On Friday, October 6, 2023, I participated in a meeting of the ESMA Securities and Markets Stakeholders Group (SMSG), an expert group that supports the EU capital markets supervisor by consulting on a range of ESMA activities prior to their implementation. During the meeting, we discussed the conclusions from the report published by Carbon Tracker Initiative in July of the report Loading the DICE against pension funds. Flawed economic thinking on climate has put your pension at risk.
The author of the report, Prof. Steve Keen, points out that all peer-reviewed articles in the field of economics that predicted the impact of climate change on the economy were based on erroneous assumptions. As a result, the authors of these articles predicted, for example, that a 6°C increase in global average temperatures would cause only a 10% decline in GDP. Advisors hired by pension funds to assess the impact of climate change on fund assets, based on these articles, led the funds to inform their clients that their retirement savings were safe.
The erroneous assumptions pointed out by Prof. Keen had three main sources. First, the authors used historical data from very limited sectors (e.g., agriculture, and even then only for selected crops) and extrapolated historical changes (recorded in periods when the temperature changed by fractions of a degree Celsius) into the future. It is as if, knowing that at a temperature of 15°C, wheat yields are 1% higher than at a temperature of 14°C, one concludes that in order to obtain the best yields, the temperature must be raised to 100°C or 500°C. Secondly, they focused exclusively on temperature increases, ignoring all other effects of climate change, such as changes in precipitation patterns or the frequency and scale of extreme weather events. Thirdly, in their models, they completely ignored the existence of tipping points which, once reached, trigger new mechanisms that exacerbate the ongoing climate crisis, over which we as humanity no longer have any control.
The conclusions drawn by economists from these erroneous assumptions cannot be confirmed by natural sciences. A temperature increase of just 5°C will lead to catastrophic consequences, including the possible destruction of human civilization. If we are talking about the destruction of humanity, how does a 10% decline in GDP relate to this? One of the reasons for this complete divergence between economists' predictions and what we know from the natural sciences is the fact that models of the impact of climate change on the economy were created and modified by a very small group of authors who cited each other. Their articles were also reviewed exclusively by other economists who had no knowledge of the natural sciences. For many years, there was no moment when a scientist from another field would point out: Hey, that doesn't make sense—there won't be any economy or GDP on a dead planet..
Climate change and its impact on the economy are not particularly relevant to someone who opens a one-year bank deposit or purchases three-year bonds. However, when it comes to pension funds, a 20-, 30-, or even 50-year time horizon must be taken into account. The funds that manage our retirement savings have fiduciary duties enshrined in law, including the duty to provide clients with accurate information about all the risks to which our future pensions are exposed. We now know that these obligations have not been performed with due diligence in recent years and that clients have been misled.
Funds, not only pension funds but also others, as well as banks, insurers, and central banks concerned with the stability of financial systems, now have a tough nut to crack. All models and stress test criteria need to be reviewed and adjusted to reflect realistic predictions of what will happen to the economy as climate change progresses. The authorities supervising these institutions also face a difficult task, as they are responsible for overseeing this process. This has already begun in Europe, and the discussion at the last ESMA SMSG meeting will continue.
I must admit that reading the Carbon Tracker report was a difficult experience for me. On almost every page of the document, my eyes widened as I wondered how such basic mistakes could have been made and perpetuated for years. I also realized how much more difficult it will be for companies to prepare scenario analyses of their business model's resilience to climate change when we have to get rid of a number of sources based on such false assumptions. Companies and their advisors also have a lot of work to do. But it is better that we know this now and can get on with the job.
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