Climate Change and the New Zealand Economy

Global warming is a fact. Figure (1) plots the average change in Global, Northern hemisphere and Southern hemisphere temperatures from 1880 to 2018 (reference). The temperature has been rising, more so in the Northern Hemisphere. 

Figure (1) 

The standard economic story is that global warming increases the cost of production of food and primary commodities, reduces their supplies, and as demand keeps rising, the price of commodities increases (excess demand).[1]

Figure (2) plots the ANZ bank, New Zealand’s commodity price index and the World commodity price index (it includes meat, skins and wool; dairy; horticulture, forestry, seafood and aluminium).

Note that both prices increasing as predicted, but the New Zealand commodity price is often lower than the world’s commodity prices.

Figure (2) 

Based on such information, The New Zealand Agricultural Greenhouse Gas Research Institute concludes, “Climate changes could further drive up international commodity prices. That in turn would benefit New Zealand farmers and agricultural exports.”

Figures (1) and (2) clearly imply that the New Zealand commodity price level (as measured by the commodity price index) is positively correlated with global average change in temperature (both rising). This is also true for the price of every commodity in the index (meat, dairy...etc.). However, the conclusion of the Institute is misguided because the demand for New Zealand’s commodities depends, not on the New Zealand commodity price alone, but on both, the New Zealand price and the world’s price.

How is that?

What matters for the demand on the New Zealand primary commodities is not the New Zaland commodity price per se, but rather the relative price that is the ratio of the New Zealand commodity price to the world’s price of the same commodities.

Figure (3) plots the data from Jan 1986 to Mar 2019. The correlation is negative.

Figure (3) 

In a global commodity market, a change in the nominal price of a NZ commodity exerts two effects on the quantity demanded of New Zealand primary commodities. First, it changes the relative price, which is a change in the terms at which a global buyer can exchange a NZ commodity for another non-NZ commodity (e.g., New Zealand’s dairy and the other countries dairy). The change in the relative price leads to a substitution effect. A lower relative price increases global demand for New Zealand’s commodities. Second, there is an income effect. A change in the nominal price of New Zealand’s commodity causes a change in real income of the buyers, or in the size of the basket of primary goods, a global buyer can buy. If global warming causes the price of a New Zealand commodity to fall, all other prices remained unchanged, the consumer’s real income rises because more of such good, or other goods, could be purchased.

Assuming that everything else remains unchanged, the patterns depicted in figure (2) remain as such under global warming, the higher the New Zealand’s productivity (in primary commodities sector) is, the lower our relative commodity prices, and the higher the global demand on our commodities.

Furthermore, although commodity prices are highly volatile, they still share significant cyclical fluctuations with nominal GDP. They are also positively correlated with expected inflation. I showed that changes in relative commodity prices fully explain the Kiwi dollar depreciation rate Razzak, 2018. Global warming is very relevant to economic policy; see Rudebusch 2019 (here).     

Global warming is clearly a danger and a game changer. The economic analyses I have seen so far are thin. Policymakers need a more general equilibrium analysis to understand the costs and the benefits. There must be some benefits, I do not know what they might be. I can imagine that truism might benefit from warmer temperature. Farmers might be able to produce new varieties that they could not produce before, hence opening new markets. 

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[1] Google for example, How Climate Change Will Alter Our Food; How Climate Change May Affect Global Food Demand and Supply In the Long Run; and Roundtable II: Economic Growth and Climate Change: Long Run Implications for Commodity Prices and Trade.