CLIMATE RESILIENCE AND ECONOMIC GROWTH IN DEVELOPING COUNTRIES

Expert Workshop 24 April 2013, OECD Headquarters, Paris Background note

The OECD is developing guidance to support governments and development partners in integrating

climate change adaptation into their development strategies. To inform the development of that guidance,

the OECD is co-ordinating two country case studies (Ethiopia and Colombia) and an Expert Workshop on

“Climate Resilience and Economic Growth in Developing Countries” that will be held in Paris on 24 April

2013. This paper is intended to support the discussion at the expert workshop, by summarising the current

knowledge in this area and highlighting some of the key challenges and emerging issues to be discussed at

the workshop.

OECD Contacts:

Michael Mullan: michael.mullan@oecd.org

Eva Hübner: eva.huebner@oecd.org

Nicholas Kingsmill: nicholas.kingsmill@oecd.org

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TABLE OF CONTENTS

INTRODUCTION ........................................................................................................................................... 2

SESSION 1: LINKS BETWEEN CLIMATE RESILIENCE AND ECONOMIC GROWTH ....................... 3

SESSION 2: KEY CHALLENGE – MANAGING RISK AT THE MACROECONOMIC SCALE ............. 4

SESSION 3: KEY CHALLENGE – PUBLIC POLICIES FOR STRENGTHENING PRIVATE CLIMATE

RESILIENCE .................................................................................................................................................. 7

SESSION 4: INTEGRATING CLIMATE RESILIENCE INTO ECONOMIC GROWTH STRATEGIES .. 9

REFERENCES .............................................................................................................................................. 10

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INTRODUCTION

1. The effects of climate change – such as rising sea-levels, droughts and floods – threaten to slow

down or, in some cases, reverse recent gains in economic and social development. Building climate

resilience will therefore be a crucial aspect of economic development in low- and middle-income countries.

In this context, the OECD project on Climate Resilience and Economic Growth in Developing Countries

aims to provide guidance on how to integrate climate resilience into economic growth strategies and

structural reforms.

2. Integrating climate resilience into growth and development planning has the potential to enable

vulnerable countries to achieve a scale of response that is commensurate with the challenges they face. An

integrated approach is also important because vulnerability to climate change results from the interplay of

economic growth and climate impacts. Climate change will affect many different economic sectors both

directly and indirectly, and the characteristics of economic systems will play an important role in

determining their resilience. A national approach to adaptation is important to provide a framework for

bottom-up initiatives and projects, to enable autonomous adaptation and to provide support and incentives

for activities that have high social benefits. While uncertainties around climate impacts and the optimal

response to them pose a challenge to adaptation planning, a “wait and see” approach may come at a high

cost.

3. The links between climate resilience and economic development span different policy

communities. There is a need to integrate emerging recommendations from these communities, to analyse

their robustness and feasibility, to identify knowledge gaps and to prioritise action. It is also important to

learn lessons from developing countries’ experiences in working towards climate resilience – both in their

development planning and in key national projects – and to consider the role of international bodies and

development partners in supporting national action. Bringing together expert knowledge on these issues is

crucial to help developing countries to address the challenges in integrating climate resilience and

development planning.

4. This OECD project builds on this body of literature and experience, and engages with two

countries that are currently building national resilience and adaptation plans (Colombia and Ethiopia) to

analyse emerging recommendations in a practical context. It looks both at past experience on approaches

that have been successful in building climate resilience, and at ways ahead for addressing remaining

challenges. Building on the introductory discussion of the links between climate resilience and economic

growth, this note provides background information on two key policy challenges: managing risk at the

macroeconomic scale and increasing private sector engagement. The former is important because climate

extremes are projected to have high economic impacts, with synergies between adaptation to future risks

and current risk management practices. The latter, public policy frameworks that enable private adaptation,

is a key theme because climate resilience will depend heavily upon the decisions of private actors, both

individuals and companies.

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SESSION 1: LINKS BETWEEN CLIMATE RESILIENCE AND ECONOMIC GROWTH

5. There is a two-way relationship between climate resilience and economic development.

Climate change is expected to have considerable impacts on developing countries, their ability to grow,

and their patterns of growth. Economic growth may in turn alter the vulnerability of developing countries

to climate change. Climate resilience and economic growth will, therefore, jointly define countries’

successes at achieving their development objectives.

