The Economics of SustainabilityAn overview of the state of knowledge

Alexander WoodSenior Director, Policy and Markets

Sustainable Prosperity

March 24, 2011

Making markets work for the environment

Sustainable Prosperity• Green economy think tank based at the University of

Ottawa

• Focus is on market and policy innovation in pursuit of stronger, greener, and more competitive Canadian economy

• Market innovation is about talking to businesses and markets about challenges and opportunities related to sustainability, and role of environmental markets

• Policy innovation is about talking to governments about positive relationship between good environmental policy and good economy policy.

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Making markets work for the environment

Presentation• Last 5 years has seen real explosion in research

around economics of sustainability

• That research comes from both traditional research community (academic and public organizations), and also business research community (mostly investment research)

• Presentation will provide overview, based on three broad themes: (ecosystems, climate, and water)

• Basic framing on these issues is around strategic risk management, based on enhanced understanding of costs and opportunities

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Making markets work for the environment

Why economics of sustainability matters

• Sir Nicholas Stern famously referred to climate change as “greatest market failure the world has ever seen”

• Such a failure presents huge challenges to governments in making policy, and to businesses in adapting to that policy

• Important to remember that “greatest market failure” can also represent greatest market opportunity world has ever seen

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Making markets work for the environment

UNEP Green Economy Report

• Report was released in February 2011

• Starting point is “gross misallocation of capital”, particularly over past 2 decades

• Report estimates that financing need for global transition to a green economy is US$ 1.05-2.59 billion p.a. (10% of annual global investments, and 2% of global GDP)

• Ensuring investment takes place is about policy

• Points to positive impact of “decoupling” resource use from wealth generation: EFFICIENCY

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Making markets work for the environment

OECD Green Growth Strategy• Acknowledges growth as engine of human

progress, but recognizes impending limits

• Challenge is to grow without paying environmental penalty

• Some of this is about definitions (i.e. GDP)

• But mostly about dramatically increased productivity of natural resource use

• Again, focus on policy as vehicle for driving enhanced value of natural resources

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Sustainable Prosperity

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Making markets work for the environment

Climate Change

• Stern Review of 2006 is landmark document. Reviewed economic theory and practice on global climate change.

• Concluded that cost of mitigating climate change would total 2% of global GDP, while cost of not addressing it would be as high as 20% of global GDP

• Still considered the seminal analysis of the economics of climate change

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Making markets work for the environment

Climate Change

• Stern report was criticized by economists, though, over rate of discounting used, which was not in line with standard practice

• Debate turns on whether one assumes that even with climate change, we will continue to see BaU growth rates. If so, then it is cheaper for future economy to address climate because it will be a larger economy.

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Making markets work for the environment

Climate Change

• More recent debate in economics research, between:– Traditionalists, who believe analysis of climate change

economics should assume no major climate disruptions and no major impact on global economy

– Liberals, who believe that relying on GDP growth as arbiter of climate policy is insufficient, and that risk management imperative dictates aggressive current action

– Reformists, who believe science points to much higher social costs of climate, much higher risks of inaction, and much lower costs of climate mitigation

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Making markets work for the environment

Climate Change

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Low carbon growth: four roads to 2020 - estimated market size in USDbn

2009e 2020e

Base Backlash Copenhagen Green growth Conviction

Low-carbon energy production 422 774 1,025 1,297 1,043 Energy efficiency and energy management 317 722 1,003 1,410 1,194 Total 740 1,496 2,028 2,707 2,238 CAGR (2009-2020e) 6.6% 9.6% 12.5% 10.6%

Making markets work for the environment

Climate Change

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% o

f tot

al c

ash

flow

% o

f tot

al c

ash

flow

Exhibit 6: For the market as a whole, 15% of total cash flow could be transferred from high to low emission companies by US$60/t carbon prices Estimated share of total cash flow accruing to companies with higher/lower carbon efficiency than sector average, total market aggregate

Exhibit 7: … with a more significant impact on the most carbon intensive industries Estimated share of total cash flow accruing to companies with higher/lower carbon efficiency than sector average, most carbon intensive industries

70% 70%

65% 65%

60% 60%

55% 55%

50% 50%

45% 45%

40% 40%

35% 35%

30%

0 10 20 30 40 50 60

Cos t of direct carbon em is s ions as s um ed (US$/t)

Leas t carbon efficient Mos t carbon efficient

30%

0 10 20 30 40 50 60

Cos t of direct carbon em is s ions as s um ed (US$/t)

Leas t carbon efficient Mos t carbon efficient

Source: Goldman Sachs Research estimates. Source: Goldman Sachs Research estimates.

Making markets work for the environment

Ecosystems and Biodiversity• Major UN report on “the Economics of

Ecosystems and Biodiversity” (TEEB) was released last year

• First systematic efforts to understand the contribution made to the global economy by our planet’s ecosystems and biodiversity

• Loss of ecosystem services by 2050 (at current degradation rates) is estimated at $2-$4.5 trillion p.a. (i.e 7% of global GDP)

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Making markets work for the environment

Ecosystems and Biodiversity

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Table 1: Relationship between biodiversity, ecosystems and ecosystem services

Biodiversity

Ecosystem goods and services (examples)

Economic values (examples)

Ecosystems (variety & extent/area)

• Recreation • Water regulation • Carbon storage

Avoiding GHG emissions by conserving forests: US$ 3.7 trillion (NPV)22

Species (diversity & abundance)

• Food, fibre, fuel • Design inspiration • Pollination

Contribution of insect pollinators to agricultural output: ~US$ 190 billion/year23

Genes (variability & population)

• Medicinal discovery • Disease resistance • Adaptive capacity

25-50% of the US$ 640 billion pharmaceutical market is derived from genetic resources24

Marine footprint

Water use

Pollution & waste

CO2Emissions

Habitat disturbance &

conversion

Sustainable fisheries (e.g. “rigs to reefs”)

Payments for watershed protection

Recycling, Tradable permits

Bio-carbon offsets & REDD

Biodiversity offsets &

conservation banking

Ecosystems and Biodiversity

Water

Canada Global

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Water

• Basic economic issue related to water, as with climate (energy) and ecosystems/biodiversity is how to manage growing supply scarcity against growing demand

• McKinsey report estimates that 60% of water demand in 2030 will have to be met by increase in productivity of supply

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Making markets work for the environment

Water

• Economic research suggests that best driver of productivity is full cost pricing of resource.

• Proof point is in comparing water use in relation to water pricing in similar economies:– Canada: average water use per day per person is

325l, cost for that use is $0.25/0.30

– UK: average water use is about 140l, cost is $1.30

– Germany: average water use is 120l, cost is about $2.20

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Key Points• Economics of sustainability have advanced greatly in

past 5 years

• Contribution to research/analysis increasingly coming from private sector

• Focus is on understanding economic risks, but also economic opportunities

• Point of convergence is around need for dramatic improvements in resource efficiency as path to green growth/green economy, and of role of policy (particularly pricing) in getting us there

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Making markets work for the environment 20

Alexander WoodSenior Director, Markets and Policy

Sustainable Prosperity613.878.7189awood@sustainableprosperity.cawww.sustainableprosperity.ca