The $36 Trillion Bill for Neglecting Climate and Free Trade

By Tom Orlik, Bjorn Van Roye, Maeva Cousin, Johanna Jeansson and Jamie Rush

November 13, 2020, 12:00 AM EST

In the Covid crisis, governments have struggled to find the right national policies—and also to coordinate an effective global response. They’ll have to do better when it comes to confronting the biggest challenges of the age: rising temperatures and a fracturing world economy.

Taken together, rapid action against rising temperatures and a renewed commitment to globalization would put the world economy on track for 2050 output of $185 trillion. Delaying moves to cut carbon emissions, and allowing cross-border ties to fray, could cap it at $149 trillion—the equivalent of kissing goodbye to the entire GDP of the U.S. and China last year.

If there were such a thing as a global economic planner, they would clearly pick the first option.

In the real world, it’s not that simple. Whether they’re in Washington DC or Beijing, Brussels or New Delhi, leaders don’t typically make the pursuit of a global optimum their top priority. They’re focused instead on national interests, and the relative economic strength that determines the geopolitical pecking order.

Choices in the fight against climate change, and the degree of cross-border integration don’t just affect the size of the global economic cake. They affect how it’s divided up as well.

An early start on cooling a hot planet would be good for everyone, but it would benefit Southern-hemisphere emerging markets much more than advanced Northern economies. And the same goes for globalization. More of it would make all countries better off—but the biggest gains would accrue to middle-income economies sprinting toward the technological frontier, not wealthier rivals attempting to cling onto their competitive edge.

In that sense, Donald Trump was right.

For the U.S., commitment to a low-carbon, free-trade future would—all else being equal—hasten the moment when it gets overtaken by China as the world’s biggest economy. In Bloomberg Economics’ baseline forecast, that seismic shift occurs in 2035. By 2050, China would have significantly extended its lead.

In an alternative future, where the U.S. delays action against climate change and throws up barriers to trade and technology transfers—as it has in the past four years—China catches up with the U.S. in the 2040s, but never moves decisively ahead. In a smaller and hotter global economy, the U.S. would still have a claim to the number one spot.

Forecasting this far into the future isn’t a precise science. Bloomberg Economics projections represent the best estimate of stylized models that don’t claim to account for every variable. Still, they provide a sense of the immense impact that paths chosen today will have on the size and shape of the world economy. And the conclusions are clear enough.

The Covid shock—more than a million dead and the worst recession since the 1930s—provides a wake-up call on the need for an early, aggressive and coordinated response to the threat of climate change and risk of de-globalization. That response will have distributional implications that may not look favorable to governments in the West, and they will be tempted to hit the snooze button.

Without farsighted leadership, progress on the greatest challenges of the age will be difficult to achieve.

The World Economy in 2050: Base Case

Bloomberg Economics has used a growth accounting framework—adding up the contributions of labor, capital and productivity—to forecast potential GDP through 2050 for 39 countries.

On its current trajectory, the world economy in 2050 will be much bigger than it is today. Bloomberg Economics’ baseline forecasts suggest global output will more than double from a projected $84 trillion in 2020.

And the balance of economic power will shift. China’s rapid catch-up on technology and India’s expanding workforce will make them the biggest contributors to global growth. With aging populations and a harder slog to boost productivity, the U.S., Japan, Germany and the U.K. face slower growth and a shrinking world role.

A baseline forecast, though, is far from a foregone conclusion. The current track will lead to some profound shifts in the geopolitical order. But not every country will welcome that outcome. Some are already adjusting policy to avert it. And those changes could put the world economy on a different path.

With that in mind, we’ve layered on scenarios for globalization—exploring whether economic, financial and technology ties will strengthen, or splinter. And we’ve worked through different trajectories for climate change. The transition to carbon neutrality could start early, lowering the cost. It could start late, raising the cost. Or it may fail to materialize at all—risking a catastrophic rise in global temperatures.

De-Globalization: Winners and Losers If Global Ties Untangle

U.S.-China relations are at their lowest ebb in a generation, a potentially chaotic British exit from the European Union looms and the pandemic has created new concerns about cross-border supply chains. It’s easy to find evidence of rising concern about the costs of globalization.

That’s understandable.

Increasing trade flows and higher levels of immigration have been good news for owners of capital, but bad news for blue-collar workers priced out of a job. The Covid shock, and the shortage of masks and medical equipment that hampered the initial response, has turned control of supply chains into a life-and-death issue. China’s rapid rise has reshuffled the global GDP rankings and shifted the geopolitical balance, to the consternation of the U.S. and its allies.

It’s also a problem.

Global trade makes the allocation of resources more efficient. Cross-border capital flows support investment that can help economies grow faster. Both encourage the free flow of ideas and innovation—pushing back the technological frontier for advanced economies, and allowing emerging economies to catch up.

Put simply: globalization is good for growth. If it stalls, or even goes into reverse, potential output will be lost.

