How climate change impacts productivity and worsens inflation
Empirical studies on the effects of climate change on economic activity have found that, in the short term, economic activity is typically hurt by climate change, especially in emerging and developing economies
Climate change today is as grave a concern for the economy as it is for the natural environment. We are already noticing how climate change affects our economy as global temperatures continue to rise. In addition to changing the supply and demand of goods, extreme weather is also causing supply chain interruptions and a labour shortage.
The Bangladesh Meteorological Department reports that over the past century, the temperature across Bangladesh has increased on average by roughly 1 degree Celsius. Due to the effects of climate change, this temperature increase has been seen to be more rapid in recent years, and it is predicted to continue to grow. Moreover, the consequences of global warming are not the same in every region and can depend on factors such as geography, weather patterns, and human activity.
As a result, summers are longer and hotter, and winters are warmer and shorter. Monsoons, in contrast, are more erratic than is typically expected. Despite the observed changes in weather and seasons due to human-induced climate change, little is known about how this phenomenon might be a covert driver of inflation.
Inflation is a sustained upward trend in the average price of goods and services over time. Therefore, as inflation rises, the value of money as a medium of exchange declines dramatically. Prices have consistently increased over time in Bangladesh, but have skyrocketed since 2021. Inflation rose from 5.51% in 2016 to 9.33% in March 2023, according to official figures. Various factors, such as changes in the money supply, government policies, supply shocks, and shifts in aggregate demand, can lead to inflation.
Inflation has several adverse effects on the economy. Consumers' purchasing power can be diminished by high inflation, which also depreciates savings and investments and lowers real income. It can lead to volatility and uncertainty in the market, making it challenging for firms and investors to make plans. Additionally, inflation is a net transfer from consumers to producers.
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Numerous empirical studies on the effects of climate change on economic activity have found that, in the short term, economic activity is typically hurt by climate change, especially in emerging and developing economies.
Over the years, temperature and inflation tend to have similar peaks and troughs, implying some form of correlation or association. Thus, spreading awareness about the consequences of our complacency towards climate change is crucial, which may be one of the hidden causes of inflation. In recent months, climate-fueled disasters have affected crop production, raised the cost of energy, and prevented workers from staying on the job in Bangladesh.
A direct consequence of climate change is that it impacts labour productivity; according to a report published by the World Bank, a one degree Celsius rise in temperature results in a 5.7 percentage point increase in the risk of developing a respiratory illness. Rising rates of respiratory infections, vector-borne diseases like dengue, and poor mental health conditions are just a few examples of how Bangladesh is already experiencing the health effects of high temperatures and increased air pollution.
Therefore, workers become more susceptible to illnesses, reducing their efficiency and ability to work and decreasing the overall labour stock and hours worked. So, the optimum level of output that they could produce eventually decreases, decreasing labour productivity.
In addition, the Dasgupta et al. (2021) paper "Effects of Climate Change on Combined Labour Productivity and Supply" found that the labour supply is not only negatively affected in the tropics but also in colder regions because of temperatures below the optimum. Using the Keynesian macroeconomic model, we can analyse how a decrease in output affects the economy.
Keynesian economics examines the theory of total spending in the economy and its effects on production, employment, and inflation. It shows that a decrease in potential output (where the economy has less capital, labour, or technological growth than it would otherwise have had) increases the general price level of goods and services.
Furthermore, an empirical study published by Elsevier Ltd. revealed that future climate change will reduce global total labour in the high-exposure sectors (e.g., the agricultural sector) by 24.8 percentage points under a 3.0°C warming scenario. In addition, studies utilising economic models have discovered that the effects of the environment on labour are one of the most significant drivers of the overall economic consequences of climate change because labour makes up a sizable portion of the total value added (according to the 2021 paper by Dasgupta et al.).
The Solow model, also known as the neoclassical growth model, suggests that when the labour supply decreases, the economy will produce less output because fewer workers are available to produce goods and services, leading to a decline in the Gross Domestic Product (GDP). So, it will not only affect the general price levels (increase inflation) but also reduce the economic growth rate.
The indirect impact of climate change is reflected in interest rates. Since fluctuations in inflation rates, in turn, affect interest rates in an inflationary environment, rising prices inevitably reduce real interest rates. When real interest rates are low, consumers may be discouraged from saving, hampering long-term economic growth prospects.
While low-interest rates may theoretically boost investment due to lower loan costs, under the ceteris paribus assumption, this may not necessarily be the case in Bangladesh. As expectation is a crucial factor in governing investors' decisions, the prevailing global uncertainty creates scepticism among potential investors, hindering economic investment.
Finally, the aggregate demand and supply model can also help us comprehend how inflation and climate change will affect the economy in the near future. Climate change and inflation also have significant impacts on consumption patterns. Given Bangladesh's heavy reliance on agriculture, the shortage of essential food products caused by climate change creates demand-pull inflation, exacerbating the country's already high inflation rates.
In addition, as already indicated, climate change and severe weather can result in labour shortages, which lower the overall supply of commodities and drive up prices. These patterns underline the immediate need to address the problem of climate change to maintain sustainable economic growth of Bangladesh.
Sanjana Khondaker is a graduate student at the Department of Economics and Social Sciences, Brac University. She can be reached via email at [email protected]
Muhammad Shafiullah is an Associate Professor at the Department of Economics and Social Sciences, Brac University. He can be reached via email at [email protected]
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.
