The E-axes Forum on Climate Change, Macroeconomics, and Finance

Ecosystem tipping points: Understanding risks to the economy and financial system

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Lydia Marsden

University College London

Recent years have seen greater acknowledgement that nature loss, and actions taken to reverse it, could have material economic and financial implications. Proposals to manage these impacts – commonly termed physical and transition risks respectively – may be inadequate in the face of extreme physical risks, such as the wholescale collapse of natural systems in non-linear, self-amplifying transitions known as tipping points. Policymakers increasingly acknowledge the threat of such “ecosystem tipping points”. This Digest reflects on how researchers have explored the socio-economic implications of tipping points in the world’s most critical ecosystems and whether these studies provide sufficient insights for financial policymakers.

Defining and Predicting Ecosystem Tipping Points: Challenges and Implications

Lenton et al (2023) define a tipping point as when a change in part of a system becomes “self-perpetuating beyond a threshold, leading to substantial, widespread, frequently abrupt and often irreversible impact”. They find evidence for potential tipping points in all parts of the Earth system – for example, ice sheets, global ocean and atmosphere circulations – as well as in social systems. Importantly, they show that ecosystems may transition into different states under natural and human-induced disturbances such as habitat loss, species invasions, pollution and climate change. For example, the Amazon rainforest could tip into a savannah or other non-forested ecosystem due to water stress from climate change and deforestation. Other ecosystems such as mangroves, coral reefs, and boreal forests may shift into alternative states that would have local, regional, and global impacts on society. Predicting the certainty and timing of ecosystem tipping points is even more challenging than other parts of the Earth system due to multidimensional pressures on ecosystems (including, but not limited to, climate change) that interact in complex ways across species and feedbacks. The authors suggest that tackling these other drivers, alongside climate mitigation, is essential to reduce the risk of tipping points and prevent widespread social impacts.

Economic and Financial Impacts of Ecosystem Tipping Points

Marsden et al (2024) explain how these types of ecological change would transmit to economies and financial systems. Ecosystem tipping points can best be understood as large-scale and potentially abrupt changes in the quantity and quality of ecosystem services provided by previously stable natural systems. As economic activity is dependent on and embedded within nature, such shifts can cause supply shocks, price rises, and damage assets, as well as affect labour productivity and household consumption. Impacts will cascade through value chains and are likely to be amplified by the macro-financial system. Moreover, the risks from ecosystem tipping points could become systemic – losses to multiple ecosystem services are likely to compound, making it challenging for any actor to adapt to or “diversify” away from large-scale nature degradation like ecosystem tipping points. The authors argue that recent efforts to dynamically model how economies could be affected by these types of catastrophic shifts in ecosystems are likely to be vast underestimates, in part because adaptation possibilities are overestimated. These issues suggest that financial policymakers may need to rely less on models accurately quantifying nature-related risks as a means to managing them. They argue that identifying where financial flows may be exposed to, or exacerbating, negative impacts on ecosystem should be an important avenue for financial policy to reduce system-wide risks.

Dynamic Modelling of Macro-Financial Risks from Ecosystem Collapse

Johnson et al (2021) is one key study that dynamically explores possible macro-financial impacts of large-scale collapses in ecosystems. They use an integrated computable general equilibrium model to simulate the effects of tipping points in three select ecosystem services – wild pollinators, fisheries, and timber provision in tropical provision from tropical forests. This results in 2030 real GDP declining by 2.3 percent, compared to a business-as-usual (BAU) scenario where no tipping points are crossed. The global figures obscure significant regional heterogeneities, for example, low-income countries could see a 10 percent drop in GDP by 2030. The authors explain that these relatively overall mild economic losses in their model hinges on the modelled ability of the economy to adapt to shocks through price adjustments, substitution, and trade. Adjusting these parameters results in higher losses for a BAU scenario, but an updated study found it was unable to solve when more conservative assumptions on adaptation were combined with the ecosystem tipping point scenario.

Potential financial influence over ecosystem tipping points

Galaz et al (2018) focus on equity markets as a potential arena where financial actors may influence the emergence of tipping points. They identify a concentrated group of financial actors, termed “Financial Giants” that hold broad and deep positions in companies associated with land use drivers of tipping dynamics in the Amazon rainforest and boreal forests in the northern hemisphere. The authors suggest avenues through which this financial influence could be mobilised to increase ecosystem resilience but point out that action may be hampered by various political and economic barriers to environmental governance through private corporate governance. Increased attention is needed from policymakers and scholars on how to move forward in addressing these links between financial actors and non-linear changes in the Earth system.

 

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