The overlooked costs of climate action (Episode 1)

Note: This transcript is auto generated and lightly edited.

JEAN: Because it's a complete retooling of the energy system, of the housing system, of the building. The buildings are overly expensive. Retrofitting the buildings, they're not made for that. The infrastructure they use in terms of the buildings, they're just not conceived for being climate neutral, as we would say. So that's very, very expensive. And the energy system itself, it's a completely different system that's based on renewables. It requires investment into the grid because the grid has to be able to function with energy sources that are completely different. So it is, for that reason, very costly.

MONICA: So we're reinventing and rebuilding an entire world economy. That is what we're doing.

JEAN: An entire energy system for sure and entire world economy, I think.

MONICA: Welcome to Policy for the Planet, a new bimonthly podcast exploring the global response to the climate crisis.  

I'm Monica de Bolle, a best-selling author and senior fellow at the Peterson Institute for International Economics, based in Washington, D.C. My work bridges the fields of economics, science, public policy, and public health–all under an international lens. 

In each episode, I speak in-depth with experts to understand how governments are responding to the monumental challenges of the climate emergency. We'll unravel the complex tradeoffs of different policy choices to steer us toward sustainable practices and public well-being. 

Welcome to the conversation!

Today, I'm speaking with Jean Pisani-Ferry, who is a senior fellow at the Peterson Institute for International Economics, and was previously a top economics adviser to President Emmanuel Macron of France. Jean is one of the world's leading experts on the macroeconomics of climate action, one of the first to really consider the full cost of moving to climate-neutral economies. 

In his new book, The Green Frontier: Assessing the Economic Implications of Climate Action, editor Jean, along with Peterson Institute President Adam Posen, gather some of the best economic minds to consider the often overlooked — and so difficult — questions: How do we pay for our efforts to reduce global warming? And how much will it actually cost?

JEAN: This book brings good news. It brings the good news that there is a conversation that can develop. Not everybody agrees on everything, obviously, but that's precisely why there can be there can be a conversation.

MONICA: Jean, thank you for joining me on Policy for the Planet and congratulations on the book. You have long been a renowned economist, and more recently, you decided to become an expert on the economics of climate change, an area that is burgeoning now with a lot of new things coming out.

Indeed, I'd like to start there: What compelled you to shift your focus to climate?

JEAN: Maybe the dissatisfaction with the way the economics of climate action was approached.

You know, when I started asking myself what kind of economic transformation it's going to trigger, and it's a major economic transformation. It's an industrial revolution. And it was treated in the literature as a sort of minor event, a minor and a positive in general.

So the sort of the approach, the prevailing approach was it's going to be good for growth, it's going to be good for jobs, and it's going to be a few percentage points higher in terms of the growth impact. So nothing to worry about. But I thought, why is it that when we have to act, we have to recognize that the deterioration of the climate is something we have to act upon. We have to change our economic model. That's essentially something we were getting for free, a clean climate, a pure, a stable climate, sorry, a clean air and a stable climate.

Suddenly we have to care about it. We have to do things to preserve it. And we have to change our energy system. We have to change our economic, many economic activities. We have to change the way we heat, the way we organize transportation, etc. And that cannot be just, you know, unambiguously positive. So that was my starting point.

MONICA: And picking up on that, recently you launched a book here at the Peterson Institute called The Green Frontier. And in that book, there are many different articles by different economists that are trying precisely to get at this problem, the problem of trying to define what are the costs of climate mitigation, because we in climate transition. We do know, of course, that the costs of doing nothing are extreme, are catastrophic. But just saying that is not very helpful because we are in the process of going to net zero emissions. We are in the process of attempting this climate transition. And therefore, you know, there are benefits, obviously, but there are there are costs, as you as you say, and these costs haven't really been very well either communicated or even flagged in some sense in the literature. And yet in the articles or in the papers for the Green Frontier, economists don't yet seem to have a consensus regarding the costs, regarding let's say the potential loss in GDP that might occur in the first few years or the potential job losses that might occur as workers get displaced from one sector to another. So can you talk a little bit about that, how economists are viewing this and how wide the distances is?

