945
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Economics of Adaptation
Coordinating Lead Authors:
Muyeye Chambwera (Zimbabwe), Geoffrey Heal (USA)
Lead Authors:
Carolina Dubeux (Brazil), Stéphane Hallegatte (France), Liza Leclerc (Canada),
Anil Markandya (Spain), Bruce A. McCarl (USA), Reinhard Mechler (Germany/Austria),
James E. Neumann (USA)
Contributing Authors:
Patrice Dumas (France), Samuel Fankhauser (UK), Hans-Martin Füssel (Germany),
Alistair Hunt (UK), Howard Kunreuther (USA), Richard S.J. Tol (UK), Paul Watkiss (UK),
Richard Woodward (USA), David Zilberman (USA)
Review Editors:
Eduardo Calvo (Peru), Ana Iglesias (Spain), Stale Navrud (Norway)
Volunteer Chapter Scientist:
Terrence Kairiza (Zimbabwe)
This chapter should be cited as:
Chambwera
, M., G. Heal, C. Dubeux, S. Hallegatte, L. Leclerc, A. Markandya, B.A. McCarl, R. Mechler, and
J.E. Neumann, 2014: Economics of adaptation. In: Climate Change 2014: Impacts, Adaptation, and
Vulnerability. Part A: Global and Sectoral Aspects. Contribution of Working Group II to the Fifth Assessment
Report of the Intergovernmental Panel on Climate Change [Field, C.B., V.R. Barros, D.J. Dokken, K.J. Mach,
M.D. Mastrandrea, T.E. Bilir, M. Chatterjee, K.L. Ebi, Y.O. Estrada, R.C. Genova, B. Girma, E.S. Kissel, A.N. Levy,
S. MacCracken, P.R. Mastrandrea, and L.L. White (eds.)]. Cambridge University Press, Cambridge, United
Kingdom and New York, NY, USA, pp. 945-977.
17
946
Executive Summary............................................................................................................................................................ 948
17.1. Background ............................................................................................................................................................. 950
17.2. Economic Aspects of Adaptation ............................................................................................................................ 950
17.2.1. Public and Private Actors in Adaptation Implementation .................................................................................................................. 950
17.2.2. Broad Categorization of Adaptation Strategies ................................................................................................................................ 950
17.2.3. Broad Definition of Benefits and Costs ............................................................................................................................................. 951
17.2.3.1. Ancillary Economic Effects of Adaptation Measures and Policies ...................................................................................... 951
17.2.3.2. Economic Consideration of Ancillary Effects ...................................................................................................................... 951
17.2.4. Adaptation as a Dynamic Issue ......................................................................................................................................................... 951
17.2.5. Practical Adaptation Strategy Attractiveness and Feasibility ............................................................................................................. 951
17.2.6. Adaptation Benefits and Costs, Residual Damage, and Projects ....................................................................................................... 952
17.2.7. A Broader Setting for Adaptation ..................................................................................................................................................... 953
17.2.7.1. Adaptation and Mitigation as Competitive or Complementary Investments ..................................................................... 954
17.2.7.2. Adaptation and Development ........................................................................................................................................... 954
17.3. Decision Making and Economic Context for Adaptation ........................................................................................ 954
17.3.1. Economic Barriers to Adaptation Decision Making ........................................................................................................................... 955
17.3.1.1. Transaction Costs, Information, and Adjustment Costs ...................................................................................................... 955
17.3.1.2. Market Failures and Missing Markets ................................................................................................................................ 955
17.3.1.3. Behavioral Obstacles to Adaptation .................................................................................................................................. 955
17.3.1.4. Ethics and Distributional Issues ......................................................................................................................................... 955
17.3.1.5 Coordination, Government Failures, and Political Economy ............................................................................................... 956
17.3.1.6. Uncertainty ........................................................................................................................................................................ 956
17.3.2. Economic Decision Making with Uncertainty .................................................................................................................................... 956
17.3.2.1. Cost-Benefit Analysis and Related Methods ...................................................................................................................... 956
17.3.2.2. Multi-Metric Decision Making for Adaptation ................................................................................................................... 957
17.3.2.3. Non-Probabilistic Methodologies ...................................................................................................................................... 957
17.4. Costing Adaptation ................................................................................................................................................. 958
17.4.1. Methodological Considerations ........................................................................................................................................................ 958
17.4.1.1. Data Quality and Quantity ................................................................................................................................................. 958
17.4.1.2. Costs and Benefits Are Location-Specific ........................................................................................................................... 958
17.4.1.3. Costs and Benefits Depend on Socioeconomics ................................................................................................................. 959
17.4.1.4. Discount Rates Matter ....................................................................................................................................................... 959
17.4.2. Review of Existing Global Estimates: Gaps and Limitations ............................................................................................................. 959
17.4.3. Consistency between Localized and Global Analyses ....................................................................................................................... 960
17.4.4. Selected Studies on Sectors or Regions ............................................................................................................................................ 960
Table of Contents
947
Economics of Adaptation Chapter 17
17
17.5. Economic and Related Instruments to Provide Incentives ..................................................................................... 963
17.5.1. Risk Sharing and Risk Transfer, Including Insurance .......................................................................................................................... 964
17.5.2. Payments for Environmental Services ............................................................................................................................................... 964
17.5.3. Improved Resource Pricing and Water Markets ................................................................................................................................ 964
17.5.4. Charges, Subsidies, and Taxes ........................................................................................................................................................... 965
17.5.5. Intellectual Property Rights .............................................................................................................................................................. 966
17.5.6. Innovation and Research & Development Subsidies ......................................................................................................................... 966
17.5.7. The Role of Behavior ......................................................................................................................................................................... 966
References ......................................................................................................................................................................... 966
Frequently Asked Questions
17.1: Given the significant uncertainty about the effects of adaptation measures, can economics
contribute much to decision making in this area? ............................................................................................................................ 954
17.2: Could economic approaches bias adaptation policy and decisions against the interests
of the poor, vulnerable populations, or ecosystems? ........................................................................................................................ 961
17.3: In what ways can economic instruments facilitate adaptation to climate change in developed and developing countries? ............ 965
948
Chapter 17 Economics of Adaptation
17
Executive Summary
In the presence of limited resources and a range of objectives, adaptation strategy choices involve trade-offs among multiple
policy goals (high confidence). The alternative policy goals include development and climate change mitigation. Economics offers valuable
insights into these trade-offs and into the wider consequences of adaptation. It also helps to explain the differences between the potential of
adaptation and its achievement as a function of costs, barriers, behavioral biases, and resources available. {17.2.7.1-2, 17.3.1}
Economic thinking on adaptation has evolved from a focus on cost-benefit analysis and identification of “best economic”
adaptations to the development of multi-metric evaluations including the risk and uncertainty dimensions in order to provide
support to decision makers (high confidence).
Economic analysis is moving away from a unique emphasis on efficiency, market solutions,
and cost-benefit analysis of adaptation to include consideration of non-monetary and non-market measures, risks, inequities and behavioral
biases, and barriers and limits and consideration of ancillary benefits and costs. One role of economics is to contribute information to decision
makers on the benefits and costs, including a number of non-monetary items, and on the equity impacts of alternative actions. It does not
provide a final ranking for policy makers. A narrow focus on quantifiable costs and benefits can bias decisions against the poor and against
ecosystems and those in the future whose values can be excluded or are understated. Sufficiently broad-based approaches, however, can help
avoid such maladaptation. Indeed the evidence shows that maladaptation is a possibility if the evaluation approaches taken are not
comprehensive enough in this sense. {17.2.3, 17.3.2}
The theoretical basis for economic evaluation of adaptation options is clear, and can be and has been applied to support decisions
in practical contexts (medium confidence). There is extensive experience of applying the concepts and methods underlying the economic
framework in non-adaptation contexts, which is useful for designing climate adaptation policies. The limited empirical evidence available
shows a number of cases where desirable adaptation strategies have been identified based on these economic tools. The findings show that
adaptation is highly regional and context specific. Thus the results do not readily permit widespread generalizations about the nature of
attractive adaptation actions. {17.2, 17.4.1-2, 17.4.4}
Both private and public sectors have a role to play in the development and implementation of adaptation measures (high
confidence).
Economic theory and empirical results show that a degree of adaptation will be autonomously carried out by private parties in
response to climate change. However, the private sector alone will often not provide the desirable level of adaptation with some types of actions
not undertaken due to costs, incentives, nature of beneficiaries, and resource requirements. This implies the public sector will need to play a
strong role. There are also other reasons for public action such as overcoming barriers, developing technologies, representing current and future
equity concerns, and other items. {17.2.1, 17.3.1}
The theory and the evidence indicate that adaptation cannot generally overcome all climate change effects (high confidence).
In addition to there being biophysical limits to adaptation, such as the inability to restore outdoor comfort under high temperatures, some
adaptation options will simply be too costly or resource intensive or will be cost ineffective until climate change effects grow to merit investment
costs. Thus the desirability of adaptation options will vary with time and climate change realization. {17.2.2, 17.2.5}
Adaptation generally needs to be seen in the frame of the overall development path of the country, particularly for developing
countries (high confidence).
Development and adaptation can be complementary or competitive. Also development can yield positive
ancillary adaptation effects or co-benefits, provided it takes into account climate change in its design. Adaptation actions can provide significant
co-benefits such as alleviating poverty or enhancing development. Many aspects of economic development also facilitate adaptation to a
changing climate, such as better education and health, and there are adaptation strategies that can yield welfare benefits even in the event of
a constant climate, such as more efficient use of water and more robust crop varieties. Maximizing these synergies requires a close integration
of adaptation actions with existing policies, referred to as “mainstreaming.” {17.2.7, 17.2.3.1-2}
Not all adaptation actions are investment-based. Policy actions are also important tools for adaptation (medium confidence).
These include direct research & development (R&D) funding, environmental regulation, economic instruments, and education. Economic
instruments have high potential as flexible tools because they directly and indirectly provide incentives for anticipating and reducing impacts
and can have lower costs in the public budget. These instruments are currently not well explored in an adaptation context apart from risk
949
17
Economics of Adaptation Chapter 17
financing instruments. Existing incentives will lead to a set of private adaptation actions. They include risk sharing and transfer mechanisms
(insurance), loans, public-private finance partnerships, payment for environmental services, improved resource pricing (water markets), charges
and subsidies including taxes, norms and regulations, and behavioral modification approaches. These instruments offer some useful possibilities
for addressing climate change but they also have problems of effective implementation that need to be addressed. The problems can be
particularly severe in developing countries. {17.4-5}
Risk financing mechanisms at local, national, regional, and global scales contribute to increasing resilience to climate extremes
and climate variability, but involve major design challenges so as to avoid providing disincentives, causing market failure and
worsening equity situations (medium confidence).
Mechanisms include insurance; reinsurance; micro insurance; and national, regional,
and global risk pools. The public sector often plays a key role as regulator, provider, or insurer of last resort. Risk financing can directly promote
adaptation through providing claim payments after an event and allow for improved decisions under risk pre-event (strong evidence). It can
also directly provide incentives for reducing risk, yet the evidence is weak and the presence of many counteracting factors often leads to
disincentives, which is known as moral hazard. {17.5.1}
Limited evidence indicates a gap between global adaptation needs and the funds available for adaptation (medium confidence).
There is a need for a better assessment of global adaptation costs, funding, and investment. Studies estimating the global costs of adaptation
are characterized by shortcomings in data, methods, and coverage (high confidence). {14.2, 17.4; Tables 17-2, 17-3}
Economics offers a range of techniques appropriate for conducting analysis in the face of uncertainties, and the choice of the
most appropriate technique depends on the nature of the problem and the nature and level of uncertainty (high confidence).
