What is Financial Crisis

The term financial crisis is applied broadly to a variety of situations in which some
financial assets suddenly lose a large part of their nominal value. In the 19th and early
20th centuries, many financial crises were associated with banking panics, and many
recessions coincided with these panics. Other situations that are often called financial
crises include stock market crashes and the bursting of other financial bubbles, currency
crises, and sovereign defaults. Financial crises directly result in a loss of paper wealth but
do not necessarily result in changes in the real economy.
Many economists have offered theories about how financial crises develop and how they
could be prevented. There is no consensus, however, and financial crises continue to
occur from time to time.
Causes and consequences of financial crisis
a. Strategic complementarities in financial markets
It is often observed that successful investment requires each investor in a financial market
to guess what other investors will do. George Soros has called this need to guess the
intentions of others 'reflexivity'. Similarly, John Maynard Keynes compared financial
markets to a beauty contest game in which each participant tries to predict which model
other participants will consider most beautiful. Circularity and self-fulfilling prophecies
may be exaggerated when reliable information is not available because of opaque
disclosures or a lack of disclosure.
b. Leverage
Leverage, which means borrowing to finance investments, is frequently cited as a
contributor to financial crises. When a financial institution (or an individual) only invests
its own money, it can, in the very worst case, lose its own money. But when it borrows in
order to invest more, it can potentially earn more from its investment, but it can also lose
more than all it has. Therefore leverage magnifies the potential returns from investment,
but also creates a risk of bankruptcy. Since bankruptcy means that a firm fails to honor all
its promised payments to other firms, it may spread financial troubles from one firm to
another.
c. Asset-liability mismatch
Another factor believed to contribute to financial crises is asset-liability mismatch, a
situation in which the risks associated with an institution's debts and assets are not
appropriately aligned. For example, commercial banks offer deposit accounts which can
be withdrawn at any time and they use the proceeds to make long-term loans to
businesses and homeowners. The mismatch between the banks' short-term liabilities (its
deposits) and its long-term assets (its loans) is seen as one of the reasons bank runs occur

(when depositors panic and decide to withdraw their funds more quickly than the bank
can get back the proceeds of its loans)
d. Uncertainty and herd behavior
Governments have attempted to eliminate or mitigate financial crises by regulating the
financial sector. One major goal of regulation is transparency: making institutions'
financial situations publicly known by requiring regular reporting under standardized
accounting procedures. Another goal of regulation is making sure institutions have
sufficient assets to meet their contractual obligations, through reserve requirements,
capital requirements, and other limits on leverage.
e. Contagion
Contagion refers to the idea that financial crises may spread from one institution to
another, as when a bank run spreads from a few banks to many others, or from one
country to another, as when currency crises, sovereign defaults, or stock market crashes
spread across countries. When the failure of one particular financial institution threatens
the stability of many other institutions, this is called systemic risk
f. Recessionary effects
Some financial crises have little effect outside of the financial sector, like the Wall Street
crash of 1987, but other crises are believed to have played a role in decreasing growth in
the rest of the economy. There are many theories why a financial crisis could have a
recessionary effect on the rest of the economy. These theoretical ideas include the
'financial accelerator', 'flight to quality' and 'flight to liquidity', and the Kiyotaki-Moore
model. Some 'third generation' models of currency crises explore how currency crises and
banking crises together can cause recessions.
Economic Crisis of 21st century
Summary in Years
20002001 Turkish Crises
2000 early 2000s recession
2001 Argentine Crises
2001 Bursting of dot-com bubble speculations concerning internet companies crashed
2008-2011 - Icelandic financial crisis
200712 Financial crisis of 20072012, including the 2010 European sovereign debt
crisis

