Climate Change: 2025-30 Rather than Long-Term Impacts

Climate economists and policymakers traditionally think about climate change issues out to 2050, but what are the macroeconomic impacts out to 2025-30 from investment plans and also the climate events that are already happening?

Figure 1: Implications of Net Zero Policy Packages on Debt, Relative to “Business-as-Usual” Baseline, by Fiscal Component (% of GDP) 

Source: IMF 

Macro Upside on Climate Change Investment

To achieve net zero by 2050, government green investment is a key catalyst to bring in private finance and also to provide leadership. The net government debt increase required to meet net zero are moderate (Figure 1) in themselves, but assume that carbon taxes will increase significantly (without this the advanced and emerging economies would be 10% and 26% higher respectively). The global estimate is that climate change investment will need to pick up to $5trn per annum by 2030 to lay the foundations to reach net zero by 2050 (Figure 2). 

Figure 2: Annual Mitigation Financing Needs by 2030 to Achieve Net Zero by 2050 ($trn per annum)

Source: IMF

While climate economist’s focus on the shortfalls of investment to get to net zero and cap the global temperatures rise to 1.5%, macroeconomists and market participants are looking at the macroeconomic benefit of an accelerated push to combat climate change, but also the wider macro and political effects. The Biden administration’s climate change policies in the IRA act has been a key factor in sustained business investment growth in the U.S. from a cyclical standpoint and is expected to continue to do so structurally in the 2025-30 period. In the EU, climate change policies are backed by both EU and national fiscal and private investment to mean a different trajectory for climate and overall investment compared to the fiscal austerity era 2009-15. China is also accelerating the roll out of solar power as part of its climate change plans.

Macroeconomics can receive a reality check from politics however, this very much part of what the IMF has termed a trilemma of achieving climate goals, fiscal sustainability, and political feasibility. If Donald Trump is reelected U.S. president in November 2024 it would likely mean withdrawal from the 2015 Paris accords and reversal of some of Biden IRA investment in electric vehicles and other climate change measures. Irrespective of party, it remains unlikely that carbon taxes will play a major role in the U.S., given political opposition. China climate policy is also fluid, with the Ukraine war spike in gas prices prompting a rebound in domestic coal production for energy security and cheap energy at the cost of climate change policy credibility among climate scientists and economists. However, President Xi does believe in climate change investment provided it is aligned with China’s overall and energy security. For the 2025-30 period, China green investment plans appear sufficiently committed to ensure that an aggressive ramp up on renewable energy (mainly solar) will be evident. Only the EU is truly committed on renewable electricity in the remainder of the 2020’s, both due to broad political consensus in most EU countries and also the energy shock caused by imported gas price surge after the start of the Ukraine war. Nevertheless, the political reality means that climate economist’s optimal investment and carbon tax plans are unlikely to be achieved in the major 3 countries/blocks. 

Other EM’s countries, face an uphill struggle, as rising government debt/GDP means that fiscal space is only modest and government have competing demands depending on their the stage of economic development. Compared to the DM world they also face higher mitigation investment needs, larger carbon revenue reliance, and higher borrowing costs that are sensitive to debt. Without government spending to draw in private finance and act as an anchor investor, EM climate change investment will likely not rise to the needed estimates of $2trn per annum and some countries will not see a windfall from green investment. On a wider perspective, it has to be remembered that the 2015 Paris accord allow countries to move at different speeds to net zero, given years of failure to agree a unified agreement.

What will the impact of new climate change investment be on GDP forecasts in the 2025-30 period? This is a big uncertainty for macroeconomists, both as these are long-term projects that kick into GDP at the start of construction and also as the political support could change (e.g. 2024 U.S. presidential election). The OECD has in the past estimated a small to modest annual GDP impact per annum in the period to 2050 (here). However, our macroeconomists are starting to notice a difference in U.S. business investment, while the EZ trend growth is better than post GFC due to the EU green deal and next generation funds. This may not dominate cyclical macro forecasts, but it something that we will monitor/integrate and continue to work on quantifying.

Figure 3: Key Energy Importers 2021 (Petajoules ) 

Source: Continuum Economics

Overall, we feel that the thrust among most DM countries ex U.S. and China will remain towards extra domestic renewable electricity investment, both as it combats climate change and provides energy security. This will also tend to curtail the drag from energy imports for certain countries (Figure 3).The U.S. is however pivotal both in itself and globally and so the big swing event is the U.S. presidential election. We feel that it will be close, but that Joe Biden will likely be reelected and sustain existing policies – though Congress will likely see the GOP control the House and curtail additional climate change investment measures.

