Weathering the storm: sectoral economic and inflationary effects of floods and the role of adaptation

This paper investigates the impact of floods on economic output and prices at the sectoral level for local authorities in England using highly granular climate and economic data. We use precipitation z-scores as an instrument for floods to deal with endogeneity stemming from adaptation capital and we obtain dynamic impulse responses to the shock on GDP and inflation with a local projection approach (LP-IV). We find significant heterogeneities across sectors in terms of size, timing and sign, with sectoral output (prices) declining (increasing) up to 20% (250 basis points) following an increase in the number of floods. This evidence explains well the response of aggregate GDP and inflation found in the literature. Our estimates suggest that reduced investment can only partially explain the decline in output, and only in manufacturing. The response of the number and value of real estate market transactions is instead consistent with a wealth effect that is line with the demand side behaviour in wholesale and retail trade. To shed more light on the interaction among sectors, we use input-output tables and show that flood shocks propagate through the production network. Finally, using local authority expenditure on flood defences and a proxy for adaptation capital, we find that investments in adaptation strongly reduce the likelihood of flooding, but are less effective at mitigating economic damages once a flood hits. Our analysis highlights the importance of disentangling the economic impact of climate change at the sectoral level and the need for adaptation investments.