Opinion: You can kiss your pension and the economy goodbye, unless we fix climate change

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John Rapley is a political economist at the University of Cambridge and managing director of Seaford Macro.

Out of sight, out of mind. That’s how many of us have shrugged off climate change. Sure, we get it’s a thing, but we reckon it won’t affect us too much since we’ll be long gone when it really hits.

But that complacency could start to tilt the calculus. Last week’s blanketing of Eastern Canada by an apocalyptic smoke cloud served as a reminder (the kind we’re getting more often), that climate change may soon be coming to a neighbourhood near us. That, in turn, may begin to hit us in our pocketbooks, in novel and unexpected ways: affecting the performance of the funds that manage your pension, for example.

Hitherto, we’ve regarded events such as floods, wildfires as unpleasant but not, in the end, particularly economically harmful. A big part of that was due to the distorting effect of central bank policies in stimulating economies, but the broader market signals also suggested we had little to fear.

That’s because of the traditional way that climate events get factored into economic models. It inadvertently mutes their effects. Most forecasts of their economic costs spread them over time, locate them disproportionately in the developing world, and expect them to be mildly incremental for years to come. So even though a changing environment may eventually force us to profoundly reshape our economies and lives, outside of specific subsectors where we can measure future costs fairly easily – say, energy companies dependent on fossil fuels that could become stranded assets, or real-estate owners in flood plains – asset markets have not really priced in climate change.

But in the same way few of us gave much thought to the rising incidence of extreme weather or zoonotic pandemics until they hit us in the face, there’s a good chance investors may soon start taking more notice.

It’s true that the daily prices on stock and bond markets are determined by very short-term considerations, such as earnings statements or central bank announcements. Nevertheless over the long term, their underlying value will tend to follow the average performance of the economy. And on that front, the prognosis gets more sobering by the day.

Most models expect that if we don’t arrest climate change, future economic growth rates will slow. Since markets are discounting mechanisms that determine prices according to anticipated future incomes, analysts will probably start taking these models more seriously. Indeed, driving through smoke clouds on the way to work may hasten that awareness.

Who might such long-term investors be? Pension funds, for starters, along with insurance companies, since they set their premiums according to the likely scale of future payouts. Forecasting long-term returns is a fiendishly difficult task, but pension funds are already doing it, and we’re also now seeing how insurance companies are withdrawing products or raising premiums to cover their rising costs. That trend will probably only intensify: Of the 10 costliest years Canadian insurance companies have ever had to bear, nine have occurred since 2011.

Besides, markets hate volatility, and the increasing unpredictability of the weather will make it harder to anticipate where the next big hit will come from, or what its effects might be. Nobody in the market foresaw COVID-19. However, we’re being told to expect more such shocks. Central banks and generous governments won’t be able to rescue us every time. So that will reduce the incentive to extrapolate from past trends to predict future returns.

Take infrastructure. Because a toll road or railway provides a steady and predictable flow of income, infrastructure has become popular among Canadian pension funds, which need to maintain long-term incomes to their beneficiaries. But it also means they own illiquid investments that are sitting ducks should weather events suddenly threaten to destroy them.

That, in turn, points to the danger in inferring that because rich countries will be spared the worst consequences of climate change, they needn’t worry. It is true that the effects will fall most heavily on the people that didn’t cause them, with flooding and diseases such as malaria and cholera hitting developing countries the worst. But the economic costs of these events are falling most heavily on rich countries, simply because we have so much more infrastructure. The bigger you are, the harder you fall.

To top it all off, the future economy underpinning today’s pension funds will require a steady supply of workers. With research suggesting that climate anxiety and economic pessimism are causing young people to have fewer children, even the hardened few who like to mock Greta Thunberg may want to start taking climate change more seriously. Because if they don’t, they may see it surface next in their investment portfolios.