6. A small but growing body of literature analyses the channels through which climate change and

economic growth mutually influence each other (e.g. Lecocq and Shalizi, 2007; Vivid Economics, 2010;

Dell et al., 2012). A key result of this research is that while economic growth has the potential to increase

adaptive capacity, the link between development and improved climate resilience is not automatic.

Instead, climate resilience will require changes to pathways of development to avoid inadvertent increases

in vulnerability and to build the additional resilience that is needed to cope with climate impacts.

7. The literature suggests that a focus on climate-sensitive sectors and capital is important

because a large part of the losses will originate here. However, it also shows that the interactions of these

sectors with the wider economy will be important in determining the overall impact of climate change.

Consequently, climate resilience needs to be promoted across the entire economic system.

8. Previous work that has looked at the links between climate resilience and growth from a

macroeconomic perspective includes Vivid Economics’ (2010) suggestion of nine factors that are widely

believed to be crucial for economic growth, but may also affect climate vulnerability or be themselves

affected by climate change (see box). These factors illustrate the synergies between growth policies and

climate resilience, and suggest areas where changes to ‘business as usual approaches’ may be needed.

Nine factors for Adaptation and Growth

Sufficient Capital Sound business

environment Easy Access High productivity

1. Natural capital

2. Infrastructure

3. Human capital

4. Macroeconomic stability

5. Institutional & regulatory framework

6. Access to markets

7. Access to capital

8. Competitive markets

9. Firm performance

Source: Vivid Economics (2010)

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SESSION 2: KEY CHALLENGE – MANAGING RISK AT THE MACROECONOMIC SCALE

9. Low- and middle-income countries tend to be more vulnerable to natural disasters than

high-income countries, with 95% of global deaths due to disasters occurring in developing countries.

Economic losses as a proportion of their GDP are also higher for low- and middle-income countries

(Cummins and Mahul, 2009; Lamframboise and Loko, 2012; Handmer et al., 2012). Economic damages

include direct losses from natural disasters, for example the value of damaged assets and destroyed crops,

and indirect losses, such as economic activity foregone and losses in efficiency after disasters, which can

substantially increase the cost of disasters and hamper long-run economic growth.

10. Economic growth can increase the adaptive capacity of developing countries. As such, it has

the potential to improve climate resilience and prevent existential threats to vulnerable populations. Yet

this link between economic growth and improved climate resilience is not automatic. Studies suggest that

economic losses due to extreme events are higher in middle-income countries than in low-income countries

compared to GDP (World Bank and UN, 2010; Cummins and Mahul, 2009). This suggests that economic

losses tend to increase more than proportionately with GDP as countries transition to a middle-income

status.

11. Countries therefore need to pay attention to the ways in which growth can potentially increase

vulnerability to extreme events. These include

A high reliance on physical infrastructure for GDP creation, and a lower share in services than in

high-income countries (Benson and Clay, 2004; Ghesquiere and Mahul, 2010),

A higher connectedness between economic sectors, which can increase indirect impacts and thus

the total economic cost of a disaster (Okuyama, 2009; Benson and Clay, 2004; Ghesquiere and

Mahul, 2010),

Limited flexibility of productive factors such as labour in the presence of high growth rates

(Hallegatte and Ghil, 2008),

Increased exposure of assets to climate risks due to increasing preference for coastal and riverside

development as income increases (Kellenberg and Mobarak, 2008),

Degradation of natural ecosystems due to uncontrolled economic growth (Secretariat of the

Convention on Biological Diversity, 2009),

12. Climate change is projected to increase the vulnerability of developing countries to climate

extremes. It will increase the intensity of some extreme events and create new climatic challenges in areas

where these were previously unknown, and it will also affect underlying risk factors by weakening the

resilience of many ecosystems and climate-dependent economic activities (IPCC, 2012). This threatens to

exacerbate the existing deficit in investment in disaster risk management, and accentuates the need for

increased overall levels of funding and engagement with a broader range of countries (Kellet and Sparks,

2012). In addition to increased funding for disaster risk management investments, climate change is also

likely to require changes in investment allocations and risk management practices. The following

sections suggest areas where climate change may require changes to risk management policies.

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Macroeconomic Planning

13. Countries need to integrate climate considerations into their macroeconomic planning because

structural features of economies play a role in how well countries adjust to new situations after disasters,

and thus determine the magnitude of indirect losses. Such structural features include general

macroeconomic stability, factor flexibility and a high social adaptive capacity (Ranger et al., 2011).