Economic Crisis of the Twenty-First Century

The collapse of the world economy and of the American economy in the Fall of 2008 was
the most severe economic crisis since the Great Depression of the 1929-30s.
There were both similarities and differences between the two. Both originated in the
United States and dramatically impacted the world economy. Both were precipitated by
collapse of the leading sector of the U.S. economy; the stock market in the 1920s, and the
housing market in the 21st century. Both occurred in economies where there were large
maldistributions of wealth between rich and poor. Both were dependent upon mass
consumption for the continuation of prosperity. Both suffered the consequences of a lack
of government regulation of economic practices and lax enforcement of existing
regulation. Both were accompanied by corrupt practices in the financial sector of the
economy. In both instances, the attempt to use government action to introduce corrective
measures was met with fierce resistance by political forces, which primarily represented
wealthy, corporate, financial interests. In both circumstances those powerful interests
dominated the political system and used it for their own private goals. Consider this
comparison
A reasonable conclusion might be drawn that lessons of the past were ignored.
There were, however, numerous differences. The American economy of the 1920s was
considerably smaller than it was in the 2000s. The United States was the leading creditor
nation of the world in the 1920s with very little debt. In the 2000s, the U.S. had become
the leading debtor nation of the world. This, in the 1920s, gave the United States an
advantageous position from which to respond to economic crises, whereas its
indebtedness in the 2000s made solutions more difficult. In the 1920s, the world economy
was in an early stage of the fossil fuel era during which fossil fuel resources were tapped
as the primary source of power fueling the economy. In the 1920s, the institutions
associated with fossil fuels were growing rapidly with little resistance from established
special interests. In the 2000s, the fossil fuel era was beginning to come to an end, but
established interests fought with every means available including warfare, to maintain
their positions of power, wealth and influence. In the 1920s, the American economy led
the world and the U.S. government could act unilaterally to stimulate growth throughout
the world. In the 2000s, the U.S. economy was still the single most influential economy
in the world, but it shared responsibility with China, which had become the largest
creditor nation, and with Europe.
In the 1920s, the prevailing economic theory for dealing with economic collapse was that
the laws determining the business cycle were immutable, and governments could do little
about it. Since then, Keynesian economic theory postulated that government or public
spending can stimulate economic growth when the private sector fails to do so. A
countervailing theory of the Chicago school of economics, which developed in the 1970s,

claims that the private sector is the essential driver of economic growth. The government,
through taxation and too much regulation, becomes a drag on the economy. These
theories are not necessarily mutually contradictory.
During eras of prosperity, the private sector is the primary driver, while the public sector
pursues long term objectives deemed to be in the public interest, at the same time,
improving and maintaining the infrastructure. During such times, it is appropriate for the
government to run a small annual surplus, pay down existing debt, or accumulate a
reserve needed to meet an economic slowdown. During recessionary eras, however, it is
desirable for the government to stimulate the economy by spending in excess of its
income, in other words, by deficit spending. To achieve the proper balance under
particular circumstances is a challenge.
Economic theory is always complicated by political realities. Private businesses and
corporations have as their primary goal, to increase the growth and profitability of the
business. These private goals may not support, and may possibly obstruct, the public
interest. In a perfectly competitive, laissez faire circumstance there is the closest
approximation between private goals and the public interest. Such a circumstance can
never, in practice, exist. Private business will use their political influence to obtain
subsidies and legislation favorable to themselves, but not to others. It is a part of the
fundamental basis of capitalism to compete, both economically and politically, for
individual advantage. Having achieved an advantage, each private enterprise will use it to
further accelerate their advantage. Those enterprises and those individuals that have
fallen behind will be driven into bankruptcy and poverty. The society will become
divided between large enterprises and few very wealthy individuals on the one hand, and
failed enterprises and a large poverty population on the other. If such a process were to
continue indefinitely, the society would collapse completely, due to lack of a middle class
and insufficient consumer demand. That point of complete economic collapse has never
occurred because, in the circumstance of a depression, an increasingly desperate citizenry
has demanded fundamental changes in the political leadership. Those changes may be
desirable or they may be catastrophic, depending upon the political circumstances in
different nations.
In the United States, the Great Depression assured a re-alignment of the political majority
from the Republican Party to the Democratic Party. There was a stable political
alternative which enabled the existing political structure to survive. The new leadership
under President Roosevelt responded inadequately, but sufficiently, to economic
hardship, to retain their mandate. They failed, however, to escape from the fears about
debt accumulation. Experimentation with a variety of government programs to increase
employment had to be carried out by deficit spending. Fears about the increasing national
debt led to decisions to reduce government expenditures long before the depression had
been resolved. The result was to bring about a decline in economic activities in 1937 and
1938. A renewal of deficit spending helped to stem the decline. The depths of the Great

