Economic Models Understating Climate Change Challenges, Study Finds

The economic models used by governments, financial institutions and investors are increasingly understating physical climate risk, according to a new analysis.

The report, published by the University of Exeter and Carbon Tracker, warns many economic models are failing to capture extreme weather events and rising uncertainty likely to dominate impacts in a hotter world.

It claims climate damages are structural and compounding, not marginal and it adds climate impacts are increasingly likely to disrupt multiple sectors at once, as physical risks cascade across trade, finance, migration.

The study argues these non-linear impacts are likely to increasingly reshape entire economies and undermine the necessary conditions for economic growth.

And it says this undercuts against a core assumption in many economic models, which assumes economic growth continues indefinitely, merely at reduced rates.

The report argues economic modelling based around gross domestic product (GDP) can mask full harms by failing to account for impacts around inequality, ecosystem and social disruption.

And with global average temperatures trending towards a rise of 2 degrees Celsius in the future, the report warns impacts will become increasingly unpredictable, as tipping points and tail risks increase.

It says policymakers should be wary of climate scenarios extending beyond certain temperature levels and take a “broad spectrum” approach to risks.

Jesse Abrams, lead author and senior impact fellow at Green Futures Solutions, University of Exeter, said climate impacts are not being assessed accurately in current economic models, during an online press conference.

Abrams added this is because current models rely heavily on global temperature averages, and assume climate damages behave like small, incremental shocks.

“The core problem is economic models assume the future behaves like the past, just a bit warmer, while climate science shows we are entering a fundamentally new regime of conditions,” said Abrams.

He added people, infrastructure, and markets are not experiencing climate change as a smooth global average.

Instead, he said they were experiencing it through extreme events, like heatwaves and floods, which can cause enormous damage “while barely moving the global average needle”.

Abrams said many economic models also assume uncertainty stays roughly constant, but as global average temperatures continue to rise, ecosystems and social responses will all become less predictable. T

“Our climate risk radar is mis-calibrated. We are fully grossly underestimating the risk to the economy and to society,” said Abrams.

“We already know enough to act more cautiously, and waiting for a perfect model or cleaner numbers is a risky decision.”

Mark Campanale, the founder and chief executive of Carbon Tracker Initiative, said incorrect economic risk models could also impact the value and performance of pension schemes, during the same online event.

Campanale added the acceleration of climate impacts will fundamentally disrupt the global economy and instead of continuous growth, pension schemes could see negative growth.

He pointed to the recent news about how a row of homes in a village in South Wales is to be bought by the local authority and demolished as they can no longer be protected from flooding caused by the climate crisis.

Campanale said this and recent flash floods across South England are evidence of the types of economic damage we are going to be seeing as a consequence of accelerated climate change.

And he said leading insurance industry experts warned last year a 3 degrees Celsius increase in global temperature could make large parts of the world uninsurable.

“What we want to see is investment managers and trustees accelerate the move away from fossil fuels to a low-carbon future in order to avoid much higher damages to the pension scheme in the future,” he added.

A separate report published by the Institute and Faculty of Actuaries and the University of Exeter last year also warned many policymakers and financial institutions have underestimated climate risks and their economic impact