The uneven effects of climate change on the global economy


Irene Lauro (Schroders) | According to the World Meteorological Organization, the past six years (2015-2020) have been the warmest on record, with the global average temperature rising 1.2 degrees Celsius above pre-industrial levels.

Corn while climate change affects all regions of the world, global warming and precipitation rates will not be distributed evenly around the world. There will be winners and losers.

The Intergovernmental Panel on Climate Change (IPCC) has sought to better understand the specific risks of climate change. To do this, he modeled the amount of greenhouse gases (GHGs) we produce to generate numerous scenarios – or trajectories – of climate change called representative concentration pathways (RCPs). Each scenario corresponds to a different level of warming.

Overheated economies?

RCP2.6 is a “best case” scenario. In this scenario, GHG emissions are sufficiently reduced that global warming is capped at around 1.5 to 2 degrees above the pre-industrial average. At the other end of the scale is RCP8.5. This is a “worst case” scenario. This reflects “business as usual”, in which no effort is made to control emissions. The scenario describes global temperatures increasing by 4 degrees above the pre-industrial average, by 2100.

The IPCC points out that – as shown in the graph above – all countries are likely to experience higher temperatures by the end of the century, but global warming will be more severe in some parts of the world. The economic impact of climate change will therefore also vary, which will have a significant impact on asset returns.

Specifically, the arctic region is expected to continue to warm faster than the global average. In addition, temperatures in higher latitudes of the northern hemisphere will increase more rapidly than in tropical regions.

Precipitation will also not be distributed evenly across the globe.. It is expected to increase in high latitude regions and in the equatorial Pacific, regions already affected by long monsoon seasons. It is expected to decrease in the mid-latitude subtropics, which tend to be arid areas.

It means that the world’s wetlands are expected to become wetter as climate change intensifies, while water is likely to become less available in areas where water supplies are already scarce. For example, India, Pakistan and Nepal are likely to experience more severe monsoon seasons, while countries in Africa and South America are likely to experience drier conditions.

The impact of climate change on productivity

We have incorporated the economic impact of climate change into our long-term productivity forecasts. The methodology and implications for investors are explained in our 30-year return forecast.

As recent research by Burke and Tanutama points out, there is a quadratic relationship between productivity growth and temperature. This means that productivity in “cold countries” increases as annual temperatures rise, but when annual temperatures are above 12-13°C, productivity begins to decline.

For example, in cold countries an increase in temperature could open up new areas for cultivation or more parts of the sea could become navigable and available for ice melt fishing. On the contrary, in hot countries, agricultural production should decrease due to the intensification of desertification. Livestock production will also decline due to increased heat stress.

Chart 2 shows the physical costs in a scenario where global temperatures increase by more than 3 degrees Celsius by 2100 compared to the pre-industrial average. This scenario suggests that global economies fail to implement adequate mitigation strategies to limit carbon emissions.

The costs are expressed in relation to the “no climate change case”, where there are no temperature effects. In 30 years, Switzerland, Canada, Germany, France and the UK will all be better off in a scenario where global warming rises more than 3°C above pre-industrial levels. . Productivity is deteriorating in Australia and in most emerging countries.

The most visible consequences of climate change

It is not only in the long term that climate change can cause economic damage. Extreme weather events show that there is also a short-term impact. Hurricanes Harvey, Irma, Katrina and Sandy have already shown how damaging climate change can be today. These are some of the most visible examples of the short-term consequences of a warming world.

It is a well-known fact that global warming has caused a significant increase in weather events over the past few decades. For example, globally, the average number of tropical cyclones in a decade has increased from 14 to 23 since the early 1980s, while the number of floods nearly doubled. The IPCC points out that the risks associated with extreme events will continue to increase, with these events becoming more frequent and more disruptive as temperatures rise.

Extreme weather events, as they strictly depend on changes in temperature and precipitation, will have an unequal impact on different regions of the world. Floods and tropical cyclones have only increased in recent decades in certain regions of the globe. Chart 3 below shows the evolution of the average number of these events during the first decade of 2000 compared to the 1980s. It suggests that floods and tropical cyclones have become more frequent in Southeast Asia, in accordance to the analysis of the IPCC.

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These events can have disruptive and devastating consequences for people. Data from the Internal Displacement Observatory highlights that since 2008, nearly 200 million people have been forced from their homes, floods and storms accounting for nearly 98% of cases.

More importantly, the data shows that people in some parts of the world have been hit harder than others. Specifically, people in the Philippines were most at risk, the number of new displacements reaching 46% of the population since 2008. The rest of Southeast Asia and China were also affected by extreme weather conditions, but also the United States and Japan. People living in European countries and the UK were the least subject to displacement due to extreme weather conditions.

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Finally, it should be emphasized that the data refer to movements within the country, but we think it is reasonable to assume that internal migration is positively correlated with external migration. This might suggest that as global warming intensifies and extreme weather conditions become more severe, we could see more people leaving high-risk areas, such as Asian countries, to live in safer parts of the world.

How much will it cost investors?

Some of the literature on the economics of climate change suggests that natural disasters may actually boost business productivity and promote long-term growth. Indeed, firms that survive disasters will update their capital stock and adopt new technologies. This assumption that disasters stimulate growth is called “creative destruction”.

However, not everything supports this view. A recent study analyzed the physical exposure of countries to the universe of tropical cyclones during the period 1950-2008. He found strong evidence that national incomes are declining, relative to their pre-disaster trend, and not recovering within 20 years. This seems to be because disasters temporarily slow growth by destroying capital, but no rebound occurs because the various stimulus mechanisms do not compensate for the short-term negative effect of the loss of capital. .

The analysis appears to support the “no recovery” hypothesis, finding that a standard deviation of one year of cyclone exposure lowers GDP by 3.6 percentage points 20 years later, setting back an average country nearly two years of growth.

In our 30-year yield analysis, we incorporated the impact of global warming on productivity to find that this will impact long-term stock returns. Over the long term, productivity is a key driver of stock performance. Therefore, equity returns will be affected by climate change through its effects on productivity.

Chart 6 compares our 30-year equity returns with and without global warming. It is clear that there will be winners and losers due to rising temperatures.

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