JEAN: To start with your question where you started, I mean, we obviously know that doing nothing would be catastrophic. But people, they don't reason this way. People, the reason they have, you know, they use it as a baseline, a sort of business-as-usual scenario. And so to tell them this is catastrophic is not going to help them change their behavior. What they need to know is what are the implications of changing their behavior? What are the personal implications? What are the implications for jobs? What are the implications for the economy?

And so they don't take into account this sort of catastrophic baseline. They take into account the way they live and the way we live and work. And so that's important. And that was precisely the reason why I thought we need to trigger a new discussion to have a debate on what are the economic implications of this action with respect to the scenario in which we continue doing nothing. Because of the way, I mean, it's a fictitious scenario, but it's a scenario that's being used by everybody, essentially. So yes, the way I tend to reason, it's very simplified way of reasoning, but it's that true. I mean, there's a consensus on the amount of investment that's needed. So it's about 2% to 2.5 % of GDP for about 20, 30 years to get to net zero. So there is. If you should look at different countries, they have different estimates, but they're broadly consistent.

MONICA: So Jean, bottom line. Yeah. How much is climate transition going to cost if we were to put it in dollar terms?

JEAN: So if we're speaking of overall costs, we can say that's probably to tune of 3% of GDP per year. Global GDP, which is $3,000 billion per year. Yes, for about 20, 30 years.

That's a lot. And the fiscal cost depends on the instrument that is being used. In my view, it is a sort of a minimum that could be sort of one-fourth of that total that's fiscal. It's also very big. Yes.

MONICA: That adds up to $3 trillion per year, for the next 20 years. And as Jean notes, a quarter of that cost is fiscal, which means public funds — as in, each country's tax revenue.

Why is it so expensive?

JEAN: Because it's a complete retooling of the energy system, of the housing system, of the building. The buildings are overly expensive. Retrofitting the buildings, they're not made for that. The infrastructure they use in terms of the buildings, they're just not conceived for being climate neutral, as we would say. So that's very, very expensive. And the energy system itself, it's a completely different system that's based on renewables. It requires investment into the grid because the grid has to be able to function with energy sources that are completely different. So it is, for that reason, very costly.

MONICA: So we're reinventing and rebuilding an entire world economy. That is what we're doing.

JEAN: An entire energy system for sure and entire world economy, I think.

The question is, obviously this is going to create demand, but if you think a second, what are these investments, what are they going to replace? If they replace investments that are meant to increase productive capacity or improve productivity, and then this investment do not take place, the margin of additional investment is taken on this user investment, then it's not going to be positive. It's going to have an effect on productivity, on the production capacity of potential output. And if they've done in addition, so you increase investment rate, then it's going to change the saving investment balance at global level because that's a transformation that needs to take place at a global level. And so that's going to have an effect on the equilibrium rate of interest, et cetera. So either way, these are significant transformations. And so I wanted to trigger this discussion.

And that's what we did with the volume, with the conference and then with the volume that is based on the conference we held here at Peterson Institute a year ago.

MONICA: So basically the bottom line is we have a climate transition. That climate transition is going to necessitate a lot of things, including investments in new sectors, investments in new, let's say, renewable energies, but also...

JEAN: Investments even in the same sectors, but you just change your technology.

MONICA: You change the technology and to change the composition of investment, which then would create these potential losses. But this isn't to say that these losses are permanent or ongoing, because of course there are benefits that will offset them eventually.

JEAN: Yes. I'm saying yes with a sort of slight hesitation, because I think it's going to be positive in the long run. I think the the technology, everything we learn about renewables, about EVs, et cetera, is to show that the potential of these technologies is considerable. So most probably, in the long run, it's a plus. But this doesn't hide the fact that the transition is going to be difficult. Just think of you have a sort of coal -fired power plant, and that's very much in the South. In the North, this technology has been, investment in this technology has stopped long ago. So the average age of our power plants is something like 20, 30 years.

Decommissioning them is not a big shock. But in the South, the average age is much shorter. I mean, it's something less than 10 years. So you have to put aside capital. And this obviously is having an impact because you're reducing the lifetime of your capital.

