In the last decade, climate change has become an integrated part of our life on daily basis, we hear and we read about it in the news, newspapers and on the internet, while we see its effects on our surroundings: glaciers melting, temperature rising or more frequent natural disasters. However, this phenomenon has not just been having changed the world as we know it, but it has been affecting another important sphere of everyone life: the economy.
Economy and climate have always been in a double effective relationship, however before the industrial revolution the climate was the independent variable of the equation (due to a primarily agricultural economy), for instance through the impact of changes in the sunlight or rainfall the harvest could be scarce or generous, affecting the market and eventually the financial balance, if any. However, once the fossil fuels started becoming the core of the worldwide economy and most of the countries began making use of it without any limit, the impacts of the economy on the climate and the nature became globally significant, leading, through the time, to a phenomenon of anthropogenic global warming. With these new technologies, the binomial relationship between climate and economy suffered a metamorphosis and it became more complex, unpredictable and marked.
The potential direct economic impacts of climate changes are various and wide-ranging, they can be expected in many sectors of the economy: agriculture and fisheries, energy, tourism, construction, insurance and many others, producing a potential substantial effect on the real GDP, which is estimated to decrease by 1.0-3.3% by 2060 and by 2-10% by 2100 if the global temperature rises of 1.5-4°C, according to the OECD. At the same time, it has been also recognized that climate change may be relevant for financial stability too, due to two types of related risks: physical risks and transition risks. The first ones can be defined as “those risks that arise from the interaction of climate-related hazards with the vulnerability of exposure of human and natural systems, including their ability to adapt” (Batten et al. 2016, p.5), the main sources are global warming and natural disasters. The latter ones are defined as those risks that might arise from the transition to a low-carbon economy.
These two types of risks manifest themselves as economic shocks and they have, without any doubt, a significant impact on the economy. For example, a physical climate risk like a flood or rising temperatures may cause in the short-term a price volatility, due to shortages of commodities or damages to the capital stock and infrastructure, potentially affecting the government, business and the household sector. Let’s imagine a river that dries up, such event will have repercussion on the fields close to the river (crop damaged due to lack of water) and it could make the navigation impossible, lowering import and exports. Such shock to the supply potential of the economy could affect its productive capacity (a significant share of the potentially adverse macroeconomic impacts stems from the effects of climate change on productivity) and it would put downwards pressure on outputs and upward pressure on prices. Moreover, the unpredictability of climate changes and the uncertainty about the pace of humankind’s ability to adapt to them, might translate into increased uncertainty about future potential growth. The overall result would converge in changes in agents’ preferences, which might influence demand for products and change in behaviors. While such damage may stimulate replacement investment in the short term, at the aggregate economy level it is likely to lower net wealth. Firms might be less incline to invest (pessimistic about the future) and households more in favor of saving and consuming less in the medium term, leading not only to changes in demand condition but as well to a demand shock, determining then a lower capital stock and potential output growth.
Following the study of Malin Andersson and Julian Morgan, which is drawn heavily on IPCC (2014c), we can briefly analyze the main sectors in Europe, that are most likely to be affected by climate change.
Agriculture, fisheries forestry and bioenergy production are expected to be directly affected by such phenomenon. As we have said before, the agricultural sector will be very likely to see change in crop yields, however some northern countries might have positive outcomes from a slightly increase of temperature. A study, by Asbjørn Aaheim, Helene Amundsen, Therese Dokken andTaoyuan Wei (2012), has shown that if the increase of temperature will be contained between +1°C and +2°C, the Baltic and CE East countries will experience a positive increase of their GDP. However, such positive effect would be offset by a higher increase in temperatures and by any other physical or transitional damage.
Also transport sectors are like to be affected as higher temperatures and more frequent natural disasters may adversely affect inland water transport on some rivers (as in the example above). There are reports that the low water levels of the Rhine Rives have already had an impact on river transport in those areas. Furthermore, weather extremes may lead to economic damage accounting to 0.5-1.0% global GDP by 2050.
Then, to conclude, the insurance and banking sectors could be faced with issues such as the accurate pricing of risks, the availability of capital after large loss events and an increasing burden of losses potentially affecting risk premia and insurability, both within and outside Europe.
Ultimately, the macroeconomic effect of climate change may also affect inflation and therefore the monetary policy of Central Banks, which will be required in the future to incorporate climate variable in their macroeconomic models. By considering what we have said until now, it’s almost natural that we consider the direct effect of change of productivity on inflation. If we consider again the extreme effects that the climate will have on the agricultural sector, it is clear that as climate change affects agricultural yields, there is the possibility for lasting impacts on the prices of agricultural commodities (for example they might be affected by reduced land availability due to sea level rise and desertification), however, as we have said, such effect is likely to depend on the location of a country. Moreover, there is also the possibility that the different impacts of climate change on demand and supply discussed above might produce some indirect impacts on inflation.
So, to conclude, we have understood that climate change in the short but also medium and long term will have wide-range effects on the economy of the EU. So, it is clear, that substantial changes in the structure of the economy are required to mitigate and adapt to this phenomenon, which is already part of our reality. If governments, central banks undertake the macroeconomic policies which are required, we might be able to achieve the EU targets for global warming and even prepare ourselves and the economy to sustain the new economic era that is approaching. However, We must say that the ECB, the European Commission and also the many European member countries have yet started implementing such approach through the “Next Generation EU”, which incentivize and focus investments towards projects for a greener and more digitalized Europe.