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The Direct and Indirect Impacts of Climate Change on Trade

The Direct and Indirect Impacts of Climate Change on Trade

The Direct and Indirect Impacts of Climate Change on Trade

The Direct and Indirect Impacts of Climate Change on Trade

The physical impacts of climate change will have direct as well as indirect consequences for trade. Direct effects encompass the effects of climate change on trade-relevant supply, transport and distribution chains, which could become manifest in damages to trade infrastructure such as ports from more frequent extreme weather events or rising sea level. Other impacts, such as retreat of polar ice under warmer temperatures can lead to opening up new trade routes in the Arctic.

Indirect impacts for trade will primarily result from the impact of climate change on the production of goods and services through changes to the factors of production of economies, i.e. land, labor, and capital. Both direct and indirect effects of climate change on trade will likely lead to changes to the comparative advantage of economies, hence trade flows and patterns.

The International Monetary Fund has long warned that climate change poses the biggest economic risks to the global economy. In its latest annual risk report, the World Economic Forum has again placed extreme weather events and the failure to deliver the Paris commitments as the two top risks facing decision makers. The Asian Development Bank recently estimated countries in Southeast Asia could see a loss of 11% in gross domestic product by the end of this century.

Until recently, the world’s best hope for combating global warming was the 2015 Paris climate agreement, which has been signed by 197 parties, including the world’s two largest cumulative emitters of greenhouse gases (the United States and the European Union) and the leading current emitter (China). All signatories have pledged to meet numerical targets to lower drastically their own emissions relative to a business-as-usual path.

At the time, many thought that the Paris agreement was the limit of what was politically feasible. Yet most climate-change models predict that even if all countries fulfilled their pledges, their efforts would not keep the increase in global temperature below 2°C above pre-industrial levels, the critical threshold beyond which catastrophic outcomes, including higher sea levels and more frequent natural disasters, would become inevitable.

All the while, the two indicators that matter annual emissions and average global temperature increases are going in the wrong direction. Global greenhouse gas emissions have climbed each year since 2012. The years 2015-2017 were, according to the World Meteorological Organization, the hottest ever recorded.

This means more action engaging all economic levers is urgently needed to shift the current trajectories towards lower-carbon outcomes.

A noticeable laggard as part of the climate solution is trade policy. Certainly, actual trade in clean technologies is now substantial and markets are growing.

The Direct Impacts of Climate Change on International Trade

Climate change will impact trade through a number of channels, not all of which can be easily quantified. This section outlines some of the main impacts, based on a brief review of the literature. One prominent explanation for the rise in international trade in the last decades was a decline in international transportation costs (Hummels, 2007). One key direct effect of climate change is that supply, transport and distribution chains might become more vulnerable to disruptions due to climate change, thereby affecting future international trade patterns.

Extreme weather events, for instance, may lead to the temporary shutdown of ports and transport routes; they might also damage infrastructure critical to trade and thus have longer-lasting effects. These and other interruptions can lead to delays, increase the costs of international trade and could lead to a shift in trade patterns as companies involved in trade seek alternatives to increase reliability of shipping (WTO, 2009).

Several issues on direct impacts of climate change on trade require further clarification. With uncertainties on the pace and extent of the logistical barriers, the lack of infrastructure, harsh weather conditions, short winter days, and on how melting ice may affect the stability of the Arctic climate, it is difficult to predict how large an effect Arctic shipping may have on international trade.

Furthermore, infrastructure in developing countries may become more climate-resilient in the future as a result of international development support, not least when donor mainstream climate considerations in their development assistance. These remain key areas for further analysis.

The Indirect Consequences of Climate Change on International Trade

Some sectors are directly impacted by specific climate impacts (e.g. services sectors are affected by health impacts, energy sectors by energy demand impacts). However, there are also substantial indirect effects that are induced by the full range of price changes that follow climate impacts. For example, impacts on the energy demands affect energy prices and thus induce changes in production in energy intensive industrial sectors.

As another example, capital destruction from sea-level rise affects all sectors through changes in the marginal productivity of capital. Of the impacts modelled in few analysis by IPCC and FAO, changes in crop yields and in health (labor productivity) are projected to have the largest negative consequences on the macro economy, causing loss to annual global GDP of 0.9% and 0.8%, respectively, by 2060 for the central projection of the climate damages scenario.

 The GDP impacts of climate change damages as projected with the ENV-Linkages model (The OECD ENV-Linkages Computable General Equilibrium (CGE) model is an economic model that describes how economic activities are inter-linked across several macroeconomic sectors and regions) can also be decomposed into changes in each specific primary factor of production. Climate impacts may directly affect labor, capital, land and natural resources.

These direct effects have been calculated by multiplying the percentage change in productivity with supply of these production factors at their no-damage baseline levels of use, i.e. before any endogenous market adaptation effects. The indirect effects can be calculated as the difference between the total effect and the direct effect.

For capital, the situation is different, as its supply is flexible in the long run, since consumers can adjust their savings patterns in response to changes in the economic situation. Thus, there is an additional effect, as changes in income levels affect savings and hence future capital accumulation. Thus, the climate impacts not only affect the level of GDP, but also the growth rate, through reduced capital accumulation.

The volume of international trade is projected to be affected by climate change to more or less the same extent as global GDP. The world exports may decrease by 1.8% in 2060, relative to the baseline without climate damage, while global imports and GDP would be reduced by 1.6% (expressed in 2010 USD using PPP exchange rates).

At the global level, the decline in exports is larger than that of imports, as both are measured in different prices (FOB and CIF, respectively). In principle, one could expect that increased trade flows are necessary to compensate for production losses in the most affected economies. However, as indicated by the GDP losses, there is a global contraction of final demands (compared to the no-damage baseline), and given the imperfect substitution between domestic and foreign goods and services, this will imply a reduction in both production and trade.

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