Depression were so profound, however, that there was not enough fiscal stimulus to bring
recovery. It required unlimited expenditures by government, and unprecedented levels of
deficit spending in World War II, to restore prosperity to the American economy.
In Germany, there was no stable, political alternative to the leadership of the German
Social Democratic Party, when it failed to respond to the Great Depression. Its ability to
respond was compromised by the prevailing do-nothing economic theory of the time.
This was reinforced by the disastrous experience in the early 1920s, when increasing the
money supply had resulted in hyper-inflation. Furthermore, the German economy was
dependent upon investments by Americans. When the Great Depression began in the
United States, those investments ceased. The circumstances of the first Great War had
left Europe decimated and dependent on the United States.
The increasingly desperate economic circumstances facing the people of Germany, and
the lack of rational political alternatives, led to the rise to power of Adolf Hitler and the
Nazi Party. The new leadership ignored economic concerns about a debt, repudiated the
international debt obligations, and engaged in deficit spending to rearm Germany in
preparation for a new war. Economic recovery, coupled with nationalist propaganda about
restoring the greatness of Germany, gave the regime popular support. The accompanying
designation of imaginary enemies as the source of their difficulties, made this regime
dangerous and irrational.
Economic depression leads to desperation and, sometimes, irrational solutions. A
particular dilemma faces world financial leaders, governments, and the people in the
early 21st century. On the one hand, over-consumption based on borrowing, reckless and
corrupt financial practices, and lack of effective regulation by government, coupled with
costly, unnecessary wars, has created high levels of debt, both public and private. These
policies and practices have gone on for 50 years or more. The problem of indebtedness
has developed over a long period and can only be resolved gradually over a long period.
On the other hand, the economic depression, which began in 2008, led to a near collapse
of the private sector. In order to create jobs and revive the economy, the government
undertook to stimulate the economy with a variety of spending programs coupled with
selective tax decreases. The stimulus helped to stem economic collapse but was
insufficient to restore a robust economy. At the same time that the Federal government
engaged in deficit spending, state and local governments, operating under constitutional
requirements to balance their budgets had to reduce spending and lay off workers. The
net result was a minimal stimulus. There were opportunities for some investors, but there
was stagnation, and chronic high unemployment rates. At this point, the Republican party,
newly rejuvenated by a populist "tea party" movement, claimed that the stimulus had
failed, and that government was an obstacle to growth in the private sector. The opposite
argument was that the stimulus had been inadequate and that the government had to take
direct action on a larger scale, and engage in more deficit spending. Failure to do so

would result in continued high unemployment and a low tax base, which would only
exacerbate the debt. The alternative of reducing government spending to deal with the
debt would continue the downward spiral of a declining tax base, and assure that the
long-term debt problem could not be resolved. Thus, the political paralysis adds great
uncertainty to the probability of reaching a solution. Consider what economist Robert
Reich has to say.
Furthermore, the approach of peak oil marks the beginning of the end of the era of the
fossil fuel energy economy. Nuclear energy, because of its horrendous safety and related
cost problems, is not a viable alternative. The transition to a renewable energy economy
will require time and heavy investment. The short-term, bottom line motivation of the
existing private energy industry opposes this transition, and is engaged in increasingly
costly and risky endeavours to prolong the fossil fuel era. Offshore and Arctic drilling for
oil, mountaintop removals for coal, fracturing of rock for additional sources of oil and
gas, and failed efforts to render nuclear energy safe, are all examples of the desperate
efforts being undertaken. The financial costs and the long term toll upon the environment
of continuing on this unsustainable path will assure failure.The solutions depend upon
government leadership, involving an immediate fiscal stimulus coupled with wise, longterm investment to grow the economy, and to restructure for a new, cleaner future.
As of the year 2011, the political trend, the impetus to cut spending in the midst of
economic decline, will assure a rush to the bottom. Will the concern for the long term
debt problem prevent the application of Keynesian techniques that are necessary to solve
the immediate problem of economic depression? Will there be sensible, rational political
leadership, or will there be catastrophic political, economic, and environmental
consequences?
International Economics
The economy in the 21st century is, more than ever, a global economy. In 1945, at the
end of world War II, the United States dominated the global economy to such an extent
that economic ministers at the Bretton Woods conference of 1944 established the
American dollar as an international currency along with gold, with the value of the dollar
fixed at $35 per ounce of gold. The United States government could, at that time, easily
support that exchange rate. This dominant position was the result of the destruction of the
European and Asian economies by the war, while the war had greatly stimulated growth
in the U.S. This was a circumstance that could not last as the European and Asian
economies gradually recovered. The overseas commitments of the United States and the
growing volume of imports by the U.S. caused a long term imbalance of payments. When
the United States became a net importer of oil in 1970, the U. S. balance of trade became
negative. It was no longer possible for the Unitd States to support the fixed exchange rate
with gold and the U.S. government announced that it wouild no longer do so.

