Does climate change affect economic growth?

Benjamin Jones, Benjamin Olken , Melissa Dell, 6 June 2009

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Decision makers readily perceive the economic costs of adopting bold climate policies such as strict cap-and-trade programmes. The opportunity cost of not adopting strict climate policies is much less apparent. It should, however, be equally important in rational decision making. If unchecked climate change will do a great deal of damage to the economy, then preventing those costs with proper climate policies should count as an economic benefit. Absent this information, setting appropriate policy to curtail greenhouse gas emissions, or other policy responses, is difficult at best and pure guesswork at worst. What does the evidence say?

One approach to this question looks at the historical relationship between climate and national economic performance. Here there is an old literature – and an old debate. One fact is clear. Hot countries tend to be poorer. Observations of this phenomenon date at least to Ibn Khaldun’s 14th century Muqaddimah, appear in Montesquieu’s 18th century The Spirit of Laws (which famously argued that an “excess of heat” made men “slothful and dispirited”), and have been confirmed in modern data (e.g. Nordhaus 2006).

Climate and income

Looking at a current cross-section of the world, national income per-capita falls 8.5% on average per degree Celsius rise in temperature (Dell, Jones, and Olken 2009), suggesting a simple method to calculate how warming might influence future standards of living. However, while the magnitude of this correlation is impressive, its interpretation is uncertain. Substantial debate continues over whether the temperature-income relationship is simply a happenstance association, while other variables, such as a country’s institutions or trade policy, drive prosperity in contemporary times (see, e.g., Sachs 2003; Acemoglu, Johnson and Robinson 2002; Rodrik, Subramanian and Trebbi 2004). These uncertainties cloud not just the historical debate over climate’s role in economic development but also, by extension, current debates about the potential impact of future climate change.

A second approach to understanding the total economic effects of climate harnesses micro-evidence, quantifying various climatic effects and then aggregating these to produce a net effect on national income (see, e.g., Mendelsohn et al. 2000, Nordhaus and Boyer 2000, Tol 2002). This approach is favoured in the climate change literature and forms the basis of many current policy recommendations regarding greenhouse gas emissions. However, this approach, while useful, also faces difficult challenges. The set of mechanisms through which climate may influence economic outcomes is potentially enormous and, even if each mechanism could be enumerated and its operation understood, specifying how the micro-level effects interact and aggregate to shape macroeconomic outcomes poses additional difficulties. Indeed, the climate literature, at the micro level, suggests a wide array of potential climatic effects, including influences on agricultural productivity, mortality, cognitive performance, crime, and social unrest, among other outcomes, most of which do not feature in current implementations of these models.

Temperature within countries

In a recent paper, “Climate Shocks and Economic Growth: Evidence from the Last Half Century” (Dell, Jones, and Olken 2008), we take a third approach. Looking worldwide over the last 50 years, we use historical fluctuations in temperature within countries to identify temperature’s effects on the path of national income. By examining aggregate outcomes directly, we avoid relying on numerous assumptions about what mechanisms to include and how they might operate, interact, and aggregate. By utilising fluctuations in temperature and precipitation, we isolate their effects from other country characteristics.

We find three main results. First, higher temperatures have large, negative effects on economic growth, but only in poor countries. In poor countries, we estimate that a 1ºC temperature increase in a given year reduced economic growth in that year by about 1.1 percentage points. In rich countries, changes in temperature had no discernable effect on growth. Changes in precipitation had no substantial effects on aggregate output in either poor or rich countries. When we examine the impact of changes in average temperatures lasting a decade or more rather than annual changes, we find very similar results.

Second, one can distinguish two potential ways temperature could affect economic activity:

  1. influencing the level of output, for example by affecting agricultural yields, or
  2. influencing an economy’s ability to grow, for example by affecting investments or institutions that influence productivity growth.

The difference between these two types of effects matters when one starts to contemplate permanent changes to temperature: would a 1ºC permanent increase in temperature reduce per-capita GDP by 1.1 percentage points, or would it reduce the growth rate by 1.1 percentage points year after year? We find that higher temperatures reduce the growth rate in poor countries, not simply the level of output. Since even small growth effects have large consequences over time, these growth effects – if they persist in the medium run – imply very large impacts of permanent temperature increases.

