Terms-of-Trade and the Funding of Adaptation to Climate Change and Variability. An Empirical Analysis

Regional economies significantly diverge in their exposure as well as their capacity to adapt to climate change and variability. Between 1984 and 2004, if measured in percent GDP, costs of climate impacts were three times smaller in high-income countries than in low- to middle-income ones, where 80 percent of the world population lives.

The COP17 meeting at Durban once again demonstrated that the world community presently is unable to establish an international agreement on greenhouse gas abatement, which extends the Kyoto Protocol. This makes adaptation an urgent option for insuring against the threat of global warming. However, adaptation to climate change is costly and many developing coun-tries lack the financial, institutional and the human resources for coping effectively with climate change.

Fairness and equity are major arguments why the industrialized countries should assist the developing countries. But there are further ones. Adaptation can help to ensure that the developing countries remain partners for economic growth, global governance and international trade. In particular, adaptation can moderate the terms-of-trade effects of climate related events as for example the one observed in 2008. After six years of drought Australia’s rice production collapsed almost completely. Combined with other factors this caused a doubling of the world market price of rice, which led to panicked hoarding and violent protests. Indeed, even if free trade can curb climate change impacts, output losses in one single country might cause rising world market prices and the resulting terms-of-trade effects can pertain to real income losses in almost any country.

This paper analyses the interrelationship between international trade, regional adaptation and North-to-South transfers for funding adaptation within the framework of a dynamic computable general equilibrium model, where impacts of climate change depend on changes in precipitation and temperature. If all regions, even the least developed ones, own the necessary resources for adapting optimally to climate change and variability, by mid-century less than 10 per cent of the regions’ GDP would be invested for avoiding almost 40 per cent of climate change dam-ages. In absolute terms global adaptation expenditure would account to more than 85 billion US$ by 2050. This has measurable effects on the regions’ competitiveness as well as on the terms-of-trade. If, however, the developing world does not own sufficient resources for adapting optimally to climate change, as is to expected, funding of adaptation, which is an element of international climate policy, can make sense from an economic perspective. In particular the Hicks-Kaldor criterion is fulfilled as aggregated welfare gains at least compensate the costs of providing financial assistance for adaptation.

Schenker, Oliver and Gunter Stephan (2012), Terms-of-Trade and the Funding of Adaptation to Climate Change and Variability. An Empirical Analysis, ZEW Discussion Paper No. 12-056, Mannheim.