2014

CIRCLECosts of Inaction and Resource scarcity: Consequences for Long-term Economic growth

The OECD’s CIRCLE project Further degradation of the environment and natural capital compromises prospects for

future economic growth and human well-being. Without more ambitious policies, the

costs and consequences of inaction on important environmental challenges such as

climate change, biodiversity loss, water scarcity and health impacts of pollution will be

significant.

The “Cost of Inaction and Resource Scarcity; Consequences for Long-term Economic

Growth” (CIRCLE) project aims at identifying how feedbacks from poor environmental

quality, climatic change and natural resource scarcity are likely to affect economic

growth in the coming decades.

Over a series of model developments, CIRCLE will generate reference projections

for economic growth which reflect the costs of policy inaction. These reference

projections will help to improve future OECD projections of economic growth, as

well as assessments of the economics of environmental policies, as they are able

to include not only costs but also benefits of policy action in terms of reduced

environmental damages. This will allow a more informed evaluation of policy options,

and a comparison of the costs and benefits involved.

The first track of the CIRCLE project is a quantitative

analysis of the economic feedbacks of climate change, air

pollution and the nexus between land, water and energy.

The core tool to be used in the analysis is the OECD’s

dynamic global multi-sector, multi-region model ENV-

Linkages, which will be coupled to biophysical models for

an integrated assessment. Using a systems approach allows

focusing on interactions between the various environmental

challenges.

The second track will scope the possibilities to

quantitatively assess water-economy linkages, the economic

feedbacks of loss of biodiversity and ecosystem services

and resource scarcity. If possible, these themes will also be

included in the modelling track at a later stage.

A two-track approach

Climate change

Air pollution

Modelling track

Land-water-energy nexus

Water

Biodiversity andecosystems

Resource scarcity

Scoping track

Climate change is causing impacts that are already affecting

the economy at present and will increasingly do so in the

future. Different impacts will affect different parts of the

economy (such as labour productivity from reduced health

and loss of land from sea level rise), causing adjustments

in all markets through production and trade changes. The

CIRCLE project quantifies the macroeconomic costs of a

set of climate impacts that affect the economy, including

sea level rise, agriculture, energy and tourism, but it also

highlights the unquantifiable consequences that climate

change may cause in the future with the increasing

occurrence of extreme and catastrophic events.

The modelling is based on available literature on how

climate impacts affect the economy of major world

regions at the macroeconomic and sectoral level. Detailed

assessments of the specific impacts are fed into the ENV-

Linkages model to assess the implications for different

economic activities and the overall macroeconomic costs.

This is complemented with a more stylised assessment of

the long-run implications, using the AD-RICE model. Further

work is planned to expand the number of impacts included

and to assess a range of mitigation and adaptation policies.

Preliminary results for the quantitative assessment of

the economic feedbacks of climate change damages have

been included in the OECD horizontal projects on New

Approaches to Economic Challenges (NAEC) and OECD@100,

and are reported in “Consequences of climate change

impacts for economic growth: a dynamic quantitative

assessment” (OECD Economics Department Working Paper,

No. 1135, 2014).

A two-track approach Climate change

Climate change

According to the model simulations, the effect of climate change

impacts on global GDP is projected to increase over time, with

damages increasing more rapidly than the global economy. These

impacts would lead to a gradually increasing global GDP loss

amounting to 0.7% to 2.5% by 2060, assuming firms and households

adapt to minimise the costs. Underlying the global GDP losses are

much larger variations on consequences from specific climate impacts

on specific sectors in specific regions. Among the impacts included in

the analysis, agricultural impacts tend to dominate in most regions.

-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

2010 2020 2030 2040 2050 2060

% change wrt no-damages baseline

Wider uncertainty rangeequilibrium climate sensitivity (1°C - 6°C)

Likely uncertainty rangeequilibrium climate sensitivity (1.5°C - 4.5°C)

Central projection

Global impacts of climate change

Source: OECD Economics Department Working Paper, No. 1135, 2014.

Air pollution is one of the most serious

environmental health risks, particularly in big

cities and highly populated areas. In absence

of new policies, urban air quality will continue

to deteriorate causing serious risks to human health. The health consequences of

air pollution come at a high cost to society, causing premature deaths as well as

increased health costs from additional hospital admissions and use of medicines

or decreased labour productivity.

For this part of the CIRCLE project, ENV-Linkages has been improved to include

emissions of air pollutants. The improved model will be used to quantify the

impacts on GDP of inaction, as well as the benefits of policy action. While the

main focus will be on health impacts, future work may, if possible, also take into

account other impacts, such as on biodiversity or agriculture. The analysis will

include both mortality and morbidity costs. As much as possible the costs will be

split between those that can be directly included

in a general equilibrium modelling framework,

and those that do not correspond to any economic

variable, such as the costs of pain and suffering.

The costs that can be modelled will be included in

ENV-Linkages as economic feedbacks to quantify

the economy-wide costs of local air pollution.

The other costs, which include the valuation of

premature deaths, will be highlighted but not

included in the model.

Policy packages will be studied to quantify

the economic benefits of policy action, with

specific attention to policies that address

simultaneously climate change and air

pollution.

Air pollution

Land-water-energy nexus Economic activity is supported by environmental resources

in many ways. One important link between the economy and

the environment is through the use of scarce land, water

and energy resources. Water, energy and land are essential

for economic growth and development, and there are strong

linkages between land, water and energy (the nexus). Barriers

to the use of these resources may limit economic growth.

Policies neglecting these linkages may be sub-optimal and

might resolve a specific problem with one of these resources

but at the same time impact the others and create additional

(and unforeseen) problems. Therefore an integrated approach

is needed.

