Droughts and Deficits: The Global Impact of Droughts on Economic Growth

As climate change intensifies, dry rainfall shocks and droughts are a growing concern. At thesame time, scientific evidence suggests that the world has surpassed the safe planetary boundary for green water, whichis water stored in biomass and soil that is crucial for maintaining climate resilience. Yet, evidence at the globalscale of these combined forces on economic growth is poorly understood. This paper attempts to fill this gap by usingdata on annual subnational gross domestic product for 82 countries from 1990–2014. Using rainfall shocks as plausiblyexogenous variations in a spatially specific panel at the grid level, the analysis finds that the global effects ofdroughts on economic activity are substantial. Moderate to extreme droughts reduce gross domestic product per capitagrowth between 0.39 and 0.85 percentage point, on average, depending on the level of development and baseline climaticconditions, with low- and middle-income countries in arid areas sustaining the highest relative losses. In high-incomecountries, moderate droughts have no impact, and only extreme droughts have adverse effects, reducing growth byabout 0.3 percentage point, a little less than half the impact felt in the low- and middle-income country sample forthe same intensity of drought. Crucially, the impact of a dry shock of a given magnitude also depends on antecedentgreen water availability. The results show that increases in soil moisture in previous years can neutralize the harmfulimpacts from a dry shock, with suggestive evidence that local and upstream forest cover are key channels throughwhich these impacts manifest. These findings have important implications for measuring the economic impact of droughts and can inform adaptation investments.