Maintaining sustainable public deficits to allow for budget reallocations increases countries’ response

capacity after climate extremes. Keeping inflation at sustainable rates limits sectoral inflation in critical

areas such as food supply and reconstruction purchasing, and enables private-sector investments in risk

reduction. Macroeconomic stability affects countries’ credit rating, which in turn allows for easier access

to capital with favourable conditions for relief and reconstruction. However, stabilising the macroeconomic

situation can come at an opportunity cost, such as loss of budgetary flexibility or alternative investments in

the short term. Similarly, measures to increase factor mobility (capital, skilled workers and products)

across borders can be politically challenging to implement. However, prior to the implementation of

longer-term reforms, such measures could be applied for a limited time horizon after disasters occur, for

instance by allowing qualified workers to settle temporarily in affected areas (Ranger et al., 2011).

Risk Response Measures

14. Countries need to ensure sufficient access to capital for emergency relief and reconstruction to

limit indirect impacts of climate extremes. The increased incidence and intensity of climate extremes

however are likely to require more capital for disaster risk response globally. This could lead to a

considerable increase in domestic funding required. Sufficient access to capital is crucial because ‘counter-

cyclical spending’, i.e. high government spending despite declining revenues, can limit negative impacts

on economic growth and loss of human life (Cavallo and Noy, 2010; Cuaresma et al., 2008; Hallegatte and

Dumas, 2009). In contrast, credit constraints can freeze economic growth during several years after a

disaster, with negative impacts persisting a decade after the event (McDermott et al., 2011). Access to

capital can be arranged through ex-ante investments such as contributions to a disaster fund or insurance or

through ex-post leveraging of capital. Developing countries have traditionally relied largely on ex-post

mechanisms, mainly budget reallocations (Benson, 2012; World Bank, 2012b).

15. Ex-post financing raises its own set of challenges, particularly when dealing with unanticipated

losses. The potential side effects of ex-post financing include: (i) an increased interest rate on capital if

states use domestic borrowing; (ii) inflation if they increase the monetary supply; (iii) an appreciated

exchange rate and negative impacts on trade if they borrow externally or reduce their foreign reserves; and

(iv) a reduction in future revenues if they sell productive assets. If climate change increases economic

damages due to climate-related extremes, these negative negative macroeconomic effects risk being

exacerbated.

16. Climate change may, therefore, require that the balance between ex-ante and ex-post financing

arrangements shifts towards more ex-ante financing in the future. However, it takes time to put ex-ante

arrangements need time to be put in place, which means it is important to start considering it early. They

require a solid evidence base regarding potential damages of climate extremes, and often new institutions

and legal frameworks need to be put in place to support their functioning. Ex-ante financing instruments

include investments in government funds, insurance, contingency credit and catastrophe bonds before

disasters strike. Investments in funds are preferable for events with relatively low costs, while insurance

and catastrophe bonds are tools for high-cost disasters that occur with a low frequency. There may be a

role for public policy in increasing private insurance, as coverage is relatively low in developing countries.

17. Countries that face liabilities beyond their ability to self-insure can opt to participate in risk-

pooling arrangements, for examples through catastrophe bonds or the insurance market. In some cases,

6

several countries may choose to bundle their risks together to lower the cost of reinsurance. Examples of

such ex-ante arrangements are the Caribbean Catastrophe Risk Insurance Facility and the use of

catastrophe bonds in Mexico. However, countries need a sound legal and institutional framework for risk

financing, as well as data about the severity and probability of catastrophic events, if they are to leverage

capital through markets (World Bank, 2011b). Catastrophe bonds may, therefore, be better suited for

middle-income countries. There are currently limited options available for low-income countries.

Risk Reduction Measures

18. Countries need to consider making higher investments in risk reduction with a view to future

climate impacts as the projected increase in vulnerability to climate extremes can further increase the

benefits of risk reduction measures over risk response tools. Combined public and private risk reduction

investments are suboptimal in most developing countries given current risks (Kenny, 2012).

19. A challenge for developing countries is that, similarly to ex-ante financing arrangements, risk

reduction investments present direct trade-offs with other investment decisions. Linking risk reduction

and risk response instruments could allow for a more efficient allocation of investments. Making risk

response instruments responsive to the level of risk (e.g. risk-based insurance premiums) can encourage the

accumulation of assets and economic activity in lower-risk areas and reward risk reduction measures in an

economically efficient way (IPCC, 2012). Public policy could have a role in supporting the establishment

of these linkages. To date, insurance arrangements in developing countries have predominantly not yet

made the link between risk response and risk reduction, and those initiatives that do have mostly required

public sector involvement or donor support (Surminski and Oramas-Dorta, 2011).

