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El Niño a risk, but not an economic game changer

By Ben May | | Updated: 2023-06-27 14:40
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Jin Ding/China Daily

The onset of El Niño may cause more extreme weather events and record high global temperatures in 2023 and 2024. While this will have major humanitarian and ecological implications, we think fears that El Niño will increase the risk of global stagflation significantly are wide of the mark.

The shift in the El Niño-Southern Oscillation cycle will increase the risk of adverse weather in some areas, potentially triggering significant problems in the form of droughts, floods and wildfires. But some regions could benefit from more favorable weather conditions.

No clear uptick in global natural disaster damage

The annual global costs of the damage to property, crops and livestock from natural disasters were just 0.2 percent of global GDP in the three years to 2021, and the impact on global activity is likely to have been smaller still. While next year's costs of extreme weather could increase, past intense El Niño phases have not always resulted in a clear uptick in global natural disaster damage.

Pockets of weather-related disruption from El Niño may trigger suspensions or curtailed production in the worst-affected regions. But these are unlikely to be large or long-lasting enough to herald a renewed supply chain crunch globally.

Another widely flagged concern is that due to El Niño, food prices may remain high or even increase further, and thus cause the consumer price index inflation to remain high. However, estimates typically show that El Niño has only a limited impact on crop yield and prices — climate is only one of many factors that will determine the path for food inflation.

The ENSO is a three-phase climate cycle (El Niño, La Niña and neutral) that influences the levels of precipitation, cloud cover and temperature across large swathes of the globe. During the La Niña phase, global temperatures are typically cooler than normal, whereas the opposite is true in El Niño, while temperatures are more likely to be closer to the average in the neutral phase.

The world periodically flips from one phase to another and the intensity and the evolution of the cycle can be forecast several months in advance, though the duration of each phase naturally varies over time.

How El Niño can affect the global economy

The ENSO cycle can cause temperatures to be hotter or cooler than normal. It's a natural cycle that's been taking place for millenniums, whereas climate change is a long-term shift in the Earth's weather patterns and temperature. The shift into the El Niño phase of ENSO this year can have economic repercussions due to two factors.

The first is higher global temperatures. Between 2020 and 2022, the world was in an unusually long “triple-dip” of the cooler La Niña phase. Despite this, global temperatures were still among the hottest on record.

In an El Niño phase, higher global temperatures typically occur a year after its onset. As a result of this shift and climate change, the World Meteorological Organization assigns a 98 percent probability to the average temperature from 2023 to 2027 being hotter than the past five years. This suggests more frequent and severe wildfires and power outages, with the greatest effects experienced in those economies where average temperatures are very high.

The second is more volatile weather and extreme weather events. El Niño may also trigger more disruptive weather patterns that can damage property and infrastructure and disrupt economic activity. Parts of South America will be at increased risks from floods, while Australia and Indonesia may be more prone to drought.

Yet some regions that have been affected by La Niña may benefit from a shift to less troublesome weather.

The costs and economic impact of extreme weather

The main concern from the changing ENSO cycle is that it brings more catastrophic events such as wildfires or floods creating humanitarian crises and major ecological damage. Such events may also have economic costs, which are the key focus here.

The damage bill from a natural disaster can be huge for an individual economy. The 2017 hurricane that devastated Dominica is estimated to have caused damage worth 220 percent of Dominica's GDP. Given the huge cost on individual economies from climate change-related extreme weather, COP27 agreed to set up a fund to compensate poorer nations for losses and damages.

But at the global level, total annual damage costs from natural disasters are typically small, when measured as a share of annual world output. In 2011, a bad year for natural disaster damage, the estimated cost of global damage was about 0.5 percent of nominal US dollar-weighted global GDP. From 2019 to 2021, the cost has averaged less than 0.2 percent of global GDP.

Note too that during the three most intense El Niños of the late 20th century in 1982-83, 1997-98 and 2015-16 the damage from natural disasters wasn't substantially higher than normal. Back in 2000, estimates of damage from the 1997-98 El Niño ranged from $32 billion to $96 billion — the equivalent of between 32 percent and 76 percent of the total estimated damage from natural disasters in 1997-98.

The odds of extreme weather pushing larger regions or the world economy on to a significantly lower growth path appear to be very low.

That said, this view is at odds with a recent research by Callahan and Mankin, which has been widely cited in the media. They attribute “$4.1 trillion and $5.7 trillion in global income losses to the 1982-83 and 1997-98 El Niño events”. But we are skeptical of these results. True, the paper argues that the 1997-98 El Niño losses of $5.7 trillion built over a five-year period, but these losses amount to the equivalent of about 11 percent of world nominal GDP on a purchasing-power-parity basis in 2003.

In essence Callahan and Mankin imply that both the 1982-83 and 1997-98 El Niño caused economic scarring to the global economy to the tune of 10 percent of GDP. This is far higher than our estimates of economic scarring from the COVID-19 pandemic and the associated lockdowns across the globe in 2020-21. This conclusion seems even less plausible when we consider the fact that the damage caused by natural disasters in these El Niño years wasn't particularly high.

Could this time be different?

Overall, we see no reason to make material adjustments to our global economic forecasts for the next year or two, particularly given the uncertainty about the strength and the intensity of the latest El Niño.

But if natural disaster damage from a combination of El Niño and climate change are unusually high in 2024, could it have substantial spillovers to other regions, intensifying the overall impact on global activity? Media reports have typically flagged two risks from unusually hot and volatile weather in 2024: renewed supply chain pressures and higher food prices.

We agree that phenomena such as wildfires, floods and power outages all could potentially disrupt production substantially in the affected areas. But for weather events to have big spillovers to supply chains beyond the affected area would likely require the affected areas to be major suppliers of particular products.

Still, such an outcome is not impossible. Japan's 2011 earthquake and tsunami only affected an area that accounted for 3 percent of total Japanese output. Even so, it caused overall Japanese industrial production to crash by 15 percent in the month of the earthquake and it took six months for production to regain its pre-earthquake level. However, the impact on world industrial production was negligible.

In short, while extreme weather could trigger supply chain problems, spillovers are likely to be confined to a small number of industries and any disruption is likely to be national or regional rather than global.

Impact of El Niño on crops and food prices

A bigger concern could be worries that El Niño might prompt a further upward leg in food prices. Academic studies suggest that the impact of ENSO on the yield of key crops is small at a global level. While the yield from large areas of cultivated land may fall significantly due to El Niño or La Niña, causing price surges in these regions, other regions may benefit from significantly higher yield. For instance, El Niño causes a reduction in mean global rice and wheat yield of about 1.3 percent and the adverse impact on corn is relatively small, whereas soybean yield typically increase.

Given that the ENSO cycle is to some degree predictable, commodity prices should already reflect the expectation that El Niño will influence agricultural output to some extent. In the aftermath of the last intense El Niño, an International Monetary Fund Working Paper showed that a one-standard deviation positive surprise in the intensity of ENSO can raise prices by 3.5-4 percent.

The European Central Bank work points to a 6 percent rise in global food prices in response to a 1 degree Celsius increase in temperatures due to El Niño. While any increase in food prices is unwelcome, neither set of figures are particularly large given the broader volatility of food commodity prices.

However, the IMF Working Paper also shows that ENSO can account for almost 20 percent of real commodity price inflation over a multi-year period, suggesting that El Niño may provide grounds not to bank on significant food price deflation ahead.

The author is the director of Global Macro Research, Oxford Economics.

The views don't necessarily reflect those of China Daily.

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