A high level of household indebtedness is reflective of a larger challenge. In the US, households owe a record-breaking $16-trillion in debt. In SA, debt to disposable income now sits at about 75%. And there’s a worrying culprit that’s here to stay: the climate.
While there are the obvious causes, such as paying off expensive cars and homes, climate change is a more worrying beast. Once deemed an ideological battle, climate change is now proving it has the force to crumble the financial stability of households, businesses and governments.
Households globally are taking out debt to pay for daily necessities — food, energy, transport — that have become more expensive due to climate change. It’s not a correlational link, it’s causation: droughts are increasing food prices due to supply shortages, cutting hydropower production and increasing shipping costs as water levels in key waterways drop.
In the UK, the biggest drought in two decades has seen farmers grapple with food shortages and supermarkets ration bottled water. It’s forcing households to take out more debt to meet the most basic needs. British supermarket group Iceland Foods is now enabling shoppers to take out interest-free loans to buy groceries and make weekly repayments. There’s no telling how long it will take for vulnerable households to repay this debt.
In the US the Colorado River, which supplies 40-million Americans with hydropower, is under threat. Resulting water shortages will see Arizona forfeit almost 99-million cubic metres of water from Lake Mead, taking water away from the state’s agriculture sector, which had already been hit by a round of water cuts.
Hydropower shortages are also affecting costs of other goods, including cars and batteries. For example, dwindling water levels in China’s Three Gorges reservoir have cut hydropower production, leading to factory shutdowns for Japanese automaker Toyota, Taiwan’s Foxconn and Chinese battery maker Contemporary Amperex Technology.
The water shortages are affecting all value chains. In Europe, droughts in key waterways, including the Rhine and Danube rivers, have led to a sharp increase in shipping costs for all goods, including agriculture, as low water levels lead to ships carrying smaller loads.
In Italy water levels have dropped to 10% of their usual level, so low that ships from World War 2 have resurfaced. The Po Valley is home to a third of Italy’s agricultural production, and over half of its pigs and cattle live there. The Monticelli d’Ongina hydroelectric power plant has been shut down due to a lack of water. This has forced the government to replace the hydropower with gas, but at a steep cost. The cost of watering orchards has also soared, which will be passed on to consumers.
Tighter monetary policy, which is being adopted by countries globally, can worsen household debt. New credit is harder to access, while existing borrowers are hit with higher debt payments. This opens the door to an increase in non-performing loans and broader financial instability.
To make inflation slightly more manageable for households, the UK government has rolled out a subsidy programme for energy through its Energy Bills Support Scheme, which will be paid in six instalments. Households will see a discount of £66 applied to their energy bills in October and November, and £67 a month from December to March 2023. While this doesn’t put a huge dent in expected energy bills — which are expected to average £3,600 for the winter — it’s something.
But the challenge we haven’t wrapped our heads around yet is how to do something that’s fiscally sustainable to manage the effects of climate change on household indebtedness. A basic universal income may help, but won’t be fiscally sustainable for most countries.
Renewable energy may lower electricity costs, but it comes with its own vulnerabilities. In 2021 we saw UK electricity prices soar when the wind didn’t blow enough, and hydropower prices rose due to drought. Affordable hybrid energy solutions will be key.
But for goods that cannot be substituted easily — like food — it’s even trickier. New research shows that hot summers and droughts can have a direct effect on food prices beyond the short term. A panel regression of 48 countries showed that during a hot summer food prices increase by 0.38 of a percentage point and decline again about a year after the climate shock.
How to manage the impact of climate change on inflation and household indebtedness will be one of the most complex and lasting economic challenges we will face going forward. It’s a beast that’s bigger than monetary policy.
• Dr Baskaran (@gracebaskaran), a development economist, is a bye-fellow in economics at the University of Cambridge.
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