Who bears the cost? The evolving economics of climate change

A growing problem, a shrinking response 

The measurable effects of climate change are accelerating worldwide. The Intergovernmental Panel on Climate Change (IPCC) reported that global surface temperatures in 2011–20 were 1.1° C (around 2° F) higher than during 1850–1900, and found a 200 millimeter (about 8 inch) sea-level rise between 1900 and 2018.¹ Copernicus Programme data show that large parts of Europe now experience weeks of consecutive heat stress ( 32° C to 38° C [around 90° F to 100° F]), which was rare 50 years ago.² And wildfires in many regions threaten lives and livelihoods with increasing regularity.

Yet despite mounting climate-related costs, the apparent impact on GDP remains limited. GDP is a flow measure that tracks current activity, whereas climate events erode the stock of wealth and threaten the reliability of production. Over a 10- to 15-year horizon, GDP may capture only a modest effect of climate-driven disruption, even as it disperses across the economy and its impact on prices grows. Inconsistent measurement can lead to misaligned incentives to tackle climate change and may partially explain the shortfall between promised and actual spending on climate remediation.

Here we explore how to better frame the economic impact of climate change, aligning the macroeconomic impact with the costs experienced at the industry and sector levels. We also consider how governments view their incentive to invest in climate remediation and sustainable technologies, and the implications for investors.

In our view, three factors are commonly underappreciated in estimating the economic effects of climate change: 

• The accounting problem: The acute costs of climate damage are measured differently at the firm, household, sectoral and national levels.
• The impact problem: Acute damage can reverberate across the economy like a supply shock, with complex impacts.
• The policy problem: The incentive for governments to invest today for a diffuse future benefit is weaker than a policy aligned to national strategic advantage.

Unpacking the accounting problem 

Debates about the economic impact of climate change often treat national economies like households: If your house is damaged, you are poorer. While this is undeniably true, GDP is not a wealth account but a measure of current production. An asset lost to climate damage isn’t booked as negative GDP,³ and the effects of output interruptions and damaged productivity accrue only slowly. Meanwhile, spending to repair or replace lost assets adds to output, even if it merely restores prior capacity.

This accounting inconsistency undermines political incentives (Exhibit 1). Policymakers anchor their efforts to headline GDP, often over a short horizon, and may systematically underestimate the erosion of capital stock and productive capacity. This in turn risks encouraging policymaker complacency if the measurable effect of climate degradation on GDP is small once an acute event passes.

Viewing climate economics as a subtraction issue counts only one side of the ledger. Damage that reduces output through asset destruction, supply chain disruption and lost working hours impairs the capital stock. While these are real and critical channels at the corporate level, they do not map cleanly onto GDP, as there is no clear depreciation term in many GDP accounting frameworks.

For a firm or sector, lost labor hours and damaged assets (or supply chains) are recognized straight away in cost accounting. This creates immediate pressure to replace lost assets, adapt processes and build resilience to maintain a competitive position. In many sectors, swift adaptation is companies’ dominant response – particularly under the invisible hand of shareholder pressure. Yet long-horizon GDP damage estimates often assume that private sector adaptation is limited, slow or exogenous.

Climate-induced losses do not necessarily stay within the affected sectors, making second-order effects important. This “incidence” or burden problem – who ultimately bears the economic cost of a climate shock⁴ – means that climate shocks can manifest as supply shocks. Where demand is inelastic (e.g., food and energy), prices adjust and higher costs pass through to consumers as inflation. Elasticity, in effect, decides whether a shock is measured as inflation or as forgone output.

The aggregate effect of remedial and adaptation investment at the firm level, in addition to the risk of higher inflation, can leave nominal GDP appearing resilient even as real incomes and welfare suffer. This tilts the balance of risk toward higher term risk premia, steeper curves and higher yields – the opposite conclusion of studies that translate incurred climate costs directly into a drag on GDP. 

Competitive and shareholder pressure incentivizes firms to remediate damage quickly after a disaster. Policymakers could wield a powerful tool by reconfiguring climate policy to encourage investment in prevention and resilience instead – for example, with nudges such as accelerated depreciation and subsidies. Such investment under an industrial strategy would, in aggregate, advance climate goals, protect welfare and support GDP. 

