Economic Implications of Climate Change

Clinton J. Andrews, Professor at Rutgers University

How should we think about climate change? Is it a scientific, political or economic issue? The answer is yes to all of the above. Over the past century in New Jersey, average annual temperatures have increased by three degrees Fahrenheit, the mean sea level has increased by 1.38 feet, average annual precipitation has increased by 2.88 inches and the average annual number of named hurricanes has increased from about 10 to about 15. Globally, similar patterns are visible, alongside other indicators such as decreasing pH levels (acidification) of oceans, decreasing extent of arctic sea ice and increasing ranges for mosquito-borne tropical diseases.

The sources of these changes are no longer mysterious. The human “signal” in the noisy climate system has become clear, as exponential population growth, agricultural land use growth, industrialization, economic growth and higher standards of living have driven fossil fuel extraction and more intensive land usage, which in turn have increased the concentrations of greenhouse gases such as carbon dioxide in Earth’s atmosphere. Observed warming is driven by emissions from human activities, with greenhouse gas warming partly masked by aerosol cooling due to air pollution. These trends will continue into the future unless greenhouse gas emissions shrink.

A natural hazards management framework is helpful here. Natural phenomena (such as rising sea levels) become natural hazards when humans put stuff in harm’s way. Over the past century, New Jerseyans have invested billions of dollars in waterfront real estate even as sea levels have risen. People have responded to these risks in part by adapting to them (such as elevating their house on the Jersey Shore) and also by mitigating them (such as by installing solar panels that reduce greenhouse gas emissions from electricity generation). Adaptation is instinctive and it is well rewarded by market forces. Mitigation requires knowledge of how Earth systems work and shared agreement on the need for action. Hence, little mitigation happens without public policy.

Economists have been writing articles for several decades that attempt to assess the impact of climate change, and metaanalyses that look for consistent conclusions across many individual studies are now emerging. A recent effort confirms a negative relationship between extent of global warming and global growth in income, with the median estimate of about 1% of income due to current levels of warming, and estimates in the 2-5% range for expected warming over the next 50 years. Estimates vary by method, such that enumerative studies (bottom-up estimates from engineering studies) track the median estimate, econometric studies (observed costs of specific events) vary widely around the median, elicitation studies (expert estimates using Delphi methods) skew strongly toward more negative impacts and computable general equilibrium models (that include adaptation) tending to track the median estimate. Meta-analyses also confirm that adaptive capacity strongly affects likely losses, such that the expected negative impact to the richer U.S. economy over the next few decades is likely less than 1% of national income, whereas in vulnerable low-income nations it could easily exceed 15%.

Are these economic impacts small or large? On global basis, the annual economic losses from disasters as a share of GDP have bounced between 0.1-0.6% (mean 0.3%) over the past 30 years. The upper end of that range is equivalent to the estimated drag on the global economy in 2022 due to the Russian invasion of Ukraine. On a national basis, the frequency of CPI-adjusted “billion-dollar disaster events” has increased roughly five-fold since 1980, so that annual losses now total $300-$500 billion. In New Jersey and environs, we recall the scale of specific events such as Superstorm Sandy in 2012 that totaled about $60 billion (of which about $8 billion is attributable to sea level rise since 1900). These economic impacts are large enough to interest risk managers.

Climate risks are systemic in the local-but-ubiquitous sense. In any specific year, the odds of local damage to a specific asset from a hurricane are low, but the odds that someone, somewhere endures losses are high. It would be nice if our systems for making risky economic and financial decisions could take care of the climate change problem by internalizing the adaptation process. Unfortunately, they only do part of the job.

We did a hedonic price regression analysis of the residential real estate market in coastal Monmouth County, New Jersey, to detect what the market learned from Superstorm Sandy in 2012. We saw that savvy, buy-to-rent investors already knew to apply a flood risk discount to properties in the flood zone, but that less-experienced owner-occupiers had to learn this the hard way by selling at a discount after Sandy. Unfortunately (from a systemic learning perspective), this market segment forgot the lesson of Sandy within three years, and today’s naïve buyers have bid the prices of shore houses right back up to eliminate the risk discount because the allure of the shore is too strong. A similar study of New York City found a more persistent risk discount in the 8% range, reflecting the lesser importance of amenity values in that market. A national study using Zillow data echoed these results.

Missing from the adaptation process in New Jersey are tools to share risk information with home buyers at the right moments in the real estate transaction process. Online searches of real estate sites often do not share flood zone status. Seller disclosure documents often state that flood risks are “unknown.” Only when a buyer seeks a mortgage does anyone check whether flood insurance is needed.

Private insurers no longer offer affordable flood insurance in the coastal zone, hence, the federal government created the National Flood Insurance Program (NFIP), and, in spite of repeated efforts by Congress and the agencies, it is not actuarially sound. When rates rise to reflect observed risk, many policy holders drop their insurance — the number of New Jersey NFIP policy holders has dropped 16% from 2012 to 2022 following revisions to FEMA’s flood maps.

Storms can cause fiscal stress for local governments, as dropping property values diminish tax receipts at the same time that emergency response expenditures soar. Following Sandy, most affected New Jersey municipalities enjoyed intergovernmental transfers from the federal government to make up their temporary shortfalls. However, as New Orleans learned following Hurricane Katrina, fiscal recovery can take longer than the lifespan of those transfers. Bond rating services are catching on to these risks.

In sum, climate change is accelerating and its effects are now visible within the time horizon of a standard 30-year mortgage. The impacts vary by location and subpopulation, and for New Jersey, flooding is a key risk (heat stress, not discussed here, is the other big risk). Adaptive responses increasingly require skilled, risk-aware public and private investment in adaptation and mitigation. Natural adaptation is underway but it happens unevenly, so that investors and lenders need detailed local risk knowledge about flood geographies, sea level rise, and wind exposure. Mitigation is underway slowly as political will gels, with the implication that investors and lenders will need to manage significant new regulatory and technological risks. Bankers will want to acquire appropriate skills to manage these distinctive types of risk.


Clinton J. Andrews co-directs the Center for Urban Policy Research and is an urban planning professor at Rutgers University.

Sources:

Chandra-Putra, H., and C.J. Andrews. 2020. An integrated model of the real estate market responses to coastal flooding. Journal of Industrial Ecology, 24: 424–435. DOI:10.1111/jiec.12957

NOAA National Centers for Environmental Information. 2023. U.S. Billion-Dollar Weather and Climate Disasters. www.ncei.noaa.gov/access/billions/, DOI: 10.25921/stkw-7w73

New Jersey Climate Change Resource Center. 2022. NJ Adapt. https://njclimateresourcecenter.rutgers.edu/nj-adapt/

Pielke, R. 2019. Tracking progress on the economic costs of disasters under the indicators of the sustainable development goals. Environmental Hazards, 18:1, 1-6, DOI: 10.1080-174-77891.2018-154-0343

Saleh, F. 2022. 10 Years After Superstorm Sandy: The Paradox of More Flooding and Less Insurance. Moody’s Blog. www.rms.com/blog/2022/10/27/10-years-after-superstorm-sandy-the-paradox-of-moreflooding-and-less-insurance.Tol, R.S.J. 2022. A meta-analysis of the total economic impact of climate change. arXiv:2207.12199. https://doi.org/10.48550/arXiv.2207.12199

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