Abstract

Climate change increases physical risks—damages from floods, storms, wildfires, droughts, heatwaves, and sea level rise. These globally accelerating risks pose a fundamental threat to economies and societies. Conventional economic analysis of climate change focuses on damages and costs/benefits of climate actions (mitigation and adaptation), relying on models that assume perfect rationality, homogeneity, and unique equilibrium. Yet this approach falls short of capturing the complexity of physical climate risks, their inherent uncertainty, feedbacks, and adaptation responses by boundedly rational actors. Complexity economics recognizes the economy as a dynamic, adaptive system in which aggregate dynamics emerge from interactions of many boundedly rational agents who learn and update their expectations about climate and economic consequences of their actions. This chapter discusses why embracing complexity matters for the assessment of physical climate risks and climate change adaptation strategies. Using illustrative examples from agent-based computational economics, we show how relaxing traditional economic assumptions enables us to study distributional impacts and the emergence of structural shifts in markets as agents learn and interact. We highlight the importance of tracing out-of-equilibrium dynamics triggered by climate damages and adaptation responses, focusing on potential nonlinearities, including socioeconomic tipping points and potential systemic risks posed by the changing climate.

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