How Climate Change Drives Inflation and What Businesses Can Do About It
July 18, 2023
Climate change will be a key political concern for the foreseeable future, especially since experts expect global temperatures to surpass the target limit set by the 2015 Paris Agreement. However, climate change has already begun to drive up costs for businesses.
A changing climate can affect price levels by impacting agricultural production. Crops primarily produced in one location are especially susceptible to the impact of climate change since another region is less likely to make up for a weather-induced shortage. For example, rising temperatures are contributing to a megadrought in the western U.S. that has cascading effects on goods made from crops grown in that region. Upland cotton, primarily grown in Western Texas, saw a severe drop in production in 2022 due to dry conditions. As a result, the price of goods made from upland cotton skyrocketed. Droughts are not exclusive to the U.S., either, as sizzling temperatures and a lack of rainfall in Europe caused the price of wheat and milk to soar in 2022.
Shortages of intermediate goods — products used as inputs in creating other goods — are especially problematic because they affect multiple markets. A cotton shortage, for example, affects not just the cotton market but also the markets for products made from cotton. Because of this, an intermediate good shortage raises costs for many private sector firms.
Rising temperatures also create additional stress that the current built environment struggles to handle. For example, damage to roads, bridges, and railroads can increase shipping costs, further disrupting the supply chain and impacting businesses. And while the U.S. is investing in rebuilding infrastructure for a hotter climate, there is still a significant risk that rising temperatures will drive up costs before these rebuilding projects are complete.
Climate change also has a stark effect on labor. As global temperatures rise, outdoor labor — especially when already physically demanding — becomes more taxing. As a result, workers in these high-risk positions tend to work fewer hours and become less productive, and these blows to productivity add up. Economists estimate the “disutility” of labor from climate change could be as much as 1.8 percent of global GDP by 2099. This impact is powerful in already hot climates, and workers in these areas may demand higher wages to offset unfavorable working conditions. As a result, a failure to curb climate change may lead to producers paying higher wages for less production, leading to even higher inflation.
How Businesses Can Respond
When facing inflation due to any cause, businesses should enact strategies to reduce unnecessary expenses. This action typically begins by carefully analyzing spending to understand what is driving costs and what is gained from the expenses incurred. A simple analysis may reveal that certain projects are more beneficial to the business than others.
However, climate change also offers opportunities for the private sector. A seismic shift toward renewable energy is inevitable, and markets for renewables are multiplying. Given these markets’ immaturity relative to those for fossil fuels, a great opportunity exists for new firms to become leaders in growing fields. Innovative ideas that can mitigate the effects of carbon emissions are in great demand, and global temperatures have already risen enough that climate adaptation is also emerging as a significant market.
Even businesses that will not become sellers in renewable markets should prepare to adjust their practices. The current level of emissions is not sustainable, so world leaders are attempting to motivate businesses to reduce their carbon footprint. In the U.S., the 2022 Inflation Reduction Act contained incentives such as tax credits for firms that shift to renewable energy sources. As global temperatures continue to rise, regulatory pressure on the private sector to cut emissions will only increase, and businesses that fail to adjust quickly to new standards may not survive.
How WBD is Helping
WBD provides expert consulting services for operations and supply chain management and has experience creating cost synergies for commercial clients. Our consultants can help private sector clients weather inflationary pressure and identify ways to improve efficiency. Using innovative technologies, services, and AI, our data scientists provide end-to-end solutions to help businesses leverage an ever-growing data pool’s strategic and operational value.
In addition, WBD has a proven track record supporting green infrastructure improvement projects and expert insights into critical issues related to climate change. And for our state and local clients, WBD’s climate change professionals are ready to help state and local communities make better decisions in creating and implementing sustainable, affordable, and achievable climate resilience plans.
Author: Gerry Flood, Senior Associate at WBD, is a financial consultant professional engaged with the firm’s Procurement and Business Analysis award with the Department of Defense.