ii.

STATE OF THE ART ON THE ECONOMICS OF ADAPTATION

The economics of adaptation to climate change – guidance for a new field of policy
Besides mitigation, adaptation to climate change is a natural component within any climate
policy strategy that aims at minimizing total costs associated with climate change. In the view of
lacking success of international negotiations on mitigation, the adaptation option becomes even
more important. Numerous countries have already initiated a process of adaptation by drafting
strategies or action plans for public adaptation measures. Hence, there is a particular need for
scientific support. The discipline of economics has a key role to play in this context since it
provides tools and methods for answering questions that are crucial to the adaptation policy
process, such as forming and operationalizing adaptation goals, identifying adequate actors and
instruments or scrutinizing interdependencies between adaptation and mitigation. The still
relatively young field of research is growing at a considerable pace and already exhibits a wide
range of methodological approaches and research questions. Against this background, this
chapter aims to provide a systematic overview of the state of the art on the economics of
adaptation – with a focus on conceptual and analytical work – and, building upon this, to outline
key pointers for future research.
The structure of this chapter is intended to capture the logical sequence of research questions.
Section 2.2 lays the foundations by defining the boundaries of the research field and framing the
concept of adaptation in economic terms. Section 2.3 focusses on the basic economic insights on
the relation between mitigation and adaptation. This is of particular importance since first, both
strategies are inevitably linked to each other in being substitutes and complements, respectively,
to confront climate change and thus require integrated analysis (Agrawala et al., 2011); second,
adaptation plays an important strategic role regarding international cooperation on mitigation.
Probably, the major task of the economic discipline is to provide guidance on how to allocate
scarce resources between different adaptation options as well as between mitigation and
adaptation (Section 2.4). This entails first identifying and analysing the optimal extent and
pathway of adaptation from a theoretical perspective. Second, in order to operationalize the
respective findings and feed them into the policy process, an empirical assessment of adaptation
costs and benefits is required. Care has to be taken when it comes to the identification of the
adequate actors for actually conducting adaptation measures (Section 2.5). From the economic
perspective, publicly provided adaptation is only legitimate in case of market failure that cause
inefficiencies in autonomous adaptation efforts. Another ground for government intervention is
given by goals that are beyond the optimality concept, such as distributive justice or security of
supply. Having identified cases for public adaptation, Section 2.6 addresses possible means and
instruments of adaptation policy that allow for overcoming barriers to optimal private adaptation
and realizing non-optimality-related goals, respectively. In this regard, it is important to see that
adaptation policy itself can also be subject to optimality barriers. Thus, Section 2.7 introduces
approaches that screen the adaptation policy process from a positive perspective, with a special
focus on self-interest driven barriers of political actors. Finally, Section 2.8 concludes and
proposes directions for future research.
Framing adaptation as an object of economic research
A system-based conceptualization of adaptation
The starting point for framing adaptation as an object of (economic) research is given by the
definition of the Intergovernmental Panel on Climate Change (IPCC, 2001), which has been
broadly accepted in the economic literature (see e.g., Tol, 2005):
Adaptation is adjustment in ecological, social, or economic systems in response to actual or
expected climatic stimuli and their effects or impacts (. . .) to moderate or offset potential
damages or to take advantage of opportunities associated with changes in climate. (. . .)
In line with this definition, Smit et al. (1999) develop from an interdisciplinary point of view the
three dimensions of adaptation, depicted by the questions ‘Adaptation to what?’ (climate-related
stimuli), ‘Who/what performs the adaptation?’ (adaptation system) and ‘How does adaptation
occur?’ (measures). The grounds for adaptation are provided by climate-related stimuli, i.e.,
altered climate conditions (e.g., precipitation or temperature) and the resulting ecological or
economic impacts (e.g., droughts, crop failures, income losses) that are linked to the sensitivity
of the (adaptation) system under observation. First, this system is to be defined according to the
level at which the adaptation takes place. For example, adaptation at the level of an agricultural
holding comprises crop diversification, whereas at a global level it can manifest as a shift in the
international food trade structure. Furthermore, the definition refers to the nature of the
adaptation system, which may be ecological, political, social or economic or may encompass a
combination of these components. Finally, the system has to be differentiated according to who
performs the adaptation (e.g., coastal protection managers) and what modifies itself or is
modified (e.g., coastal settlements). The last adaptation dimension focuses on the question of
how, i.e., with what measures, the adaptation system confronts climate-related stimuli (structure
of adaptation). Table 2.1 shows the characterization of adaptation measures according to Smit et
al. (1999).
 General differentiating concepts or attribute Examples of terms used
Purposefulness Autonomous planned
Spontaneous purposeful
Automatic intentional
Natural policy
Passive active
strategic
Timing Anticipatory responsive
Proactive reactive
Ex ante ex post
Temporal scope Short term long term
Tactical strategic
Instantaneous cumulative
Spatial scope Localized widespread
Function/effects Retreat – accommodate – protect prevent –
tolerate – spread risk – change - restore
Form Structural – legal – institutional – regulatory –
financial – technological
Performance Optimality – efficiency – implementability -
equity

