Developed nations have pledged to send developing countries a combined $100 billion a year to help them reduce their emissions and adapt to a warming world. A new study looks at why access to “climate finance”—especially in the form of bank financing—could be so critical for a community’s ability to adapt and prosper. The researchers look at a specific case study: an historic drought in the United States in the 1950s.

“While large changes to the climate, such as sweeping multi-year droughts, can cause residents to flee and the communities they flee from to suffer, access to bank financing changes all of that,” says Raghuram Rajan, the Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. “With equal access to finance, investments increase and local economies can experience long-run productivity, while fewer people immigrate to richer places. Simply put, access to finance can mediate a climate crisis, an economic crisis, and an immigration crisis.”

In their study, Rajan and his co-author, Rodney Ramcharan from the University of Southern California, were interested in answering two questions: What factors can help a population adapt to adverse climate shocks? And, can these factors affect long-range outcomes? To answer these questions, they examined the consequences of the United States’ second most severe drought (following “the Dustbowl” during the Great Depression), which occurred in the 1950’s and was both long and affected a large swath of the country.

Looking specifically at the role of access to bank finance, the researchers discovered that drought-stricken counties without access to finance saw more of their residents leave than counties with access to finance: a 6.3 percentage point decline versus a 1.5 percentage point decline in population growth, respectively, over a decade (1950-1960). These effects persisted long after the drought. When comparing two drought-exposed counties with identical populations in 1950, counties with more access to finance had a 4.5 percentage point higher population than the counties without access to finance by 1980. Over the three decades, the population in the counties without access to finance declined by 10.3 percentage points overall. One explanation for the long-run shifts, the researchers explain, is that more younger people left areas with little access to finance, while people over 70 stayed. This resulted in fewer people being born in these areas during the post-drought era, while the mortality rate increased.

At the same time, the drought spurred a technological revolution in irrigation systems that communities with access to finance were able to embrace, shielding themselves from the drought. This induced long-run changes in productivity and income for the counties with access to finance. By 1978, the value of farmland in counties with access to finance grew by 5.2 percentage points. Over the same period, the value of farmland in counties without access to finance declined by 6.45 percentage points. In fact, these drought-exposed farms with both access to finance and means to adapt through new irrigation systems became more productive than even farms in areas not exposed to the drought.

“When local communities have sufficient access to external sources of finance—in this case bank credit—and the physical means to adapt—through groundwater irrigation in our particular setting—climate shocks can speed innovation and lead to positive long-run outcomes,” the researchers write.

These opposing forces—declining populations in counties without access to finance and improving productivity and income in counties with access to finance—alter the supply and demand, leading to cascading changes throughout the economies. Both the retail and manufacturing sectors took a hit in counties without access to finance, while they prospered in areas with access to finance that were able to better adapt to the drought.

“The effects leave their shadow long after the drought ends,” the researchers write.

Rajan and Ramcharan connect this case study to important policy conversations happening today.

“Improving people’s access to finance is one way to help poor countries that are most affected by climate change, in part because they depend so heavily on agriculture,” says Rajan, a former Governor of the Reserve Bank of India and Chief Economist at the International Monetary Fund. “It is in the best interest of richer nations to provide access to finance in these poor countries not just because it is the right thing to do but because it limits uncontrollable climate-induced immigration into their own countries. And while banking regulators may instinctively be cautious about investing in areas that are highly vulnerable to climate impacts, our case study shows that these finance-infused communities are better able to embrace innovation, adapt to climate change, and prosper in the long run. These clear benefits must be weighed against the risks.”

Areas of Focus: Climate Change
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