Third, we find that temperature affects numerous dimensions of poor countries’ economies in ways consistent with an effect on the growth rate. While agricultural output contractions appear to be part of the story, we find adverse effects of hot years on industrial output and aggregate investment. Moreover, we document that poor countries produce fewer scientific publications in hot years, which suggests that higher temperatures may impede innovative activity. Higher temperatures lead to political instability in poor countries, as evidenced by irregular changes in national leaders. Many of these effects sit outside the primarily agricultural focus of much economic research on climate change and underscore the challenges in building aggregate estimates of climate impacts from a narrow set of channels. These broader relationships also help explain how temperature might affect growth rates in poor countries, not simply the level of output.

Climate change and future economic prospects

To the extent that responses to future climate change are similar to historical responses, our findings have implications for quantifying potential future impacts of climate change. Even assuming that countries adapt fully after only a decade to temperature changes, if the future response follows our historically-driven estimates, the future effects of climate change for poor countries would be substantially more negative than those implied by existing models. For example, our estimates imply that global climate change would lower the median poor country’s growth rate by 0.6 percentage points each year from now until 2099. Extrapolated over 90 years, the median poor country would then be about 40% poorer in 2099 than it would have been in the absence of climate change. While this estimated effect of higher temperatures is quite large, it is actually quite consistent with what one would predict just by looking at the cross-section of countries in the world today. Since we find no effects on rich countries, the results imply that future climate change may substantially widen income gaps between rich and poor countries.

Of course, the extent to which our historically-driven results can be used to assess the impact of climate change depends on whether historical responses to temperature shocks are good predictors of how economies will respond in the future. Very large changes in temperatures, beyond the range of recent historical experience, could produce nonlinear effects that are not captured by our estimates. Nevertheless the qualitative patterns we find – larger effects in poor than rich countries, growth effects rather than level effects, and impacts of temperature on economic and political activity – are important patterns that models of climate’s economic impacts should be able to reproduce.

Our results also inform the older debate over climate’s role in economic development. As noted above, climatic theories of development have a long history and have remained a subject of contemporary debate. Our estimates identify a substantial, contemporary effect of temperature on the development process, not just on important sub-channels but on the aggregate economy. It appears that Ibn Khaldun really was ahead of his time.

References

Acemoglu, Daron, Simon Johnson, and James Robinson. “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution,” Quarterly Journal of Economics 117, 1231-1294, 2002.

Dell, Melissa, Benjamin F. Jones, and Benjamin A. Olken. “Climate Shocks and Economic Growth: Evidence from the Last Half Century,” NBER Working Paper 14132, 2008.

Dell, Melissa, Benjamin Jones and Benjamin Olken. “Temperature and Income: Reconciling New Cross-Sectional and Panel Estimates,” American Economic Review Papers and Proceedings, 2009.

Mendelsohn, Robert, Wendy Morrison, Michael Schlesinger and Natalia Andronova. “Country-specific market impacts of climate change,” Climatic Change 45(3-4): 553-569, 2000.

Nordhaus, William and Joseph Boyer, Warming the World: The Economics of the Greenhouse Effect, Cambridge, MA: MIT Press, 2000.

Nordhaus, William. “Geography and Macroeconomics: New Data and Findings,” Proceedings of the National Academy of Science 103, 3510-3517, 2006.

Montesquieu, Charles de. The Spirit of Laws, 1750.

Rodrik, Dani, Arvind Subramanian, and Francesco Trebbi, “Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development,” Journal of Economic Growth 9, 131-165, 2004.

Sachs, Jeffrey D. “Institutions Don’t Rule: Direct Effects of Geography on Per-Capita Income,” NBER working Paper 9490, 2003.

Tol, Richard. “Estimates of the damage costs of climate change – part II: dynamic estimates,” Environmental and Resource Economics 21, 135-160, 2002.

Topics: Development, Environment
Tags: climate change, growth

Massachusetts Institute of Technology

Associate Professor of Management and Strategy at the Kellogg School of Management and Faculty Research Fellow at NBER

Associate Professor of Economics in the MIT Department of Economics and CEPR Research Affiliate