It’s possible to estimate what those costs would be. Bloomberg Economics has used the KOF Institute’s measures of globalization, along with in-house measures of investment and productivity, to estimate the relationship between globalization and potential growth.

We use that information to model two scenarios:

• Advance. Globalization continues at a slow but steady pace matching the average over the past decade.

• Retreat. Global integration reverts to the level reached in 2000—the year after the creation of the euro and before China joined the World Trade Organization. By 2050, that results in a 17% shortfall in world output relative to the advance scenario.

The costs of a retreat would not fall equally amoung countries. In general, emerging markets—the biggest winners from export opportunities and technology transfer—would pay the highest price. Advanced economies would suffer smaller losses:

Among the biggest losers: Vietnam, South Korea and China. In our model, a rollback of globalization would knock around 30% off 2050 GDP for this group of Asian exporters, relative to the outcome if global ties continue to advance.

The U.S., France and the U.K., in contrast, would escape relatively unscathed. For mature, advanced economies, a reversal of globalization would lower 2050 GDP by about 5 to 10 percent.

King of a Hot Planet: How Climate Change Affects Economic Rankings

Wildfires in California, drought in Africa and floods in South Asia hammer home the danger of rising temperatures. Bloomberg Economics has built long-term GDP forecasts for major economies on three stylized scenarios: a hot planet—where temperatures rise an additional two degrees by 2050; a smooth transition to carbon neutrality, capping the rising in temperatures; and a bumpy transition.

The forecasts integrate estimates from the Network for Greening the Financial System (a working group of central banks), the Organization for Economic Co-operation and Development and Bloomberg Economics’ work using the National Institute Global Econometric Model—a structural model of the global economy.

Rising temperatures depress productivity, as workers swelter. They also divert capital from infrastructure and industrial projects to less productive uses, like flood defences. The costs have already reached an estimated 1% of global GDP. Forecasts drawing on climate-impact models suggest they will rise by another 2% through 2050 if emissions are left unchecked. By 2100, the total hit to global output will be about 10%.

Once again, the blows to growth land unevenly, with emerging economies close to the equator suffering the most damage.

India and China are among the biggest losers, facing an additional drag on 2050 GDP of around 4%, as more extreme weather events, from heatwaves to floods, hit populous and productive urban regions. Losses for Asia’s emerging giants are five to six times larger as a share of GDP than those projected for the U.S. or major European economies.

It’s too late to prevent climate change from doing further economic harm. But according to the best estimates, the world has a shot at avoiding costs equal to 1% of GDP by 2050—and 8% by 2100—if emissions cuts begin immediately.

To avoid the worst consequences of global warming, the rise in temperatures has to be capped well below two degrees. That requires net CO₂ emissions to hit zero between 2050 and 2070—an outcome that’s inconceivable without sweeping changes in the way economies work.

In an orderly adjustment scenario, action begins immediately, with the cost of a ton of carbon rising by $10 dollars a year from 2020. As prices increase, the development of new technologies accelerates. Greater efficiency, electrification, more renewables in the energy mix and—crucially—carbon capture help economies switch from increasingly expensive fossil sources to cheaper green alternatives.

These technological adjustments would greatly reduce the economic costs of the transition. While some regions will still suffer more than others, the global impact would be manageable—only about 2% by 2050.

If action is delayed, the cost will be higher. In a bumpy transition scenario, governments belatedly recognize that not enough has been done to cap rising temperatures. They respond by ramping up the cost of carbon sharply—by $35 per ton each year from 2030.

The abrupt adjustment raises the risk that technologies like carbon capture can’t develop fast enough to to cushion the impact. In that case, the economy can only meet emissions targets by producing less—raising the cost to 6% of world GDP by 2050.

India, Saudi Arabia and China are among the worst-affected countries. In the smooth mitigation scenario, they face a shortfall in 2050 GDP of close to 3%. If efforts to cap temperature gains start too late for advances in technology to take the strain, those costs rise to an eye-watering 12%, 10% and 7% respectively.

Hot and Fragmented or
Cool and Co-ordinated?

The outlooks for globalization and climate change are interconnected. A world where cross-border economic, financial and technological ties are fraying is also one where it will be harder to achieve consensus on how to cap temperatures.

And the reverse is also true. A world where rising temperatures and extreme weather events drag on growth, and climate refugees clamor at the border, is likely not a world where the case for long-run benefits from trade and immigration will get much traction with voters.

Putting the scenarios together, the consequences for the overall size and structure of the global economy are enormous. By 2050, a world where globalization continues to advance and efforts to mitigate climate change are early and effective would have annual GDP at around $185 trillion. In a world of unravelling globalization and a delayed response to rising temperatures, that figure falls to $149 trillion.

A hotter and more fragmented world, with a smaller economy, would also be one where GDP rankings change by evolution rather than revolution. High-potential emerging markets like China and India would suffer most from de-globalization and a delayed carbon transition. The more serious those problems are, the smaller the change in the economic hierarchy.