MONICA: And of course, this brings up a point that you have stressed several times about the political economy aspects of climate mitigation. Because if we're gonna face the costs of climate mitigation upfront, but we are going to see the benefits in the long term. So there's a timing issue. We first see the cost, later we see the benefits. The typical way by which people react is they react to the cost first, but they don't necessarily associate the benefits that come later with the climate transition per se. And how do we how do we deal with that? How do we deal with that potential political economy problem, which might lead a lot of people to say, well, no, you know, if we're going to have these costs up front, then no, we don't really want this to happen.

JEAN: That's what's called a tragedy of the horizon. Because for people don't have such long horizons. I mean, in their life, in their economic choices, their employment choices, they have much shorter horizons. So yes, it's going to be difficult. It requires a degree of understanding, rationality, trust. Trust also in what Other countries are going to do because there is also this fact that we're speaking of a global common. So the outcome depends on action that's being conducted throughout the planet. So it's really difficult and it's easy to find reasons not to act.

MONICA: Who pays for it all, Jean?

JEAN: Well, that essentially depends on the countries, depends on their conditions, depends on the political economy, depends on the choice of instrument. In some countries, you can ask the private sector to pay more, meaning households and companies. In some other countries, you can't. But there is always a sort of combination of private and public funding. So my rough estimate is that below one-fourth that's being paid by the public budgets, it's hard to think you can achieve the transformation, but it can be much more costly, especially if you're subsidizing massively and if you're doing it the way the US does it.

MONICA: And in a world where we have so much mistrust, especially mistrust in political systems and politicians, that's going to be especially hard. And I think that's another thing that you have highlighted many times. Let me switch a little bit into the tools for climate mitigation, the economic tools for climate mitigation. And there are two that are essentially discussed the most. They're not necessarily the only ones, but they're the ones that are discussed the most.

So one is carbon pricing, the other one is carbon subsidies.

JEAN: That's a very important issue and also an issue that separates the US from the rest of the world, from Europe. I mean, different countries have different strategies in this regard. So let's start with carbon pricing. That's perhaps the preferred option of economists, because it basically has the property of leaving open individual choices. They don't constrain, they don't interfere. It doesn't interfere with individual choices. It just puts a price that corresponds to the external effect of your consumption of fossil fuels.

So this is a preferred instrument of economists and this has a long tradition. I mean, because it started in the 19th century with what we call Pigouvian taxation. There is an externality, just put a price and leave the rest to the market. Yeah, it's like taxes on pollution. Exactly. I mean, yeah, it was actually invented because of the pollution in London and then Pigo put forward this idea of taxing pollution. So that's true, but people don't see it that way. People see they have to pay more for something they used to do. And so why should they change their behavior again? And who is paying for who is supporting them to change their behavior. So that's why I think the US took the opposite option of subsidizing. The Biden administration introduced with the Inflation Reduction Act wholesale subsidies for, you know, paying for investment, paying for EVs, paying for installation of buildings, et cetera. So this obviously has, fiscally, this has the opposite effect. Because instead of taxing and getting a revenue from those taxes, the government has to pay. And so the fiscal consequences are exactly the opposite. But moreover, the big difference is that when you subsidize to reduce your carbon footprint, you do not necessarily do that.

MONICA: There's a price on it, period. It's like, well, how, what you do when you put a price on anything, when you put a price on an iPhone, when you put a price on a book, when you put a price on whatever we think we want to price and we know exactly how much that's going to cost, period. That's it.

With a subsidy, what you're really, what the government is doing is that it is trying to provide an incentive for a company, an individual, whatever it is, to act in a certain way.

And then that individual might act in exactly that way, or it might do something slightly different.

JEAN: So if you're, and this is very much the case in Europe, I mean, if you're helping people insulate their houses, some people, they keep in winter the temperature at a relatively low level because they spend less on heating. But if you're subsidizing the insulation, they may choose to spend the same amount but just be more comfortable. And so that's good from the point of view of helping people to live in better conditions. But that's not helpful at all for the climate.

MONICA: The other issue, I guess, with subsidies is if everybody, let's say every country, tried to go down the subsidy path, you end up with countries undercutting each other. Yes. And with certain countries not being able to apply those subsidies because they don't have the fiscal capacity given that a subsidy is a government expenditure. Can you talk a little about that?

JEAN: We have to always ask yourself, perhaps it's good to start with subsidies. Perhaps it's good to trigger improvements in goods that are available through learning by doing, through research subsidies, et cetera. So that's part of the toolkit.