Uncertainty is unavoidable in analyses of adaptation to climate change because of lack of data, the efficacy of adaptation actions, and
uncertainties inherent in forecasting climate change. Approximate approaches are often necessary. There is a strong case for the use of economic
decision making under uncertainty, working with tools such as cost-benefit and related approaches that include time dimensions (real options
techniques), multi-metrics approaches, and non-probabilistic methodologies. There are methodologies that are able to capture non-monetary
effects and distributional impacts, and to reflect ethical considerations. {17.3.2.1-3}
Selected regional and sectoral studies suggest some core considerations and characteristics that should be included in the
economic analyses of adaptation (medium confidence). These desirable characteristics include a broad representation of relevant climate
stressors to ensure robust economic evaluation; consideration of multiple alternatives and/or conditional groupings of adaptation options;
rigorous economic analysis of costs and benefits across the broadest possible market and non-market scope; and a strong focus on support of
practical decision making that incorporates consideration of sources of uncertainty. Few current studies manage to include all of these
considerations. {17.4.3}
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Chapter 17 Economics of Adaptation
17
17.1. Background
This chapter assesses the literature on the economics of climate change
adaptation, building on the Fourth Assessment Report (AR4) and the
i
ncreasing role that economic considerations are playing in adaptation
decision making and policy. AR4 provided a limited assessment of the costs
and benefits of adaptation, based on narrow and fragmented sectoral and
regional literature (Adger et al., 2007). Substantial advances have been
made in the economics of climate change adaptation after AR4.
The specific objectives involved in an adaptation effort can be diverse.
One may try to cancel all impacts (negative and positive), maintaining
the status quo. Alternatively one can try to cancel adverse impacts
and capture positive opportunities, so that the welfare gain (or loss) is
maximized (or minimized).
Part of the literature presents adaptation as a continuous, flexible
process, based on learning and adjustments (see, e.g., IPCC, 2012).
Adaptation projects informed by this approach emphasize learning and
experimenting, plus the value of using reversible and adjustable strategies
(Berkhout et al., 2006; McGray et al., 2007; Pelling et al., 2007; Leary et
al., 2008; Hallegatte, 2009; Hallegatte et al., 2011c).
Adaptation action and policy has also advanced since AR4, and the
literature on the economics of adaptation has reflected this. This chapter
builds on other chapters in this assessment—in particular Chapter 2,
which sets the basis for decision making, recognizing economics as a
decision support tool for both public and private actors. The type of
economic approach used depends on factors discussed in Chapter 2,
among others, including the agent making the decision, the nature or
type of decision, the information used to make the decision, who
implements the decision, others affected by the outcomes, and the
values attached to those outcomes. While realizing the linkages
between adaptation and mitigation, the starting point of this chapter
is that adaptation is a given need.
This chapter assesses the scientific literature covering the economic
aspects of adaptation; decision making and the economic context of
adaptation, including economic barriers to adaptation decision making,
and uncertainty; costing adaptation; and the economic and related
instruments to provide incentives for adaptation.
17.2. Economic Aspects of Adaptation
When considering adaptation, economic studies give insight into issues
regarding the roles of various actors in society, the character of
adaptation strategies, the types of benefits and costs involved, the role
of time, and a number of other factors that we discuss in this section.
17.2.1. Public and Private Actors in
Adaptation Implementation
Previous IPCC reports—i.e., the Third Assessment Report (TAR) and
First Assessment Report (FAR)—indicate adaptation actions can be
a
utonomous, planned, or natural. Autonomous actions are undertaken
mostly by private parties while planned can be undertaken by private
or public actors. Natural adaptation is that occurring within the ecosystem
in reaction to climate change but may be subject to human intervention
(see discussion in Section 14.1).
In terms of human actions there are important economic distinctions
regarding the roles of private and public actors. Some adaptation
actions create public goods that benefit many and in such cases the
implementing party cannot typically capture all the gains. For example,
if an individual pays to protect a coastline or develop an improved
irrigation system, the gains generally go to many others. Classical economic
theory (Samuelson, 1954) and experience plus observations regarding
adaptation (Mendelsohn, 2000; Osberghaus et al., 2010a; Wing and Fisher-
Vanden, 2013) indicate that such actions will not receive appropriate
levels of private investment (creating a market failure). In turn, this calls
for public action by elements of broader society (e.g., governments, non-
governmental organizations (NGOs), or international organizations).
Other reasons for public provision or public regulation of certain adaptation
measures that lead to less than a socially desirable level of adaptation
are discussed in Section 17.3.
17.2.2. Broad Categorization of Adaptation Strategies
There are many possible adaptation measures, as indicated in the TAR
and FAR, plus Chapters 14 and 15. In economic terms these include a
mixture of public and private actions taken in both domestic and
international settings. A broad characterization of these and who might
undertake them follows:
• Altered patterns of enterprise management, facility investment,
enterprise choice, or resource use (mainly private)
• Direct capital investments in public infrastructure (e.g., dams and
water management—mainly public)
• Technology development through research (e.g., development of
crop varieties—private and public)
• Creation and dissemination of adaptation information (through
extension or other communication vehicles—mainly public)
• Human capital enhancement (e.g., investment in education—
private and public)
• Redesign or development of adaptation institutions (e.g., altered
forms of insurance—private and public)
• Changes in norms and regulations to facilitate autonomous actions
(e.g., altered building codes, technical standards, regulation of
grids/networks/utilities, environmental regulations—mainly public)
• Changes in individual behavior (private, with possible public
incentives)
• Emergency response procedures and crisis management (mainly
public).
Not all adaptation involves investment or is costly. Some adaptation
measures involve modification of recurring expenditures as opposed to
new investments (replacing depreciated equipment with more adapted
items). Sometimes adaptation involves changes in behaviors and
lifestyles (e.g., due to increased frequency of heat waves).
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Economics of Adaptation Chapter 17
17.2.3. Broad Definition of Benefits and Costs
The consequences of adaptation decisions cannot be expressed
comprehensively through standard economic accounting of costs and
revenues. Adaptation decisions can also affect other items such as
income distribution and poverty (Jacoby et al., 2011); the regional
distribution of economic activity, including employment; non-market
factors such as water quality, ecosystem function, and human health;
and social organization and cultural practices.
Adaptation choices have broad ranging and complex impacts on such
issues as:
• Macroeconomic performance (see, e.g., Fankhauser and Tol, 1995)
• Allocation of funds with a crowding out effect on other climate and
non-climate investments with consequences for future economic
growth (Hallegatte et al., 2007; Hallegatte and Dumas, 2008; Wang
and McCarl, 2013)
• Welfare of current and future generations through resource availability
and other non-monetary effects
• Risk distributions on all of the above due to routine variability plus
uncertain estimates of the extent of climate change and adaptation
benefits and costs.
A number of these items pose challenges for measurement and certainly
for monetization. Generally this implies that any analysis be multi-metric,
with part in monetary terms and other parts not, and some in precise
quantitative terms and others not (for more discussion see Section
17.3). In view of this, it is reasonable to conclude that an unbiased,
comprehensive analysis would consist of a multi-metric analysis
encompassing cost-benefit and other monetary items plus non-monetary
measures. That analysis would support adaptation decision making.
17.2.3.1. Ancillary Economic Effect
of Adaptation Measures and Policies
In addition to creating an economy that is more resilient to the effects
of climate change, adaptation strategies often have ancillary effects of
substantial importance. These can be positive (co-benefits) or negative
(co-costs). Ancillary effects also arise when actions aimed primarily at
mitigation or non-climate-related matters alter climate adaptation.
Examples include:
• Sea walls that protect against sea level rise and at the same time
protect against tsunamis. However, they can have co-costs causing
damages to adjacent regions, fisheries, and mangroves (Frihy, 2001).
• Crop varieties that are adapted to climate change have enhanced
resistance to droughts and heat and so also raise productivity in
non-climate change-related droughts and temperature extreme
(Birthal et al., 2011).
• Better building insulation that mitigates energy use and associated
greenhouse gas emissions also improves adaptation by protecting
against heat (Sartori and Hestnes, 2007).
• Public health measures that adapt to increases in insect-borne
diseases also have health benefits not related to those diseases
(Egbendewe-Mondzozo et al., 2011).
• More efficient use of water—adaptation to a drier world—will
also yield benefits under current conditions of water scarcity.
D
evelopment of improved desalination methods has the same
merits (Khan et al., 2009).
• Locating infrastructure away from low-lying coastal areas provides
adaption to sea level rise and will also protect against tsunamis.
• Reducing the need to use coal-fired power plants through energy
conserving adaptation will also provide mitigation, improve air
quality, and reduce health impacts (Burtraw et al., 2003).
17.2.3.2. Economic Consideration of Ancillary Effects
Many studies argue that co-benefits should be factored into decision
making (e.g., Brouwer and van Ek, 2004; Ebi and Burton, 2008; Qin et
al., 2008; de Bruin et al., 2009a; Kubal et al., 2009; Viguie and Hallegatte,
2012). If a country has a fixed sum of money to allocate between two
competing adaptation projects, and both strategies generate net positive
ancillary effects, then the socially optimal allocation of adaptation
investment will differ from the private optimum and will favor the
activity with the larger direct plus ancillary effects.
17.2.4. Adaptation as a Dynamic Issue
Adaptation is not a static concern. Rather it evolves over time in response
to a changing climate (Hallegatte, 2009). Adaptation is perhaps best
handled via a long-term transitional, continuous, flexible process that
involves learning and adjustment (Berkhout et al., 2006; McGray et al.,
2007; Pelling et al., 2007; Leary et al., 2008; Hallegatte, 2009; Hallegatte
et al., 2011c; IPCC, 2012). Generally the literature indicates that optimal
adaptation and the desirability of particular strategies will vary over
time depending on climate forcing plus other factors such as technology
availability and its maturity (de Bruin et al., 2009b). In the next few
decades, during which time projected temperatures do not vary
substantially across socioeconomic/climate scenarios, adaptation is the
main economic option for dealing with realized climate change. Risk is
also an important aspect, with the longer term being more uncertain
that the near term. Risk-sensitive decisions often include the options of
acting or of waiting (Linquiti and Vonortas, 2012). The issue of options
is discussed further in Beltratti et al. (1998), which covers uncertainty
about future preferences through option values.
Dynamics also are involved with strategy persistence owing to the
decadal to century time scale implications of some adaptation strategies
such as construction of seawalls or discovery of drought-resistant crop
genes. The desirability of investments with upfront costs and persistent
benefits increases when the benefits are long lasting or when climate
change damages accumulate slowly (Agrawala et al., 2011; de Bruin,
2011; Wang and McCarl, 2013). However, maladaptation effects rising
over time are also possible as protecting now can expand investment
in vulnerable areas and worsen future vulnerability (Hallegatte, 2011).
17.2.5. Practical Adaptation Strategy
Attractiveness and Feasibility
Adaptation cannot reasonably overcome all climate change effects
(Parry et al., 2009). A number of factors will limit strategy adoption and
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Chapter 17 Economics of Adaptation
17
preclude elimination of all climate change effects. A conceptual way of
looking at this for a given adaptation endeavor is in Figure 17-1. The
first outside circle represents the “adaptation needs,” that is, the set of
adaptation actions that would be required to avoid any negative effect
(and capture all positive effects) from climate change. It can be reduced
by climate change mitigation, that is, by limiting the magnitude of
climate change. The second circle represents the subset of adaptation
actions that are possible considering technical and physical limits.
