Environmental Consequences Of The Financial Crisis (Crisis? Which Crisis?)

Environmental Consequences Of The Financial Crisis (Crisis? Which Crisis?)

By Paul E Hardisty

Prof Hardisty examines the parallels between the causes of the current global financial crisis and the emerging global environmental crisis, and the differences in the ways that the world has responded to each. He discusses the possible consequences to the planet’s environment from the effects of the crisis, particularly in the energy sector, and suggests that a real opportunity exists in the current climate to make profound changes to our institutions and decision-making processes, which will re-establish long-term environmentally, socially and economically sustainable improvements in the human condition. Prof Hardisty is Global Director, Sustainability and EcoNomics^TM for WorleyParsons, a major engineering services provider to the petroleum and resources industries. He is a Visiting Professor of Environmental Strategy at Imperial College, London, UK, and Adjunct Professor of Environmental Engineering and Economics at the University of Western Australia.

Introduction – The Exponential Era

We live in the exponential era – a time unique in history, when a confluence of overlapping and mutually reinforcing factors is propelling the world into unknown economic and environmental territory at an exponentially accelerating rate. All eyes today are fixed on the sudden and violent impacts of the financial and banking crisis on the global economy. In the background, however, a rapidly rising global population is combining with quickening development and resource use, surging energy demand and associated atmospheric emissions, expanding need for water and food, over-fishing, forest clearing, alarming loss of biodiversity, and increasingly stronger evidence of the impacts of climate change, to create what many are calling an emerging global environmental crisis^1,2,3.  The questions facing people and governments around the world today are which of these simultaneous crises do we deal with, and how? 

The Financial Crisis: Causes And Responses

The current financial crisis is the result of an improperly-regulated banking and financial sector where the drive for corporate profits and personal wealth created a culture of risk-taking on an unprecedented scale. By “engineering” new debt-based financial products, creating the illusion of value by packaging up high-risk assets (such as mortgages on over-valued properties to people who could not afford them) and presenting them to the market as high-value low-risk securities, profits soared. But, as property prices began to fall and homeowners started to default on their mortgages, these products, now firmly embedded throughout the global financial system, were revealed for what they were – vulnerable and of questionable value. Institutions began unwinding their positions, resulting in accelerating losses, a dearth of liquidity, and eventually the collapse of over-exposed organizations. The repercussions are now flowing through the real economy, stifling investment and eroding business confidence. This crisis is no accident, no stroke of bad luck. Bankers have known from the outset what was involved in this high-risk game. But with such a compellingly large up-side, and little in the way of regulation to constrain activity, the outcome seems in retrospect almost inevitable.

Faced with global financial upheaval, the world has acted quickly and globally. The plans unveiled by various governments over the past weeks to stabilize banks and financial markets involve the allocation of well over $1 trillion of taxpayers’ money. Governments have warned that without this injection of funds to restore the status quo in the banking system, we risk economic disaster on an unprecedented scale.

The US and other governments are now busy buying up the near-worthless securities polluting the balance sheets of financial institutions, supposedly to allow a resumption of lending on a more normal basis. So far however, there is little evidence that funds injected into financial institutions, at the core of the problem in the first place, have calmed equity markets or prevented the onset of recession. The presumption that we need to get the financial sector “back to normal” is flawed, and only exonerates past practice. Aside from the doctrinal hypocrisy of a system that claims to be devoted to the free market, but effectively privatizes profits and socializes losses, the bailout strategy (now likely to extend to the big three US auto makers) contravenes the healthy functioning of the free market by rewarding bad business decisions. Overall, the current strategy is a bad deal for taxpayers.

The Environmental Consequences Of The Financial Crisis

There are also other indirect consequences of this massive public investment which could have significant impacts. Among them are the possible repercussions on the planet’s environment, and in particular efforts to arrest the effects of climate change. Recent studies by the Intergovernmental Panel on Climate Change (IPCC) and national governments have suggested that the cost of transitioning the global economy to a new lower-carbon footing, thus significantly reducing the risks of damage from climate change, is in the order of 1% of global product per year over the next generation^3,4,5.  Depending on the rate of global growth, we need to spend in the order of $200bn a year over the next 20 years or so building new cleaner and more efficient power plants, deploying new low-emissions vehicles and fuels, constructing energy-efficient buildings and communities, saving and protecting forests, planting new trees, vastly improving agricultural and water efficiency, and reducing poverty around the world^3,4.  This spending would generate direct economic activity, stimulate demand for goods and services throughout the global economy, and support innovative new products and businesses⁵.  The energy sector in particular needs significant investment to transition to lower carbon footing. World natural gas production and delivery need to be boosted significantly as part of a massive effort to substitute carbon-intensive coal for cleaner natural gas. Our electrical power generation mix needs to shift fundamentally over the next 20 years towards renewable energy, nuclear power, and clean coal technology^3,4,6,7.  The benefits of all of this investment to the world’s real economy, the planet’s environment, and ultimately the well-being of humankind, would be considerable. 

