Key Messages 
  • Planned adaptation consists of measures promoted by government as planned policy interventions to address adaptation issues. These often complement autonomous adaptation which refers to the degree to which individual institutions, enterprises, communities or individuals, such as farmers, independently adjust to changing climate conditions.
  • Computational general equilibrium models can be used to consider the economy-wide implications of planned adaptation actions.
  • The Insight presents the extension of a CGE model to account for public sector investment in planned adaptation to the impacts of sea level rise.
  • Results suggest that support to adaptation in deficit spending is thus not necessarily negative for GDP growth and might also trigger positive effects on public finance sustainability. However this occur under specific circumstances.

Context

Some adaptation responses can be driven by self-regulatory mechanisms or autonomous reaction, other by planned policy intervention. Typical examples of autonomous adaptation at the national and international level are changes in agents’ behaviour adjusting/adapting to new price conditions. These autonomous responses can be strengthened by planned strategies, often promoted by governments.

Planned adaptation will require increased public expenditure, both on climate related public goods (such as information acquisition and dissemination on likely extreme events) and to protect public and private assets at risk like transportation systems, water and health systems. Eventually, adaptation can reduce or increase the stress on public budgets depending on its effectiveness, the structure of the tax system, the size of adaptation investment, and the funding sources available (Osberghaus and Reif, 2010).

The economy-wide effects of planned adaptation can be modelled through a computable general equilibrium (CGE) framework. CGE models consider, by construction, the so called “market-driven adaptation” i.e. the functioning of autonomous mechanisms – primarily, demand and supply reactions to endogenous changes in relative prices – which characterize instantaneous resource allocation across two market equilibria in response to exogenous economic shocks (Bosello and Parrado, 2014). There are few examples of the modelling of planned adaptation to sea level rise using a static CGE model with investments carried out by the public sector (Bosello et al, 2007 and Ciscar et al, 2009).

This insight presents the changes made to a CGE model (ICES) extended with a sophisticated description of the public sector to integrate planned adaptation to the impacts of sea-level rise. The final goal is to account not only for the GDP effects of adaptation, but also for the impacts on public finance. More specifically, we assume that adaptation expenditure is not financed through new taxes but issuing government bonds.

Policy and methodological developments 

Planned adaptation against sea level rise takes the form of public investments and expenditure for operation and maintenance addressing the building sector. Future projections of sea level rise damages come from the DIVA model (Hinkel et al, 2014), perturbed with inputs from two climate models (MIROC and NorEsm) and two RCP scenarios (RCP8.5 and RCP2.6). The DIVA model also provides information on the optimal levels of protection, costs, and residual damages of adaptation, in the different scenarios. The DIVA assessment however is of partial equilibrium in nature as it cannot capture explicitly neither the intersectoral and international economic impacts triggered by sea level rise, nor their rebounds on the sectors and countries initially impacted. This is however possible with CGE models that ultimately quantify the impacts on the value of production and ultimately on GDP accounting for all those interactions.

The basic ICES CGE model used is a multi-region, multi-sector, recursive dynamic CGE model of the global economy, derived from the GTAP-E model (Burniaux and Truong, 2002), which in turn is the energy environmental extension of the standard GTAP model (Hertel, 1999). Features of ICES are similar to most CGE models: domestic production is determined by a series of nested constant elasticity of substitution (CES) functions, which specify substitutability between primary factors, energy and non-energy intermediates.

The demand side of the economy is characterized by a representative household, who receives income from primary factors, and allocates it across private consumption, public consumption and saving so as to maximize per capita aggregate utility, according to a Cobb-Douglas function. A global bank collects global net savings and allocates them amongst regions according to relative rates of return to capital. Bilateral trade is specified by assuming imperfect substitutability to consider product heterogeneity by country origin (Armington, 1969).

In the basic ICES model, the government behaves as a representative household. This has two major implications. Firstly, the public income uses are completely independent from their sources. Secondly, the possibility for the public sector to save is not considered at all. This represents a limitation when public spending on adaptation has to be evaluated. To address this issue an extended model version was developed where the government is a separate actor with its own budget constraint.

