Consequences of extreme weather events such as heat and drought are disruptive to our global economy. How large these negative effects are going to be, is yet to be decided (by ourselves). You might think that the negative effects of climate change are only visible in the long term, but we can already see the impact of extreme heat and severe drought in the economy.
The Copernicus Climate Change Service (C3S) reports that May 2020 was the warmest month on record globally and the Spring in Europe was 0.7°C above the 1981-2010 average. This drought already threatens the production of wheat crops for farmers and the recent dry period in Europe also has consequences for the transport sector. Low water levels of the Rhine River, Europe’s most important inland river, will lead to shipping disruptions. The problems are not limited to Europe, as the South African government recently extended its national state of disaster due to the drought the country has been faced with for the last seven years. And if these issues were not enough, severe drought is already damaging the highest valued asset owned by households: their very own house.
Heat and drought in the economy
It would be easy if the consequences of an increase in global temperature were just a few extra sunny days per year. Some of us might even like the idea of having these extra days to go to the beach or have a few drinks on a terrace with friends and family. However, too bad climate change is not just a matter of a few extra sunny days. There are serious economic mechanisms at play here which impact the GDP growth rate. Heat and drought can be linked to some components of the GDP: consumption, investments and trade. They even have consequences for the productive capacity of the economy.
The increase in frequency and severity of heatwaves and droughts due to climate change has negative effects on the GDP of a country through demand and supply shocks. Demand shocks work through the three aggregate demand factors: investments, consumption and trade, while supply shocks work through the productive capacity of an economy: labour, capital and technology.
First of all, heat and drought lead to less investments in new productive capital and technology. The figure below shows that heatwaves and droughts will account for around 60% of the total climate hazard damage in the 2020s, while it rises to nearly 90% by the end of the century. The economic losses are highest for the industry sector and the transport sector through damage to critical infrastructure. As heatwaves affect railways and roads through buckling of rails and melting of asphalt, investments will be made in repairing and replacing infrastructure. Inland waterway transport is also affected by drought through less navigation capacity due to low water levels in rivers. This causes disruptions in the supply chains of the industry sector, which increases the economic losses. There is also an increased risk of mechanical failures in machinery due to heatwaves for the industry. Investments in repairing and replacing machinery and infrastructure are needed due to these extreme weather events, impacting a key driver of GDP growth.
Second, consumption decreases through economic damage to houses. Problems arise with the foundation of houses as periods of drought and heat happen more often. When heat and drought increase in frequency and severity, groundwater levels decrease more than normal and do not rise back to the original levels in wet periods. The consequence of these low groundwater levels is that it exposes the foundation poles under the buildings to oxygen, causing them to rot. What happens then is that these poles lose their load-bearing capacity, leading to the subsidence of buildings. We can already see this problem for older houses with a wooden foundation and houses on clay and peat soil. For the Netherlands, this issue is most prominent in Amsterdam and Rotterdam as shown in the figure below.
To avoid damage to their houses, households have to replace and repair the foundation of their house. Replacement costs can go from 30.000 EUR all the way up to 120.000 EUR. The impact on consumption directly follows from the need to replace and repair the foundation. Households have to decrease their consumption and this negatively affects aggregate demand, lowering GDP growth.
Last but not least, trade is also impacted because of heat and drought. As drought impacts the transport sector through an interruption in the logistics chain, this has consequences for the import and export. Drought impacts railways and roads, as well as transport over water. As mentioned before, disruptions of the inland waterway transport through rivers will happen more often due to low water levels. The interruption in the logistics chain led to a loss of almost EUR 5 billion for the German industrial output in 2018 because of a decline in transport through the Rhine. These consequences on import and export come together into a negative shock to the GDP.
Heat and drought also work through the productive capacity of an economy. First, the labour supply is affected by heat and drought. Carbon Brief reports that the global exposure to heatwaves increases significantly and that the average drought length increases because of climate change. The heat exposure can affect worker’s health, safety and productivity. This becomes worse when the extreme summer heat is increasing in frequency and intensity. The Environmental Protection Agency published a report showing that workers are at risk for heat-related illness and therefore need to take more breaks or have to stop working entirely, resulting in lower overall labour capacity. Furthermore, capital and technology are directly affected through the decline in investments in these factors. Repair and replacement costs of capital lower the amount of investments into new capital and technology. Together with consequences on labour productivity, heat and drought also impact capital and technology; all negatively affecting the GDP.
The challenges ahead
The points above make one thing clear: The risks of climate change are already materializing and they will become worse in the coming years if no action is taken. The warming of our planet is not about having a few extra warm days, but it is about the disastrous consequences for the economy and the health and safety of workers. And besides the economic consequences, I have not even touched upon the social risks that arise from heat and drought. The population that is exposed to water scarcity increases by almost 400 million if we do not reach the goals of the Paris Agreement. The practical examples above, the mechanisms that work through the economy and even the social risks that arise from heat and drought are just a small piece of the challenges we face.
Luckily, large institutions are focusing on the risks of climate change. From the Dutch Central Bank calling for a green recovery after the crisis, to the International Energy Agency on their Sustainable Recovery Plan to stimulate economic growth, create millions of new jobs and put the greenhouse gas emissions into a structural decline. I have hope that we can tackle the problems that are already materializing and the risks we face in the near future. At least the statements and calls from large institutions on greening the economy and lowering carbon emissions are steps in the right direction.