The Economic Impact of Climate Change and How to Protect Against It

By Nicole Young on July 12, 2022

Climate change keeps many people up at night. From those experiencing extreme weather events firsthand, to parents worried about the quality of their children’s future, to those seeing it slowly transform the natural environments they hold dear, the issue is difficult to ignore.

The same is true for economists and professional investors, who recognize the enormous financial implications of climate change. And while looking at it from an economic perspective may seem less important than looking at it from a humanitarian angle, the two are inextricably linked: Understanding and mitigating the economic consequences of climate change can save and improve lives.

This link is why research on the subject — such as a recent analysis published by Vanguard, The Economics of Climate Change^[1] — is so important. It is also why understanding broad economic consequences can help you prepare personally.

Research Framework

To provide a framework for the significant task of estimating the economic impact of climate change, researchers at Vanguard focused on the following three dimensions:

1. The direct physical impact of higher temperatures, for example, from falling crop yields, reduced labor productivity, lower biodiversity and an increased incidence of extreme weather events such as storms, forest fires and droughts.
2. The effect of stricter environmental policies asclimate policies are enacted to reduce emissions and transition toward net-zero emissions.
3. The positive boost from greater “green investment” to help mitigate and adapt to climate changes.

Main Takeaways

Employing sophisticated statistical techniques and leveraging a variety of academic research, the researchers at Vanguard — led by a global team of economists and PhDs — drew the following conclusions:

• The physical impact of climate change on the economy will increase significantly as temperatures rise, but the impact will vary considerably across regions. Economies operating in relatively cooler climates will benefit as warmer temperatures lead to new economic opportunities, while economies in already warm climates will suffer more as productivity declines. For example, their analysis suggests economies such as the U.K., Germany and Italy are predicted to experience only a modest negative gross domestic product(GDP) impact relative to countries such as Brazil, Mexico and Australia. By contrast, they predict Canada is likely to gain in economic terms as rising temperatures open new economic opportunities.
• Stricter environmental policies consistent with meeting the goals of the Paris Agreement^[2] will exert an estimated 5% to 8% drag on global GDP by 2050. Not surprisingly,economies that require greater emissions-policy tightening to reach their goals (e.g., Spain and the U.S.), and/or that have a larger proportion of their economy skewed toward high- and medium-emitting sectors, will experience larger drags on economic growth.
• Increased investment in green infrastructure and technologies will partly offset the growth drag from higher temperatures and stricter environmental policies. For small temperature rises, investment will be directed toward climate mitigation. For large increases, more spending will be targeted toward adapting to the consequences of climate change.
• Overall, climate change will have a negative estimated drag on global GDP of between 2% and 4% by 2050 for small temperature rises. However, costs escalate thereafter, estimated at closer to 10% of GDP for temperature increases above 3 degrees Celsius.

What can individuals do to brace for the economic impact on their households?

Please note the following considerations were provided by us, Private Vista, not Vanguard, and are completely independent from Vanguard’s research discussed above.

While Vanguard’s research has significant implications for economists, the investment industry and policymakers, you may wonder how it translates to your life — and what to do about it. While the answer for every individual and household differs — and certainly goes well beyond financial planning — there are a few broadly applicable steps to consider taking, including: 

• Review your insurance coverage

Climate change appears to already be increasing the risk of personal property destruction. Case in point: The average number of weather-related disasters resulting in more than $1 billion of damage over the past five years (2017–2021) is 17.8 events, compared to the 1980–2021 annual average of 7.7 events.^[3] Yet many property owners, including those with significant assets, lack sufficient coverage. Talk to your advisor, who can coordinate with insurance specialists/agents as needed to determine if you have sufficient coverage. Depending on the region in which you live, this may mean supplementing your property and casualty insurance with additional coverage specific to natural disasters such as floods or earthquakes.

• Allocate to climate-conscious investment strategies in your portfolio

As defined by Morningstar (other firms may have slightly different names and definitions for this investment category), these strategies select or tilt toward companies that consider climate change in their business strategy and therefore are better prepared for the transition to a low-carbon economy.^[4]

• Reevaluate relocation plans

If you plan to relocate in retirement — or sooner — have you included potential costs related to climate change as you weigh the pros and cons? Many popular areas for retirees may become riskier from a natural disaster perspective. Once you attempt to quantify the costs associated with insurance, you may decide to choose another region.

Eyes Wide Open

One of the reasons climate change can invoke significant anxiety is that it is well beyond one’s control. However, as Vanguard’s research helps highlight, there are certain “known unknowns” for which the world — and we, as individuals — can prepare. If you are concerned about climate change and would like to protect against it where you can in your financial plan, please reach out to us for help.

_{[1] https://institutional.vanguard.com/insights-and-research/report/the-economics-of-climate-change.html}

_{[2] See https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement.}

_{[3] NOAA National Centers for Environmental Information (NCEI) U.S. Billion-Dollar Weather and Climate Disasters (2022), https://www.ncei.noaa.gov/access/monitoring/billions/, DOI: 10.25921/stkw-7w73. Accessed April 20, 2022. Data is adjusted for inflation.}

_{[4] Stuart, Elizabeth. “How Can Climate-Aware Funds Fit Into Your Portfolio?” Morningstar, April 16, 2021, https://www.morningstar.com/articles/1033132/how-can-climate-aware-funds-fit-into-your-portfolio. Accessed June 23, 2022.}