Improving what can be done, for instance, through research and
development, can expand this circle. The area between the first and
second circles is the area of “unavoidable impacts” that one cannot
adapt to (for instance, it is impossible to restore outdoor comfort under
high temperature). The third circle represents the subset of adaptation
actions that are desirable considering limited resources and competing
priorities: some adaptation actions will be technically possible, but
undesirable because they are too expensive and there are better
alternative ways of improving welfare (e.g., investing in health or
education). This circle can be expanded through economic growth,
which increases resources that can be dedicated to adaptation. Finally,
the last circle represents what will be done, taking into account the fact
that market failures or practical, political, or institutional constraints will
make it impossible to implement some desirable actions (see Chapter
15 and Section 17.3). The area between the first and the last circles
represents residual impacts (i.e., the impacts that will remain after
adaptation, because adapting to them is impossible, too expensive, or
impossible owing to some barriers).
This discussion has consequences for timing of adaptation financing,
given continuous changes in climate over time and uncertainties in the
resulting impacts. Mathew et al. (2012) recommend the use of soft,
short-term and reversible adaptation options with co-benefits for local
governments. Giordano (2012) recommends the use of adaptive policies
for modifying infrastructure, which can be robust across a wide range
of plausible futures under climate change. Hochrainer and Mechler
(2011) suggest that tools such as risk pooling may be more cost effective
t
han risk reduction through engineering methods for low-frequency but
high-impact hazards.
Financing adaptation programs is further discussed in the literature
through the lens of distribution of costs. Stern (2006) argues climate
change is characterized by a “double inequity,” with those countries
that are most vulnerable having generally contributed least (on a per
capita basis) to the climate change drivers (Panayotou et al., 2002; Tol
et al., 2004; Mendelsohn et al., 2006; Patz et al., 2007; SEGCC, 2007;
Srinivasan et al., 2008; Füssel, 2010).
Distribution of responsibilities for financing adaptation has been the
subject of lively debate. Füssel et al. (2012) note that answering the
following questions can inform the debate on such burden sharing
issues:
• Who pays for adaptation and how much should they contribute
into the adaptation fund, and what criteria are appropriate in
determining this?
• Who is eligible for receiving payments from the fund, and which
criteria could be used for prioritizing recipients and for allocating
funds?
• Which adaptation measures are eligible for funding, and what are
the conditions and modalities for payment?
• How and by whom are such decisions made?
As of now no definitive conclusions have been reached. Table 17-1 sets
out different approaches to defining eligibility for receiving adaptation
funds.
17.2.6. Adaptation Benefits and Costs,
Residual Damage, and Projects
Adaptation benefits are the reduction in damages plus any gains in
climate-related welfare that occur following an adaptation action
(National Research Council, 2010; World Bank, 2010a). Simplistically
described, the cost of adaptation is the cost of any additional investment
needed to adapt to or exploit future climate change (UNFCCC, 2007).
But a full accounting needs to consider the resources spent to develop,
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Figure 17-1 | The narrowing of adaptation from the space of all possible
adaptations to what will be done. Forces causing the narrowing are listed in black.
Motivation
for action
Relevant climatic factors
Observed and /or
projected climate change
Climate change as well as
natural climate variability
Climate is the
main reason
Defi nition 1: Action occurs
mainly to reduce the risks of
observed or projected climate
change.
Example: Raising of existing
dykes.
Defi nition 2: Action occurs
mainly to reduce risks of climate
change and climate variability.
Example: Building of new dykes
in areas that are currently
unprotected.
Climate is one of
several reasons
Defi nition 3: Actions that
reduce the risks of observed or
projected climate change even
if they are also justifi ed in the
absence of climate change.
Example: Economic
diversifi cation in predominantly
agricultural regions.
Defi nition 4: Actions that reduce
the risks of climate change and
climate variability even if they
are also justifi ed in the absence
of climate change.
Example: Improved public health
services.
Table 17-1 | Four defi nitions of eligible adaptation.
Source: Füssel et al. (2012), adapted from Hallegatte (2008).
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17
Economics of Adaptation Chapter 17
i
mplement, and maintain the adaptation action along with accruing
reduced damages or welfare increases involving monetary and non-
monetary metrics.
Figure 17-2 provides a graphical representation of the link between the
cost of adaptation (on the x-axis) and the residual cost of climate
change (on the y-axis). A fraction of climate change damage can be
reduced at no cost (e.g., by changing sowing dates in the agricultural
sector). With increasing adaptation cost, climate change costs can be
reduced further. In some cases (left-hand panel), sufficiently high
adaptation spending can take residual cost to zero. In other cases (right-
hand panel), some residual cost of climate change is unavoidable.
Economics tells that the optimal level of adaptation equalizes the
marginal adaptation cost and the marginal adaptation benefit, given
by the point on the adaptation curves where the slope is –45°. If barriers
and constraints (see Section 17.3) impose a suboptimal situation, the
marginal costs and benefits of adaptation are not equal, possibly
because there is too much investment in adaptation, so that investing
$1 in adaptation reduces climate change residual cost by less than $1,
or because there is not enough investment in adaptation and investing
$1 more in adaptation would reduce residual cost by more than $1 (the
situation in the right-hand panel).
Defining the costs and benefits of an “adaptation project” raises
conceptual issues. Many actions have an influence on the impact of
climate change without being adaptation projects per se (e.g., enhanced
building norms). Many “adaptation projects” have consequences beyond
a reduction in climate change impacts or an increase in welfare from
e
xploiting opportunities (as discussed in the ancillary impacts section).
Defining the adaptation component requires the definition of a baseline
(What would be the impact of climate change in the absence of the
adaptation action? What alternative projects would be implemented in
the absence of climate change?), and the definition of “additionality”—
the amount of additional loss reduction or welfare gain that happens
because of the project. For instance, the building of new infrastructure
may be marginally more costly because of adaptation to climate change
but would still be undertaken without climate change and thus only a
fraction of that cost and the resultant benefits would be labeled as
occurring because of adaptation (see Dessai and Hulme, 2007).
In the climate change context, residual damages are those damages
that remain after adaptation actions are taken. De Bruin et al. (2009b)
and Hof et al. (2009) have examined the relationship between increasing
adaptation effort and diminished residual damages.
17.2.7. A Broader Setting for Adaptation
Adaptation can be complementary to mitigation and to non-climate
policies. An important concern is determining the balance between
spending on adaptation versus that on other investments—mitigation
and non-climate endeavors. Economics indicates the marginal social
returns to all forms of expenditure should be the same, allowing for
distributional impacts which can be done by differential weightings of
benefits and costs to alternative income groups (Musgrave and Musgrave,
1973; Brent, 1996).
Cost of climate change
Adaptation cost
Free
adaptation
Technology limits
(”What we can do” in Figure 17-1)
Optimal balance between adaptation
costs and residual impacts
When full adaptation is possible When full adaptation is not possible
Cost of climate change (no adaptation)
Residual
costs/impacts
Avoided
impacts
Cost of adaptation
(to avoid all impacts)
Suboptimal balance with imperfection
(”What we will do” in Figure 17-1)
Optimal balance
(”What we want to do” in Figure 17-1)
Costs that
cannot be
avoided by
adaptation
Adaptation cost
Cost of climate change
Avoided
impacts
Residual
impacts
Adaptation
costs
Figure 17-2 | Graphical representation of link between the cost of adaptation (on the x-axis) and the residual cost of climate change (on the y-axis). The left panel represents a
case where full adaptation is possible, while the right panel represents a case in which there are unavoidable residual costs.
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Chapter 17 Economics of Adaptation
17
17.2.7.1. Adaptation and Mitigation as
Competitive or Complementary Investments
Adaptation and mitigation funding require coordination as they are
competing uses for scarce resources (WGII AR4 Chapter 18; Gawel et al.,
2012). They also compete with consumption and non-climate investments.
For example, some adaptation strategies use land (a shift from crops to
livestock), as does mitigation via afforestation or biofuels, and all three
would reduce ongoing crop production. Nevertheless, considering both
adaptation and mitigation widens the set of actions and lowers the
total cost of climate change (de Bruin et al., 2009a; Koetse and Rietveld,
2012; Wang and McCarl, 2013).
17.2.7.2. Adaptation and Development
There is a relationship between adaptation and socioeconomic
development, particularly in lower income countries (as extensively
discussed in Chapters 10, 13, and 20). In terms of complementarity
between the two, studies show that both development and adaptation
can be enhanced via climate-resilient road development (World Bank,
2009); installation of agricultural investments that enhance income,
heat tolerance, and drought resilience (Butt et al., 2006;Ringer et al.,
2008); or improvements in public health infrastructure that increase
c
apability to deal with climate-enhanced disease and other diseases
(Markandya and Chiabai, 2009; Samet, 2010). In addition, development
in general can increase adaptive capacity through enhancements in
human and other capital (Schelling, 1992, 1997; Tol, 2005; IPCC, 2012).
Finally, adaptation efforts may reduce adaptation deficits regarding
vulnerability to existing climate and enhance general development
(Burton, 2004). Thus, development goals can be generally consistent
with adaptation goals, with one possibly being an ancillary effect of
the other, although this is not always the case. For example, Hansone
et al. (2001) find that urbanization of flood-prone areas increases
vulnerability and adaptation needs while Burby et al. (2001) and
Hallegatte (2012) indicate better protection may trigger additional
development in at-risk areas and create increased vulnerability to
extreme events.
17.3. Decision Making and
Economic Context for Adaptation
Adaptation will be carried out by multiple public and private actors who
face a number of decision-making barriers that may limit adaptation.
Chapter 16 and many papers (e.g., Fankhauser et al., 1999; Cimato and
Mullan, 2010; Moser and Eckstrom 2010; Biesbroek et al., 2011;
Fankhauser and Soare, 2013) investigate these barriers. This section
Frequently Asked Questions
FAQ 17.1 | Given the significant uncertainty about the effects of adaptation measures, can
economics contribute much to decision making in this area?
Economic methods have been developed to inform a wide range of issues that involve decision making in the face
of uncertainty. Indeed some of these methods have already been applied to the evaluation of adaptation measures,
such as decisions on which coastal areas to protect and how much to protect them.
A range of methods can be applied, depending on the available information and the questions being asked. Where
probabilities can be attached to different outcomes that may result from an adaptation measure, economic tools
such as risk and portfolio theory allow us to choose the adaptation option that maximizes the expected net benefits,
while allowing for the risks associated with different options. Such an approach compares not only the net benefits
of each measure but also the risks associated with it (e.g., the possibility of a very poor outcome).
In situations where probabilities cannot be defined, economic analysis can define scenarios that describe a possible
set of outcomes for each adaptation measure that meet some criteria of minimum acceptable benefits across a
range of scenarios, allowing the decision maker to explore different levels of acceptable benefits in a systematic
way. That, of course, hinges on the definition of “acceptability,” which is a complex matter that accounts for
community values as well as physical outcomes. These approaches can be applied to climate change impacts such
as sea level rise, river flooding, and energy planning.
In some cases it is difficult to place specific economic values on important outcomes (e.g., disasters involving large-
scale loss of life). An alternative to the risk or portfolio theory approach can then be used, that identifies the least-
cost solution that keeps probable losses to an acceptable level.
There are, however, still unanswered questions on how to apply economic methods to this kind of problem
(particularly when the changes caused by climate change are large and when people’s valuations may be changed),
and on how to improve the quality of information on the possible impacts and benefits.
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Economics of Adaptation Chapter 17
r
eviews them from an economic perspective, and then turns to the
decision-making frameworks that can help implement adaptation
actions in spite of these barriers.
