not account (or pay) for the societal harm caused by their operations – such as a power plant emitting carbon dioxide.

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