International Trade and the Adaptation to Climate Change and Variability

There are different reasons, why countries trade. The most important one, economists typically refer to, is that trade is a source of wealth. There is, however, a further reason, which usually is not mentioned in the economic literature, but is in the center of this analysis. Since the impact of global warming considerably varies across countries, trade is a kind of insurance against the risks of climate change. For example, if in some region because of weather extremes food production is reduced, over the short-run the resulting losses might be substituted by imports. Over the long-run production could even shift to regions, which have the comparative advantage of being less vulnerable to climate change and variability. Seen in this way, trade is a means to adapt to the increasing risks of global warming.

Moderating climate impacts is one side of the coin. The second one is that trade can spread the cost of climate change across regions. After six years of drought, Australia’s rice production almost collapsed in 2008. This was one of several factors contributing to a doubling of the world market price of rice, which led to panicked hoarding and violent protests in low income countries. In other words, output losses in a single region might cause higher world market prices, and the resulting terms-of-trade effects could pertain to real income losses in almost any country. In countries, where direct impacts of climate change are relatively moderate and where sufficient financial and technical resources for adaptation exist, terms-of-trade effects can be responsible for a significant fraction of a country’s total costs from climate change. This provides an argument to policy makers, why funding adaptation in the poor developing countries can be in the self-interest of the rich, industrialised ones.

This is to our knowledge the first paper, which analyses in a systematic manner the interaction between adaptation to climate change, international trade and terms-of-trade effects in a simple model. It has three messages mainly: First, trade can be viewed as a kind of adaptation to climate change and variability, as trade can help to reduce direct impacts of global climate change on a region’s welfare. In particular, the less affected and the richer nations are, the more they can profit from moderating the impacts of global climate change through trade. Second, if regions are rich enough to adapt optimally to climate change, the resulting allocation of adaptation measures is Pareto-efficient. In this case, funding of adaptation does not make sense from an economic perspective. Finally, since the regions of the South typically lack the resources for adapting optimally to climate change, because of terms of trade effects, it might be in the self-interest of the industrialised nations to fund adaptation in the developing part of the world. However, providing financial assistance for adaptation can be Pareto-improving only, if the benefits of funding, i.e., damages, which are moderated through adaptation, are big enough, and hence, if the recipient’s own expenditure for adaptation is low. If not, the paradoxical effect of recipient immiserization through tied transfers can occur.

Stephan, Gunter and Oliver Schenker (2012), International Trade and the Adaptation to Climate Change and Variability, ZEW Discussion Paper No. 12-008, Mannheim.