Intergenerational thoughts

The Treasury’s latest Intergenerational Report has made headlines for the following claim:

“The direct impacts of higher temperatures on how we work are just one of the channels through which climate change will impact labour productivity, but one which could be significant. If global temperatures were to increase by up to 3°C or over 4°C, without adaptive changes to current ways of working, Australia’s aggregate labour productivity levels could decrease by 0.2 to 0.8 per cent by 2063.

This is a significant economic cost, reducing economic output over this period by between $135 billion and $423 billion in today’s dollars, through the direct impacts of higher temperatures on labour productivity.”

If $423 billion sounds like a big number, that’s because it is. But Treasury isn’t saying that we could lose nearly 20% of GDP if the globe warms by over 4°C; it’s saying that we will lose that much “by 2063”, at which point the economy will be significantly larger:

“The real economy is projected to be around two and a half times larger than today, and real incomes around 50 per cent higher, by 2062–63.”

Australia’s GDP is about $2.2 trillion today. That means that by 2063, Treasury expects it to be $5.5 trillion in today’s dollars, equating to an annual growth rate of about 2.4%: (5.5/2.2)^(1/(40-1))-1.

So the worst case scenario of “over 4°C, without adaptive changes to current ways of working” that leads to the $423 number would mean Australia’s GDP is instead about about 7.7% smaller than projected by 2063. On an annual basis, GDP grows by around 2.2% each year instead of 2.4%: (5.1/2.2)^(1/(40-1))-1.

A future loss of that magnitude is nothing to sneeze at, but it’s also important to put it into context when deciding what the appropriate policy response today should be. For example, it wouldn’t make much sense to spend more than 0.2% of GDP each year over 40 years so that future Australians will potentially be 7.7% better off – i.e., equal to that 0.2% a year over 40 years.

But how much are we already spending, you ask? In its most recent Budget, the Australian federal government allocated $24.9 billion out to 2029–30 “to deliver climate change and energy transformation priorities”.

On top of that there’s considerable state and territory climate abatement spending, and the off-balance sheet Clean Energy Finance Corporation, Australian Renewable Energy Agency, National Reconstruction Fund, and Clean Energy Regulator. Those combined would all run well into the tens of billions. And that’s just spending: there are also considerable costs to economic activity today that come from abatement legislation, such as mandating the shutdown of coal-fired power plants and requirements to use only energy efficient vehicles and appliances (no more gas stoves for you, Victoria!).

But let’s just ignore all of that for now. The total recent Budget spending out to 2029-30 alone equates to about 1.13% of GDP, or nearly 0.2% per year.

In other words, the amount the Australian federal government is currently spending each year to prevent climate change equals the potential annual cost of the Intergenerational Report’s worst case scenario. And if the government’s spending does nothing to reduce global climate change – quite likely, given Australia accounts for just 1% of global CO₂ emissions – then most of that spending will be for nought: economic activity will still be 7.7% smaller by 2063 due to climate change plus about that much again due to the government’s abatement spending, which could have been used more productively otherwise.

Now don’t get me wrong, there are very good reasons for wanting to become more carbon conscious and to gradually shift economic activity in that direction (a revenue neutral carbon price would be a good start!). But the potential economic cost of climate change in Australia is not one of them, and we certainly shouldn’t be paying overs to transition to carbon-smart alternatives before it makes fiscal sense.