The Risk of Switching Too Late

Refinery WaterThere is very little doubt that large scale urban and industrial transformations are necessary if we want to move to a low-carbon economy. The 2015 Climate Agreement in Paris is an important and necessary step towards reducing global carbon emissions, but is it enough?

Switching to low-carbon, renewable and sustainable industrial processes and ditto urban lifestyles is urgent and – crucially – much more cost-effective when done sooner rather than later.

The European Systemic Risk Board just released a report that underscores this point. The report is titled “Too late, too sudden: Transition to a low-carbon economy and systemic risk”. It states:

Global warming, and its implications for the frequency and severity of natural catastrophes, is increasing with the stock of greenhouse gases in the atmosphere. As such, a late transition to a low-carbon economy will aggravate the costs of transition for, among others, general insurers, reinsurers and governments.

This “adverse scenario” could have a serious systemic risk to global and local economies. Directly, because reduced energy supply andClick to download the report increased energy costs would impair macroeconomic activity. But also through second order effects, for instance, because of the collapse of financial institutions with exposure to carbonintensive assets (i.e. real and financial assets whose value depends on the extraction or usage of fossil fuels and other carbon-intensive resources).

The report notes:

These two channels could generate contagion in the broader financial system by interacting with other financial frictions. They might further interact with a third channel: the impact of physical shocks (e.g. natural catastrophes) associated with climate change, which become more likely as the stock of greenhouse gases accumulates in the atmosphere.