The scenarios used in today’s climate risk projections were created by economists with little understanding of global heating, but experts say they can be improved with the help of scientists, better data, and greater attention to the needs of the most vulnerable.
Co-hosted by Green Central Banking and the Climate Safe Lending Network and moderated by Madison Condon, associate professor of law at Boston University, a panel of experts discussed the problems with current climate risk scenarios—and how to fix them.
Underestimated Risk ‘Like The Titanic Sinking’
One fundamental problem with the climate risk scenarios financial institutions are using to guide investment decisions is that the numbers they deploy “have been made up” by people who have no understanding of climate change, said Steven Keen,an economist and research fellow at University College London. Such ignorance is long-standing and entrenched, he said, citing American economist and 2018 Nobel Prize winner William Nordhaus as one of the originators of the “nonsense” numbers that underpin mainstream climate risk scenarios today.
Nordhaus assumed as early as 1991 that 87% of GDP would hardly be affected by climate change because it happens indoors (this is mistaking the weather for the climate, Keen has written in a blog post). He also thought the relationship between temperature and GDP at the time could be used to predict what will happen as the whole planet’s climate changes. And he neglected tipping points “to predict a small and smooth fall in GDP from a given rise in temperature.” Correcting for such persistent errors could mean that “the economic damages from climate change are at least an order of magnitude worse than what are now forecast,” Keen said. “Unfortunately, the scenarios we’re all using are based on the work of the economist, not the climate scientists.”
The financial sector’s modelling is akin to “modelling the scenario of the Titanic hitting an iceberg, but excluding from the impacts the possibility that the ship could sink, with two-thirds of the souls on board perishing,” wrote executives from the Institute and Faculty of Actuaries, in their introduction to The Emperor’s New Climate Scenarios, a book co-authored by panelist Sanjay Joshi, a consultant at Hymans Robertson in London.
“Many of the most severe impacts we can expect from climate change, such as tipping points and second order impacts, simply do not exist in the models,” they added. Such myopia needs to be corrected, as it produces scenarios of “limited” use which “do not communicate the level of risk adequately.”
“More dangerously, the artificially benign results can easily serve as an excuse for delaying action, as consumers of these results, such as policy-makers and business leaders, may reasonably believe the results to adequately capture the risks.”
Echoing these concerns, Sahil Shah,co-founder of the Tipping Frontier, said standard economic models are “incredibly reductive” and inclined to “heavily underestimate what seem to be the overwhelming majority of the macro-economic impacts of climate hazards.”
Central Banks Compound the Problem
Given the uncertainty inherent in even the most granular climate risk scenarios, central banks must refrain from acting as intermediaries for global financiers, said political economist Ann Pettifor,a member of the Scottish government’s Just Transition Commission.
“Right now our central banks exist primarily to maintain security and stability in global financial markets, and global financial markets are effectively out of control,” Pettifor added.
Central banks must acknowledge that they have a key role to play in helping the world decarbonize, and act upon that knowledge. As things stand, they deny they have agency and that they can play a role in helping governments finance the transition, Pettifor said.
Taking on that role is imperative for central banks, “because the private sector are timid mice in the face of a crisis,” Pettifor added. By contrast, a central bank has the power to act like “a roaring lion” in defense of national security threats like those posed by climate breakdown.
Levels of Risk
Shah flagged the complexities and difficulty in assessing the deeper impacts of major natural hazards alongside the more direct, immediate damages. Citing Hurricane Katrina as an example, he said that “if you look at the speed of response and the divergent macro-economic outcomes in terms of recovery between the poor communities and the wealthier communities, when you have hurricanes in other parts of the United States, there’s a very strong divergence even for similar hazards or similar intensities.”
A related problem, particularly for poorer jurisdictions, is the lack of “vulnerability data” that would allow policy-makers to anticipate the kind of infrastructure collapse—of a bridge, for example—that leads to other “non-linear” damages. These in turn can drive a community’s experience of damage “an order of magnitude higher” than an economic model might otherwise project.
Differing time frames are also an issue, Shah added, contrasting the one-year time horizon of, say, the World Food Program anticipating food shocks in an El Niño year, to the 50- to 70-year view of an infrastructure investor.
Those differences are a particular problem “in the democratic West,” Shah said, “where the short-term incentives and the long-term incentives aren’t necessarily aligned for climate resilient infrastructure.”
In emerging markets that are being “starved of finance, he added, the urgent need for climate adaptation means the whole idea of a time horizon is moot.
“Mitigating climate risk in and of itself is not just about reducing emissions,” Shah said. “It’s also about financing adaptation.”
Better Risk Models
While it’s impossible to give stakeholders “a full, quantitative picture of all the possible severities of a climate catastrophe and the likelihood of each one,” Joshi said he and his colleagues were working on “narrative-based approaches,” built on “an actual event happening in the actual world”—like a shock to the global food system—that might either provoke protectionism or be seen as a “wake up call” to rapidly decarbonize. The important twist, he added, is that these scenarios “aren’t abstract numbers coming from other numbers, but are about real things happening.”
For Shah, the future lies in “significantly more complex bottom-up modeling at a more localized level.” He compared global models with the “much more granular” and therefore “much more useful” modelling done on a national level.
Risk modellers must also find ways to share more critical infrastructure data, for example on hydro dams, without compromising national security. Shah said “new sets of data governance trusts” like Icebreaker One are worth exploring.
Finally, because climate risk is “incredibly multidisciplinary,” so too must be the expert communities that generate the scenarios of what will happen, under what levels of warming, and when, Shah said.
Keen advocated excluding economists from the process entirely, but Shah said an ideal mix would be one-third each of climate scientists, economists, and social scientists. That latter group is critical, he added, because so much “depends upon human behaviour.”
Swifter, Fairer Climate Action
Condon asked panelists whether encouraging financial institutions to “efficiently and effectively price their risk” could lead to “rapid divestment from the most vulnerable of places,” leading to a rise in human suffering.
Joshi said a partial answer lies in educating investors on the idea of “universal ownership”: that “the systemic harms that come about from externalities in one corner of your portfolio, affect the rest of your portfolio.”
But Keen pointed to a more basic problem: “We don’t actually have the decision-making systems to handle the scale of the challenge we face, and this is largely a product of deregulating and privatizing everything,” he said.
The fact that we are now asking pension funds how to mitigate climate change shows just how much of a fix we are in, he added. “How do I maximize the returns to my shareholders while mitigating climate change? The answer is, you don’t.”
Agreeing that a massive regulatory overhaul is overdue, Pettifor recommended beginning with central banks. Lending for the purposes of speculation must be banned so that all available funds are available to “productive activity”—which in these overheating times means climate mitigation and adaptation, she said.
“This is not radical. This is not new,” Pettifor added, describing “wise lending” as the default practice of 50 years ago.
Citing the bailout of Silicon Valley Bank, and asserting that “very few of us know that the banks are too big to fail,” Pettifor made a pitch for a well-educated public. Climate action requires political will, she said, and a dearth of will correlates to a lack of public understanding and a public unable to act in its own defence.
