Economic Case for Fighting Climate Change: Stronger Than Ever

For decades, we’ve been told that economic growth and environmental protection are in conflict. It’s a zero-sum game where gains in one come at the cost of the other. But that idea isn’t just a bit flawed, it’s counterfactual.

A new wave of data-driven economic thinking suggests climate action and economic prosperity aren’t enemies at all. In fact, tackling climate change might be the most profitable path forward.

Climate Change as a Market Failure

The science on climate change is clear: human-driven climate change is real, and its consequences are accelerating. Thousands and thousands of peer-reviewed studies document this. While our climate models are constantly being refined, the basic cause-and-effect relationships are well understood, as are the effects of climate change. But understanding science isn’t the same as knowing what to do about it, especially when it comes to economics.

In economic terms, climate change is a classic market failure. For generations, we’ve treated the atmosphere as a free dumping ground for pollution and greenhouse gas emissions. That’s textbook “tragedy of the commons” behaviour: no one individual or company pays for the full cost of degrading a shared resource and in the end, everyone suffers.

As a result, the price of carbon-heavy goods and services doesn’t reflect their true cost to society. These unaccounted-for damages (rising sea levels, extreme weather events, crop failures) are examples of negative externalities.

Take the example of a coal plant. It emits carbon dioxide and causes downstream pollution. But costs like health issues, environmental degradation, or infrastructure strain aren’t included in the price of electricity. They’re externalized. Other industries, like alcohol or tobacco, face taxes to account for their externalities. Fossil fuels? Not so much, and it’s costing us a great deal.

According to a 2023 analysis, climate change in the form of extream weather events is costing us $16 million an hour, or close to $2 trillion per year globally. This includes the cost of damage to infrastructure and property, agricultural losses, as well as human health costs. That figure may grow as the effects of climate change add up. This, of course, depends on how much we do to reduce and address climate change. Every degree of average temperature increase will cost us around 12% of global GDP, according to some estimates. Without any action, half of our economy could be wiped out by climate change by the end of the century.

Of course, these are all just general estimates, and there’s a great deal of uncertainty when it comes to climate change economics. But this uncertainty shouldn’t paralyze us. Economics Laureate Lars Peter Hansen, whose work focuses on uncertainty in markets, says we need to work with this uncertainty and accept it. He also worked on mechanisms for pricing this uncertainty, and improving such mechanisms will be crucial for our climate transition. So how do we fix this market failure?

Emissions Have a Cost

The most straightforward way is with a carbon price. There are two main ways to do it, both with their supporters. The first one is a carbon tax: set a fee for each ton of greenhouse gas released. Businesses will know exactly how much pollution will cost them, and this helps them predict and prepare. The problem is you don’t know how much this will cause emissions to fall, and the “correct” price for carbon is a subject of heated debate. The second is called an Emissions Trading System, or ETS. You set a total cap on emissions and sell or auction tradable permits. This way, you let the market decide how much emissions are worth, which can offer more predictability regarding the total cost of emissions, but the price can swing wildly, which makes it difficult for companies to react.

Hybrid approaches are also possible. The European Union, for instance, is coupling its existing ETS with a Carbon Border mechanism, adding tariffs on carbon-heavy imports from countries with weaker rules. California also has a floor and ceiling for its ETS; but ultimately, the problem is that the carbon price is too low to drive a globally meaningful impact.

Joseph E. Stiglitz has called for more impactful policy. Stiglitz who will take part in the Panel Discussion on Climate Change in Lindau next week has called climate change humanity’s World War III to convey the gravity of this crisis and underscore the need for an urgent and global respond, and has spoken in favor of carbon pricing. In a recent report, he called climate change a “wicked problem” that cannot be easily or quickly solved, but rather must be addressed by a variety of interventions over an extended period of time. “Carbon prices are immensely valuable policy instruments. They bring many benefits, which include encouraging cost-effective emissions reductions, helping to harmonize policies with climate goals, and enlisting all of society’s efforts in reducing carbon emissions: if everyone faces the consequences of higher prices associated with carbon emissions, then everyone has an incentive to reduce those emissions.”

William Nordhaus, another Laureate in economics, has integrated climate change into long-run macroeconomic analysis. He, too, advocates for carbon pricing as a means to incentivize emission reductions. This approach could have other benefits in society. There’s a common concern that carbon taxes may hurt low-income households. But if revenue from carbon pricing is redistributed, through tax cuts or green investment, it can actually reduce inequality. A well-designed system can be progressive, not regressive. But governments can’t and shouldn’t have to do it alone. Public policy can be the catalyst and the market maker, but the scale of the problem means we need to align massive investment to make an impact.

These can come through tools like Public-Private Partnerships (PPPs), which bring private capital and expertise into big infrastructure projects, from offshore wind farms to electric rail systems. Climate investment grants and funds, especially to support underdeveloped nations in their green transition, can make an outsized positive impact. And then there’s the rise of green bonds – debt instruments earmarked for sustainable projects. The market is now worth nearly $3 trillion, growing sixfold since 2018. Green bonds reached 6.9% of all bonds issued by corporations and governments across the European Union in 2024.

The Elephant in the Room

Despite overwhelming scientific consensus and growing economic incentives, political action remains the elephant in the room when it comes to climate change. While technologies are improving and markets are slowly aligning with green priorities, real progress hinges on bold, coordinated policy – and that’s where momentum stalls.

Climate change may be a global issue, but national politics are local, short-term, and increasingly polarized. Many leaders still see climate action as politically risky, and in some cases, outright denial or delay wins votes, even when it’s economically counterproductive. Investing in climate action makes economic sense, but economic sense doesn’t always get you elected. The result is a patchwork of underwhelming efforts, voluntary pledges, and inconsistent enforcement.

There’s also a perverse incentive to let others do the work for you. If one country slashes emissions, everyone benefits – whether they helped or not. The Paris Agreement tried to solve this by getting every country to submit its own climate plan, then ratcheting up ambition over time. But because participation is voluntary and there’s no practical enforcement, progress has been too slow.

Some economists, like Nordhaus, have proposed a tougher approach: climate clubs. Members would agree on strong climate policies like a carbon price and green investment. Then, they would add sanctions or tariffs for other countries or products that are bad for the climate. Suddenly, cutting emissions isn’t just about saving the planet – it’s about keeping access to lucrative markets. This is what the EU has tried to implement, with limited success.

Yet, ultimately, climate change is in itself an economic problem that can be addressed economically. The cost of inaction is staggering. The opportunity for innovation and investment is massive. If we can align markets, policy, and public support, saving the planet may just become the best deal we can get.