Wednesday, May 11, 2011

Minus First Draft on Markets and Development: Comments invited


Minus first draft by Richard Tol

10.9.                                Impacts on markets and development (1328 out of 1900 words)
Above, we discuss the direct impacts of climate change on the economy sector by sector. There are, however, also indirect impacts. We first discuss the effects that impacts in one sector may have on the rest of the economy. We then turn to the impacts on economic growth and development.

10.9.1.                          General equilibrium effects (492 out of 950 words)
General equilibrium analysis considers the effect that climate change impacts in one sector may have on the rest of the economy. There are three channels through which this would occur. First, the output of one sector is used as an input to other sectors. For example, agricultural products are used in the food-processing industry. Second, products compete for the consumers’ expenditure. If, for example, food becomes more expensive, less money would be spent on other goods and services. Third, sectors compete for labor and capital. If more labor is needed in agriculture to offset a drop in crop yields, less labor is available to produce other goods and services.

Computable general equilibrium models have long been used to study the wider economic implications of changes in crop yields (Kane et al., 1992). Markets matter in agriculture. (Yates and Strzepek, 1998) show for instance that the impact of a reduced flow of the Nile on the economy of Egypt is much more severe without international trade than with, because trade would allow Egypt to focus on water-extensive production for export and import its food.

Older studies focused on the impact of climate change on patterns of specialization and trade, food prices, food security and welfare. This has been extended to land use (Lee, 2009; Ronneberger et al., 2009), water use (Calzadilla et al., 2011), and multiple stresses (Reilly et al., 2007). General equilibrium models have also been used to estimate the value of improved weather forecasts (Arndt and Bacou, 2000), a form of adaptation to climate change.

Computable general equilibrium analysis has also been used to study impacts other than agriculture, notably sea level rise (Bosello et al., 2007; Darwin and Tol, 2001), tourism (Berrittella et al., 2006; Bigano et al., 2008), and human health (Bosello et al., 2006). (Ciscar et al., 2011) study the combined effect of agriculture, sea level rise, river floods and tourism on the European economy. They find a welfare loss of 0.2-1.0% of income by the end of the century for the European Union. There are large regional differences with losses in Southern Europe and gains in Northern Europe.

The following conclusions emerge. First, markets matter. Impacts are transmitted from one place and sector to the rest of the world. Landlocked countries are affected by sea level rise because their agricultural land increases in value as other countries face erosion and floods. Second, consumers and producers are often affected differently. The price increase induced by a reduction in production may leave producers better off while hurting consumers. Third, relatives are more important than absolutes. A loss of production may be advantageous if the competition loses more. Fourth, the distribution of the direct impacts can be very different than the distribution of the indirect effects. Fifth, a loss of productivity or productive assets in one sector leads to further losses in the rest of the economy. Direct impacts are therefore a lower bound estimate of the true economic impacts.

10.9.2.                          Growth effects  (769 out of 950 words)
Climate change would also affect economic growth and development, but our understanding is limited.  (Fankhauser and Tol, 2005) investigate four standard models of economic growth, including the impact of climate change on economic production, capital depreciation, and the labor force. They find that, in three models, the fall in economic output is slightly larger than the direct impact on markets – that is, the total impact is more than twice as large as the direct impact – while the 4th model (which emphasizes human capital accumulation) points to indirect impacts that are 1.5 times as large as the direct impacts. (Hallegatte, 2005) reaches a similar conclusion. (Hallegatte and Thery, 2007; Hallegatte and Ghil, 2008; Hallegatte and Dumas, 2009) highlight that the impact of climate change on economic growth can be amplified by market imperfections and the business cycle. (Eboli et al., 2010) use a multi-sector, multi-region growth model. The impact of climate change would lead to a 0.3% reduction of GDP in 2050. Regional impacts are more pronounced, ranging from -1.0% in developing countries to +0.4% in Australia and Canada. Sectoral results are varied too, with output changes ranging from output of +0.5% for power generation (to meet increased demand to air conditioning) to -0.7% for natural gas (as demand for space heating falls) and rice.

Using a biophysical model of the human body’s ability to do work, (Kjellstrom et al., 2009) find that by the end of the century climate change may reduce labor productivity by 11-27% in the humid (sub)tropics. Assuming a output elasticity of labor of 0.8, this would reduce economic output in the affected sectors (involving heavy manual labor without air conditioning) by 8-22%. Although structural change in the economy may well reduce the dependence on manual labor and air conditioning would be an effective adaptation, even the ameliorated impact would have a substantial, but as yet unquantified, impact on economic growth.

(Tang et al., 2009) find empirical evidence for a climate-health-poverty trap. This is supported by yet-to-be-published model analyses (Bretscher and Valente, 2010; Gollin and Zimmermann, 2008; Gollin and Zimmermann, 2010; Ikefuji et al., 2010). Climate-related diseases such as malaria and diarrhea impair children’s cognitive and physical development. This leads to poverty in their later life so that there are limited means to protect their own children against these diseases. Furthermore, high infant mortality may induce parents to have many children so that their investment in education is spread thin. An increase in infant and child mortality and morbidity due to climate change would thus trap more people in poverty.

Poverty is concentrated in the tropics and subtropics. This has led some analysts to the conclusion that a tropical climate is one of the causes of poverty. (Gallup et al., 1999) emphasize the link between climate, disease, and poverty while (Masters and McMillan, 2001) focus on climate, agricultural pests, and poverty. Other studies (Acemoglu et al., 2001; Acemoglu et al., 2002; Easterly and Levine, 2003) argue that climatic influence on development disappears if differences in human institutions (the rule of law, education, etc) are accounted for. However, (Van der Vliert, 2008) demonstrates that climate affects human culture and thus institutions, but this venue has yet to be explored in the economic growth literature.

In a statistical analysis, (Dell et al., 2009) find that one degree of warming would reduce income by 1.2% in the short run, and by 0.5% in the long run. The difference is due to adaptation. (Horowitz, 2009) finds a much larger effect: a 3.8% drop in income in the long run for one degree of warming. In a yet-unpublished study, (Dell et al., 2008) find that climate (change) has no effect on economic growth in countries with an income above the global median ($PPP,20003170) but a large impact on countries below the median. If adaptation can be completed within 10 years, economic growth in the 21st century would be 0.6% slower if climate changes according to the A2 scenario than in the case without climate change. If economic growth is 2.6% per year without climate change, and 2.0% with, then a century of climate change would reduce income by 44%.

In sum, the literature on the impact of climate and climate change on economic growth and development has yet to reach firm conclusions. There is agreement that climate change would moderate the rate of economic growth, by a little according to some studies and by a lot according to other studies. There is disagreement whether climate change would affect the process of climate change, with some studies suggesting that more people may be trapped in poverty and fewer people enjoying exponential growth.

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