Climate Change Adaptation in a Spatial Economy

The point of this blog post is to explore how to use the Rosen/Roback spatial compensating differentials model to evaluate the challenge of climate change adaptation.  In the original Rosen/Roback model, tied local public goods were exogenously determined, common knowledge, and not changing over time.  In English, San Francisco has great summer weather and Detroit does not and everyone knows this.  The final assumption in the model is that people face zero migration costs.  Given these assumptions, people arbitrage as they move across locations.  In equilibrium, nobody moves because they are indifferent between paying more for great amenities through lower earnings and higher rents in the places with great quality of life.  

Climate change shakes up the rankings of locations as Mother Nature punches some areas harder than other areas but the equilibrium pricing gradients adjust and the local land owners in the places that suffer more from the punches bear the incidence of these shocks.  This logic suggests that such land owners have strong incentives to seek out solutions both through private markets and through local government policy to offset Mother Nature’s harder local punches.

This was the core logic of my 2010 Climatopolis book and forms my core argument for why I continue to be optimistic about our potential to adapt to climate change’s very real challenges.  Here is my 2010 book and here is the two page summary.   Competition between cities in supply climate resilience (a increasingly valued local public good) helps to protect urbanites.  Many environmental scholars ignore the benefits of competition. If Miami fails to cope with sea level rise, other cities such as Atlanta gain population and jobs. This cross-elasticity is ignored in the simple “climate damage” regressions.  

We can relax many assumptions in the core model.  Suppose that people do not know each of the dynamic attributes of each location (the differentiated products).   If they know that they do not know these attributes, they will seek out new trusted information.  Entities such as First Street Foundation pop up to supply such information.

Suppose there is durable capital that turns out to be in the wrong place so that it now faces sea level rise.  Durable capital does not last forever and maintenance investment can be shrunk to zero to allow for faster depreciation. I explore that point in my 2017 paper with Devin Bunten.  In this sense, the spatial capital stock is reversible.  

 Suppose that poor people face higher migration costs and live in increasingly risk cities due to place based natural disasters.  We explore this in our new 2020 NBER working paper.      It is true that minority cities have been more likely to be hit with storms over the last 40 years.  If this triggers out migration, then given that the housing stock is durable — rents decline in such areas.  This hurts minority home owners but helps minority renters if their gains from paying lower rents exceeds their losses from rising exposure to disaster risk. These nuances are missing in the popular media discussions.

There are certainly some people who deny the importance of the climate change challenge.  The climate economics literature has not fully explored the general equilibrium consequences of such individuals populating the economy. In our 2018 paper we explore how the market rate of adaptation innovation and the hedonic rental gradient across safe and increasingly risky cities is affected by the presence of climate skeptics.

The COVID-19 shock hit all spatial markets at the same time. In contrast, the climate change shocks feature some degree of spatial independence across the U.S and they are serially correlated over time (in English, the same places get hit again and again).  These facts mean that insurance markets can be used to offset the risks of the climate punches and that aggregate output is less affected by place based shocks. These points become even more accurate in a Work from Home economy.  Think. What climate shock could slow down Jeff Bezos and Amazon?    In our 2016 paper, we argue that larger firms with higher quality managers have a comparative advantage in coping with such shocks.  

Note how microeconomic ideas are at the core here.  Climate change shakes up the hedonic assignment problem of people across space.   People are finite lived. In an Over Lapping Generations model, there is always a new generation of young people choosing their own place to live their lives. They take into account the circumstances they encounter and anticipate where and how they will live their lives.  This leads  to migration to higher ground if land use zoning codes permit this.

Some reduced form researchers would say; “Okay , let’s use the baseline hedonic gradients and a climate change model to see which areas lose from climate change.  I did these calculations in this 2009 paper.    The weakness of such an approach is that it forgets that the reduced form coefficients depend on the existing technological menu. If the set of air conditioners improves over time then the housing discount one receives for living in a very hot place will shrink over time.  This is Walter Oi’s old point. Read his paper.  

If this discussion interests you, I encourage you to buy my 2021 Yale Press book titled “Adapting to Climate Change:  that expands on these themes.