20. Other challenges include the integration of future risk into current asset prices given that future

risk is often unknown and that current profits are often not influenced by future risks. However, in cases

where the economic benefits of development in relatively safe areas today could be outweighed by high

costs of climate change in the future, the inclusion of future risk could be crucial. Developing countries in

particular face a tension between the goals of efficiency and solidarity if premiums are differentiated

depending on risks, since people with fewer resources often live in places with higher risk exposure, but

might not be able to pay high premiums. As such, there is a need to consider together the respective roles

of (public) social safety nets and insurance, particularly for low-income households.

21. Access to capital for risk reduction activities at relatively low interest rates is essential to offer

attractive rates of return for risk reduction measures. Currently, many countries offer tax deductions for

reconstruction costs, but do not provide a similar subsidy for risk reduction efforts. More broadly, access to

credit at household and firm level can enable investments in risk reduction, but general programs may need

to be complemented with special financial products for long-term investments in risk reduction. In key

areas such as coastal zoning and large infrastructure projects, it is likely that government will need to

require and enforce risk reduction efforts.

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SESSION 3: KEY CHALLENGE – PUBLIC POLICIES FOR STRENGTHENING PRIVATE

CLIMATE RESILIENCE

22. A macroeconomic approach to climate resilience requires the development of public policy

frameworks that enable and strengthen private sector resilience to climate change. As the main

contributor to economic growth, the private sector plays an essential role both as an actor vulnerable to

climate change and as an innovator and provider of goods and services that can increase climate resilience.

By taking an integrated approach to growth and climate resilience planning, governments can avoid an

inadvertent increase in vulnerability and harness synergies between climate resilience and growth, as

barriers to them are often identical. The private sector includes private corporations, households and non-

profit institutions (OECD, 2001).

23. The establishment of public policy frameworks for private sector action needs to respond to the

context in developing countries. The private sector is characterised by the prevalence of micro, small and

medium-sized enterprises (MSMEs), and by a high degree of informality of companies and economic

activities at subsistence level. Small and medium-sized businesses with high operating flexibility may have

limited incentives to prepare for the impacts of climate change. However, the cumulative effect of these

private actions (and inaction) can also reduce climate resilience by damaging the natural environment or

creating hubs of economic activity in areas at high risk from climate impacts. The consequences of private

decisions could exceed the capacity of the economic system for flexible adaptation.

24. The existing literature suggests several areas where governments can facilitate private sector

adaptation, while supporting economic growth:

Provide information on climate change impacts, and on the costs and benefits of adaptation

options: Information about climate risks and adaptation options has public good characteristics

and often needs to be provided by the government, or through public co-operation or co-funding.

Set out clear rules concerning legal liabilities: To avoid perverse incentives against climate

change adaptation, governments need to be clear about their level of support for private actors

that suffer climate-related damages, both from climate extremes and from gradual change

(Heipertz and Nickel, 2008). A challenge is to establish sufficient incentives for private sector

action without disregarding the need for social protection for highly vulnerable groups.

Address collective action problems: Incentives for climate adaptation can be insufficient when

the providers of adaptation measures do not reap all benefits from their actions. To address

collective action problems, governments can use various mechanisms such as, supporting the

establishment of community groups or providing additional financial incentives.

Improve access to capital: In many developing countries, private-sector options for credit have

high interest rates and thus do not offer attractive rates of return for adaptation investments that

may only pay off in the medium to long term. To improve access to capital, governments can

establish programmes that lower transaction costs, take macroeconomic measures to lower

inflation, set up specific programmes that do not have exclusively monetary components (such as

food for work programmes), establish risk-sharing arrangements with banks that have a climate-

sensitive loan portfolio, and encourage banks to offer long-term financial products for climate

adaptation investments.

Support market access: Insufficient market access can prevent private actors from increasing

their income or diversifying their product portfolio. While policies for increased market access

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are usually promoted for economic development, climate change might warrant a closer look at

climate-sensitive sectors and project portfolios, and at combining market access programmes and

policies with measures that increase the capacity of private-sector actors to cope with climate

change.

Support productivity: There is also a case for supporting productivity to increase adaptive

capacities. Government measures to increase productivity should be designed with a view to

sustaining productivity given climate change impacts.

Support vulnerable private sector actors: Not all small entrepreneurs will be able to comply with

government regulation concerning climate resilience. Sometimes making the investments needed

for compliance can exceed their means and capacities. More targeted initiatives might therefore

be needed for vulnerable households and MSMEs. It is important to recognize that vulnerability

to climate change will be dynamic and that support policies may need to be adapted over time.