17.3.1. Economic Barriers to Adaptation Decision Making
1
7.3.1.1. Transaction Costs, Information, and Adjustment Costs
Transaction costs include the costs of accessing markets and information,
along with reaching an agreement and enforcement costs (Coase, 1937,
1960; Williamson, 1979). Because of transaction costs, a beneficial
adaptation action may be undesirable. Two specific types of transaction
costs are those relating to information and those relating to adjustment.
Information acquisition costs can represent a significant obstacle, for
instance, when climate and weather data are costly or difficult to access
(e.g., Cimato and Mullan, 2010; Ford et al., 2011; Scott et al., 2011).
Because information is a public good, private actors tend to under-
provide it and there is a role for government and public authorities to
support its production and dissemination (e.g., through research funding,
observation networks, or information distribution systems; Fankhauser
et al., 1999; Mendelsohn, 2000; Trenberth, 2008).
Adjustment costs represent another barrier, especially in the presence
of uncertainty and learning, and when long-lived capital is concerned.
Fankhauser et al. (1999) discuss adjustment costs as a barrier to early
capital replacement to adapt to a different climate. Kelly and Kolstad
(2005) define adjustment costs as the cost incurred while learning about
new climate conditions. Using these different definitions, these analyses
suggest that adjustment costs can represent a significant share of
adaptation costs.
17.3.1.2. Market Failures and Missing Markets
Adaptation may also face market failures such as externalities,
information asymmetry, and moral hazards (see Section 17.2.1;
Osberghaus et al., 2010a). As a consequence, some socially desirable
actions may not be privately profitable. For example, flood mitigation
measures may not be implemented in spite of their benefits, when flood
risks are partly assumed by insurance or post-disaster support,
transferring risk to the community (a case of moral hazard; Burby et al.,
1991; Laffont, 1995). There are also externalities, as adaptation actions
by one household, firm, or even country may create higher damages for
others. This is the case with transboundary waters, when increased
irrigation in one country creates water scarcity downstream (Goulden
et al., 2009). Trans-sector effects can also take place, for instance when
adaptation in one sector creates needs in another sector (e.g., the
impact on transportation of agriculture adaptation; see Attavanich et
al., 2013). Incentives for private adaptation actions may also be lacking
for public goods and common resources without property rights (e.g.,
biodiversity and natural areas, tradition, and culture). And adaptation
may exhibit increasing returns or large fixed costs, leading to insufficient
adaptation investments (e.g., Eisenack, 2013). In such contexts, public
norms and standards, direct public investment, tax measures, or national
o
r international institutions for adaptation coordination are needed to
avoid maladaptation.
17.3.1.3. Behavioral Obstacles to Adaptation
Economic agents adapt continuously to climate conditions, though not
always using the available information, especially long-term projections
of consequences (Camerer and Kunreuther, 1989; Thaler, 1999; Michel-
Kerjan, 2006). Individuals often defer choosing between ambiguous
choices (Tversky and Shafir, 1992; Trope and Lieberman, 2003) and make
decisions that are time inconsistent (e.g., they attribute a lower weight
to the long term through “hyperbolic discounting”; see Ainslie, 1975).
They also systematically favor the status quo and familiar choices
(Johnson and Goldstein, 2003). Also, individuals value profits and losses
differently (Tversky and Kahnman, 1974). Behavioral issues may lead
to suboptimal adaptation decisions, as illustrated with case studies in
Germany and Zimbabwe in Grothmann and Patt (2005). Particularly
important is the fact that the provision of climate information needs to
account for cognitive failures (Suarez and Patt, 2004; Osberghaus et al.,
2010b). Individual behavioral barriers extend to cultural factors and
social norms, which can support or impair adaptation as illustrated by
Nielsen and Reenberg (2010) in Burkina Faso.
17.3.1.4. Ethics and Distributional Issues
A difficulty in allocating adaptation resources noted in Section 17.2.3
is the limitation of indicators based on costs and benefits (Adger et al.,
2005; Füssel, 2010). Outcomes are often measured using such methods
but their limits are well known, (e.g., CMEPSP, 2009; OECD, 2009; Heal,
2012) and include the failure to take into account resource depletion,
environmental change, and distributional issues.
Distributional issues may justify public intervention based on ethics and
values. Climate change impacts vary greatly by social group, and many
have suggested that the poor are particularly vulnerable (e.g., Stern,
2006; Füssel et al., 2012). Some individuals, firms, communities, and
even countries may be unable to afford adaptation, even if it is in their
own interest. Also, individuals with different world views or preferences
(e.g., regarding risk aversion; see Adger et al., 2009) may ask for different
adaptation measures and have different views of what is an acceptable
level of residual risk (Peters and Slovic, 1996). Consideration of justice
and fairness will play a role in adaptation option design (Adger et al.,
2006; Brauch, 2009a,b; Dalby, 2009; O’Brien et al., 2009, 2010; Pelling
and Dill, 2009). The implementation of adaptation options may thus
require taking into account the political economy of reforms and the
need to compensate losers (World Bank, 2012).
The traditional economic approach suggests choosing the most cost-
effective projects and then resorting to financial transfers to satisfy
equity objectives (Atkinson and Stiglitz, 1976; Brown and Heal, 1979).
However, this embodies strong assumptions including the ability to
realize perfect and costless financial transfers. In more realistic
situations the choice is not so clear cut. In practical terms, transfers are
difficult to organize and may not be politically acceptable (Kanbur, 2010).
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Chapter 17 Economics of Adaptation
17
I
n these cases, adaptation decision making needs to account for both
the net benefits and the impacts on equity (Aakre and Rübbelke, 2010).
17.3.1.5 Coordination, Government Failures,
and Political Economy
One of the main roles of governments and local authorities is to remove
barriers—realigning the incentives of individuals with the goals of
society, providing the public goods needed for adaptation, or helping
with behavioral and cognitive biases. But governments and local
authorities face their own barriers, often referred to as government or
regulatory failures (Krueger, 1990). First, government and local authority
decision makers, as individuals, face their own barriers, such a cognitive
and behavioral biases (Podsakoff et al., 1990). Public decision makers
are also confronted with moral hazard, for instance, when subnational
entities are provided support from the government in case of disaster
(Michel-Kerjan, 2006). Second, governments may have access to
insufficient resources or limited adaptation capacity, especially in
poorer countries and where governments have limited access to capital
markets and are unable to fund projects, even when they are cost
efficient (e.g., Brooks et al., 2005; Smit and Wandel, 2006; World Bank,
2012). There can also be coordination failures within the government,
as many adaptation options require multi-ministry actions (e.g., the
reduction of flood risks may require some prevention measure
implemented by the environmental ministry and an insurance scheme
regulated by the ministry of finance; World Bank, 2013).
Other government failures can arise. Frequently government action is
driven by narrow interest groups and is not in the public interest (Levine
and Forrence, 1990; James, 2000). Multi-stakeholder approaches have
been shown to help address these problems, with a relevant example
for this context being coral reef management in Tobago (Adger et al.,
2005).
17.3.1.6. Uncertainty
Decisions about adaptation have to be made in the face of uncertainty
on items ranging from demography and technology to economic futures.
Climate change adds additional sources of uncertainty, including
uncertainty about the extent and patterns of future climate change (see
the WGI contribution to the AR5), which is dependent on uncertain
socioeconomic development pathways and climate policies (see the
WGIII contribution to the AR5), and uncertainty about the reaction and
adaptation of ecosystems (see Chapters 3 to 13).
Patt and Schröter (2008) show in a case study in Mozambique that
major uncertainties are a strong barrier to successful adaptation.
Uncertainty, coupled with the long lifespan of a number of options, can
lead to “maladaptation,” that is, an adaptation action that leads to
increased vulnerability. An “avoidable” maladaptation arises from a
poorex ante choice, where available information is not used properly.
An “unavoidable” ex post maladaptation can result from entirely
appropriate decisions based on the information that was the best
availableat the time of decision making, but subsequently proves to
have been wrong. An example of the latter is a precautionary restriction
p
rohibiting new construction in areas potentially at risk of sea level rise.
Applying such a precautionary approach makes sense when (1) decisions
are at least partly irreversible (e.g., building in flood-prone areas cannot
easily be “un-built”) and (2) the cost of a worst-case scenario is very
high. Such a precautionary measure can make economic senseex ante,
even if sea level rise eventually remains in the lower range of possible
outcomes, making the construction restriction unnecessary.
17.3.2. Economic Decision Making with Uncertainty
Decision making under uncertainty is a central question for climate
change policy and is discussed in many chapters of the AR5, especially in
Chapter 2 and WGIII AR5 Chapters 2 and 3. This section focuses on the
economic approaches to decision making under uncertainty, including
decision-making techniques, valuation tools, and multi-metric decision
making.
17.3.2.1. Cost-Benefit Analysis and Related Methods
There are different tools for decision making that can be applied in
different contexts and with different information. Cost-benefit analysis
under uncertainty applied to adaptation uses subjective probabilities
for different climate futures (e.g., Tebaldi et al., 2005; New and Hulme,
2006; see also Chapter 2). The “best” project is the one that maximizes
the expected net present value of costs and benefits. Risk aversion can
be taken into account through (nonlinear) welfare functions or the
explicit introduction of a risk premium.
When conducting cost-benefit analyses under uncertainty, an important
question is the timing of action, that is, the possibility of delaying a
decision until more information is available (e.g., Fankhauser and Soare,
2013). Real option techniques are an extension of cost-benefit analysis
to capture this possibility and balance the costs and benefits of delaying
a decision (Arrow and Fisher, 1974; Henry, 1974). The benefits depend
on how much learning can take place over time. A key issue concerns
irreversible actions, such as the destruction of a unique environment
(Heal and Kristrom, 2003).
Application of cost-benefit or real option analysis requires evaluations
in monetary terms. For market impacts, prices may need to be corrected
for policies, monopoly power, or other external factors distorting market
prices (Squire and van der Tak, 1975). But a cost-benefit analysis also
often requires the valuation of non-market costs and benefits. This is
the case for impacts on public health, cultural heritage, environmental
quality and ecosystems, and distributional impacts. Valuation of non-
market impact is difficult because of values and preferences heterogeneity,
and subject to controversies—for example, on the value to attribute to
avoided death (see Viscusi and Aldy, 2003).
There has been progress in valuation of ecosystem services, as elaborated
in the Millennium Ecosystem Assessment (MEA, 2005), The Economics
of Ecosystems and Biodiversity (TEEB, 2010), and Bateman et al. (2011).
Two main categories of approaches have been developed: revealed and
stated preference methods. The latter is based on what people say about
their preferences, while the former uses their actual decisions (e.g., how
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Economics of Adaptation Chapter 17
m
uch they pay for a house) and is often considered more accurate. Other
approaches include avoided or replacement cost, that is, measuring the
cost of providing the ecosystem service artificially. When local information
is not available, value transfer techniques can be applied moving
information from other locations. For example, Brander et al. (2012)
applies value transfer to climate change impacts on wetlands but
caution is required in making such transfers (National Research Council,
2005; Navrud and Ready, 2007).
Theoretically, cost-benefit approaches can account for distributional
impacts, for instance, through attribution of a higher weight to the poorest
(Harberger, 1984). Results are however highly dependent on preferences
that can be extremely heterogeneous and difficult to measure (Barsky
et al., 1997). As discussed in detail in Chapter 2, valuation and decision
making cannot be separated from the institutional and social contexts
(e.g., what is considered as a right). Yet, overall, as concluded by the IPCC
Special Report on Managing the Risks of Extreme Events and Disasters
to Advance Climate Change Adaptation (SREX), the applicability of
rigorous community-based adaptations (CBAs) for evaluations of
adaptation to climate variability and change may be limited (Handmer
et al., 2012).