The economics ministers of the leading nations agreed a year later to a new system,
which retained the dollar as the international currency but allowed its exchange value to
fluctuate with respect to gold and to other currencies in accordance with supply and
demand. The exchange rate by the year 2011 was more than $1600 per ounce of gold.
This reflects the reduced role of the United States economy in the world economy.
Consistent unfavorable balance of payments by the United States has changed the
position of the United States from the largest creditor nation to the largest debtor nation
in the world. American consumers have been enjoying a large share of the produce of the
global economy, which has stimulated growth abroad and is gradually balancing the
position of the U. S. economy in the global economy. Economies are being lifted
elsewhere, while the U.S. economy is becoming increasingly indebted. The U.S. negative
balance of trade is unsustainable, but is difficult to correct. U.S. exports are restrained by
the higher labor costs in the U.S., while imports grow to maintain consumption levels.
These circumstances complicate the efforts of the U.S. government to stimulate the
economy. When the government follows Keynesian techniques, increases spending, and
creates jobs, there is a multiplier effect as increasing numbers of workers create more
demand which leads to more spending and the creation of more jobs. This multiplier
effect, however, is minimized if the new demand is for products from abroad. That
creates jobs overseas, but not in the United States. Consequently, any stimulus has to be
larger than otherwise.
At the same time, multi-national corporations have been shifting their production
facilities overseas in order to take advantage of lower labor costs. In other words, more
produce is imported, while jobs are exported thus adding to the imbalance of payments.
This has been partially counter-balanced by the development in the United States of new
technology and new innovations which temporarily have given the U.S an advantage in
trade.

The economic crisis and the two great challenges of the 21st century
1. Two great global challenges and a serious economic crisis
The two great challenges of the 21st century are the battle against poverty and the
management of climate change. On both we must act strongly now and expect to
continue that action over the next decades. The current crisis in the financial markets and
the economic downturn is new and immediate. All three challenges require urgent and
decisive action, and all three can be overcome together through determined and concerted
efforts across the world. It is important, however, to understand the depth and severity of
the two long-term challenges, and their intimate relationship, before we turn to the
shorter term.
Our response to climate change and poverty reduction will define our generation. If we
fail on either one of them, we will fail on the other. Unmanaged climate change will
irretrievably damage prospects for development in many parts of the world, and action on
climate change which hinders development can never build the global coalition on which
such actions depends.
We know only too well the impact of poverty around the world. But what may be less
well-known are the potential risks of climate change, risks to which poor people will be
most exposed and vulnerable.
The concentration of GHGs in the atmosphere that cause climate change is already over
430ppm CO2e. That is over 50% more than the level prior to industrialisation, and we are
adding to it at a rate of 2.5ppm per year, and that rate is rising. If we carry on with
'Business-As-Usual' the concentration of GHGs could rise to 750ppm or more by the end
of the century. According to the Met Office's Hadley Centre model, a concentration of
750 ppm would result in a roughly 50% likelihood that the world will be 5C hotter than
pre-industrial levels. That is not a remote possibility of some minor event, but a large
probability of a devastating transformation of our planet.
It is difficult to imagine what it would be like to try to live in a world that has
experienced a rise in temperature of 5C. Lives and livelihoods would be disrupted in
every country. Sea level rise would fundamentally re-draw the outlines of our
continents. Patterns and flows of rivers could be radically different. There would be many
areas that would become deserts. Populations would be threatened by reductions in the