An action-based conceptualization of adaptation

However, for economic sciences, this comprehensive system-oriented conceptualization of
adaptation might be inappropriate. Rather, a stronger focus on economic systems that are subject
to climate change impacts or even more on related actors might by necessary. For this reason,
Eisenack and Stecker (2012) offer an alternative framework that conceptualizes climate change
adaptations as actions, restricting themselves to adaptations made by human actors (see Figure
2.1).
Similarly to Smit et al. (1999), the starting point is given by a stimulus, i.e., a statistical change
in meteorological variables due to climate change. The stimulus is only relevant for adaptation
when it affects an exposure unit, which may comprise actors or all kinds of systems (i.e., social,
ecological and so forth) that depend on climatic conditions. When combined, the stimulus and
exposure unit form a climate change impact. The response to the latter is carried out by
individual or collective actors, called operators. In this sense, the operator’s activities only
qualify for being an action when serving a certain purpose. Finally, the actor or system being the
target of an action is called the receptor. Note that exposure unit, operator and receptor may
either coincide or (partly) fall apart. Finally, the implementation of adaptation measures requires
means in a broad sense, ranging from financial or material resources through to legal power and
information.
The purpose of this framework is on the one hand to structure the analysis of adaptation with a
focus on related actors and institutions. In this way, barriers of adaptation can be revealed and
systemized. Barriers typically emerge when there is a mismatch of the actors’ functions
described above. On the other hand, the framework allows for clarifying the concept of
adaptation and for getting over shortcomings of the so far established frameworks. For instance,
some of the questions raised by Smit et al. (1999) in order to point out the adaptation dimensions
can be clarified by using the introduced concepts (‘Adaptation to what?’ – impact, i.e., stimulus
combined with exposure unit; ‘Who or what adapts?’ – operator, receptor and their relation to the
exposure unit; and ‘How does adaptation occur?’ – linkage of means and purpose, consideration
of processes vs. actions).

Figure 2.1 Framework for analysing adaptation as actions* (Eisenack and Stecker, 2012, p. 246)
*Boxes with rounded corners can be both actors or biophysical units, while operators are always
actors. Operator, receptor and exposure unit are not necessarily identical (indicated by
overlapping boxes). The straight arrow indicates a causal relation, and the large arrow a
teleological relation.
The basic approach of economic adaptation research
Aaheim and Aasen (2008) demonstrate how, building upon such frameworks, adaptation can be
tackled as object of economic research. The basic idea is that “(. . .) the impacts of climate
change can be analysed with the same economic tools used for analysing the impacts of changing
economic conditions” (Aaheim and Aasen, 2008, p. 1). Simply speaking, the basic task of the
economic discipline is to provide tools for investigating adaptation to changing economic
constraints, whereas specific behavioural assumptions concerning the economic agents are taken
for granted. Thus, provided that it is known how climate change affects these constraints,
adaptation can be tackled and understood by the economic discipline. The advantage of this
approach rests upon its capability of making understandable to which extent and in what way
economic agents autonomously adapt. In this respect, Aaheim and Aasen (2008, p. 2) distinguish
between direct autonomous adaptation, referring to the changes that economic actors make when
confronted with climate change (e.g., increased demand for air conditioners), and indirect
autonomous adaptation, referring to the market response resulting from the direct adaptation
(e.g., increased price for air conditioners leading to a new market equilibrium). Additionally, the
approach allows for revealing cases in which autonomous adaptation may be insufficient and
thus requires public adaptation efforts (see Section 2.5).