17.3.2.2. Multi-Metric Decision Making for Adaptation
Multi-metric decision making provides a broader framework, which also
permits balancing among multiple, potentially competing objectives
(Keeney and Raiffa, 1993). This branch of decision analysis is also known
as multi-criterion analysis. Such an approach is helpful when decision
makers have difficulty in trading off different objectives (Martinez-Alier
et al., 1998). Using multiple criteria, decision makers can include a full
range of social, environmental, technical, and economic criteria—mainly
by quantifying and displaying trade-offs. Multi-criterion analyses have
been applied to adaptation issues including urban flood risk (Kubal et
al., 2009; Grafakos, 2012; Viguie and Hallegatte, 2012), agricultural
vulnerability (Julius and Scheraga, 2000), and choice of adaptation
options in the Netherlands (Brouwer and van Ek, 2004; de Bruin et al.,
2009a), Canada (Qin et al., 2008), and Africa (Smith and Lenhart, 1996).
The United Nations Framework Convention on Climate Change (UNFCCC)
developed guidelines for the adaptation assessment process in developing
countries in which it suggests the use of multi-criteria analysis (UNFCCC,
2002). As an illustration, Figure 17-3 shows a multi-criteria analysis of
three urban policies in the Paris agglomeration, using five policy objectives
and success indicators (climate change mitigation, adaptation and
risk management, natural area and biodiversity protection, housing
affordability, and policy neutrality).
17.3.2.3. Non-Probabilistic Methodologies
Cost-benefit analysis and related methods require probabilities for each
climate scenario. But in most cases, it may be impossible to define (or
to agree on) probabilities for alternative outcomes, or even to identify
the set of possible futures (including highly improbable events) (Henry
and Henry, 2002; Gilboa, 2010; Millner et al., 2010; Kunreuther et al.,
2012). This is especially true for low-probability, high-impact cases or
poorly understood risks (Weitzman, 2009; Kunreuther et al., 2012). In
such contexts, various approaches have been proposed (see reviews in
Ranger et al., 2010; Hallegatte et al., 2012; see also Chapter 2).
Scenario-based analyses study different policies in different scenarios
that try and cover the uncertainty space for key parameters (Schwartz,
1996). This is the approach followed by many climate change impact and
adaptation studies when using several IPCC Special Report on Emission
Scenarios (SRES) scenarios (Carter et al., 2001, 2007; Hallegatte et al.,
2011). Then, various methodologies or criteria can be used to make a
decision.
The maxi–min criterion suggests choosing the decision with the best
worst-case outcome and the mini–max regret criterion (Savage, 1951)
suggests choosing the decision with the smallest deviation from optimality
in any state of the world. Proposals for “no regrets” adaptation decisions
(Callaway and Hellmuth, 2007; Heltberg et al., 2009) employ such criteria.
Hybrid criteria balance between optimal and worst case performance
(Hurwicz, 1951; Aaheim and Bretteville, 2001; Froyn, 2005).
Another criterion is based on “robustness” and seeks decisions that
will perform well over a wide range of plausible climate futures,
socioeconomic trends, and other factors (Lempert and Schlesinger, 2000;
Lempert et al., 2006; Dessai and Hulme, 2007; Lempert and Collins,
2007; Groves et al., 2008; Wilby and Dessai, 2010; WUCA, 2010; Brown
et al., 2011; Lempert and Kalra, 2011). Instead of starting from a few
scenarios, these methods start with an option or a project and test it
under a large number of scenarios to identify its vulnerabilities to
uncertain parameters. Small adjustment or large changes in options or
projects can then be identified to minimize these vulnerabilities. Example
implementations include InfoGap, which has been used to inform
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Chapter 17 Economics of Adaptation
17
a
daptation decisions in water management (Ben-Haim, 2001; Korteling
et al., 2013); RDM (robust decision making), which has been used for
water management and flood risk management planning (Lempert et al.,
2003; Lempert and Groves, 2010; Lempert and Kalra, 2011; Matrosov et
al., 2013); and robust control optimization (Hansen and Sargent, 2008).
Figure 17-4 illustrates the application of robust decision making on
flood risks in Ho Chi Minh City (Lempert et al., 2013). The analysis
examined different risk management portfolios (including, for instance,
raising homes and retreat). Each portfolio was simulated in 1000
scenarios, covering socioeconomic and climate uncertainty. The RDM
analysis found that the current plan is robust to a wide range of possible
future population and economic trends. But it would keep risk below
current levels only if rainfall intensities increase by no more than 5%
and if the Saigon River rises less than 45 cm. Additional measures were
found that made the situation robust for increases in rainfall intensity of
up to 35% and increases in the level of the Saigon River of up to 100 cm.
17.4. Costing Adaptation
Interest in estimating the costs of adaptation has grown as the need
for action has become clearer. The literature focuses on two levels of
costing: global scale estimates, largely to assess the overall need for
adaptation finance funds; and regional and local-scale estimates, often
limited to a particular vulnerable economic sector, which may be applied
to inform budgeting or to support adaptation decision making, or
to allocate scarce resources among the best prospects for effective
a
daptation. The methods for these two types of studies vary widely, but
for the important methodological considerations for costing adaptation
are similar for both types.
17.4.1. Methodological Considerations
1
7.4.1.1. Data Quality and Quantity
There is very little discussion of data gaps related to assessing the
benefits of adaptation, but poor or sparse data obviously limit the
accuracy of these estimates. Callaway (2004) suggests that a major
challenge is the low quality and limited nature of data, especially in many
developing countries, and notes many transactions are not reported
because they occur in informal economies and social networks. In a more
general setting Hughes et al. (2010) note that historical weather data
are not typically sufficiently detailed while others note sparse data on
costs of adaptation actions. For example, Bjarnadottie et al. (2011) note
incomplete and contradictory data on house retrofit costs for hurricane
protection. Also there are simply missing non-market data on such items
as the value of ecosystem services (Agrawala and Fankhauser, 2008),
particularly as affected by climate and possible adaptation.
17.4.1.2. Costs and Benefits Are Location-Specific
Calculating localized impacts requires detailed geographical knowledge
of climate change impacts, but these are a major source of uncertainty
Rainwater
(10%,100 cm)
Relocate
(17%,100 cm)
All options
(32%,100 cm)
Elevate and relocate with adaptive
groundwater and rainwater
(26%, 100 cm)
Elevate and relocate
(21%, 85 cm)
Groundwater and
rainwater with adaptive
elevate and relocate
(17%, 100 cm)
Groundwater and
rainwater
(17%, 100 cm)
NOAA SLR estimate with
continued subsidence (75 cm)
Groundwater
(7%,55 cm)
Baseline
(6%,55 cm)
Elevate
(23%,55 cm)
MONRE SLR estimate (30 cm)
IPCC SREX
mid value (20%)
IPCC SREX
high value (35%)
10
20
30
40
50
60
70
80
90
100
110
0
0% 5% 10% 10% 20% 25% 30% 35% 40% 45% 50% 55% 60%
Percent increase in rainfall intensity
Increase in Saigon River levels (cm)
Figure 17-4 | Various risk management strategies in Ho Chi Minh City, and their robustness to increases in river levels and rainfall intensity. Different options can cope with
different amplitudes of environmental change (Lempert et al., 2013).
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Economics of Adaptation Chapter 17
in climate models (see Refsgaard et al., 2013). Global estimates of
adaptation cost are generally not grounded in local-scale physical
attributes important for adaptation, which in part explains why local
and regional-scale adaptation cost estimates are not consistent with
global estimates (Agrawala and Fankhauser, 2008). Compared with
developed countries, there is also a limited understanding of the potential
market sector impacts of climate change in developing countries.
17.4.1.3. Costs and Benefits Depend on Socioeconomics
It is sometimes assumed that climate will change but society will not
(Pielke, 2007; Hallegatte et al., 2011; Mechler and Bouwer, 2013). Future
development paths affect climate change impact estimates, and can alter
estimates from positive to negative impacts or vice versa. Some studies
show higher growth rates raise hurricane vulnerability (Bjarnadottir,
2011). On the other hand, higher incomes allow the funding of risk-
reducing policies.
17.4.1.4. Discount Rates Matter
Because adaptation costs and consequences occur over time, discount
rates are a core question. Opinions vary sharply on this question (Baum,
2009; Heal 2009). Hof et al. (2010) notes that a low discount rate is
needed for distant future climate change to matter. A low discount rate
is the primary reason for the relatively high estimates of climate damage
in the Stern Review (Stern, 2006). For climate adaptation projects, the
social or consumption discount rate is the relevant one (Heal, 2009).
The rates used fall between 0.1 and 2.5%, although without good
arguments for specific values (see Heal, 2009). Nordhaus (2008) chooses
a value of 1.5% while Stern uses a much lower value of 0.1%. Nordhaus
emphasizes consistency with the rate of return on investment as a driving
rationale while Stern points to ethical issues. Allowing environmental
services to enter consumption can change the social discount rate
substantially and generate a low or even negative social discount rate
(Guesnerie, 2004; Sterner and Persson, 2007; Heal, 2009). The UK
Treasury now mandates the use of declining discount rates for long-
term projects, as suggested by behavioral studies and by theoretical
analysis (Arrow et al., 2012).
17.4.2. Review of Existing Global Estimates:
Gaps and Limitations
There has been a limited number of global and regional adaptation cost
assessments over the last few years (Stern, 2006; World Bank, 2006,
2010a; Oxfam, 2007; UNDP, 2007; UNFCCC, 2007, 2008). These estimates
exhibit a large range and have been completed mostly for developing
countries. The most recent and most comprehensive to date global
adaptation costs range from US$70 to more than US$100 billion annually
by 2050 (World Bank, 2010a; see Table 17-2).
IPCC (2012) considers confidence in these numbers to be low because
the estimates are derived from only three relatively independent lines
of evidence. World Bank (2006) estimates the cost of climate proofing
foreign direct investments (FDI), gross domestic investments (GDI), and
Official Development Assistance (ODA), as does the Stern Review (2006),
Oxfam (2007), and UNDP (2007). UNFCCC (2007) calculated existing and
planned investment and financial flows (I&FF), and then estimated the
additional investment required for adaptation as a premium on existing
and planned investments. The World Bank (2010a) followed the UNFCCC
(2007) methodology of estimating the premium climate change imposes
on a baseline of existing and planned investment, but included more
extensive modeling (as opposed to developing unit cost estimates),
constructed marginal cost curves and climate stressor-response functions
for adaptation actions, and included maintenance and coastal port
upgrading costs.
Given their common approaches these estimates are interlinked, which
explains the seeming convergence of their estimates in later years, as
discussed by Parry et al. (2009). However, there are important differences
in terms of sectoral estimates, as Figure 17-5 shows in comparing the
UNFCCC (2007) and World Bank (2010a) studies. Extreme events, a
potential source of large adaptation costs, are not properly covered,
and these studies take into account a limited set of adaptation options.
In addition, the World Bank (2010a) estimates report higher ranges of
estimates, reflecting additional effort to account for uncertainty. Parry
et al. (2009) consider the UNFCCC (2007) estimates a significant
underestimation by at least a factor of two to three plus omitted costs
in ecosystem services, energy, manufacturing, retailing, and tourism.