availability of basic necessities, such as clean water and food. Many would have to move
away from the most-affected regions, creating new competitions and conflicts.
Poor people would be the most exposed and vulnerable to these changes. The UN
estimates that by 2080, climate change could lead to an extra 600 million people affected
by malnutrition, 400 million exposed to malaria and 1.8 billion without enough water. In
a world ravaged by climate change, the struggle against poverty would become still more
difficult for hundreds of millions of people.
So it is imperative that when we think of the problems involved in development, we
understand that they are inextricably linked to the problems we face in tackling climate
change. But whilst recognising that we must respond, and respond strongly, to both
challenges, we should also recognise the opportunities: a well-constructed response to
one can provide great direct advantages and opportunities for the other.
Some may argue that the global financial crisis and economic downturn means we should
delay our efforts to tackle poverty and climate change. But delaying on poverty would
condemn millions of people to many more years of hardship. And delaying on climate
change would mean the stock of GHGs in the atmosphere grows, making the task of
dealing with the problem more costly and difficult in the future. Failure at the UNFCCC
conference on a new global deal on climate change in Copenhagen in December would
badly damage the confidence in and prospects for an agreement, undermining the key
private investments and public action.
We cannot afford to delay. We can and must face up to all three challenges together.
So what do we need to do to combat the threat of climate change whilst boosting efforts
to reduce poverty and tackling the global economic downturn?
2. Mitigation and adaptation
The management of climate change requires the reduction of emissions of GHGs. The G8
nations at recent summits have endorsed the goal of reducing global emissions by at least
50% by 2050 (which should be relative to 1990). Such cuts are broadly in line with a path
could hold greenhouse gas levels below 500ppm CO2e and then start to reduce
them. According to the Hadley Centre climate model, this would reduce the probability
of a 5C increase in global temperature from around 50% to 3% or less. Such insurance
could be bought for a worldwide cost of 1 or 2% of GDP over the coming decades and
may well be lower than that if technical progress continues with its current
acceleration. That action is very sound economics as well as a moral imperative.

We know from the long-term target where countries will need to be in 2050 and we can
infer current actions from this. The target 50% reduction means halving global emissions
from 40 gigatonnes a year to 20, or around 2 tonnes per capita, given that there are likely
to be around 9 billion people in 2050.
For the global target to be achieved, few countries can be much above the annual
emissions level of 2 tonnes per capita, since there are likely to be few that are far
below. This provides a benchmark against which countries can assess how the sectoral
pattern of their emissions may need to change for them to reach this level costeffectively.
These simple headline numbers mean that, even if developed countries reduced their
emissions to zero, the forecast 8 billion people living in developing countries in 2050
would still be able to emit only 2.5 tonnes per capita. With the majority (by population)
of countries not covered in Annex 1 of the UN Framework Convention on Climate
Change, broadly the non-Annex 1 are the developing countries, already above this level,
it is clear that emissions in these countries will have to fall in the long term. Aggregate
emissions by developing countries will probably need to peak in the next 20 years if the
global 2050 targets are to be achieved. Emissions in rich countries must decline, and
decline strongly, from now and be at least 80% lower in 2050 than 1990 if they are to get
their emissions in the region of 2 tonnes per capita by then.
With energy investments potentially locking-in emissions for 40 plus years and urban
investments often far longer, developing countries risk making high-carbon investments
that they will have to be either prematurely retired or expensively amended.
We know what actions we need to take to cut emissions. They fall into three categories:
energy efficiency, low-carbon technologies, and a halt to deforestation.
We also know what policies are necessary to drive these actions: tax, carbon trading and
regulation; increased technology support; and measures that halt deforestation.
Those countries that persist along the high-carbon route face additional risks. As other
countries cut their emissions and attitudes shift, 'dirty' countries will be less competitive
if other manufacturers routinely factor in the carbon price, or find new technologies
which undercut their high-carbon predecessors. There would also be a threat, whether we
like it or not, of countervailing action against exports from 'dirty' countries or production
methods.

