Firm heterogeneity and regional economic recovery from environmental shocks

Destructive climate-induced extreme events increasingly affect people and economies worldwide. Their impacts are widely studied using both empirical and simulation methods. Yet, the scientific debate on whether environmental shocks induce growth spurts, leave persistent scars on the economy, or barely have any long-term effects, remains unresolved. Here, we show how differences in aggregate economic dynamics can be explained by heterogeneity at the firm-level, specifically the distribution of damages among firms and different productivity level of affected firms. We employ a novel multi-regional economic agent-based model, where firms in one of the regions are struck by a climate-induced shock. We find that these firm-level heterogeneities have significant effects on aggregate economic dynamics, with long-run outcomes ranging from full recovery to modest growth, and even to persistent depression. Our results show that shocks to clusters of economic activity can have outsized impacts on regional economies compared to a representative distribution of impacts. This highlights fundamental problems with conventional aggregated analysis of physical climate risks and of overall costs of climate change, suggesting that policy-focused analysis could be misguided when omitting a granular representation of economic agents.