Thus the numbers have to be treated with caution. There are a number
Study
Results
(billion US$
per year)
Time frame Sectors Methodology and comments
World Bank
(2006)
9 – 41 Present Unspecifi ed Cost of climate proofi ng foreign direct investments, gross domestic investments,
and Offi cial Development Assistance
Stern (2007) 4 – 37 Present Unspecifi ed Update of World Bank (2006)
Oxfam (2007) >50 Present Unspecifi ed World Bank (2006) plus extrapolation of cost estimates from national
adaptation plans and NGO projects
UNDP (2007) 86 – 109 2015 Unspecifi ed World Bank (2006) plus costing of targets for adapting poverty reduction
programs and strengthening disaster response systems
UNFCCC
(2007)
28 – 67 2030 Agriculture, forestry and fi sheries; water supply; human
health; coastal zones; infrastructure
Planned investment and fi nancial fl ows required for the international
community
World Bank
(2010a)
70 – 100 2050 Agriculture, forestry and fi sheries; water supply; human
health; coastal zones; infrastructure; extreme events
Improvement on UNFCCC (2007): more precise unit cost, inclusion of cost of
maintenance and port upgrading, risks from sea level rise and storm surges
Table 17-2 | Estimates of global costs of adaptation.
Source: Modifi ed from Agrawala and Fankhauser (2008) and Parry et al. (2009) to include estimates from World Bank (2010a).
960
Chapter 17 Economics of Adaptation
17
of gaps, challenges, and omissions associated with those global estimates
that merit further discussion.
The practical challenges of conducting global adaptation cost studies are
apparent in the literature (as assessed in Parry et al., 2009; World Bank,
2010a; IPCC, 2012). The broad scope of these studies limits the analysis
to few climate scenarios, and while the scenarios might be strategically
chosen it is difficult to represent fully the range of future adaptation
costs across all sectors. The broad scope also limits comprehensive
consideration of adaptation options, non-market and co-benefits, equity
issues, and adaptation decision making (such limitations also apply to
local and regional scale studies; see Section 17.4.3). The global studies,
designed to reflect the best available methods and data for the purpose
of estimating the magnitude of the global economic adaptation challenge,
achieve this limited goal but must be interpreted in light of these
important limitations and uncertainties.
17.4.3. Consistency between Localized and Global Analyses
Adaptation costs and benefits are derived to guide specific investment
decisions, generally at national and local levels, or to derive a “price tag”
for overall funding needs for adaptation (generally at a global level).
Given these different purposes it is difficult to compare “local,” that is,
national and sectoral, with global numbers. The quantity/quality of local
studies also varies by sector with more treatment of adaptation in
coastal zones and agriculture (Agrawala and Fankhauser, 2008; see
Table 17-3). Less is known and many gaps remain for sectors such as
water resources, energy, ecosystems, infrastructure, tourism, and public
h
ealth. Also assessments have predominantly been conducted in a
developed country context (see Table 17-1 for examples of costs and
benefits assessment).
However, as Fankhauser (2010) notes, with the sole exception of coastal
protection costs, adaptation costs have shown little convergence locally
or in terms of sectoral to global costs. The World Bank (2010a) study
uniquely takes a two-track approach doing parallel national (seven
cases) and global adaptation estimates. For a number of country studies
(Bangladesh, Samoa, and Vietnam) a cross-country comparison of local
and global adaptation costs was made, with the costs in terms of gross
domestic product (GDP) found to be in reasonable agreement. Costs
for strengthening infrastructure against windstorms, precipitation, and
flooding were about 10 to 20% higher compared to disaggregated
global estimates, largely owing to the ability of country-level studies to
consider at least some socially contingent impacts (World Bank,
2010a,b,c,d). Further, there is evidence of under-investment in adaptation
(UNDP, 2007), with global estimates of the need for adaptation funds
variously estimated in the range of US$70 to US$100 billion annually
(World Bank, 2010a), but with actual expenditures in 2011 estimated at
US$244 million (Elbehri et al, 2011), and in 2012 estimated at US$395
million (Schalatek et al., 2012).
17.4.4. Selected Studies on Sectors or Regions
This section focuses on studies that illustrate current practice in estimating
adaptation economics, with a particular focus on support of adaptation
decision making through economic analysis. Within that class of work,
there are two broad categories of economic analyses of adaptation at
the sectoral level: econometric and simulation approaches.
Econometric studies generally examine the nature of observed adaptations
or the estimation of climate change effects to which farmers have adapted.
Such studies rely on observed cross-sectional, time series, or panel data.
Examples include those where one implicitly assumes adaptation has
occurred linking temperature and precipitation to land values and crop
yields or land values (e.g., Mendelsohn et al., 1994; Schlenker et al.,
2006) or those identifying adaptations in terms of altered decisions, for
Table 17-3 | Coverage of adaptation costs and benefi ts.
Sector Analytical coverage
Cost
estimates
Benefi t
estimates
Coastal
zones
Comprehensive
✓✓✓ ✓✓✓
Agriculture Comprehensive —
✓✓✓
Water Isolated case studies
✓✓
Energy North America, Europe
✓✓ ✓✓
Infrastructure Cross-cutting, partly covered in other sectors
✓✓
—
Health Selected impacts
✓
—
Tourism Winter tourism
✓
—
Note: Three checks indicates good to excellent coverage of the topic in the literature;
two checks indicates medium coverage; one check indicates limited coverage; the
absence of a check indicates extremely limited or no coverage. Note that indicators
refl ect literature review through publication of source in 2008.
Source: Agrawala and Fankhauser (2008).
961
17
Economics of Adaptation Chapter 17
example, Seo and Mendelsohn (2008a,c) look at enterprise choice, while
Mu et al. (2013) look at stocking rate adjustments. Such approaches
can also be used to estimate the marginal effect of adaptation, provided
that “without adaptation” estimates can be developed (Mendelsohn
and Dinar, 2003).
The simulation approach, by contrast, traces costs and benefits of
adaptation strategies through mechanisms of interest, typically through a
series of climate-biophysical-behavioral response-economic components.
Within simulation modeling there are two main threads in the behavioral
response-economic component of the simulation. The first involves
rational actors who consider the benefit and cost consequences of their
choices and pursue economically efficient adaptation outcomes, and
the second involves a decision-rule or reference-based characterization
of the response of actors to climate stressors (Schlenker et al., 2006;
Dinar and Mendelsohn, 2011). As noted later, in many sectors the
current practice begins with the simpler decision-rule based approach,
and may progress to consider benefits and costs, and then perhaps to
consider other factors, such as equity and non-market values.
The key advantages of an econometric approach are reliance on real-
world data, the use of “natural experiments” in some cases, and an
ability to reflect the joint costs and benefits of multiple adaptation
strategies to the extent they are employed together in the real world
(Mendelsohn and Neumann, 1999; Dinar and Mendelsohn, 2011). The
econometric approach does not require the analyst to simulate all
adaptation mechanisms, only to establish that there is a robust
relationship between a climate stressor and the outcome of interest. The
data required to implement the approach are limited, so the approach
can be applied broadly. The key disadvantages of the econometric
approach are an inability to trace transmission mechanisms of specific
adaptation measures or to isolate the marginal effect of these strategies
or measures; the inability to transfer estimates out of context (e.g., an
African study does not apply to Asia, where the climate, adaptation,
and social context all differ and affect the marginal costs and benefits
of adaptation measures); and that the statistical estimation can be
challenging and sometimes subject to multiple interpretations (Schlenker
et al., 2005).
Simulation modeling can be demanding—a key disadvantage—as it
requires extensive data inputs and careful calibration. Where data and
models are available, however, the simulation modeling method works
well. For example, an agricultural adaptation modeling system can
estimate such factors as the incremental change in crop output and water
Frequently Asked Questions
FAQ 17.2 | Could economic approaches bias adaptation policy and decisions against
the interests of the poor, vulnerable populations, or ecosystems?
A narrow economic approach can fail to account adequately for such items as ecosystem services and community
value systems, which are sometimes not considered in economic analysis or undervalued by market prices, or for
which data are insufficient. This can bias decisions against the poor, vulnerable populations, or the maintenance
of important ecosystems. For example, the market value of timber neither reflects the ecological and hydrological
functions of trees nor the forest products whose values arise from economic sectors outside the timber industry,
like medicines. Furthermore, some communities value certain assets (historic buildings, religious sites) differently
than others. Broader economic approaches, however, can attach monetary values to non-market impacts, referred
to as externalities, placing an economic value on ecosystem services like breathable air, carbon capture and storage
(in forests and oceans), and usable water. The values for these factors may be less certain than those attached to
market impacts, which can be quantified with market data, but they are still useful to provide economic assessments
that are less biased against ecosystems.
But economic analysis, which focuses on the monetary costs and benefits of an option, is just one important
component of decision making relating to adaptation alternatives, and final decisions about such measures are
almost never based on this information alone. Societal decision making also accounts for equity—who gains and
who loses—and for the impacts of the measures on other factors that are not represented in monetary terms. In
other words, communities make decisions in a larger context, taking into account other socioeconomic and political
factors. What is crucial is that the overall decision framework is broad, with both economic and non-economic factors
being taken into consideration.
A frequently used decision-making framework that provides for the inclusion of economic and non-economic
indicators to measure the impacts of a policy, including impacts on vulnerable groups and ecosystems, is multi-criteria
analysis (MCA). But as with all decision-making approaches, the challenge for MCA and methods like it is the
subjective choices that have to be made about what weights to attach to all the relevant criteria that go into the
analysis, including how the adaptation measure being studied impacts poor or vulnerable populations, or how fair
it is in the distribution of who pays compared to who benefits.
962
Chapter 17 Economics of Adaptation
17
Continued next page
Sector
Study
and scope
Methodology Key points illustrated
Agriculture,
forestry,
and livestock
S
eo and
coinvestigators (e.g.,
S
eo et al., 2008b,
2
009b, 2011): Impacts
to livestock producers
i
n Africa
E
conometric. Examines the economic choices that livestock owners make to
maintain production in the face of climate. Insights into adaption possibilities
a
re achieved by examining the ways economic choices vary over locations and
t
imes with varying climate conditions.
•
C
onsideration of multiple options (implicit)
• Residual impacts refl ected
• Applicable at multiple geographic scales
•
R
esults provide a ready means to re-estimate results for
multiple climate scenarios.
B
utt et al. (2006):
Crop sector in Mali
S
imulation. Simulates the economic implications of potential adaptation
possibilities. Examines the consequences of migration in cropping patterns,
d
evelopment of heat resistant cultivars, reduction in soil productivity loss,
c
ropland expansion, and changes in trade patterns.
•
B
road consideration of options (explicit, allowing for ranking
of measures)
•
R
esidual impacts refl ected
• Rigorous economic costing of adaptation options and
c
onsequences for yields, revenue, and food security
Sutton et al. (2013):
C
rop and livestock
sector in four eastern
European and central
A
sian countries
Simulation with benefi t /cost analysis. Ranks options initially based on net
e
conomic benefi ts over 2010 – 2050 period. Considers non-market and socially
contingent effects through stakeholder consultation process.
• Broad consideration of options (explicit, measures ranked)
•
V
ery broad representation of climate scenarios (56 General
Circulation Model–Special Report on Emission Scenarios
c
ombinations)
• Rigorous economic costing of adaptation options
• Integrated analysis of agriculture and irrigation water sectors
Sea level rise
and coastal
systems
N
ichols and Tol
(
2006): Coastal
regions at a global
scale
S
imulation of adaptation through construction of seawalls and levees,
a
doption of beach nourishment to maintain recreational value, and migration
of coastal dwellers from vulnerable areas. The study refl ects an economic
decision rule for most categories and benefi t /cost analysis for a few categories
•
C
apable of broad representation of sea level rise scenarios
•
O
ptimization of alternatives considering both the impact of
adaptation and resulting residual impacts
• Rigorous economic costing of adaptation options
Neumann et al.
