The financial crash of 2009 dramatically demonstrated the interconnected nature of the global financial system. A downturn in the US housing market triggered a financial crisis that rippled across the globe incurring huge economic costs, bankruptcies and job losses. This is because flows of finance, from investors to investments, frequently cross national borders – disruption in one part of the financial system can quickly propagate to other geographically distant parts.
Now more than ever before the world is aware of another interconnected global crisis – the climate crisis. The impacts of human societies on the earth’s climate and ecological systems in one part of the world are cascading to other parts of the world with catastrophic implications. For example, carbon dioxide emissions from highly polluting developed economies in the global North contribute to rising global temperatures that increase the likelihood of drought and crop failures in the global South, affecting vulnerable countries with historically low carbon emissions. The impacts of the climate crisis are currently being felt disproportionately by those who have contributed the least, bringing issues of social justice to the fore.
Crucially, the Earth’s climate system and the global financial system are themselves inter-linked. This presents opportunities, but also dangers. The activities of the global financial system are exacerbating the climate crisis, through its funding of polluting and destructive activities. At the same time the global financial system is threatened by climate-related risks. However, the financial system will also be the enabler of a transition to a sustainable world, transforming economies and redistributing the resources of rich nations to the most vulnerable.
Identifying the ways in which the changing climate can affect the financial system through their many complex interconnections is a huge challenge, but it is essential if we are to predict and prevent financial disasters. Both researchers and policymakers are developing new and sophisticated tools which embrace this complexity. Network models are being developed to explain how a dynamic and evolving financial system emerges from the interactions between individual economic agents. Such models can detect the groups of influential investors and their investment patterns that are most effective at transferring capital to where it is needed, and such findings can act as a guide for policymakers. This type of thinking will be critical to the equitable distribution of climate finance across the world. In order that the pledged $100 billion a year from the developed to the developing world reaches the most vulnerable and is distributed fairly, it is vital to monitor the financial channels through which it flows and its impact on the economies of recipient countries.
Complexity science, such as network-based tools, can help us to understand the finance-climate system, mitigate these risks and seize the opportunities. It is the time to embrace the complexity of our world, rather than oversimplifying the picture. To quote Stephen Hawking, this is “the century of complexity”. This global effort will require collaboration between businesses, governments and researchers around the world. While the challenge is huge, the first steps are already being taken.
Check our new explainer ‘Finance for the climate: charting a complex relationship’ for a full overview of the topic: https://www.ucl.ac.uk/bartlett/news/2021/may/finance-climate-charting-complex-relationship
