Transcript

Charles Gerena: I'm Charles Gerena, online editor for the Research Department at the Federal Reserve Bank of Richmond.

Today, I am speaking with Toan Phan, a senior economist who joined the Richmond Fed in 2017. Toan explores various macroeconomic issues, including asset price bubbles, debt crises, and the effects of climate change on economic growth.

His published research on this last topic has garnered attention in the economics profession as well as in the business press. Climate change will also be the focus of an upcoming virtual conference that Toan is organizing. We'll talk about both during today's conversation.

Thanks for joining us, Toan.

Toan Phan: Great talking with you today.

Gerena: Let's begin at the beginning. Why did you decide to explore the economics of climate change? What motivated you?

Phan: I was in graduate school for a PhD in economics at Northwestern University. I was studying macroeconomic problems, especially the problem of debt and debt crises that are very relevant for developing countries, including Vietnam where I came from.

Then I started to learn about the ongoing climate crisis. Not so long ago, we breached the concentration of CO2 in the atmosphere of 350 parts per million. Then we breached the 400 parts per million threshold, and it keeps going.

From a historical perspective, for the past few hundred thousands of years — pretty much encompassing all of human existence on our planet — the atmospheric CO2 concentration has never breached the 300 parts per million threshold. You can see this so-called "hockey stick graph" of historical CO2 concentration on NASA's website on climate change.

So, why does this matter? This increased concentration of CO2 and other greenhouse gases in the atmosphere is going to lead to global warming, increasing the risk of various other kinds of climate-related disasters like flooding [and] hurricanes. From an economic perspective, there are a lot of implications to it. And all of these potential negative consequences not only relate to humans around the world but are also contributing factors to an unprecedented rate of extinction of animal and plant species across the world.

This motivated me to want to do something. And the only thing that I know to do is to do research.

Gerena: Great. So, how did you start exploring such a big topic using the tools of an economist?

Phan: I started small. I started exploring the link between rising temperatures and economic growth immediately after graduate school and at the very beginning of my research career. I was an assistant professor of economics at the University of North Carolina in Chapel Hill. [I worked] with my co-authors Ric Colacito, who is currently a professor of finance at UNC, and Bridget Hoffman, a former classmate from Northwestern and currently an economist at the Inter-American Development Bank.

Previously, there was an idea in the economics literature that rising temperatures were more likely to affect developing countries than developed ones. The developed countries like the U.S., Japan [or those in] the European Union are much less reliant on the agriculture industry. We know that agriculture is excessively exposed to outdoor temperatures.

When we did our analysis, to our surprise, we found that an increase in summer temperatures is associated with a significant decline in GDP growth at the state level. We found these effects across various different sectors, including some sectors in services. The effect is felt well beyond just agriculture to various other sectors that comprise a significant portion of the economy. The effects are quite significant, both statistically and economically, throughout many of our robustness checks.

Our research was published last year, 2019, in the Journal of Money, Credit and Banking. To our surprise, it was cited by several newspapers [and media] outlets, such as the Wall Street Journal, Bloomberg, CNN, the Guardian. It was also cited in a congressional report to the president and another congressional testimony last year.

That's how my research agenda in the climate economy literature began.

Gerena: So far, what have you learned from your research and the research of your colleagues?

Phan: I have learned a lot, by reading the research literature and by conducting research with my co-authors. In particular, I have learned that there are many ways in which climate change has affected and will likely to continue to affect the global and U.S. economies.

For example, rising temperatures have been documented to raise mortality and morbidity risks across the world, from India to the U.S.

There is evidence that it lowers labor productivity, even in industries that are potentially isolated from outdoor temperatures. For example, even manufacturing labor productivity can be negatively affected by rising temperatures.

The literature has found that rising flood risks due to sea level rise affect property and mortgage markets in the East Coast, and recent papers document that the rising exposure to wildfire risks similarly affect the property markets in the West Coast. Now, there is evidence that climate risks affect sovereign and municipal bond markets, both at the national and state levels.

Another strain of very interesting research is documenting the effects of climate denial on the economy. As you know, in the U.S. there is a lot of heterogeneity about the degrees in which people believe in climate science, whether climate change is happening at all, or the degree people are worried at all about global warming. Several recent papers have shown that property [owners] in "climate denial" areas tend to be imperfectly pricing, not fully incorporating the risk of future flooding due to sea level rise. Also, there is some ongoing work showing potential evidence that areas that have more climate denial may be less prepared and, therefore, more vulnerable to climate risks like hurricanes.

Gerena: It sounds like you have learned a lot so far, and you've continued to do this line of research at the Richmond Fed. Other Reserve Banks have written about climate change as well, and a couple have held conferences on the topic. What is the Federal Reserve's interest in this?