25. Public policy may also facilitate risk transfer arrangements such as insurance. Private

insurance significantly reduces the negative effects of disasters on economic growth (von Goetz et al.,

2012). However, coverage is low in most developing countries (Cummins and Mahul, 2009). At the same

time, more intense climate extremes will pose considerable challenges to the sustainability of traditional

insurance models. Publicly funded risk reduction measures and public-private partnerships where the

public sector covers responsibility for exceptionally high damages can improve insurability (Mills, 2008;

OECD, 2008). Subsidised premiums can support the establishment of an insurance market, but may

threaten the financial viability of the system and/or be less efficient than alternative mechanisms for

achieving the same goals (Botzen and van den Bergh, 2008). Subsidies can also encourage more risky

behaviour among insurance holders. Policy makers need to ensure that measures that socialise risk, for

example through subsidies or public risk guarantees, provide a fair way of sharing the burden between

potential victims of losses, insurance providers and taxpayers.

26. An essential yet open question is whether countries should encourage economic

diversification within and across sectors. Economic dependence on climate-sensitive sectors can

increase the costs of climate change and limit options for adaptation. In many developing economies,

private sector activities are concentrated in a few sectors that often depend on the natural environment and

thus the climate (Imbs and Wacziarg, 2003). However, more evidence is needed on the following three

issues to inform decisions about diversification:

It is not always clear what types of diversification would be beneficial for adaptation. Historical

temperature variations may not provide a clear answer to which sectors are most affected. For

example, some analyses show that extreme weather events and temperature increases have

considerable impacts on sectors that do not directly rely on the natural environment (Dell et al.,

2012; Jones and Olken, 2010). This might not always be due to indirect losses that originate in

climate-sensitive sectors, particularly in the case of storms (Hsiang, 2010).

Encouraging diversification might come at a trade-off against the benefits of increased

specialisation for economic growth. While many countries specialise in climate-sensitive sectors

because they lack the means to invest in other sectors, sectoral specialisation can also be a

competitive advantage, particularly in an international context.

More work is needed to identify implementable strategies for diversification – it is not clear

whether diversification is an automatic process that goes hand in hand with economic growth, or

whether policies to encourage diversification are required (Imbs and Wacziarg, 2003; Vivid

Economics, 2010; Mendelsohn, 2012).

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SESSION 4: INTEGRATING CLIMATE RESILIENCE INTO ECONOMIC GROWTH

STRATEGIES

27. As discussed in this paper, many potential elements of linking climate resilience with strategies

for economic growth have been explored in the literature and, to a lesser extent, in policy practice. There

is, however, currently limited guidance on how to put insights from the literature into practice. There is a

need to assess their robustness and practicability, prioritise areas for intervention and identify knowledge

gaps. Key questions relate to: optimal decisions on trade-offs between investments in economic

development and investments in climate resilience; the allocation of scarce financial and technical

resources; and considerations of equity and poverty reduction alongside efficiency and economic growth. It

is, therefore, essential to learn from developing countries’ experiences thus far in developing strategies for

green growth and adaptation, and in incorporating climate resilience into domestic policies and

programmes. Countries can learn lessons from best practice and key challenges both from their own

experiences, and from other countries’ efforts.

28. International bodies are likely to play a key role in supporting an integrated approach to climate

resilience and economic development. Support from development partners and international agencies can

help developing countries to generate an initial body of knowledge about climate impacts, improve

understanding of the costs and benefits of adaptation actions, and develop strategic adaptation plans. In

addition to supporting developing countries to develop the foundations and capacity needed to build

strategic responses to climate change, development partners should also consider the macroeconomic

effects of their activities in developing countries and how to integrate climate resilience into their

operations. In doing this, donors can learn lessons from existing efforts to incorporate adaptation into large

development projects.

29. In co-operation with developing countries, donors can also help to link risk response and risk

reduction investments through their funding arrangements, and by further integrating disaster risk

management and climate change adaptation, where many synergies in financial support remain unexploited

(IPCC, 2012). There is scope to strengthen the mainstreaming of climate resilience into their operations,

particularly outside those sectors that directly rely on natural assets such as agriculture, forestry and

fisheries (OECD, 2009; IEG, 2012). Given the systemic nature of climate change, it is particularly

important that donors develop an awareness of the potential systemic impacts of their policies and projects

on climate resilience.

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