Over the past 20 years, the world’s economy has experienced a golden age of sustained growth. Despite this, major efforts to confront global environmental issues such as climate change have been largely deferred, often because governments did not want to harm the economy. Now that we have succeeded in damaging the economy by other means, governments and business are starting to claim that now is not the right time to confront climate change and other pressing environmental issues. The massive bailout and impending recession are already being used as convenient justification for yet more delays in taking real action against global warming – in physical, moral and economic terms a far more serious threat to us all than a temporary cooling of the economy. We are now facing the very real prospect of several more years of inaction on climate change and global environmental stabilization, a delay which could end up costing us all very dearly.

The Economic Consequences Of The Environmental Crisis

Part of the problem is that we continue to treat the economy and the environment as mutually exclusive and in conflict. We think that saving the planet will hurt the economy, and that saving the economy means we cannot save the planet. This is perilous thinking. In fact, the economy and the environment are inextricably linked – the economy cannot exist without a healthy robust environment⁶.  Inaction on climate change is expected to result in widespread damage to the world’s economy, costing the planet at least 5%, and as much as 20% of global product every year, now and forever^4,5 (these figures do not include the value of the environmental ecosystems and species that would be irretrievably damaged by significantly altering the terrestrial climate). This level of permanent economic damage would make the current financial crisis seem trivial in comparison. Moreover, recent studies by industry groups such as the US Electricity Production Research Institute (EPRI) have shown that there is a significant economic procrastination penalty associated with inaction on climate change⁷ – the longer we take to make the necessary changes, the more it will cost us overall. From a purely economic cost-benefit perspective, investing in preventing climate change and arresting global environmental degradation is a very good deal for taxpayers (assuming that they would be asked to foot the whole bill, which of course they would not).

Investment In Economic And Environmental Sustainability: An Opportunity For Change

The financial system clearly needs overhaul, and the world’s economy looks increasingly moribund. This period of fluidity represents a unique opportunity to create widespread structural changes to the global financial system and the world’s energy economy which would help drive a more sustainable future for us all, underpinning global efforts to combat climate change, eliminate poverty, and create real wealth. Governments could, for instance, use a goodly portion of the public funds earmarked for the bailout of banks to act directly to inject liquidity into the market, protect mortgage holders and citizens caught in the fall-out, and engage in widespread economic stimulus to business and industry. This could include a significant effort to support businesses developing climate-change combating technologies, services and products, stimulating new exports to a world crying out for low-carbon solutions, lessening the world’s dependence on oil and fossil fuels, and helping to prevent potentially trillions of dollars of future damage from climate change. The amount of money currently being pumped into troubled financial institutions around the world, spread judiciously over a 10-year period, could allow us to make major progress towards saving the planet from a multitude of much more tangible, real risks – rising sea levels, droughts and crop failure, loss of biodiversity and marine productivity, and social upheaval (a recent Pentagon study called climate change the most important threat to world security⁸). Dollar for dollar, this is a significantly better deal for taxpayers. 

At this point in history, business-as-usual, be it in banking, engineering, finance, business, government, or our own personal lives, will simply no longer do. With the effects of global warming and widespread environmental degradation now accelerating alarmingly^2,5,7, rational and ethical foresight is needed. The world’s governments have shown that faced with a crisis, they are capable of acting quickly – this is encouraging. What is needed now is a similar response to deal with the global environmental crisis. If we really want to protect the world’s economy, we need to invest in assets of tangible value, instead of worthless paper. What more tangible that the planet itself?

References

1.   US Committee on Environment and Natural Resources and the US National Science and Technology Council, 2008. Scientific Assessment of the Effects of Global Change on the United States.  

2.   Worldwatch Institute, 2008. State of the World, 2008. Worldwatch Institute, Washington, DC.

3.   Intergovernmental Panel on Climate Change (IPCC), 2007. Fourth Assessment Report. The Physical Science Basis. Cambridge University Press.

4.   Stern, N 2006. The Economics of Climate Change – The Stern Review. Cambridge University Press.

5.   Garnaut, R 2008. Garnaut Climate Change Review. Commonwealth of Australia, Canberra.

6.   Sachs, J 2008. Commonwealth: Economics for a Crowded Planet. Allen Lane, NY.

7.   EPRI, 2007. The Power to Reduce CO₂ Emissions. Discussion Paper, EPRI 2007, Summer Seminar, Energy Production Research Institute, US.

8.   Schwartz, P and Randall D, 2003. An Abrupt Climate Change Scenario and its Implications for United States National Security. Report to the US Department of Defense, Washington, DC.

Copyright MEES 2008.