But this omits a key point: developing countries should want to go low-carbon. Not only
is it the future, but it brings huge benefits. Renewable energy sources can free countries
from a dependence on imported fossil fuels. Cleaner transport means less pollution and
better health. Halting deforestation protects water supplies, controls flooding and
provides bio-diversity. The list goes on.
The transition to a low-carbon future can bring major economic gains. Energy efficiency
can help boost incomes. Low-carbon technologies can open up new sources of growth
and jobs. They can help even the poorest countries leap-frog old approaches they can
avoid the cost of large grids in the way cell phones helped cut the need for telephone
wires. And smarter grids can both enhance energy efficiency and enable new
technologies whilst cutting transmission costs. New sources of low-carbon energy
hydro, solar could help create a comparative advantage for some of the poorest
countries.
We should not pretend that de-coupling emissions from economic growth will be easy,
especially in the poorest countries. We know many of the barriers to the necessary
changes. None is insurmountable, and overcoming many is part and parcel of
development.
We should remember that, though the cost of action may be high, the cost of inaction is
much higher. Low-carbon growth is the only sustainable option. High-carbon growth will
choke itself, first on hydrocarbon prices and second, and more fundamentally, on the
hostile physical environment it will create. Low growth is unacceptable in a world of
poverty and of aspiration. We know what we must do and if we act we create a safer,
more equitable and prosperous world. It is now a matter of political will and the greatest
international collaboration the world has seen.
But the fact remains that no matter how successful we are with mitigation, we are now
committed over the next few decades to some degree of climate change due to the levels
of GHGs already in the atmosphere and those which will be emitted in the coming years.
That means countries, all countries, will have to adapt. The challenge is particularly
urgent for developing countries as they are earliest and hardest hit.
Adaptation is essentially development in a more hostile climate. It is pointless, and
indeed even diversionary or disruptive, to attempt a rigid and comprehensive separation
of elements of investments in physical or human capital which are marked for
'development' or 'adaptation'.

Many of the poorest people in the world will be the most exposed and vulnerable to the
impacts of climate change that will occur over the next few decades. These are also the
people who are least able to afford the costs of adaptation, and who have contributed
much less than those in the rich world to the current levels of GHGs in the atmosphere.
There is a fundamental inequity here and a strong imperative for the rich countries to
provide more funds to developing countries, in addition to current development
commitments, to fund the extra costs created by climate change.
Sub-Saharan Africa, where per capita emissions from energy are mostly less than 0.5
tonnes per annum compared with over 20 tonnes for the United States and between 10
and 13 tonnes for European countries, will be particularly hard hit by climate change,
unless there is a significant investment in adaptation.
We should also be under no illusion that the developed world is exempt from climate
risks: it too must and will adapt. In the short to medium term, we risk a drift
into 'adaptation apartheid' in which the rich world adapts in the short run by spending
more on flood defences and air conditioners, while the developing world faces increased
hardship and risk. In the long run, however, as Archbishop Desmond Tutu argued 'the
problems of the poor will arrive at the doorstep of the wealthy, as the climate crisis gives
way to despair, anger and collective security threats.'
Neither adaptation nor mitigation will be cheap if carried out properly and
responsibly. The global estimates which are necessarily approximate from the UNDP
of the extra costs for development arising from climate change are in excess of US$80bn
annually by 2015; and that is for a temperature increase of just 0.8 C relative to the 19 th
century. They will be far, far higher for the extra 1 to 2C that now seem likely even if we
act responsibly as a world.
On mitigation, the Stern Review estimates that by 2050 the world could hold below
550ppm CO2e for about 1% of global GDP per annum while holding below 500ppm
would cost us about 2%. If the average cost per tonne reduced relative to BAU were $30
in 2050 for the roughly 60 GtCO2e less than BAU that will be necessary, then the overall
cost ($30 60 annual emissions reductions relative to BAU) would be around $2trn, or
2%, of world GDP in 2050, projected to be around $100trn. I think that the costs may
well be less than this given the very rapid pace of technical progress now that the world is
concentrating on this issue.