The ICES-XPS (ICES-eXtended Public Sector) model now includes different transfers between the government and households such as social transfers, and interest payments on debt stock. There are also transfers among governments in the form of international aid. Government transfers, consumption, and investments build government expenditure, government income derives from taxes. Accordingly, at the regional level, investments are both private and public linked into a Cobb-Douglas formulation.

The gap between public savings and public investments represent the government’s financial needs (borrowing). This gap is financed by private households’ savings, since both domestic and foreign households supply a homogenous saving commodity. Investment is internationally mobile and regional savings (private plus public) from all regions are pooled in a global bank. Subsequently investment is allocated to equalize expected rates of return to capital in the long-run.

Savings and investments are equalized at the world, but not at the regional level. Therefore, each region could have an imbalance between disposable savings and investment demand. This imbalance is closed by a surplus/deficit in foreign transactions (considered as the sum of trade surpluses/deficits and the net inflows of international transfers). In this context, government borrowing reduces the availability of regional savings with a consequent increase in saving prices which are negatively correlated to the rate of return to capital.

The general equilibrium analysis is developed comparing three scenarios.

  • The reference “No impact” scenario is based on the SSP2 “Middle of the Road” scenario for GDP growth projections from the OECD based on population projections from IIASA and do not include any impact from sea level rise.
  • The “No Adaptation” scenario includes sea level rise impacts. This represents a counter factual scenario of adaptation frozen at 1995 protection levels.
  • The “Adaptation” scenario includes public intervention to protect coastal zones against sea level rise as prescribed by the DIVA model and includes some residual damages.

Results indicate the following:

  • The ‘no additional adaptation’ scenarios (No Ad) feature a generalized GDP loss in all regions for both RCPs except South Korea (Figure 1). The magnitude of losses is strictly dependent on the size of impacts on capital, land and labour productivity. The most affected countries are East Asia that could lose from 3% to 5% of GDP in 2050, China (up to 2%), North Europe and South Asia (both by more than 1%). In the rest of Asian countries, Middle East, North and South Africa and Canada the GDP decreases less than 1%, in European regions less than 0.5%.
  • Public deficits also worsen due to the erosion of the input and output tax base as sea-level rise affects negatively land, capital and labour and ultimately GDP. These increases can be substantive in absolute terms: e.g. more than $ 200 billion in China, $ 80 billion in East Asia, $ 25 billion in Latin America and the Caribbean and $ 17 billion in India. With a higher deficit the government borrows more from household savings, which eventually reduces also the available resources for private investments and growth.
  • When coastal protection occurs, GDP gains are observed everywhere and especially in developing countries where sea-level rise impacts are higher and adaptation expenditures are particularly effective (Figure 1). On the one hand, adaptation reduces direct impacts (loss of labour productivity, land and capital). On the other hand it translates in lower deficits, lower debt accumulation, and consequently lower debt service which allow for more resources devoted to growth

Figure 1: Impacts on real GDP by region and RCP in 2050 (with and without Adaptation)

  • Figure 2 highlights some typical patterns in the evolution of deficit with and without adaptation in four EU regions and two Asian regions. Initially, public deficits are higher when adaptation investments are being put in place, to become lower only in the long run. This is a direct consequence of the long-run nature of sea-level rise impacts that are more damaging for GDP and also deteriorate the ability to raise tax revenues in the longer term.
  • All in all, at least in the case of sea-level rise impact, support to adaptation in deficit spending is not necessarily bad for GDP growth, and might trigger positive effects on public finance sustainability. This highlights a potentially interesting policy insight: adaptation expenditure can enable virtuous processes even though initially financed with debt.

Figure 2: Impacts on public deficit by RCP for selected regions in 2050 (with and without additional adaptation)

Main implications and recommendations 

The use of CGE models for investigating the economy-wide effect of planned adaptation is a useful addition to existing approaches. Investigating the economy-wide of planned adaptation can provide useful insights into the macro-benefits of public investments in adaptation. Results suggest that support to adaptation in deficit spending might be not necessarily bad for GDP growth, and might also trigger positive effects on public finance sustainability. This highlights a potentially interesting policy outcome. Adaptation expenditure could enable virtuous processes even though initially financed with debt. This can be a good new for countries where increasing tax pressure is particularly problematic. This raises the issue of the different results that could be obtained through for instance earmarked taxation for adaptation that can potentially trigger different dynamics on debt accumulation and thus on the consumption-investment balance and growth.

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