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Climate change and emerging markets after Covid-19

Foreword

The world stands to lose nearly half of its potential economic output by the end of the century. That’s the shortfall we face if we fail to make further progress on climate change.

Laurent Ramsey
Co-CEO Pictet Asset Management, Managing Partner Pictet Group
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But this is only an average. Emerging markets are at risk of faring even worse given their particular vulnerabilities to rising sea levels, drought and slumps in agricultural output.

It’s a bleak picture. But there are also reasons for hope.

The scientific consensus on climate change is becoming widely accepted, and governments, individuals and businesses have started to act. With the benefit of some clear thinking and careful planning, much more can be done. Particularly across the emerging world.

Everywhere, human ingenuity, technological advances and the understanding that comes from experience and education are all positive forces that will drive efforts to mitigate climate change and to help us adapt to its effects.

This paper by Professor Cameron Hepburn and his team at the University of Oxford Smith School of Enterprise and the Environment offers a deep and broad analysis of the risks and opportunities emerging economies – and the world more generally – face from climate change. Their insights are based on the latest economic and climate modelling techniques.

It is research we at Pictet Asset Management are proud to have sponsored. The dynamics this report describes will play a critical role for investors over the coming decades. The pace at which governments act will determine how capital should best be allocated, be it regionally or across asset classes.

 

Do you integrate climate change issues in your asset allocation?

Our responsibility as managers of our clients’ assets is to understand the forces that shape our world, not just during the coming quarter or two, but sometimes over lifetimes – indeed, this frames our pioneering thematic approach. It also underpins our commitment to investing in emerging markets, which, notwithstanding short-term fluctuations, represent the greatest potential for long-term economic growth. Just think of the enormous strides these countries have made over recent decades.

Such are the foundations on which Pictet has grown during the past two centuries. But as talented as our own analysts, economists and investment managers are, we recognise there is always more to learn. For nearly a millennium, Oxford’s academic community has created a well of knowledge that has profoundly influenced the course of humanity. Our own history suggests that we have also had some success in taking the long-term view. 

Which is why we have forged this partnership with Oxford’s Smith School. Thanks to their vast expertise in both environmental economics and emerging economies, 

Professor Hepburn and his team have produced insights here that aren’t available anywhere else.

Laurent Ramsey
Laurent Ramsey Group Managing Partner and co-CEO, Pictet Asset Management

And, extraordinarily, they’ve done so through the lens of one of the most traumatic global developments in modern memory.

Compounding the challenge of how to negotiate the long-term peril presented by climate change is a more immediate crisis – the Covid-19 pandemic that has ravaged communities around the world. As this paper makes clear, the vast fiscal and monetary packages governments continue to put in place to support their economies over the near term can also considerably help efforts to limit global warming over decades to come if invested wisely.

Thankfully, the worst-case outcome, that of failing to do anything more to prevent global warming than we already have, is unlikely. Governments, businesses and individuals have recognised the need for action and have put steps in place.

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Rather, the issue is: how much do we do? We can’t take for granted that all the effort will come from the developed world. Emerging countries are at risk of suffering disproportionately from the effects of global warming. And I think they are rising to the challenge – not least because taking measures is an investment that will often reap considerable rewards, and not just over the very long term.

In some areas, emerging economies are even well placed to take a lead. China already accounts for the lion’s share of photovoltaic cell manufacturing, is at the forefront of research and development and is one of the biggest adopters of the technology. Renewables combined with decentralised energy systems could help other emerging economies escape the need for massive investment in large networks. And as renewables become ever more cost effective, many of these countries could end up with cheaper energy than their developed rivals.

Some of the measures governments introduce, such as redirecting fossil fuel subsidies towards renewable energy sources, will be temporarily unpopular because they run counter to embedded interests. But the economic justification is clear. As the cost of power generated by renewables falls, fossil fuels will become ever less attractive. Great swathes of infrastructure devoted to fossil fuel production and use will be mothballed.

Ultimately, the work done by Professor Hepburn and his team leaves us hopeful. The challenges posed by climate change are huge. But they’re not insurmountable. And the emerging world has both its role to play and rewards to reap.