The majority of these costs will be borne by the private sector. In Europe the main private
emitters are already subject to caps and encouraged to live within these by the carbon
price. The private sector will also bear the bulk of the cost of adaptation, as people, firms
and farms amend their practices and possibly location to fit with changing weather
patterns. Indeed, a vibrant, responsible private sector, faced with sound public policies is
best placed to deliver the scale of change demanded.
There will clearly be a key financing role for the public sector. Public funding additional
to current commitments for ODA is required for adaptation. It is also needed for
mitigation, particularly over the next few years, before carbon markets realise their
potential. Financial support will be needed for activities as varied as the introduction of
new technology (such as the Clean Technology Fund which the British Government
helped to establish at the World Bank) and for reducing deforestation. Both are activities
where the market may eventually provide substantial or most of the finance, but there is a
need for front loading. The UN Environment Programme (UNEP) estimates that, if done
well, public funds can leverage 3 to 15 times the value in investment in low-carbon
technologies.
3. A global deal on climate change
We now recognize the problems and understand what needs to be done to combat climate
change. What we need now is leadership and collaboration to achieve a global deal.
The global deal must be effective, efficient and equitable.
For developed countries this means commitments to cut their emissions by at least 80%
from 1990 levels by 2050, with credible plans to deliver interim targets consistent with
this goal. Given the inequities of the history of emissions, whilst the actual emissions of
rich countries would fall by at least 80% they should be responsible for paying for more
than this. Though part of their overall effort should take place in developing countries
where it can be more cost-effective, developed countries must demonstrate the feasibility
of low-carbon growth and set an example for others. Whilst most richer countries are in
Annex 1of the Kyoto protocol, and thus have commitments to cut emissions, there are a
number of middle income, or indeed, high incomenon-Annex 1 countries which should
start now to scale-up their own action.
For their part, developing countries, although they have contributed less to the build-up
of GHGs in the atmosphere than the richer industrialised countries should nonetheless
establish and implement their own climate change action plans starting now. They should

also signal their long-term commitment to mitigate, but make this commitment
conditional on strong action by the developed countries. The conditions placed on
developed countries by the developing, a reversal of conventional conditionality, would
consist of i) strong targets ii) clear examples of low-carbon growth iii) carbon finance iv)
technology sharing v) funding for adaptation. Under these conditions they would take on
targets by 2020 as part of a credible plan to cut global emissions to around 2 tonnes per
person by 2050. This would require aggregate developing country emissions to peak by
2030, or earlier. But the feasibility of the necessary commitments, and timely peaking,
will require strong climate change action plans in developing countries and support from
developed countries now.
The proposal by South Korea of a registry of non-Annex 1 actions and requirements is
one way of formalising this contribution into a Copenhagen agreement. Many countries
are already starting to step up to the plate they recognise the challenges and are
positioning themselves to take advantage of opportunities. Some are ahead of the curve
and showing visionary leadership. And they recognise that many of the actions on energy
efficiency and technology show strong returns for development even before one allows
for climate change.
Stricter caps for Annex 1 countries, combined with credible long-term mitigation plans
by them and, developing countries, should help stimulate the flow of carbon finance from
the developed world. Reformed markets could be providing between US$50 to US$100
billion a year to developing countries by 2030.
Public funding commitments by developed countries will also be a central part of any
deal. Public funding should be invested heavily in developing the low-carbon
technologies the world requires, including those appropriate for low-income developing
countries. Public funding could deliver quick emissions cuts by supporting initiatives
limiting deforestation: it is estimated that $10 to 20 billion a year could halve global
deforestation, that is, cut up to 9% of global emissions. It can and must be integrated with
the development choices of the countries where trees stand. Finally, public funding will
also be required to help countries adapt to more hostile climates.
We understand now the structure and key elements of a global deal. 2009 is the year
when this deal must be struck. Delay will lead to still higher concentrations, greater
damage, higher costs later on when we try to start mitigation from higher concentration
levels, and an undermining of market confidence now.

