Climate change and the cost of inaction

Ric Colacito, Bridget Hoffmann, Toan Phan
28 October 2016

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To date, much of the research on the impact of rising temperature on economic activity concerns only developed, rather than developing countries (Dell et al. 2012). Also, it has examined the small fraction of economic activities that are naturally exposed to outdoor weather conditions, such as agriculture (Nordhaus 2014). Our research provides direct evidence of a strong negative effect from rising summer temperatures on a wider range of US economic activity (Colacito et al. 2016).

We combined our estimated impact coefficient with projections of the expected temperature increases under different emissions scenarios provided by climatologists. Our analysis ignores the potential effects of new technologies to cope with rising temperatures, but it measures the cost of inaction.

We calculated that the cost of climate change could be as large as one-third of the growth rate of US GDP over the next 100 years.

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Our analysis quantified the effect of rising temperatures across sectors of the US economy. We find that an increase in average summer temperature has a pervasive effect on all industries, not just the sectors that are traditionally assumed to be vulnerable to climate change. Figure 1 shows that, in the most recent part of our sample, an increase in the average summer temperature has a negative effect on the growth rate of output of many industries, including finance, services, retail, wholesale, and construction that represent more than a third of gross domestic product (GDP). Only a few sectors such as utilities (1.8% of GDP) benefit from an increase in the average summer temperature.

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The size of this impact on growth depends on the time horizon. When comparing one year to the next, the net effect of temperature is small. According to our estimates, a 1°C increase in the average summer temperature is associated with a reduction in the annual GSP growth rate of 0.086 percentage points, and a 1°C increase in the average fall temperature is associated with an increase in the annual GSP growth rate of 0.057 percentage points. Therefore, a uniform warming of 1°C across both seasons reduces economic growth by about 0.03 percentage points. The aggregate effect in one year appears too small to influence political debate.

The cumulative effect over longer horizons, such as those of the Paris Agreement, is significantly greater.

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Figure 2 shows that, in the most conservative scenario (B1), the projected trend is expected to reduce the growth rate of US output by 0.2 to 0.4 percentage points by the end of the century. At the historical growth rate of US GDP of 4% per year, this would correspond to a reduction of up to 10%. The results are even more dramatic in the high emissions scenario (A2). Here, the reduction of economic growth could reach 1.2 percentage points, corresponding to roughly one-third of the historical annual growth rate of the US economy.

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