ESG Economist - How big is the impact of extreme weather on GDP?

News article
Article tags:
  • Sustainability

The fourth vintage NGFS scenarios incorporate four acute physical risk hazards: heatwaves, drought, flooding and tropical cyclones. The frequency of these hazards under different scenarios are combined with location characteristics to produce impacts. These are then translated to the broader economy using transmission mechanisms. Globally, GDP impact from drought is largest, while in Europe the impact from heatwaves is largest. The impacts are dependent on how the hazard is defined and on the transmission mechanisms. Acute physical risk damages are significantly more sizeable in the fourth vintage, with GDP losses at 8% by 2050 in Current Policies, against 1.4% in the previous version. Still, it is clear that this is still an underestimation of physical risk as not all hazards and impacts are taken into account.

Introduction

In November 2023, the fourth vintage Network for Greening Financial Services (NGFS) climate scenarios were published. We earlier wrote a general note on the fourth vintage scenarios here. We now go into more details. One of the main steps forward in the fourth vintage was the more extensive and more granular incorporation of acute physical risk. In this note, we look further into these acute physical risks.

Risk, transition, chronic physical and acute physical

Risks associated with climate scenarios come in three flavours. Transition risk is the risk associated with the transition towards a greener economy. The size of transition risk depends partly on the speed and extent of the transition taking place, relative to the capacity and readiness of the private sector to adjust. If the transition is orderly, gradual and expected, transition risk is lower than when the transition occurs in a disorderly, sudden, unexpected or delayed fashion. Chronic physical risk is the risk associated with the average temperature change, for instance through trend changes to labour productivity and agricultural productivity as the earth warms. Acute physical risk is the risk associated with the increased frequency and severity of extreme weather, such as heatwaves, drought or floods. The NGFS climate scenarios illustrate that an immediate coordinated transition will be less costly than inaction or a disorderly transition in the longer term. This is due to the prominence of physical risk. Chronic physical risk becomes gradually more prominent over time, especially in the hot house world scenario Current Policies (this scenarios assumes continuation of current policies without any further action and leads to global warming of 2.9 degrees Celsius at the end of the century). But the most sizeable source of risk across all scenarios and time horizons is acute physical risk, and this source of risk increases further in relative terms towards the longer term: since physical risk is unaffected by mitigation efforts in the short run (given that the impact works with a lag), acute physical risk is similar across scenarios until 2040, with a strong surge in damages in Current Policies thereafter.

Hazard impacts

Acute physical risk modelling has been enriched to include more hazards and increasing geographical granularity. In the previous version, there was some coverage on a global scale of acute physical risk. The fourth vintage expands the coverage of acute physical climate risks and specific hazards, such as heatwaves, droughts, floods, wildfire, and storms, and their impact on the macro economy. This is done through more granular indicators, the use of global climate models, and impacts at specific locations. These impact are then put into the economic model NIGEM (the macroeconomic model used to transmit the transition and physical risks into the fundamental macroeconomic variables). GDP impacts are estimated in NIGEM using specific transmissions mechanisms. Read the full article here