Phan: In my opinion, the Fed and other central banks around the world are interested in understanding how the climate crisis and its consequences can impact macroeconomic and financial stability, which as you know are clearly related to our mandate. Recent research papers have found that heightened flood risks due to sea level rise, for example, are already affecting coastal property prices. Climate-related disasters can have amplified effects through the financial market.

To give a concrete example, a recent working paper from Cornell University documented that Superstorm Sandy had a negative and persistent effect on coastal property prices in Boston. [The city] was not at all physically damaged by the storm itself. The authors argue that this effect was driven by homebuyers and investors revising their beliefs about future climate change risks after seeing the damage done by Sandy in New York and New Jersey. That is an example of how the costs of a disaster can be amplified beyond its direct physical damage through the financial market.

Climate-related disasters will also amplify existing economic problems. Hurricane Maria had a devastating and persistent effect on the economy in Puerto Rico. The hurricane destroyed much of the island's infrastructure, including roads, electricity, schools, and hospitals. The island's government had a hard time borrowing money to rebuild, largely because it was already in the middle of a debt crisis when the hurricane hit. Taking a step back, a general finding in the literature recently is that heightened exposure to climate-related disasters like hurricanes increase the borrowing costs and the risk of defaults by governments across the world, including small island states in the Caribbean and municipalities right here in the United States.

If I may add, there is also an exciting area of research trying to investigate the heterogeneous effects of climate change on different communities.

Gerena: For sure, the Federal Reserve has been really interested in the topic of economic inequality. So, it's not surprising that it would be the focus of some research on the effects of climate change.

Phan: There is a literature on so-called "environmental justice" economics. It documents excessive exposure to pollution like air and water pollution [in] minority communities across the U.S. I'm trying to do some work on this topic as well, trying to investigate whether communities of color are more exposed to climate-related risks.

For example, in our ongoing project, my co-authors and I found that minorities — particularly blacks and Latinos — in surveys conducted by Gallup are more worried about global warming than whites, controlling for education, income, and various other factors. That begs the question, "Why?"

That reminds me of a recent paper studying the effects of redlining in Richmond. Historically, many communities of color in Richmond were subjected to redlining practices in the property markets. The authors of this paper found that redlined communities have less tree coverage. As a consequence, when a heat wave comes, these communities face higher temperatures than other communities with more tree cover. On a hot summer day, these redlined communities face a higher heat index and, as a consequence, they are at higher risks to health.

Gerena: It's not hard to see why the Richmond Fed would convene a conference about this topic. What were your reasons for organizing it?

Phan: We want to play an active role in getting together the best researchers and research on this topic. We need a very careful understanding of the economic impacts of climate change.

The San Francisco Fed organized a similar conference last year, and I am involved in organizing a biweekly seminar series on climate change economics with colleagues from the San Francisco Fed, Arizona State, and the University of Hamburg. There are so many exciting research projects and research papers that are being done right now on this vast topic of how climate change affects the many different aspects of the world's economy. So we thought there was an excellent opportunity for us at the Richmond Fed to bring together top scholars on various climate-related topics together for two days of virtually exchanging knowledge.

Gerena: What aspects of climate change will the conference presenters talk about?

Phan: The topics of the conference will be quite wide ranging, from the economic implications of natural disasters to the long-run climate implications of the shale gas boom. This breadth is quite necessary as the climate crisis is going to have wide-ranging effects across almost all aspects of our lives.

For example, Per Krusell from Stockholm University at the conference will compare the effects of suboptimal climate policies across the world, compared to what we think would be optimal climate policies. Jim Stock of Harvard will talk about his empirical findings of the impacts of the various carbon taxes imposed across various European economies. Clare Balboni at MIT will talk about the effects of inefficiently building infrastructure in coastal areas of Vietnam that will be at risk due to sea level rise. I will speak about an ongoing project with a Richmond Fed co-author, Felipe Schwartzman, about how climate related disasters will affect the cost of borrowing and the risk of debt crisis in small open economies around the world.

There are many more papers, and I'm quite excited about this conference.

Gerena: Sounds like there's going to be a lot of interesting research being presented.

Going forward, what will be the role of the economics profession as the world figures out what to do about this climate crisis?

Phan: I personally think that the worst damages of the climate crisis can be avoided if we make drastic changes to our business-as-usual path. Throughout history, drastic changes required redirecting scarce resources — by that I mean human capital, physical capital, political capital — towards developing a more sustainable way of living our lives together and with other beings on this planet.

When we make changes, we need to carefully understand the costs and the benefits of each step along the way. I think this is where economic research can be extremely valuable. It can provide estimates of what will be the costs, what will be the benefits, what will be the optimal path, what could be the suboptimal path, and what are the trade-offs.

That's how economists can make a difference, and that's how I hope to make a small but hopefully discernable difference on this very important topic.

Gerena: Well, thank you for your work on this, and for sharing some of your insights today, Toan.

Phan: Thank you, Charles.