If globalization continues to advance, and major economies launch an early and effective campaign to cap rising temperatures, by the mid-2030s China will outstrip the U.S. as the world’s biggest economy. And by 2050 it will have opened up a considerable lead.

If globalization swings into reverse, and the fight against climate change starts too late, China won’t catch up with the U.S. till the 2040s. From that point on, our forecasts show the two global giants moving in parallel, with neither pulling decisively ahead.

It’s a high-stakes prisoners’ dilemma—and one made more complex by the unequal payoffs and low trust between the sides. Is a cooperative solution possible? Can the U.S. and China defuse tensions between them and refocus on the shared gains from global engagement?

Security hawks in the U.S. would say no: the differences between democratic and single-party political systems, market-and state-based economies, are too wide to bridge. Many in Beijing would reach the same negative conclusion, but for different reasons. In their view, Washington has turned against China because it fears losing global supremacy, not out of concern for human rights or market freedoms—so nothing China can do, short of curtailing its own development, will satisfy the hawks.

Still, the experience of the late 1990s and early 2000s—when a China pursuing governance and market reforms and a U.S. and Europe confident in their own capabilities found a way to work together—shows a possible path forward. As China prepares to launch its 14th Five Year Plan, Joe Biden’s election win opens a new set of policy possibilities for the U.S., and the Covid crisis lays bare the costs of coordination failures, there just might be an opportunity to take that higher road.

Sources: Bloomberg Economics, NGFS, OECD, NiGEM, KOF Institute

Editor: Ben Holland

Graphics: Sam Dodge

Methodology

To quantify the relationship between globalization and potential growth, we employ trivariate VAR models with time-varying parameters and stochastic volatility (TVP-VAR) in the spirit of Del Negro and Primiceri et al. (2015).

We estimate a model that combines the KOF Institute’s aggregate globalization index with Bloomberg Economics’ estimates for capital deepening and total factor productivity. The point estimate as well as the uncertainty bands for the elasticity over time are estimated with Bayesian methods; the uncertainty bands represent 68% of the posterior probability distribution. The model is estimated over a time span from 1980–2019. Structural shocks are identified by means of a lower triangular factorization. For the globalization scenarios, we run shock-specific, conditional forecast exercises with our model’s posterior median point estimates as in Antolin-Diaz et al. (2020). For the conditional forecasting exercise, the most recent elasticity estimates from the TVP-VAR are used. All estimates are carried out with the new version of the BEAR toolbox.

Estimates for physical costs from climate change and for mitigation costs associated with capping global temperature rises to well below two degrees are derived from three representative scenarios developed by the NGFS—for a hot house world, orderly transition and disorderly transition. These estimates are supplemented by analysis from the OECD and by NiGEM modelling to obtain more granular estimates at country level. We use global estimates of physical costs from climate change from the NGFS and map these estimates onto countries by scaling country-level results from the OECD (2015 and 2018) to global estimates from the NGFS. These estimates only capture chronic impacts from climate change and miss low-probability, high-cost risks such as ice-sheet collapse, mass migrations or social conflict, which are too complex to model. Mitigation costs are derived from the NGFS integrated assessment models at the global and regional scale. Country-level estimates are then obtained by shocking the cost of carbon in the climate change extension to the NiGEM model.

NiGEM is not built to capture the deep structural changes and technological progress that will be triggered by such a large increase in carbon prices. It tends to overestimate the shock by ignoring productivity improvements that make the cuts easier to achieve. We therefore apply regional productivity shocks to country results, so that regional estimates from NiGEM match that from the NGFS.

This approach assumes homogenous regional productivity shocks—not all regions are homogenous and we have made adjustments to ensure that individual countries are associated with groups that better match their technological, institutional and geographical features.

The $36 Trillion Bill for Neglecting Climate and Free Trade

The World Economy in 2050: Base Case

Heading East

De-Globalization: Winners and Losers If Global Ties Untangle

Growing Together or Slowing Separately?

Globalization in Reverse

King of a Hot Planet: How Climate Change Affects Economic Rankings

Better Start Early

The Uneven Costs of Rising Temperatures

The Price of Delay

Hot and Fragmented or
Cool and Co-ordinated?

Cool and Coordinated or Hot and Fragmented?

Larger Pie, Bigger Share for New Economies

Smaller Pie, Smaller Share for New Economies

The $36 Trillion Bill for Neglecting Climate and Free Trade

The World Economy in 2050: Base Case

Heading East

De-Globalization: Winners and Losers If Global Ties Untangle

Growing Together or Slowing Separately?

Globalization in Reverse

King of a Hot Planet: How Climate Change Affects Economic Rankings

Better Start Early

The Uneven Costs of Rising Temperatures

The Price of Delay

Hot and Fragmented or Cool and Co-ordinated?

Cool and Coordinated or Hot and Fragmented?

Larger Pie, Bigger Share for New Economies

Smaller Pie, Smaller Share for New Economies

Hot and Fragmented or
Cool and Co-ordinated?