During the last Pleistocene ice age 20,000 years ago, large parts of the Earth were covered by thick ice sheets. Yet, global mean temperature was only 4-5°C lower than it is today. While it is difficult to forecast what will happen once accumulated greenhouse gas emissions will have added 3-4°C to pre-industrial global temperature by 2100, there is no doubt that the world will be very different from what we have been used to.
Hence, climate change is one of the most pressing topics in today’s policy discussions. This salience is backed by a longstanding consensus among climate scientists, who have consistently warned about the potentially catastrophic consequences of climate change.
There is less consensus about the impact of climate change among economists. Classic studies estimate that a 1°C increase in temperature implies at most a 3% reduction in output in the medium run (Dell et al. 2012, Burke et al. 2015). In the face of continued background economic growth, the argument goes, a few degrees of warming by the end of the century seems hardly problematic.
That argument, however, relies on a critical leap of faith. These classic studies relate changes in a country’s output to changes in its local temperature, by effectively comparing how France’s output changes relative to Germany’s when France happens to be a little warmer than usual in a year while Germany is not.
But local temperatures and global temperature are not the same. For instance, global temperature includes ocean surface temperatures, while local temperatures do not. When the oceans warm, evaporation and precipitation regimes can change much more than when a single country happens to warm. To understand the impact of climate change on the economy, we are ultimately interested in global temperature. The key question is then: Is the effect of local temperature comparable to the effect of global temperature?
We address this question in Bilal and Känzig (2024) and propose a direct estimate of the impact of global temperature changes on economic activity. We demonstrate that global temperature implies economic losses that are five to six times larger than local temperature. A 1°C increase in global temperature leads to a 12% decline in output at peak. By contrast, we confirm previous findings that a 1°C increase in local temperature leads to a 1.5% decline in output. Figure 1 shows the response of output to these temperature changes.
Why, then, does global temperature depress economic activity so much more than local temperature? We demonstrate that global temperature captures damaging consequences of changes in the climate system more comprehensively than local temperature. Consistently with geoscientific models, we find that global temperature changes predict a large and persistent rise in extreme climatic events that cause economic damage: heatwaves, droughts, and storms. By contrast, local temperature changes predict a much weaker rise in climatic extremes.
How do these new global temperature estimates change our view of economic activity throughout the 21st century? Consider a scenario in which global temperature rises by 2°C above 2024 levels. Climate change implies precipitous declines in output, capital and consumption that reach nearly 47% by 2100. These changes are equivalent to an immediate and permanent purchasing power reduction of 29%. Put differently, climate change leads to economic losses comparable to the 1929 Great Depression, but experienced forever. Under conventional local temperature estimates, this equivalent purchasing power reduction is only 4%.
We gauge the implications of our results for decarbonization policy by calculating the social cost of carbon—the dollar value of all present and future economic losses around the world associated with emitting one ton of carbon. Under global temperature estimates, the social cost of carbon is $1,065 per ton of carbon dioxide. This value is four to six times larger than existing estimates or our own value based on local temperature estimates ($223 per ton).
The social cost of carbon based on global temperature reverses established policy trade-offs. Most decarbonization interventions in the Inflation Reduction Act cost $80 per ton of carbon dioxide abated (Bistline et al., 2023). A conventional social cost of carbon of $223 per ton implies that these policies are cost-effective only if governments take the benefits to the entire world into account. However, a government that only considers domestic benefits values decarbonization with a domestic cost of carbon, which is much lower than the worldwide social cost of carbon. Under conventional estimates, the domestic cost of carbon of the United States is $45 per ton, making unilateral emissions reduction prohibitively expensive. Under our new global temperature estimates however, the domestic cost of carbon of the United States becomes $212 per ton. In that case, unilateral decarbonization policy becomes cost-effective for large economies such as the United States.
This E-Axes Policy Brief is an abridged version of the 7/21/24 VoxEU column “Why Global Temperature Matters”