The land-water-energy nexus is modelled through linking the

Netherlands Environment Assessment Agency PBL’s spatially

explicit biophysical IMAGE model with OECD’s ENV-Linkages

model. A range of scenarios will be developed to assess the

consequences of reduced availability or quality of land,

water and energy resources. The analysis will first focus on

biophysical bottlenecks regarding water availability, looking

at groundwater depletion and water allocation across sectors.

Next, bottlenecks regarding land availability will be studied,

including scenarios for land degradation and limits to land

conversion. The consequences of these bottlenecks for key

variables such as crop yields will then be linked to economic

activities where appropriate.

The links between biodiversity and ecosystem services

and the economic and social values that they support

are extremely complex. First, economic activities have

an impact on the services that these systems provide.

These services have a value not dissimilar to the values

provided by other goods and services and changes in these

values need to be taken into account in project and policy-

related decisions. Second, a loss of ecosystems makes the

functioning of the economic system less effective. The

regulating services that ecosystems provide contribute to

transport, energy, agriculture, recreation and related sectors.

There are also important feedback links. For instance when

wetlands are converted into agricultural land, its role in

regulating water flow is removed to a large extent and the

risk of floods increases.

These linkages between ecosystems and the economic

system need to be better understood, ideally by integrating

ecosystem functions into traditional economic models.

Furthermore, very little literature is available on how

biodiversity is linked to specific economic activities, and how

biodiversity loss interrupts these activities.

A full integration of the costs of a loss of biodiversity

and ecosystem services into the economic modelling

framework may therefore be beyond the reach of the

project. The scoping activities in this area will focus on the

main opportunities and obstacles in providing a tentative

assessment of the consequences of the loss of biodivefsity

and ecosystems on the macro economy.

Land-water-energy nexus Biodiversity & ecosystems

Biodiversity & ecosystems WaterThere are complex channels through which water affects economic growth, and

traditionally economic models are not suited to investigate the impact of water scarcity

and pollution on economic growth. Water can be seen as partially replenishable. For

production, water is an input that combines with other production factors to generate

output. A key sector is agriculture (both irrigated and rainfed crop production), but

there are also many industrial uses, including cooling for electricity generation and

municipal water uses. Pressure on the resource has significantly increased, in line with

demographic growth and economic development. And even when water use is not

directly consumptive, it may diminish the potential uses by altering the quality of the

water source.

The analysis of water-economy linkages starts with an investigation of the economic

feedbacks of water scarcity and water use. If possible, the water-economy linkages will

be included in ENV-Linkages, and the assessment will be harmonised with the insights

from the assessment of the land-water-energy nexus.

The water-economy linkages work may at a later stage be extended to an analysis of the

consequences of water pollution on economic activity. The latter could focus on health

impacts, analogous to the analysis of air pollution.

Global water demand: Baseline scenario, 2000 and 2050

Source: OECD (2012), OECD Environmental Outlook to 2050; output from IMAGE.

0

1 000

2 000

3 000

4 000

5 000

6 000

2000 2050 2000 2050 2000 2050 2000 2050

OECD BRIICS RoW World

Km3

irrigation domestic livestock manufacturing electricity

The work focuses

on assessing supply

and consumption

characteristics ,

looking at both

supply risks and the

importance of materials

for the economy.

Mineral resources cover a large variety of natural

resources from metals to fossil fuels and enter the global

economy through various applications. Minerals prices

have been decreasing throughout the 20th century due to

technological progress towards extraction and exploration.

This price pattern seems to have found an end with the

sharp increase in world demand and a slowdown in high-

grade deposits discoveries after 2000.

Given the central role played by minerals in the economy,

it is therefore critical to investigate minerals scarcity and

what would be the consequences of supply disruptions,

long-lasting high minerals prices, or high price volatility

on the economy and geopolitics. The Grantham Research

Institute at the London School of Economics contributes

to this analysis through a study which aims at measuring

the criticality of specific non-energy material resources.

Work focuses on assessing supply and consumption

characteristics , looking at both supply risks and the

importance of materials for the economy. A wide range of

materials are being assessed to identify which ones are

most critical. Robustness of available information and

projected trends will also be taken into account. A case

study will then identify the consequences of this critical

material for economic growth. In contrast to the other

CIRCLE themes, this analysis will not be global, but focus on

OECD countries.

Resource scarcity

Project partners The CIRCLE project is led by the OECD Environment

Directorate, with the engagement of other parts

of the OECD and experts nominated by member

governments. CIRCLE also draws upon the expertise

of a number of other institutions which are engaged as

collaborating partners.

These include:

• The Basque Center for Climate Change (BC3),

Spain.

• The Fondazione Eni Enrico Mattei at the

Mediterranean Center for Climate Change

(CMCC-FEEM), Italy.

• The Grantham Research Institute at the London School of Economics and Political

Science (LSE-GRI), United Kingdom.

• The Institute for Applied Systems Analysis (IIASA), Austria.

• The Institute for Global Environmental Strategies (IGES), Japan.

• The Institute for Prospective Technology Studies (JRC-IPTS), Spain.

• The National Institute for Environmental Studies (NIES), Japan.

• The Netherlands Environmental Assessment Agency (PBL), The Netherlands.

More information

Please visit the project website:

www.oecd.org/environment/circle.htm

For information about the main modelling tools used for the CIRCLE project:

www.oecd.org/environment/modelling

Contact us:

shardul.agrawala@oecd.org

(Head of the Economy Environment Integration Division)

rob.dellink@oecd.org

(Co-ordinator Modelling and Outlooks)

Project partners CIRCLECosts of Inaction and Resource scarcity: Consequences for Long-term Economic growth