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Climate change and Covid-19: reflections on efficiency versus resilience

According to the author for both, the climate change risks and the Covid-19 pandemic, there is a discrepancy between how scientists worry about these global risks and how most risk managers and economists integrate them into costs and prices. Therefore, both pose the question of how to reconcile these different approaches of dealing with them. The author explains the common intuitive thread between a Black Swan and what he calls a Green Swan. Due to the global nature of Green Swans, he advocates more cooperation to prevent them. He provides some additional thoughts on global negative externalities, and suggests that Covid-19 could be classified as a Green Swan. In his view, the effects of global risks such as pandemics illustrate the trade-off between efficiency and resilience. He argues that the lessons should help to engineer a recovery that mitigates, or at least will not aggravate, the risks of new climate-related Green Swans.

BIS: speech
14 May 2020
Source: Bank for International Settlements

Speech by Luiz A Pereira da Silva based on remarks at the OECD Chief Economist Talk Series, Paris, 23 April 2020 and a Research Webinar at the BIS, 13 May 2020.

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The speech/paper elaborates on ‘The green swan – Central banking and financial stability in the age of climate change’, an e-book published by the BIS and the Banque de France. It discusses how to deal with global risks such as climate-related risks, as manifested in more frequent and more destructive weather catastrophes, which pose a growing threat to financial stability. It suggests that climate-related risks and pandemics such as Covid-19 have similarities. Both are massive global negative externalities and both are related to changes in our natural ecosystems. In addition to the extensive economic and financial damage they both produce, both directly affect human lives and thus could be classified as Green Swans. And, for both, there is a discrepancy between how scientists warn us about the quasi-certainty of their occurrence and how we fail to systematically consider their potentially huge costs and integrate them into risk frameworks and final prices.

Due to the global nature of these risks, the paper advocates more global coordination and local cooperation to prevent them, which will require changes in risk models and mindsets in many directions and by many agents (central banks, governments, civil society, the private sector etc). Since these global risks threaten financial stability, the current mandate of central banks has an important role to play, which has led to their timely and encompassing response. But no single actor has a silver bullet to solve this type of crisis. So, what lessons should we draw from the current crisis to better prepare our socio-economic organisation? The major issue is the cost of prevention and of insuring ourselves, in order to reduce these risks and better price them. Importantly, the unprecedented loss of global welfare associated with Covid-19 this year, coming along with growing social awareness of climate-related risks in the last few years, might have led to a tipping-point for social behaviour, by convincing people that it is best to pay for some form of insurance against these global risks.

More generally, the effects of global risks such as pandemics illustrate the trade-off between the efficiency and resilience of our production systems. Insurance is a small price to pay (locally and globally) for greater sustainability and resilience. Finally, many policymakers are advocating a ‘green recovery’, learning from the crisis but also recognising the challenges. In that light, there are many practical suggestions for, inter alia, massive but selective public investments that might contribute delivering a timely, more sustainable, ‘green recovery’ with a lower carbon footprint, mitigating or at least not aggravating the risks of new Green Swans.