Climate change policies are also not solely renewable electricity investment however, which can sustain fossil fuel demand and energy imports. Opposition to heat pumps in Germany, curtailing of methane from cows in the Netherland and Ireland, plus the delay in the 2030 target for new cars in the UK have shown that even Europe’s long-term policies face political opposition. Additionally, green hydrogen is the 2030-2040’s solution for steel/cement production and truck/ship/plane transport actually reducing emissions, but committed investment for green hydrogen is modest compared to the renewable electricity production boom. It is appropriate to think of the green investment wave as split in two: renewable energy and green hydrogen. And even in regard to renewables, there other considerations, as changes in wind speed caused by climate change may affect future wind power output.

For the rest of EM ex China, it is also a question of domestic and international finance for renewable electricity investment and other climate mitigation. India has sufficient momentum to sustain the boom in new solar production, but S Africa had to depend on G7/China support and the next couple of years will remain dominated by power cuts due to old electricity production. Weaker EM and frontier countries are the most at risk of not having the funding to ramp up the easy and cost effective renewable electricity production (e.g. solar and wind).

Climate Change in the 2020’s and Inflation

Huge flooding in Pakistan, heatwaves in India and China, droughts in Brazil, have temporarily impacted GDP in the last couple of years for EM countries. Additionally, this summer U.S./Canada heatwave and wildfires, plus EU heatwave and fires (here), did have an adverse economic effect by reducing production on a temporary basis and causing damage to homes and other assets. The vast majority of scientists say that these events have been made much more likely by climate change and are a taste of still larger climate change disruption to come, while also causing major social and politics concerns. However, in narrow cyclical macroeconomic terms, DM economies can quickly undertake temporary extra government spending to curb the impact of these climate events. Meanwhile, north hemisphere countries are resilient economically and institution wise to deal with the climate change events. Most long-term studies find that northern European countries are likely to see the least direct climate change fallout e.g. Climate Change Performance Index (here) and Figure 4. Even so, some in the ECB are wary that climate change could bring with it a series of new adverse supply-side shocks, with a much greater frequency of extreme weather events resulting in the destruction of harvests and agricultural land. As this would likely affect mostly energy and food prices, which tended to be particularly salient for consumers, they caution that this would affect household inflation expectations and, in turn, wage negotiations.

Figure 4: Climate Change Performance Ranking

Source: CCPI

Instead, the most directly affected countries are lower income emerging markets such as Sudan, Chad, Mali, which is important to the human race but has only a small too modest impact on global GDP until mass migration starts. An IMF working paper shows that temperature shock tends to persistently reduce GDP growth (here), while drought and storms have more transitory impacts. When temperature persistently rise too high, it risks a major migration wave northwards from Africa to Europe and Middle East/SE Asia probably also towards Europe, as Russia and China will block such movements. This has obvious added political repercussions.

Larger DM and EM countries are impacted by other issues arising from climate change. Probably the most important is global food production, where a rise in global temperature suppresses crop yield and hence potentially overall food production (Figure 5). As with other climate issues the complexity is the non-linearity, where 2c of warming has a much greater impact than 1.5c of warming. Food production being suppressed hurts production and output, but the demand/supply impact also pushes up food inflation that can curtail consumption and also hurt GDP growth. For EM countries with high weight of food in CPI baskets this is important and our EM economists are sensitive to this impact on their 1 and 2yr inflation forecasts as well as medium-term. The impact of green investment on base metal prices and cost of production is also an issue.

Figure 5: Accelerated Fallout From Overshooting Temperatures (%) 

Source: IPCC 

Renewable energy investment, plus electric vehicles, should boost structural demand for base metal commodities during the 2020’s. The risk is that this will lead to higher base and rare metal prices in the second half of the decade, as mining experts note that demand will likely exceed supply estimate and prices will have to rise to incentivize new mining and also reflect the long delay before new supply occurs. This will likely feedthrough the production system for green investment.

Meanwhile, the lack of investment in new oil production in recent years also means that the second half of the 2020’s could see a squeeze on oil prices. As we noted the transport revolution is a separate story from the faster electricity power transition. IEA and other estimates are that oil demand will decline in the 2030’s, but still reach a peak in the second half of this decade. If OPEC+ cap oil prices by increasing production then this should not produce a super spike for oil prices and related products, but if OPEC+ for geopolitical or economic reasons squeeze oil then a period of $100 plus per barrel could be evident. 

However, gas prices are also an influence on CPI inflation baskets, especially in Europe where they are critical for home heating and retail electricity prices. The good news for European disinflation is that 2025 sees the North Qatar gas field coming on stream and new LNG export facilities in the U.S. that are expected to significantly shift the global demand/supply balance in the gas market. This is expected to lead to persistently lower European gas prices from Eur55 to Eur25 looking at the TTF forward curve (Figure 6).

Overall, this is a cross current of forces on CPI inflation, though we maintain the view that these will likely modestly added to inflation in the second half of the 2020’s. However, the impact will vary through years given the disruptive nature of the climate transition on commodity prices. Our economists will incorporate this theme alongside other influences, though the impact will diverge across the countries that we cover.

Figure 6: European Forward Gas Prices (TTF Eur Mwh)

Source: Bloomberg