Climate change could drive the next financial crisis

The climate crisis will not only have disastrous effects on human life, it will also lead the next global financial crisis – unless something changes drastically. 

The world is facing two interrelated crises which cannot be solved under the current global economic structure. On the one hand, there is a lack of sustainable and equitable growth and on the other is the issue of environmental degradation that will ultimately make the world unlivable.

A report released by the United Nations Conference on Trade and Development (Unctad) notes how economic growth across the world is reliant on the intensive and exploitative use of natural resources and the consequences of this, particularly carbon-heavy growth, are now starting to be felt across the globe.

Climate ‘Minsky moment’

“We have a financial crisis looming because of environmental changes and we have a crisis to existential life,” says Unctad economist Dr Diana Barrowclough. She was speaking on the sidelines of the launch of the report in Pretoria on Wednesday.

Barrowclough provided examples of how climate change could disrupt the effective functioning of the financial system:

• Extreme weather such as floods and drought will result in food insecurity and ultimately extreme migration as people are no longer able to farm in the areas they live in.
• Insurance companies could become bankrupt due to rising claims against flood damage and other weather conditions.
• Carbon-dependent assets will become sunk assets and the values will collapse along with the balance sheets of banks and firms that are heavily exposed to them.

The report argues for a financial and prudential system that is aligned with climate policies in order to avoid a “climate Minsky moment”, where a rapid system-wide adjustment to climate change threatens financial stability, in addition to wider impacts on productivity and growth.

The 173-page document outlines a series of reforms that will need to be instilled under a “new global green deal” in order to achieve this within the next decade. The envisaged deal is a globally coordinated strategy to create increased economic growth, employment and climate stability.

It draws on the 1930s New Deal policy enacted by former US president Franklin D Roosevelt as a response to the need for relief, reform and recovery from the Great Depression.

No more of the same old thing

“The economic mantra that we have been following in the post-financial crisis environment is worsening the planet and not improving it, and [is] benefitting the minority and not the majority,” says Barrowclough.

The new deal calls for a “clean break” from years of public sector austerity and market-friendly policies since the global financial crisis.

Instead, says Barrowclough, the move should be towards fiscal stimulus, increasing wages for low-end workers, growing public investment in decarbonised energy, and green industrial policies enacted through public banks, central banks and development institutions.

Read: Standard Bank shareholders defy board in vote for greener disclosure

Unctad estimates that the new deal could lead to GDP growth rates in developed economies of up to 1.5%, above those generated by current patterns of global demand. For developing economies, excluding China, the gains will be larger, at up to 2% per annum.

If the world increases its total green investments by 2% of global output, which is around $1.7 trillion per year, Unctad economists estimate that this could see the creation of at least 170 million additional jobs while leading to cleaner industrialisation in developing countries and an overall reduction in carbon emissions by 2030. 

This may seem like a lot of money but it accounts for just a third of the amount currently being spent by governments subsidising fossil fuel activity.

South Africa

Gilad Isaacs, head of the Wits centre for the study of industrial development, notes that the policies being implemented by the South African government and the SA Reserve Bank are unfortunately moving us in the opposite direction from what is outlined as being needed for a global new deal. 

The report says we can’t rely on private banking to invest and promote productive and inclusive growth because the sector has failed to do so in the past, with its activities heavily concentrated in speculative activities and channelled through shadow banking practices. 

Unctad maintains that public finance and banking “does the heavy lifting” – therefore public banking should be better supported in the future for it to meet its mandate of focusing on long-term projects whose benefits exceed purely commercial returns. 

On public financing alone, Isaacs notes how National Treasury’s recent economic strategy discussion paper does not speak to the type of fiscal expansionism and centring of public banks and institutions outlined in the Unctad report. Instead, the document places a lot of emphasis on the role of private finance in bankrolling development through private-public partnerships and blended finance.

“The Unctad report shows how this has failed to mobilise large pools of private financing – and when it has succeeded, it has been more expensive than public finance and has amounted in the public purse derisking and subsidising private profits.”

Isaacs says the argument that there is no fiscal room to fund public spending for development does not hold as government can rein in the wasteful expenditure resulting from corruption and inappropriate spending.

He says there are areas of government spending that can be reprioritised without hurting the domestic economy further.

There needs to be an acknowledgment that South Africa’s debt-to-GDP ratio is not particularly high at just under 60%, he adds. 

In addition, the state can still look for progressive ways to increase tax revenue. 

Isaacs says there is room for fiscal borrowing and critical to this is where the money is spent.

The Unctad report’s modelling extrapolates that increases in government spending will pay for themselves, with an increase of $1 billion spending by the South African government resulting in a $1.5 billion dollar increase in GDP. 

Isaacs says it is critical that debt be measured relative to GDP, and that if extra borrowing and spending is able to have a multiplier effect in a way that increases GDP, you both increase revenue to pay the debt and achieve an increase in GDP so that relative debt levels fall.