(
2010a): Risks of sea
level rise for a portion
o
f the coastal United
States
Simulation of adaptation decision making including seawalls, bulkheads,
e
levation of structures, beach nourishment, and strategic retreat, primarily
using a benefi t /cost framework but with alternatives based on local land use
d
ecision-making rules
• Capable of broad representation of sea level rise scenarios
• Flexibility to consider both benefi t /cost and rule-based
d
ecision making
• Rigorous and dynamic economic costing of adaptation
options
Purvis et al. (2008):
Risks of coastal
fl ooding in Somerset,
England
Simulation using a probabilistic representation to characterize uncertainty in
future sea level rise and, potentially, other factors that could affect coastal
land use planning and development investment decisions
• Considers the impact of both gradual climate change (sea
level rise) and extreme events (the 1-in-200-year recurrence
interval coastal fl ooding event)
• Incorporates probabilistic uncertainty analysis
Water
Ward et al. (2010):
Future needs and
costs for municipal
water across the
world, scalable to
national and local
scales
Assesses costs with and without climate change of reaching a water supply
target in 2050. The aggregation level used is the food producing units level,
and storage capacity change, using the secant peak algorithm to determine
the storage yield relationship and the cost of various alternative sources
of water. The authors fi nd that baseline costs exceed adaptation costs ($73
billion per year versus $12 billion per year for adaptation), with most of the
adaptation costs (83 – 90%) incurred in developing countries.
• Multiple climate scenarios
• Scalable to multiple spatial resolutions, with national and
regional results reported
• Multiple alternative adaptation options considered
• Rigorous economic costing of site-specifi c capital and
operating costs
Urban fl ooding
Ranger et al. (2011):
direct and indirect
impacts of fl ooding in
Mumbai, India
Investigates the consequences of fl oods with different return periods, with
and without climate change; the effect of climate change is from a weather
generator that downscales simulations from a global climate model. Estimates
direct losses from a 100-year event rising from $600 million today to $1890
million in the 2080s, and total losses (including indirect losses) rising from
$700 to $2435 million. Impacts give rise to adaptation options, some targeting
direct losses (e.g., improved building quality, improved drainage infrastructure)
and others targeting indirect losses (e.g., increased reconstruction capacity,
micro-insurance). Analysis fi nds that improved housing quality and drainage
could bring total losses in the 2080s below current levels and that full access
to insurance would halve indirect losses for large events.
• Considers multiple adaptation options
• Explicitly considers both direct and indirect costs
• Rigorous economic costing of adaptation options
Energy
Lucena et al. (2010):
Energy production
in Brazil, particularly
from hydropower
Simulation of multiple adaptation options, including energy source
substitution and regional “wheeling” of power coupled with modeling of river
fl ow and hydropower production under future climatic conditions. Uses an
optimization model of overall energy production.
• Considers two greenhouse gas emissions scenarios and a
“no-climate change” baseline
• Scalable to multiple spatial resolutions, with national and
regional results reported
• Considers multiple adaptation strategies
• Rigorous economic costing of capital and recurring
adaptation costs
Health
Ebi (2008): Global
adaptation costs of
treatment of diarrheal
diseases, malnutrition,
and malaria
The costs of three diseases were estimated in 2030 for three climate scenarios
using (1) the current numbers of cases; (2) the projected relative risks of these
diseases in 2030; and (3) current treatment costs. The analysis assumed that
the costs of treatment would remain constant. There was limited consideration
of socioeconomic development.
• Multiple climate scenarios
• Clear description of framework and key assumptions
• Rigorous economic costing of adaptation options using
multiple assumptions to characterize uncertainty
Table 17-4 | Studies illustrating economic evaluation of adaptation options.
963
17
Economics of Adaptation Chapter 17
supply in response to changes in climatic conditions and agricultural and
water resource management techniques. A further advantage of the
simulation approach is that it provides an opportunity for stakeholder
involvement at several stages of the analytic process: designing
scope, adjusting parameters, selecting inputs, calibrating results, and
incorporating adaptation measures of specific local interest (Dinar and
Mendelsohn, 2011).
A wide range of studies attempt an economic evaluation of adaptation
options. From these, several desirable characteristics can be identified:
• A broad representation of climate stressors, including both gradual
change and extreme events, spanning multiple future outcomes
(e.g., a range of individual climate model forecasts and greenhouse
gas emissions scenarios). Consideration of multiple outcomes reflects
forecasting uncertainty and can help to ensure the adaptation
rankings that result from the analysis are robust across a range of
future outcomes (Lempert and Kalra, 2009; Agrawala et al., 2011;
see also Chapter 2).
• Representation of a wide variety of alternative adaptation responses
(e.g., in the agriculture sector, consideration of changes in crop
varieties and farmer education to ensure the varieties are grown with
the best available know-how). Depending on the context, single
adaptation response with variation in dimension may be useful
(e.g., varying the height of a levee or the capacity of a dam spillway)
(Fankhauser et al., 1999; Fankhauser, 2010; World Bank, 2010a).
• Rigorous economic analysis of costs and benefits, which ideally
includes consideration of market, non-market, and socially contingent
implications (Watkiss, 2011); one-time and replacement capital and
ongoing recurring costs; and costs of residual damages after an
adaptation response is implemented (World Bank, 2010a).
• A strong focus on adaptation decision making, including a clear
exposition of the form of adaptation decision making that is implied
in the study, and consideration of both climate and non-climate
sources of uncertainty (Lempert et al., 2006; see also Chapter 2).
Table 17-4 highlights studies that illustrate some of these characteristics.
The studies include both simulation studies of the economic implications
of adaptation options, and econometric ones that examine choices that
producers make to adapt. These studies generally fall in the category
of positive economics, where economic tools and analysis are used to
examine the implications of alternative choices without imposing values
of the author (see Friedman, 1953). A few studies incorporate a normative
perspective, either explicitly or implicitly, reflecting value judgments of
authors or study participants.
17.5. Economic and Related Instruments
to Provide Incentives
Through regulations, subsidies, and direct intervention, there are many
opportunities for policymakers to encourage autonomous adaptation.
However, these efforts need to be designed so as to yield efficient, cost-
effective responses while avoiding perverse results. A basic issue of
designing efficient policies is to understand that they affect the behavior
of those who have the most to gain. For this and other reasons,
economists tend to favor policies based on voluntary actions influenced
by incentives, either positive or negative, over mandates or uniform
policies. Examples of these include insurance markets, water markets,
and various payments for environmental services (PES) schemes. A
second consideration in policy design is cost effectiveness, that is, the
extent to which governments make the best use of their resources. The
measurement of the net effect of a policy is challenging because it is
difficult to anticipate what would have occurred without the policy.
Finally, policies must be carefully designed to avoid perverse outcomes
that run counter to the policymaker’s objectives. A classic example is
found in policies that encourage adoption of water-saving technology.
Pfeiffer and Lin (2010) review cases where subsidizing irrigation water
conservation leads farmers to increase total water use by increasing the
acreage under irrigation. This is an example of what is often called the
rebound effect (Roy, 2000), whereby increases in efficiency of resource
use result in more being demanded.
With the exception of insurance- and trade-related instruments there
is relatively little literature on the use of economic instruments for
adaptation (see Chapter 10). One reason is that, apart from insurance, few
adaptation policies work directly via economic incentives and markets. The
potential of economic instruments in an adaptation context is, however,
Sector
Study
and scope
Methodology Key points illustrated
Macroeconomic
analysis
D
e Bruin et al.
(2009b): Adaptation
s
trategies compared
to mitigation
s
trategies within
the context of a
g
lobal integrated
a
ssessment model
U
se of an integrated assessment model (the DICE model) with refi ned
adaptation functions. Examines the effi cacy of “stock” adaptations (mainly
i
nfrastructure) adaptations versus “fl ow” adaptations (mainly operational or
market responses), with comparisons to mitigation investments.
•
M
ultiple climate scenarios
•
C
lear description of framework and key assumptions
• Considers multiple adaptation strategies
• Rigorous economic costing of adaptation options
Margulis et al. (2011):
C
limate change
impacts in the
e
conomy
Use of a general equilibrium model to simulate two climate change-free
s
cenarios regarding the future of Brazil’s economy. Climate shocks were
projected and captured by the model through impacts on the agricultural /
l
ivestock and energy sectors. The socioeconomic trends of the scenarios with
and without global climate change were reviewed in terms of benefi ts and
costs for Brazil and its regions.
• The economic impacts of climate change are experienced
a
cross business sectors, regions, states, and large cities and
were expressed in terms of gross domestic product losses.
•
T
he simulation disaggregates results for up to 55 sectors
and 110 products and also provides macroeconomic
p
rojections such as infl ation, exchange rate, household
sector consumption, government expenditures, aggregate
i
nvestment, and exports. It also includes expert projections
and scenarios on specifi c preferences, technology, and sector
policies.
Table 17-4 (continued)
964
Chapter 17 Economics of Adaptation
17
widely recognized. In line with Agrawala and Fankhauser (2008), we
distinguish, among others, the following incentive-providing instruments
relevant for key sectors: (1) insurance schemes (all sectors; extreme
events); (2) price signals/markets (water, ecosystems); (3) regulatory
measures and incentives (building standards, zone planning); and (4)
research and development incentives (agriculture, health).
17.5.1. Risk Sharing and Risk Transfer, Including Insurance
Insurance-related formal and informal mechanisms can directly lead to
adaptation and provide incentives or disincentives. Informal mechanisms
include reliance on national or international aid or remittances, and
though such mechanisms are common, they tend to break down for
large, covariate events (Cohen and Sebstad, 2005). Another informal
mechanism is the inclusion of climate change risk under corporate
disclosure regulations (National Round Table on the Environment and
the Economy, 2012). Formal mechanisms include insurance, micro-
insurance, reinsurance, and risk pooling arrangements. Insurance typically
involves ongoing premium payments in exchange for coverage and post
event claim payments. In contrast to indemnity-based insurance, index-
based insurance insures the event (as, e.g., measured by lack of rainfall),
not the loss, and is a possibility for providing a safety net without moral
hazard, yet suffers from basis risk, the lack of correlation of loss to event
(Collier et al. 2009; Hochrainer et al., 2009; see also Section 10.7 for a
supply-side-focused perspective on insurance). Markets differ substantially
according to how liability and responsibility is distributed (Aakre et al.,
2009; Botzen et al., 2009), and in many instances governments play a
key role as regulators, insurers, or reinsurers (Linnerooth-Bayer et al.,
2005). Insurance penetration in developed countries is considerable,
whereas it is low in many developing regions. In the period 1980–2004
about 30% of losses were insured in high-income countries, but only
about 1% in low-income countries (Linnerooth-Bayer et al., 2011).
Developing countries are beginning to pool risks and transfer portions
to international reinsurance markets. The Caribbean Catastrophic Risk
Insurance Facility (CCRIF) set the precedent by pooling risks basin wide,
thus reducing insurance premiums against hurricane and earthquake risks
(World Bank, 2007). Similar schemes are under development planning in
Europe, Africa, and the Pacific (Linerooth-Bayer et al., 2011).
Insurance-related instruments may promote adaptation directly and
indirectly: (1) Instruments provide claim payments after an event, and
thus reduce follow-on risk and consequences; and (2) they alleviate
certain pre-event risks and allow for improved decisions (Hess and
Syroka, 2005; Hoppe and Gurenko, 2006; Skees et al., 2008). As one
interesting example, using crop micro-insurance linked to loans, farmers
exposed to severe drought in Malawi were able to grow higher-yield, yet
higher-risk crops, which allowed them to increase incomes (Linnerooth-
Bayer and Mechler, 2011).