4. Climate change and development policy

The design and support of action on mitigation and adaptation in developing countries
requires the careful attention of all those working on development. Delivering additional
funds on scale is crucial the long-standing target of 0.7% of GDP of developed
countries devoted to ODA, the 2002 Monterey commitments on funding the Millennium
Development goals and the G8 2005 Gleneagles agreement for Africa would almost
certainly be higher if we had thought more carefully about climate change. The targets
were always bare minimum for reaching the Millennium Development Goals before
factoring in climate change. Adaptation will increase the burden on developing
governments and compensatory funding for this must be additional to current
commitments on ODA. In the circumstances any undershooting on those commitments in
the coming years would be unjustifiable. As we look forward to the challenges the
developing world faces beyond 2015, and we must soon be examining and formulating
the successors to the MDGs beyond 2015, I think that our targets for support from the
public budgets of rich countries are likely to be closer to 1.0% of GDP than 0.7% for the
coming 2 decades. With the private flows that could come with them and the growth and
poverty reduction they could help foster, I think that these flows would constitute very
wise investments for the world as a whole as well as being our duty as citizens of the
world.
However, though funding should be additional, it does not mean that adaptation funds
should be programmed separately from development assistance as a whole. Since
adaptation is basically development in a hostile climate, there is no sense in separating
out funds and thereby distorting our efforts. Some aspects of the ways in which the funds
should be allocated will differ from our usual methods for development assistance, for
example, where 'compensation' for direct climate effects such as rising sea levels are
involved, but even this does not imply that we need new institutions to manage
them. One option would be a window alongside IDA. The same would apply for
mitigation funding.
Climate change must be factored into the analysis and actions of all development
agencies including DFID, we will find that most of the tools needed for adaptation and
the challenge of building low-carbon economies are those of mainstream
development. And we shall also find that many aspects of development, such as lower-till
and lower-irrigation rice cultivation, save resources, reduce emissions and make for
greater resilience against climate change. There will be many other examples, including
buildings and infrastructure.

Much of the funding for mitigation is expected to come from the private sector, from
carbon finance and private investment. There will be strong ODA elements in both
mitigation and adaptation. Risk management and guarantee instruments will be important
too as will technological agreements. Development agencies must find ways of helping
combine and channel all these sources. This will require them to work in new ways and
with new actors.
5. Overcoming our three global challenges together
I have focused so far on the two big global challenges of this century. Let me now say
something about the current financial and economic crisis; it is the most serious such
crisis for 80 years. This crisis is having a deeply damaging effect on the developing
world. Demand for its exports of commodities and manufacturers have been strongly
reduced and capital flows are dramatically lower including direct and portfolio
investment and remittances. A world recovery is of vital importance to the developing
world, and we must remember that this crisis originated in the rich world. And during the
downturn and in the process of recovery we must do our outmost to ensure that the
methods that are used do not do further damage. I am thinking in particular of the danger
of protectionism. But we must also work hard to ensure that our efforts to reconstruct our
financial sectors by overly focusing on domestic banks, risks and issues, do not
discriminate against trade finance or assets held in and flows to emerging markets.
We should learn two lessons from what has happened:
First, the longer risks are ignored and allowed to grow, the bigger the
consequences when the crash occurs. The origins of the financial crisis go back
several years, to the time financial markets were deregulated, to the dotcom
bubbles and the complex derivatives which were erected on the back of a housing
bubble. We must not underestimate its seriousness. Strong and co-ordinated
monetary, fiscal and financial measures are essential now. We must not make the
same mistakes again with climate change, where the costs of delay are much
worse and far harder to reverse.
Second, the financial and economic crisis brings the critical opportunity and the
requirement to find a driver of long-term sustainable economic growth to lead us
out of this crisis: we do not want again to sow the seeds of the next bubble as we
emerge from the crash of the last. The US$2 trillion global fiscal stimulus for
2009/10, if implemented with a long-term vision, offers the chance to invest in
new technologies and investments for low-carbon growth. In the next few years
we can invest in new patterns of growth that can transform our economies and
societies, in much the same way as the railways, electricity, the motor car and IT

did in earlier eras. At the Grantham Research Institute, we have called for US$400
billion of extra public funding to be made available for the 'green component' of
the world stimulus over the next year or so; that would be around 20% of a global
package of US $2 trillion. This could enable us to grow out of this recession in a
way that both reduces the risks for our planet and sparks off a wave of new
technologies which will create 2 or 3 decades of strong growth and a more secure,
cleaner and more attractive economy for all of us.
We can and must, now and simultaneously, handle the short-term crisis, foster sound
development and economic growth in the medium term, and protect the planet from
devastating climate change in the long term. To try to set the three tasks against each
other as a three-horse race is as confused analytically as it is dangerous economically and
environmentally. In particular, the developed world must demonstrate for all, especially
the developing world, that low-carbon growth is not only possible, but that it can be a
productive, efficient and attractive route to overcome world poverty. It is indeed the only
sustainable route.