24 September 2024

ECB: Economic and financial impacts of nature degradation and biodiversity loss

by Ceglar, Parker, Pasqua, Boldrini, Gabet and van der Zwaag: Businesses, the financial sector and policymakers have long underestimated, or even disregarded, the economic significance of ecosystem services, many of which are neither traded in markets nor directly assigned a monetary value.

Nature is crucial to human wellbeing and provides essential ecosystem services that support economic activity. Nature encompasses all living and non-living elements on our planet, forming ecosystems such as forests, lakes and wetlands.^[1] These ecosystems provide habitats for numerous species and tangible goods like food, freshwater, timber and medicinal resources. These also maintain environmental balance, for example by regulating air quality, controlling climate and mitigating floods. Key processes facilitated by ecosystems include soil formation, nutrient cycling and pollination. Nature also offers intangible benefits such as recreation and tourism. These benefits are greatly at risk from the current unprecedented rate of nature degradation and biodiversity loss.

Businesses, the financial sector and policymakers have long underestimated, or even disregarded, the economic significance of ecosystem services, many of which are neither traded in markets nor directly assigned a monetary value. For example, wetlands act as natural water filtration systems and storm barriers, saving billions in water treatment and disaster mitigation costs. Forests absorb carbon dioxide, playing a vital role in climate regulation and reducing the economic impacts of climate change. Healthy soils and pollinators are essential for crop production. Without pollinators, crop yields would decrease, leading to higher production costs, increased consumer prices and potential food shortages. Many of the services provided by ecosystems are public goods and are either undervalued in markets or not currently priced in at all. As a result, they are often overlooked in economic decisions, which has significant consequences for the natural world. The Integrated Natural Capital Accounting (INCA) project, an integrated system of ecosystem accounts for the EU, estimated that in 2019, ten ecosystem services in the EU28 generated a total annual flow of benefits worth €234 billion.^[2] Box 2 in this issue of the Economic Bulletin sets out in more detail the challenges of incorporating ecosystem services into measures of economic activity.

Recent research has demonstrated the highly non-linear nature of biodiversity loss.^[3] While financial losses identified so far may seem limited, it is important to recognise that even seemingly minor events – such as the loss of a single species of bee – may have knock-on effects that have a substantial economic impact. Species loss can hold back economic productivity and make the provision of ecosystem services more fragile. This fragility can compromise economic resilience, lower growth opportunities and exacerbate our vulnerability to future biodiversity loss. So nature degradation can have important economic effects that central banks should be aware of to maintain price and financial stability. Indeed, negative news about biodiversity already increases financial market measures of risk, especially in countries where ecosystems are more depleted.^[4]

Central banks can only achieve their objectives for price and financial stability if they understand and forecast how economic shocks and trends affect inflation, the broader economy and the financial system. Given the potential of climate change and nature degradation to cause significant economic disruptions, these environmental crises should be integrated into policy frameworks alongside factors such as globalisation, demographics and financial innovation. They pose severe risks that can affect the business cycle and there is an urgent need for thorough analysis and decisive policy action. During Hurricane Sandy, for example, coastal wetlands in the northeastern United States prevented USD 625 million in flood damages.^[5] This illustrates how reduced capacity of ecosystems to protect against floods increases the likelihood that future extreme rainfall events will cause flooding, disrupting economic activity at the business cycle frequency. The loss of such ecosystem services can lead to greater damage, with long-lasting effects on the economy, infrastructure and financial stability of the region concerned...

 more at ECB

© ECB - European Central Bank