The indirect effects occur via the provision of incentives and disincentives.
Premiums for risk coverage can provide an incentive to reduce the
premium by reducing the risk. In practice, the incentive effect is generally
weak. Kunreuther et al. (2009) found that insurance decisions are not
based solely on costs and premiums, but also desires to reduce anxiety,
comply with mortgage requirements, and satisfy social norms. Further,
purchasing insurance may reduce adaptation with insured agents
reducing their risk-minimizing efforts after taking out coverage. This is
termed moral hazard and has been found to be rational (Kunreuther,
1
998). Moral hazard can be reduced through the use of index-based
insurance, although this has the drawback of operating from a high
base risk (Collier et al., 2009; Hochrainer et al., 2009). Another difficulty
arises when local or state regulations undermine incentives to decrease
risk (for instance, by not allowing insurance rates to be fully risk adjusted).
Some analysts suggest the removal of existing regulations that distort
market signals in order to re-align incentives, yet this is likely to be
ineffective given that the incentive effect is not considered very strong and
often premiums are not fully risk-based (Michel-Kerjan and Kunreuther,
2011). Also, Rao and Hess (2009) argue there is the possibility that some
current insurance schemes may increase maladaptation. Under-insurance
can also arise when agents expect that the public sector will provide
disaster assistance. Some refer to this as the Samaritan’s dilemma
(Gibson et al., 2005; Raschky et al., 2013).
17.5.2. Payments for Environmental Services
Payments for environmental services (PES) pay landholders or farmers
for actions that preserve the services to public and environmental health
provided by ecosystems on their property, including services that
contribute to both climate change adaptation and mitigation. There are
ample cases of mitigation-focused PES schemes (e.g., Pagiola, 2008;
Wunder and Albán, 2008; Wunder and Borner, 2011), and more recently
emerging evidence of the use of PES in adaptation which are of pilot
nature and location-specific, however (Butzengeiger-Geyer et al.,
2011; Schultz, 2012; van de Sand, 2012). Potentially well designed PES
schemes offer a framework for adaptation and there is a view among
development agencies that with more experience and guidance on
implementation PES might well contribute to adaptation as one of a
multitude of feasible measures (e.g., taxes, charges, subsidies, loans).
Chishakwe et al. (2012) draw comparisons and find synergies between
PES community-based natural resources management approaches in
southern Africa and community-based adaptation.
17.5.3. Improved Resource Pricing and Water Markets
Studies of water sector adaptation often begin by citing the implications
of future water shortages and the potential for conflict. Techniques
frequently cited for resolving these conflicts include the establishment
of water markets or water pricing schemes (e.g., Vorosmarty et al., 2000;
Adler, 2008; Alavian et al., 2009), which is in itself, however, also often
associated with conflict (Miller et al., 1997). Traditionally water markets
facilitate transfer from lower to higher-valued uses (Olmstead, 2010)
but pricing rules can also function through urban fees and real estate
taxes (as they do for water supply and urban stormwater regulation in
many countries). A few studies make the case that water markets and
pricing improves climate change adaptation (Medellin-Azuara et al.,
2008). In many cases, the projected increase in climate-induced water
demand (particularly in the agriculture sector), coupled with a projected
decrease in water supply, suggests that adaptation will be needed.
Many countries have instituted structures for water pricing in the
household and agricultural sectors. Nevertheless such prices are unevenly
965
17
Economics of Adaptation Chapter 17
applied, collection rates are low, metering is rarely implemented (at
least for the agricultural sector, which is typically the largest water
user), and pricing is often based on annual rather than usage-based
fees (Saleth et al., 2012). In many countries, a number of important
institutional barriers to water markets and pricing remain. These include
a lack of property rights including a thorough consideration of historical
and current entitlements, limits on transferability, legal and physical
infrastructures, and institutional shortcomings (Turral et al., 2005; Saleth
et al., 2012) coupled with issues involved with return flows, third-party
impacts, market design, transactions costs, and average versus marginal
cost pricing (Griffin, 2012).
17.5.4. Charges, Subsidies, and Taxes
The environmental economics literature over the past 30 years has
emphasized the importance of market-based instruments (MBIs) relative
to command and control regulations. MBIs are shown to be generally
more cost effective, providing stronger incentives for innovation and
dynamic efficiency. Within the wide range of instruments that qualify as
market based, there is a general preference in terms of overall efficiency
for taxes over subsidies (Sterner, 2002; Barbier and Markandya, 2012).
MBIs include charges on harmful emissions and wastes, subsidies to
clean energy, subsidized loans, and others.
Frequently Asked Questions
FAQ 17.3 | In what ways can economic instruments facilitate adaptation
to climate change in developed and developing countries?
Economic instruments (EIs) are designed to make more efficient use of scarce resources and to ensure that risks are
m
ore effectively shared between agents in society. EIs can include taxes, subsidies, risk sharing, and risk transfer
(including insurance), water pricing, intellectual property rights, or other tools that send a market signal that shapes
behavior. In the context of adaptation, EIs are useful in a number of ways.
First, they help establish an efficient use of the resources that will be affected by climate change: water pricing is an
example. If water is already priced properly, there will be less overuse that has to be corrected through adaptation
measures should supplies become more scarce.
Second, EIs can function as flexible, low-cost tools to identify adaptation measures. Using the water supply example
again, if climate change results in increasing water scarcity, EIs can easily identify adjustments in water rates needed
to bring demand into balance with the new supply, which can be less costly than finding new ways to increase supply.
Insurance is a common economic instrument that serves as a flexible, low-cost adaptation tool. Where risks are
well defined, insurance markets can set prices and insurance availability to encourage choices and behaviors that
can help reduce vulnerability, and also generate a pool of funds for post-disaster recovery. Insurance discounts for
policy holders who undertake building modifications that reduce flood risk, for example, are one way that EIs can
encourage adaptive behavior.
Payments for environmental services (PES) schemes are another economic instrument that encourages adaptive
behavior. This approach pays landholders or farmers for actions that preserve the services to public and environmental
health provided by ecosystems on their property, including services that contribute to both climate change mitigation
and adaptation. A PES approach is being used in Costa Rica to manage natural resources broadly, for example.
Paying timber owners not to cut down forests that serve as carbon sinks (the idea behind the Reduced Emissions
from Deforestation and Forest Degradation (REDD) proposal to the United Nations Framework Convention on
Climate Change (UNFCCC)) or paying farmers not to cultivate land in order reduce erosion damage (as is being
done in China and the USA) are examples. In developed countries, where markets function reasonably well, EIs can
be directly deployed through market mechanisms. In developing countries (and also in some developed ones),
however, this is not always the case and markets often need government action and support. For example, private
insurance companies sometimes don’t cover all risks, or they set rates that are not affordable, and public intervention
is required to make sure the insurance is available and affordable. Government also has an important role in
ensuring that voluntary market instruments work effectively and fairly, through legal frameworks that define property
rights involving scarce resources such as land and water in areas where such rights are not well established. An
example of this is the conflict between regions over the use of rivers for water supply and hydropower, when those
rivers flow from one jurisdiction to the next and ownership of the water is not clearly established by region-wide
agreements. PES schemes can only function well when the public sector ensures that rights are defined and
agreements honored.
966
Chapter 17 Economics of Adaptation
17
I
n many cases climate change exacerbates the effects of pricing
resources below their social costs. This is true for some forms of energy
(e.g., hydro- and fossil fuel-based) as well as many ecosystem services. If
these resources were optimally priced, there would be greater incentives
to investment in clean technologies and the need for additional public
sector adaptation measures would be lessened (ESMAP, 2010).
In addition to the instruments already identified, others that are potentially
important include raising the price of energy through a tax (Sterner,
2011), developing markets for genetic resources (Markandya and Nunes,
2012), and strengthening property rights so schemes such as PES can
be more effective. These measures are desirable even in the absence of
climate change; they become even more so when climate impacts are
accounted for. Yet it is important to note that though the case for such
social cost pricing through the use of charges is strong, it also has its
limitations. Higher prices for key commodities can hurt the poor and
vulnerable and complementary measures may need to be taken to
address such effects.
17.5.5. Intellectual Property Rights
Technology transfer is increasingly seen as an important means of
adaptation because of the global benefits it provides through the
transfer of knowledge. Christiansen et al. (2011), in a Technology Needs
Assessments carried out in developing countries, list about 165
technological needs related to mitigation and adaptation. Examples
include applications to agriculture in Cambodia and Bangladesh and
coastal zones in Thailand. In many of these cases patents and other
intellectual property protection constrain technology transfer. Patent
buy-outs, patent pools, compulsory licenses, and other open source
approaches have been used to relax this constraint (Dutz and Sharma,
2012). Patent buy-outs involve third parties (e.g., international financial
institutions or foundations) acquiring the marketing rights for a
patented product in a developing country. Patent pools represent a
group of patent holders who agree to license their individual patents
to each other (closed pool) or to any party (open pool). Compulsory
licenses are issued by governments and allow patent rights to be
overridden in critical situations. For all the above reasons, therefore, it
is suggested that limits to technology transfer are limiting climate
change adaptation (Henry and Stiglitz, 2010). There is also the view,
however, that strong intellectual property (IP) protection in receiving
countries is facilitating technology transfer from advanced countries,
and the evidence indicates a systematic impact of IP protection on
technology transfer through exports, FDI, and technology licensing,
particularly for middle-income countries for which the risk of imitation
in the absence of such protection is relatively high.
17.5.6. Innovation and Research & Development Subsidies
Subsidies to encourage innovation through research and development
(R&D) may be employed as a measure to encourage adaptation
investments as well as behavioral change (Bräuninger at al., 2011).
Subsidies involve direct payments, tax reductions, or price supports that
enhance the rewards from the implementation of an activity (Gupta et
al., 2007). There has been some criticism of the efficiency of subsidies
i
n terms of rent seeking and adverse effects on competitiveness (Barbier
and Markandya, 2012). They are often poorly targeted and end up
getting captured by middle and upper income groups. Moreover, they
imply increasing budgetary burdens. Yet they are popular with decision
makers and the wider public. Subsidies are today mostly used for
reasons other than climate adaptation, and evidence regarding its use
for adaptation as well as regarding the incentivizing of adaptation R&D
specifically is missing. Popp (2004) is partly an exception, which focuses
on subsidies for mitigation. It shows that such subsidies have little
impact on their own but they do work to enhance the effects of
other instruments such as energy taxes and regulations that mandate
improvements in energy efficiency and the use of lower carbon options.
17.5.7. The Role of Behavior
It is well recognized that often human behavior is characterized by
bounded rationality, particularly in relation to choices under risk
and uncertainty, which affects the effectiveness of incentive-based
approaches. Individuals may over- or underestimate risks (Ellsberg,
1961; Kahneman and Tversky, 1979), and may not consistently weigh
long-term consequences (Ainslie, 1975). One well documented
explanation is that individuals do not fully use available information on
risks when they make their choices (Magat et al., 1987; Camerer and
Kunreuther, 1989; Hogarth and Kunreuther, 1995). Policies that well
consider such risk perceptions and behavioral biases increase their
efficiency. For instance, people react differently to abstract information
on distant events as opposed to concrete, current, emotionally charged
information (Trope and Liberman, 2003). In practice, this can limit the
impact of simply communicating “dry,” emotion-free information, such
as that on flood return periods, and underlines the importance of
participatory, reflexive, and iterative approaches to decision support
(Fischhoff et al., 1978; Slovic, 1997; Renn, 2008; IRGC, 2010; see also
Section 2.1.2).
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