Unpacking the impact problem 

Over the next decade, climate events will likely appear as volatility and localized disruption, not clean drags on trend growth. Investors should focus not only on the assumed aggregate costs of climate change but also on where frictions are emerging and which firms can pass through costs or recover capital. 

Climate impact varies by sector but follows a common pattern. Agriculture experiences climate variability as yield volatility and elevated crop failure risk. Transport faces disruptions (e.g., low river flow limiting shipping, heat buckling rail tracks). Construction and manufacturing confront heat-driven productivity and safety constraints, forcing a reallocation of labor that may preserve output but raise unit labor costs. This matters beyond those sectors’ own margins, as labor-intensive industries are central to the adaptation and transition build-out. Climate stress raises the cost of the supply-side response at the same time that it raises the demand for it, making the delivery of physical capacity more inelastic than capex plans may assume.

Incidence – the rate, frequency or probability of an event that can multiply its impacts – complicates the picture. For example, in Europe, Rhine river shipping disruptions don’t hit the transport sector in isolation. Goods can be rerouted to road or rail. Rising freight prices support sector income, while losses are incurred downstream, in industrial supply chains, higher shipping rates and lost output. 

Agriculture is another sector in which GDP understates climate stress. Despite evidence that climate stress meaningfully reduces agricultural productivity (Exhibit 2A), the small size of the sector in many developed nations mutes the overall impact on GDP (Exhibit 2B). The supply response is slow: Adjusting cropping patterns, irrigation and land use takes seasons or years, so yield shocks pass into prices before capacity adjusts.

Despite the limited GDP effect, the implications for food inflation and real incomes are considerable. Mapping where climate damage is felt, who bears the ultimate costs and where profits generated by remediation accrue would help identify sectoral winners and losers from climate degradation (as we discuss next and map in Exhibit 3).

Unpacking the policy problem

Climate investment has lagged commitments: The USD 100 billion annual pledge for developing economies, made at the UN’s 15th Conference of the Parties (COP15, 2009) was met in 2022, two years late,⁵ and public adaptation finance commitments cover less than a tenth of estimated needs.⁶

Investors may view global climate policy as purely an international relations subject when it is in fact a key transmission mechanism directing capital flows. While climate investment may be underwhelming today, we believe leaders are beginning to consider it a matter of strategic advantage with profound economic and financial implications.

Two armed conflicts in four years, in Ukraine and the Gulf, have roiled energy markets and underscored the strategic advantage of energy independence. Europe has felt this acutely: With almost half of the Continent’s energy grid due for replacement in the next 15 years⁷ and the cost of renewable technology falling rapidly, building a sustainable grid has become a clear strategic issue.

Outside the European Union (EU), leaders are reframing climate investment similarly – not only for energy security but also from the perspective of technology leadership (decarbonization and renewable energy rely on technical innovation and critical minerals) and industrial competitiveness.

The dominant levers differ by jurisdiction: regulation in Europe,⁸ tax incentives in the U.S.,⁹ revenue floors in Australia¹⁰ and state-directed planning in China.¹¹

This policy variation in climate economics and investment is linked inexorably with geopolitics and national resilience considerations. Such pressures may in turn create subsidy races, protectionism and bottlenecks that reshape winners and losers. Fiscal constraint shapes the choice of lever. Governments with elevated debt burdens favor policy – mandates, tax expenditure, revenue underwriting – over direct budget spending, shifting costs onto companies and households and adding regulatory complexity to an already inelastic supply response.

Viewing climate investment as a matter of national self-interest is revealing. The offensive realism¹² view of international relations fits today’s multipolar world. Expecting global cooperation, even against severe climate threats, may be more hope than reality. Recognizing that strategic advantage is a powerful incentive for states – and that it doesn’t preclude cooperation but makes it transactional and contingent – is a helpful starting point for investors exploring climate economics.

The investing implications of climate economics

Climate investment requires understanding the incentives and costs felt by all actors. Misalignment of incentives or mismeasurement of costs can lead to complacency and can delay investment. We believe climate should be seen less as a global coordination problem with an international policy solution and more as a matter of strategic advantage with an industrial policy solution.

At the state level, policymakers, who tend to optimize for growth, are drawn to investments that secure a strategic advantage. Meanwhile, firms, which are feeling the effects of climate damage acutely through asset losses and production downtime, are motivated to invest to mitigate those costs. We expect national industrial strategies will increasingly and more explicitly seek to align climate investments across these interests.

