Climate events and adaptation: effects on environmental policy and abatement

Abstract

We examine how an extreme climate event affects the incentives of regulators to invest in adaptation measures that reduce the impact on firms’ production costs, and how this investment affects environmental policy and firms’ incentives to invest in abatement. Different government agencies implement these policies (adaptation and emission fees) and can exhibit asymmetric preferences for pollution. We find that investment in adaptation and abatement are complements, and more likely climate events decrease firms’ investment in abatement. We also find that severe climate events can induce less investment in adaptation, as they can be used as a tool to reduce expected output and pollution. In addition, we show that symmetric agencies induce a lower investment in adaptation. Finally, we separately identify the welfare gains from adaptation and environmental policy.