May 23, 2024

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Economic and Financial Impacts of Climate Change

3 min read

Climate change will reduce wealth as crop yields decline and natural disasters strike, according to Swiss Re, one of the world’s premier insurance providers. They estimated that even an increase of two degrees Celsius could reduce global wealth levels by 20% by 2050.

Individuals and communities can create financial resilience against climate-related risks and their associated impacts.

Economic Impacts

Climate change wreaks havoc on economies through direct impacts to property and infrastructure as well as indirect disruptions of supply chains. Companies like PG&E Energy Company and Western Digital Technologies, manufacturers of hard disk drives, have suffered large losses because natural disasters disrupted production and caused shortages that in turn forced their closure at the tail-end of distribution chains.

Floods, droughts, wildfires, heat waves and hurricanes have the ability to disrupt productivity in an instant, leading to lost wages for workers in low-income countries where climate risks are particularly intense.

Economic damage wrought by climate hazards can also increase credit risks as households must use loans to cover expenses or rebuild following disasters, leading to delinquency, forbearances and rising debt service costs. Financial institutions are responding by including environmental, social and governance (ESG) factors into business and investment decisions.

Financial Impacts

Global GDP declines are often discussed when discussing climate change’s financial repercussions; however, household finances may also be negatively affected as costs vary depending on their geographic location and exposure to climate hazards.

Families living in flood-prone areas may find it challenging to secure affordable insurance, while those engaged in outdoor jobs such as farming and fishing may suffer significant income losses as a result of adverse climate conditions.

Households may experience higher energy bills as temperatures heat up and cooling needs for air conditioners increase due to higher temperatures and increased cooling needs, and transportation costs increase due to flooding or heat waves disrupting travel routes.

Estimating financial impacts is dependent upon the time horizon and discount rate used in analyses. Therefore, some researchers use a disaggregated approach for measuring impacts that takes into account various time horizons and welfare criteria to provide more precise accounting of individual risks and cost-benefit trade-offs.

Social Impacts

Many poor people, especially in developing nations that contributed least to climate change, will bear its consequences. Income will drop when crop production declines and natural disasters strike; they’ll need to migrate in search of work, water, food and shelter; their migration will be compounded by factors like poverty and political instability that exacerbate it further.

Damage projections increase in relation to the shape of the climate “damage function.” Depending on its design, it could indicate small damages for small temperature increases or an exponentially increasing damage bill as temperatures climb (Diffenbaugh and Burke 2019).

For our planet to survive climate change, it is imperative that climate action accelerate. Finance can play an integral part in this effort by driving carbon pricing, investing in sustainable infrastructure projects and disclosing climate risks posed by companies. Furthermore, a people-centred approach should be adopted when transitioning off fossil fuels.

Environmental Impacts

Climate change will cost the global economy as crop yields decrease, diseases spread and seas rise. According to one Swiss Re Institute study, an increase of just 3.2 degrees Celsius could reduce economic output by 18% or more.

Estimating the effects of climate impacts can be challenging, as estimations depend on both the shape and timing of damage functions. Damage functions indicate how steeply damages increase with temperature and their duration; their timing relates to both a time horizon and discount rate used for future consumption estimation versus today.

Location plays an integral role. Flood exposure, for instance, can place financial strain on Appalachian households while heat exposure raises healthcare costs in Mississippi Delta and U.S-Mexico border regions. These differences are partly a function of inequality; poor countries contribute less to climate issues yet experience their consequences more acutely than their wealthy counterparts.

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