Economic models need to go beyond GDP to account for climate change

Regulators need to move beyond traditional economic models to assess and understand the devastating and compounding impacts of climate change, a survey of climate scientists has found.

Governments, regulators and investors tend to understate the impact of climate change on long-term economic growth because the models they rely on do not hold up under higher levels of global warming, the study from the University of Exeter, Carbon Tracker Initiative and Aurora Trust found.

While climate stress testing and estimates used by central banks and other economists use mean annual temperature and GDP, the climate scientists surveyed believe the estimates are too low, as relying on just GDP does not capture the full picture.

“There was strong agreement that standard economic models seriously underestimate the real risks from climate change, with many climate scientists finding that linear damage curves do not match what they observe in science,” the report says.

Economic modelling flaws

The flaws in economic modelling around climate change have been criticised before. Previous reports from the University of Exeter find that climate economists are not accounting for tipping points – climate events that create irreversible change – in their models.

Even the Network for Greening the Financial System (NGFS) has acknowledged their short-term scenario analysis does not account for tipping points and estimates could be worse than expected.

Meanwhile, a widely referenced paper used by central bankers that found climate change would cause far greater economic damage than had previously been reported was retracted after economists noticed an issue with some of the data. While the researchers are planning to resubmit the paper with the correct data, there is a worry that it could cause more scepticism around climate change research, said Jesse Abrams, lead researcher on the study and senior research impact fellow at the University of Exeter.

Using models that are known to be wrong by climate scientists leads to “incorrect or dangerous decisions, and doesn’t prepare us for the risk that’s coming,” said Abrams.

Sophie Heald, senior climate specialist at Ortec Finance, said that while she’s been critical of the NGFS, they do encourage users to build on their models where the information is available, and to incorporate uncertainties like tipping points.

“A lot of NGFS scenarios are being used or applied incorrectly because they’re just being taken as given and not factoring in many of these other risk drivers, which I think that the scenarios are designed for those other factors to be incorporated in as well,” she said.

Closing the knowledge gap

Abrams and the other researchers want to help close the gap between what climate scientists and economists say is the future of the world under climate change. There is not enough time for regulators and decision makers to wait for models to be perfect.

“Governments, regulators, investors should already be adjusting how they use scenarios and risk assessments … the flaws of these models need to be acknowledged by or made known to decision makers, governments, and they need to not be used to make decisions,” said Abrams.

One of the themes in the report isn’t about pricing everything with precision, but ensuring the resilience of the financial system, said Heald.

“There’s really a fundamental shift in mindset that’s going to be required for exploring and modelling these types of scenarios,” she said.

The report calls for closer collaboration between economists, asset managers and climate scientists.

It also suggests several ways that economists might be able to move away from using GDP as the only estimate of growth. While GDP is often used because of its convenience, understanding the economic impact from climate change goes beyond just one single number, the study finds. GDP does not take into account mortality, inequality, cultural loss or disruption from climate change and “underestimate[s] true losses by recording spending flows rather than the destruction of capital and wellbeing”.

Respondents also found that relying on global mean temperature hides regional differences and could cause an oversight in potential shocks to supply chains and financial systems.

Instead, respondents suggested taking into account other measures, such as expanding climate to go beyond just global temperature but also precipitation, humidity, sea-level rises, and the frequency of extreme events. Others suggested broadening what is measured to include metrics like mortality and inequality, and paying greater attention to tail risks rather than estimates.

The survey is just the start, says Abrams.

The researchers hope to find funding to further their project to include organisations of roundtables and workshops with climate scientists and economists, as well as expand the survey reach to include more exports from the global south.

“We need to get to a point where we’re more proactive and identify these risks, and start trying to implement adaptation measures [so] that once these risks materialise, we have a way to defend against them,” Abrams said.

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