On Climate Change and Economic Growth

The economic impact of climate change is usually measured as the amount by which the climate of a given period will affect output or GDP in that period. This paper draws attention to some of the dynamic effects through which climate change may affect economic growth and hence future output. In particular, the paper looks at saving and capital accumulation. With a constant savings rate, a lower output due to climate change will lead to a proportionate reduction in investment which in turn will depress future production (capital accumulation effect). If the savings rate is flexible, forward looking agents may change their savings behavior to accommodate the impact of future climate change. Again this alters growth prospects (savings effect). In an endogenous growth context, the two effects may be exacerbated through changes in labour productivity and the rate of technical progress. Simulations using a simple climate-economy model suggest that the capital accumulation effect is important, especially if growth is endogenous, and may be larger than the direct impact of climate change. The savings effect is less pronounced and its sign is ambiguous. In most cases, the savings effect is negative, that is, faced with climate change households increase current consumption rather than saving more to compensate for future damages. The indirect effects are relatively larger for smaller direct effects; the indirect effects are also relatively larger for growth mechanisms more prevalent in richer countries. Ignoring the growth effects of climate change thus leads to a substantial underestimate of the impacts of climate change, particularly in richer economies.