Basic economic insights on the relation between mitigation adaptation

Needs for and limits of an integrated assessment of mitigation and adaptation

Basically, there are two reasons requiring an integrated consideration and analysis of adaptation
and mitigation. First, both are strategies to confront the adverse impacts of climate change and
thus need to be taken into account at the same time when it comes to the question of how to
allocate scarce resources such that total climate change costs are minimized (Agrawala et al.,
2011; cf. Section 2.4). Second, the option of adaptation plays a crucial role in influencing the
countries’ strategic behaviour in international cooperation on mitigation (Heuson et al., 2012b;
Marrouch and Chaudhuri, 2011; cf. Chapter 3). However, Tol (2005) argues that mitigation and
adaptation should largely be considered separately, because they generally do not fit into the
same analysis framework for three reasons. First, there is a discrepancy in the basic scope of
action. While mitigation efforts are part of the area of competence of national governments
against the backdrop of international climate protection negotiations, adaptation measures are
primarily implemented by local managers of natural resources, households and firms.
Furthermore, the tools for decision support relating to the planning and implementation of
mitigation and adaptation measures are directed at different addressees (mitigation – e.g.,
ministries for energy or environment; adaptation – e.g., local water management or farmers).
Finally, there is also a discrepancy in terms of the temporal scope of decision support (mitigation
– short-term measures aimed at long-term effects; adaptation – short-term measures targeted at
short- to long-term developments). Nevertheless, Tol (2005) sees so-called facilitative adaptation
– measures for building up adaptive capacity – as an exception, i.e., as suitable for a joint
analysis with mitigation, since it has similar scales. Referring to this case, now the two reasons
for joint analysis stated above are examined in detail.

Mitigation and adaptation as inevitably interlinked components of a comprehensive climate

policy
Adaptation is now widely acknowledged as an indispensable component besides mitigation in
any policy that ameliorates climate change-related damages at the least possible cost (Agrawala
et al., 2011). Buob and Stephan (2011a) point out that, a priori, the relation between the two
strategies in economic terms is not unambiguous. From a static perspective, mitigation and
adaptation are substitutes in protecting a country or region against climate change damages.
However, from a dynamic perspective, the strategies may be complements in the sense that
mitigation slows down climate change. Consequently, societies gain time and are likely to face
lower future costs of adaptation (Ingham, 2005). In any case, a comparison of the fundamental
characteristics of mitigation and adaptation is recommended in order to achieve a clear
distinction of both strategies, which is essential for any further in-depth economic analysis,
especially in terms of optimization (Section 2.4). Such a comparison is, amongst others, carried
out by
Füssel and Klein (2006) – see Table 2.2 . Traditionally, mitigation receives greater attention than
adaption, both from the scientific and political angle for the following reasons: mitigation can
avert negative effects of climate change on all climate-sensitive systems, whereas in many
systems the scope for adaptation is limited – think of small island states that are virtually
defenceless against rising sea levels. Moreover, the benefits of mitigation are certain because
mitigation combats climate change-related problems directly at the source. In contrast, the
effectiveness of (proactive) adaptation frequently depends on predictions about the regional
vulnerability situation and the related, typically highly uncertain, climate change impacts. Also,
mitigation complies with the polluter-pays principle, contrary to adaptation: developing countries
generally demonstrate the greatest need for adaptation even though they have contributed far less
to climate change than the industrial nations. Finally, obtaining quantitative data on greenhouse
gas emissions is relatively unproblematic, which allows for monitoring the success of mitigation
efforts. It is much more difficult to measure the effectiveness of adaptation since, due to its
heterogeneity, no universal measure of success exists (Cimato and Mullan, 2010).
However, some characteristics favour stronger consideration of adaption. According to the scope
of their effects, adaptation measures can be implemented at local or regional level. The situation
is different for mitigation, the effectiveness of which depends on collective global efforts. Thus,
adaptation is typically a private good, 2 mitigation a public good, which is subject to the free-
rider problem. Moreover, compared with mitigation, adaptation measures are often associated
with an added benefit, in particular in terms of reducing the risks of current climate variability.
With regard to the lead time, the benefits of (reactive) adaptation measures are often immediately
effective, whereas the effect of mitigation will only kick in after a delay of several decades due
to the inertia of the climate system.

