Climate Change: “Is It Hot in Here or Is It Me?” (Joan of Arc)
We’ll leave the argument over the cause or causes of climate change, the discussion of the science of climate change, and even environmental economics to the specialists who write voluminously about those subjects. However, we can address some of the implications of the impact of climate on the U.S. and global economies.
What economics does for science is provide a motive for accumulating data. Lloyds of London has data on hurricanes dating back centuries, not so much due to an interest in hurricane science but because they were insuring ships. They needed to track storms that threatened vessels so they could determine risk and premiums. As such, that discipline, a facet of environmental economics, preceded what we call economics today, and originally, political economics. Climate has an enormous impact on commerce, and those mounds of related data gathered over decades and centuries are, in a way, accidentally of great use in understanding how our climate is changing.
Climate and commerce are historically and inevitably interconnected in how they influence physical economic development. In those initial centuries Lloyds was insuring ships, commerce was based essentially on moving things by boat, if some movement was by land along the Silk Road. By and large trade was done in ports, and fostered the development of the largest cities. Even in the United States, there are few large landlocked cities, and those—Atlanta, Dallas, Denver, Phoenix—became large relatively recently.
With the advent of climate change, port cities began facing disproportionate challenges. If the kind of tropical storm that flooded New York City’s subways in 2019 had been a recurring incident over years, the subways would have been designed and built differently, that is, to withstand floods. There are posh neighborhoods in Miami where the streets routinely flood during a high tide and full moon. Such persistent events call into question the ongoing viability of some of these locations—and present a major challenge to our economy.
Evaluations and Insurance
Climate change threatens property valuations. Homes on beachfronts that are not elevated to withstand today’s storm surges are subject to devaluation. Property valuations are forward-looking, and within a decade or so these homes may be considered uninsurable, unviable, perhaps even unusable.
Insurance is not just about compensating for contemporaneous damages, but assessing the probability of those damages over time—for example, flood insurance for a mountain cabin versus a cottage on a barrier island. Premiums are “experience rated,” but those years of experience are not as useful as in the past for establishing risks today. Homebuyers in California know that the Santa Ana winds come every fall when the state is dry and at risk of fires. But now those fires are widespread, all up and down the West Coast, well beyond the areas traditionally subject to the Santa Ana winds, even into Colorado and the Rockies. Fire insurance valuations based on historic experience substantially underestimate the current risks. The implications extend to the entire economy because risks are shared. If you live in that mountain cabin and your risk of fire is essentially unchanged over the last decade, you might be in an insurance pool with greater exposure and the associated higher premiums.
Insurance companies may make good faith efforts to provide insurance at fair prices, but climate change has made it difficult if not impossible to determine actuarially fair pricing. That translates to greater uncertainties and disruptions of property valuations. Climate change makes it difficult to value and difficult to assess risks, which makes it difficult to insure, and insurance is a part of the valuation process. It is a big and unpleasant loop.
Climate change affects property values and how they are assessed, in part because of property rights and how the actions of some impact the properties of others. We have yet to perfect a way to assess the value of the pollution from vehicles and manufacturing plants in terms of the larger setting of global climate change. It might be possible to do so theoretically but not in a practical sense. Our approach has been to assign the responsibility broadly by regulating vehicles or industries that pollute.
Economists favor a carbon tax because it addresses the overuse of one particular input creating an environmental problem. If carbon-based emissions cause environmental damage, then taxing the use of carbon is a direct way of discouraging carbon-based pollution. A carbon tax has not been politically popular in the United States; a large portion of our energy depends on carbon and a carbon tax would result in a tax increase for a large swath of our population. It would also make for dramatic changes in how we power vehicles. Vehicles that emit a great deal of carbon exhaust would be economically disadvantaged, as would carbon-intensive industries.
The negative externalities associated with pollution and property rights are massive and global in nature. While the United States might make strides in curbing pollution, we are a large emitter because we are a large economy. One of the top concerns of environmental economists is that other nations trying to become large might not have the same level of commitment to the environment as the United States and other developed nations.
Takeaways
• It is fundamentally more difficult today to value large segments of the physical structure of U.S. cities that are located near bodies of water or in the West, and enormous risks from rising seas and fires make them increasingly difficult to insure.
• The combination of property valuations and insurance as affected by climate change disrupts financial markets, particularly property- and insurance-related markets.
• A carbon tax is popular with economists because it directly addresses the overuse of one particular input creating an environmental problem.
Equilibrium
Things interact with each other in ways that aren’t always immediately obvious. Climate change, for example, casts uncertainty on the long-term viability, or at least valuation, of some currently very important properties because of the increased probability of some expensive natural disaster. Given the likelihood of increasingly frequent and damaging natural disasters, it is difficult to figure out risk-appropriate insurance rates. The uncertainty in insurance markets adds further uncertainty to valuing property where insurance is a critical part of the valuation. That simultaneous system of uncertainties in prices and values becomes increasingly problematic as climate change accelerates.