But to imagine that you can do everything just by scaling up the subsidies that would be unaffordable for government. There is a fiscal dimension in all this debate, which is really significant.

We're speaking of fiscal costs that could easily reach 20% of GDP. I mean, that's huge. That's huge. That's huge for any country, let alone for developing nations.

MONICA: With respect to the mix, how do you see, because I know that this is another topic that you've discussed before, the mix between the two instruments? So in other words, a country that could potentially not have to choose between carbon pricing and carbon subsidies as either you do this or you do that, but rather have both. Have a mix that is that in the end you generate some revenues, you generate some expenditures, both of them are related to climate and you undo in a sense the sort of pushback that you usually get on carbon prices and you also ameliorate a little bit or you offset a little bit the implications of using subsidies alone, something like that.

JEAN: Yeah, the case for a mixed strategy is a very strong case because subsidies alone, as I said, are not an efficient way to trigger this transformation.

Regulation alone is just not possible because you're putting people on front of a prohibition. In Germany they tried. They tried by mandating that when you change your heating system you have to go for a carbon neutral heating system which is more expensive. So people said no, people said no, people in a German way, in a very calm way, but very steady. So it didn't work. And so the case for something that borrows, I mean draws on the various solutions, they're basically pricing, regulation, and subsidies. And finding the right mix, I think, is essential.

MONICA: On the Global South, so switching gears again, we know that the Global South, this is a very broad way of speaking of those countries because we both know and everybody knows that they're very heterogeneous and they're very different. But we do know that they are not yet as advanced economies are close to achieving any of the Paris Accord goals and that they do not have in a lot of cases the fiscal capacity or the technological capacity or both, or, you know, there are a number of issues in global South countries that currently prevents them from moving fast or faster in the direction of climate transition and net zero emissions. So what is your recommendation here? What do you think should be?

JEAN: Well, first of all, I would like to emphasize that, you know, the success of the transition will be decided by what happens in countries like India, South Africa, Indonesia, et cetera. Because that's where they're investing massively in carbon intensive power plants. So coal-fired power plants are still being built at a very high rate.

And the reason is that they're cheaper. They're cheaper to build. And the cost of capital is an obstacle. And the saving-investment balance is an issue. So we can't let these countries, we can't ask them to choose between development and climate preservation.

And we know that if they put ahead of this choice, they would choose development. So we've got to find ways to reduce the cost of capital. And we've got to find a way to support them in their efforts. That's a big discussion now. Because essentially, in the US, in Europe, in China, you can discuss the speed of change. But the direction of change is clear. In those countries of the global south, it's not the direction of change is not clear. I mean, they're still, their emissions are growing and they're growing fast. So it's vital that something be done to support their efforts. And that's going to cost money in one way or another.

 MONICA: With Brazil heading the G20 and with the G20 meeting or the G20 summit coming up later in the year, do you see, because this is on the agenda, these issues related to climate transition are near and dear to the Brazilian president's heart. Do you see the prospect for some advances in the global south discussion of climate mitigation?

JEAN: I think that discussions are taking place. I think that Brazil is also holding the COP 30, so the Conference on Climate. So there is a strong focus of the president government on these issues. And I think it's uniquely placed also to sort of find, to broker a compromise that will ask developing countries, emerging countries to contribute, but also ask advanced countries to find ways to support their efforts.

MONICA: What a great conversation. I want to thank Jean Pisani-Ferry for joining us today — and for sharing findings from his new book, with Adam Posen, The Green Frontier.

The climate transition is going to be expensive and many challenges lie ahead. But, research like Jean's on what we need to invest in and pay for to ensure our planet's future is essential.

Thank you for joining me on Policy for the Planet. Have a question or a topic to suggest? Email me at [email protected]. I'd love to hear from you. 

Don't forget to rate, review and subscribe to Policy for the Planet today so we can keep this podcast going! And even better, please share our show with your friends and colleagues. 

Special thanks to Jennifer Owens and Alex Martin, our producers, and Melina Kolb, our supervising producer. This podcast is brought to you by the Peterson Institute for International Economics. Learn more at piie.com.  

Until next time, here's to creating meaningful impact. Stay motivated, stay curious.