Download the full report

>



webinar

 


Webcast with Professor Cameron Hepburn and Laurent Ramsey

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Costing climate change

Climate change will cause enormous damage to economies, especially in the emerging world. People in China could be 25 per cent poorer by the end of the century than if there were no further climate change if we do nothing more to slow the rise in global temperature. For Brazil and India the shortfall is likely to exceed 60 per cent, according to modelling by a team of environmental economists at Oxford University’s Smith School in a new report sponsored by Pictet Asset Management.

Globally, that deficit could reach some USD500 trillion – as a worst case, nearly half of the world’s potential economic output would be lost by the end of the century compared to potential in the absence of further global warming. But this impact won’t be spread evenly. Some of the world’s biggest emerging economies are at greatest risk, particularly if they leave the heavy lifting on slowing climate change to the developed world and do little themselves. Vulnerable to rising sea levels, drought and severe weather events, these countries need to take action to limit climate change.

Climate change could cost some USD
500tn
to economies globally by the end of the century.
Source: Climate Change and Emerging Markets after COVID-19 report, October 2020

Fortunately, they increasingly recognise that the effort will be worthwhile. Worldwide, people are aware of the challenges presented by climate change, understanding that it leads to a loss of biodiversity, more flooding, arid farmland, forest fires and the like. And so governments are being forced into action. Thankfully this now makes the worst case a relatively unlikely one.

But merely sticking to current policies doesn’t do enough either.  The loss in potential GDP per capita would be smaller, but not by much. At best the loss in potential GDP per capita might be reduced to 32 per cent from 46 per cent. And that’s without factoring in impossible-to-predict cascading effects where small incremental changes lead to a suddenly catastrophic outcome.

But were countries to act collectively, they could make up a significant chunk of that foregone output. That means action by developed and developing countries.

The Oxford team’s “current policies” scenario is that global warming would be some 2.8 degrees Centigrade above pre-industrial levels if efforts were limited to the richest countries, with 1 degree of that warming having already occurred. Should that temperature increase be cut to 1.6 degrees under an ambitious programme that included emerging economies, potential losses could shrink to a quarter or less.

GDP per capita impacts by country by 2100 by scenario
% change relative to SSP2*
Fig5e_website

High-Ambition Scenario: immediate climate action is taken by all countries, including in emerging-market economies, thus limiting the rise in global average temperature to 1.6°C above pre-industrial levels in 2100.
Current Policies Scenario: mostly follows current policy pledges, largely involving action by developed countries (2.8°C in 2100). 
Worst-Case Scenario: no action to mitigate global climate change (4.3°C in 2100).

* The Shared Socioeconomic Pathways (SSPs) are a family of five modelled socioeconomic pathways of global change that each draw on several plausible ways societies might evolve through the 21st century. SSP2: Middle of the Road consists of a world following a path in which social, economic, and technological trends follow historical patterns including growth inequality.

And right now, there is a unique opportunity for countries, rich and poor, to make radical progress towards limiting the likelihood of catastrophic climate change. The Covid-19 pandemic has been a huge global shock. Public health measures, such as lockdowns, have inflicted huge financial costs. Governments were quick to respond and have committed vast sums to economic recovery. In many cases it makes financial sense for this expenditure to be directed towards measures that mitigate climate change.

Download the full report

>



webinar

 


Webcast with Professor Cameron Hepburn and Laurent Ramsey

webinar


Emerging woes

China and India are jostling for greater geopolitical influence, within the emerging world and beyond. Their ambitions are manifold. For instance, China aims to lead the world in AI technology, India to take China’s manufacturing mantle. But over the long run, they won’t achieve their aims through armed conflict on some high Himalayan glacier.

Rather, they’ll only do so by working towards the same goal of limiting global warming – and, along the way, will ensure the survival of the glacier they both claim.

A major, concerted effort at limiting how much global temperatures rise over the coming decades will pay significant dividends not just in China and India but for emerging economies generally. Were developed and emerging countries to work together in limiting global warming, they could roughly halve the loss in output they face by the end of the century compared to if there were no further climate change.

Emerging economies are much more vulnerable to rising global temperatures than their advanced counterparts. For instance, major cities around the world face annual losses of between USD300 billion and USD1 trillion in output from climate change-related sea level rises, according to modelling by Oxford University’s Smith School, in a report sponsored by Pictet Asset Management. China alone has 15 cities that risk losing as much as 4.7 per cent in GDP per capita per year from rising sea levels.

Sea-level damage
Average annual losses as share of GDP, %
Fig5c_website