Distinguishing sectoral winners from losers rests on three questions:

First, who can pass through costs? Firms serving inelastic demand can recover much of the climate hit through price; those facing elastic demand absorb it in their margins.

Second, who captures remediation spending? Suppliers of adaptation goods and services, such as engineering, grid technology and resilient infrastructure, tend to gain as remediation and prevention budgets expand.

Third, who bears the residual? Those left carrying the loss are typically downstream processors and end consumers. Exhibit 3 maps sectors against these three tests. 

There are three key implications for long-term investors: 

• Don’t assume climate damage subtracts from trend growth over a 10- to 15-year horizon. Expect it to manifest as periodic supply shocks leading to elevated inflation volatility and term risk premia.
• As renewable technology cheapens, energy-intensive industries will benefit in those regions able to reduce their dependence on fossil fuels. Europe leads in this regard.
• Regulated utilities, some consumer staples and reinsurers with pricing power, as well as companies that process key minerals to a usable purity (often domiciled in China), stand to be relative winners.

Climate costs are booked in different places by different actors – as impairments and capex for firms, as revaluation on national balance sheets, as the price of goods and services for households – and barely at all in the GDP flow that policymakers watch. That dispersion, not a smooth drag on trend growth, is what investors should underwrite. The question is not how large the climate discount should be but who bears the cost, who captures the remediation and who controls its delivery.

¹ “AR6 Synthesis Report: Climate Change 2023,” IPCC. A sea-level rise of 20 centimeters pushes shorelines back by meters and makes once-rare coastal floods recurrent, magnifying the economic exposure of coastal assets.

² Copernicus is the European Union’s Earth observation program, which provides open climate and environmental data through a network of satellites (the Sentinel missions) and in situ measurements.

³ GDP accounts do not have a line item that subtracts the value of assets destroyed by disasters.

⁴ Incidence, or burden, can be shifted and shared across sectors after an initial hit – for example, to utilities hit by storms or real estate by floods. Second-order effects, as we discuss, include supply chains, prices, employment, insurance, credit markets, public finance and lost inputs in some geographies.

⁵ According to the OECD and the UN Framework Convention on Climate Change forum.

⁶ Estimates of international public flows to finance climate adaptation in developing countries were USD 26 billion in 2023, vs. needs of USD 310 billion–365 billion per year by 2035. “Adaptation Gap Report,” UN Environment Program, 2025.

⁷ An assessment by the European Court of Auditors found that almost half of the EU’s electric power distribution lines are more than 40 years old. The European Commission estimated that €1.99 trillion–€2.29 trillion (USD 2.31 trillion–USD 2.66 trillion) of grid investment will be required 2024–50 to modernize and expand the network.

⁸ The European Union has introduced multiple legislative measures to reduce carbon emissions, including the 2009 Renewable Energy Directive (RED), updated in 2023; RED III, which established a binding EU-wide target for renewable energy by 2030; the Fit for 55 package (2021–23), which expanded the emission trading scheme to cover new sectors; and the Carbon Border Adjustment Mechanism that applies a carbon cost to certain imported goods so their embedded emissions are priced similarly to products made under the EU’s carbon rules.

⁹ Two significant laws on tax incentives for renewable energy in the U.S. were the PATH Act (2015), providing an extended tax credit for solar and wind investment, and the Inflation Reduction Act (2022), offering new tax incentives for U.S. manufacturers of eligible clean energy inputs, although the One Big Beautiful Bill Act (2025) curtailed some incentives.

¹⁰ Australia’s Capacity Investment Scheme, launched in 2023, a government revenue-underwriting mechanism, provides a floor and ceiling for pricing renewable energy generation and battery storage contracts, providing greater certainty for investors and providers of finance.

¹¹ The 13th, 14th and 15th Five-Year Plans set national targets for renewable energy as a share of total power generation and directed state financing and investment to both state-owned enterprises and private developers.

¹² John Mearsheimer’s The Tragedy of Great Power Politics defines “offensive realism” as the view that great powers in an anarchic world are driven to maximize relative power, often seeking regional dominance, to ensure their security. He suggests that global solutions require contingent cooperation because governments first act to project their own strategic leadership.