Table 2.2 Fundamental characteristics of mitigation and adaptation (following Füssel and Klein,
2006)
Mitigation Adaptation
Benefitted system All systems Selected systems
Effectiveness/benefits Certain Generally uncertain
Polluter pays Typically yes Not necessarily Advantage mitigation
principle
Monitoring success Relatively easy More difficult
Scale of the effect Global Local to regional
Payer benefits Only little Almost fully Advantage adaptation
Added benefit Sometimes Frequently
Lead time Decades None up to decades

The second rationale for jointly analysing mitigation and adaptation is given by the fact that
adaptation has crucial impacts on the outcome of international cooperation on mitigation.
Most of the related studies are based on game theory models. Auerswald et al. (2011) point out
the basic strategic role of adaptation: by adapting to climate change, a country reduces its
associated residual damage, which leads to an enhanced pay-off in the non-cooperative
equilibrium. Consequently, the country improves its threat point within international negotiations
on mitigation and thus can influence the related burden sharing in its own interest. Starting from
these basic insights, several contributions study the countries’ strategic efforts in mitigation and
adaptation with varying framework conditions. Buob and Stephan (2011a) apply a model with
several world regions having available a limited budget to be invested in mitigation and
adaptation. They discover that the budget allocation crucially depends on the regions’ initial
endowment concerning environmental quality and financial means. A special setting is studied
by Barrett (2008) in restricting to the case of fixed adaptation and mitigation costs caused by
related investments. This constellation provokes corner solutions, i.e., countries solely invest in
adaptation (mitigation) in case of non-cooperative or cooperative behaviour. Zehaie (2009)
introduces a static, non-cooperative framework comprising two countries, focusing on the role
the sequence of mitigation and adaptation decisions plays for the countries’ behaviour. When
adaptation is timed before mitigation, countries strategically raise their adaptation effort in order
to commit to a lower mitigation level in the second stage. In the opposite case, there is no scope
for strategic behaviour since adaptation is a private good. Ebert and Welsch (2012) apply a
similar framework to study the impact of productivity, pollution sensitivity and adaptive capacity
on the countries’ emission and adaptation decisions.
A recently evolving branch of literature investigates institutional aspects of climate finance.
Buob and Stephan (2011b) analyse the basic incentives for industrialized countries to contribute
to adaptation funds. 3 Pittel and Rübbelke (2011) demonstrate that adaptation funding increases
the developing countries’ fairness perception and which promotes their willingness to contribute
to joint mitigation efforts. Heuson et al. (2012b) study the strategic effects, such as incentives for
strategic mitigation, arising from the various funding instruments that are about to be
implemented in the post-Kyoto process. Moreover, it is shown that some of the instruments fail
in fulfilling a minimum requirement for sustainable funding since they do not induce the
recipient country to increase its contribution to the public good of mitigation. However, this is
the only way for the donor country to profit from funding.
Besides these non-cooperative settings, a few contributions deal with the role of adaptation
within given mitigation agreements. Benchekroun et al. (2011) argue that the basic strategic role
of adaptation depicted above naturally reduces the stability of such agreements. Principally, this
problem can be healed by explicitly including adaptation in the negotiation process. In this way,
adaptation loses its commitment function, which boosts the free-riding incentives in terms of
mitigation, and the agreement’s stability increases. However, the effect of such an extended
mitigation-adaptation-agreement on the global emission level is ambiguous a priori, since the
countries might agree on substituting mitigation through adaptation, depending on the cost-
benefit-ratio.

Optimal extent and pathway of adaptation