The pandemic has underlined the importance of preparing for unlikely risks and provides useful lessons on how the world should tackle climate change, said Joseph Stiglitz at NN Investment Partners’ Upside Down event last this week.

The Nobel prize-winning economist said the crisis presents an opportunity to reshape the economy to one which is better prepared for long-term risks like global heating.

As the recovery from the pandemic will not be V-shaped, governments must continue to support economies to prevent them from being destroyed. If additional backing is not provided then billions already spent will amount to nothing, he said.

With government spending entering into uncharted territory, it’s imperative to ensure this money is well spent. That means ensuring this investment does ‘double duty’. Not only should it seek to protect its citizens from the impact of the virus but it should help to create the kind of economy the world wants after the crisis.

The objective should not be to return to life earlier this year but instead to move towards a greener economy which seeks to address inequalities, said Stiglitz. Economic growth should be based on sustainable goals, he added.

Improving resilience
Governments have multiple ways they can shape the economy which emerges after the crisis. It can affect what happens by how it allocates funds and imposing conditions on who receive the capital. And as so much public money is in play, citizens should have a say in what kind of economy emerges from the crisis.

One of the issues this new economy needs to overcome is the lack of resilience in the private sector. These companies were unable to respond to the crisis and produce simple products like masks. The over-emphasis on short-term profits meant companies lacked flexibility and had inadequate regard to potential risks, said Stiglitz.

A useful analogy is the production of cars in the US without spare tires. The industry has focused the ability to save some money over the short-term – it seemed a waste to carry the extra weight and a good idea to avoid the sunken cost of an extra tire.

In effect, automobiles were created without resilience. But those who broke down in the middle of nowhere knew how costly this lack of flexibility can be.

This focus on the short-term needs to be addressed because the global economy is not currently prepared for climate change, he added.

The pandemic provides a cautionary tale: the world was not prepared for this crisis nor is it prepared for climate change. With the evidence mounting global warming will be more rapid than had previously been assumed with more devastating effects, urgent action needs to be taken.

The need for better metrics
One of the reasons the economy lacks resilience is because gross domestic product is not a good measure of performance. That’s because it does not adequately capture inequality, sustainability or health of citizens, said Stiglitz.

These metrics are important to measure in order to address climate change because this has the potential to introduce fragility.

For example, changes in the price of fossil fuel assets could happen dramatically and that collapse in valuation could lead to a systemic problem. Economic metrics need to start reflecting these risks so the global economy can better prepare, said Stiglitz.

There are already signs that accurate risk assessments help. Assets with high environmental, social and governance characteristics have performed better during the recent financial turbulence than those which ignore environmental impact, labour practice and effective management.

That’s because these companies take a longer term view. What has repeatedly got the world into trouble is emphasising the short-term. Using better metrics helps to encourage a better long-term approach, said Stiglitz.

The world has been warned about the impact of climate change and it now has ways of assessing systemic fragility which we should be using so we do not repeat the mistakes of the pandemic, he said.

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