When people think about global warming, they think about the environment and the impact it has on the animals and people who inhabit that location. However, we know little about the impact of global warming on the manufacturing industry.
Recently, UC Santa Barbara researchers have shown that climate change will dramatically lower output for the Chinese manufacturing sector. They found that by the mid-21st century, if we are not able to successfully slow or stop global warming, climate change will reduce Chinese manufacturing output annually by 12 percent, which is equivalent to a loss of $39.5 billion in 2007 dollars. The results indicate substantial local and global economic consequences, as the Chinese manufacturing sector produces 32 percent of national gross domestic product (GDP) and supplies 12 percent of global exports.
“Previous work has largely focused on how climate change may affect economic activity by lowering the productivity of workers,” co-author Kyle Meng, an assistant professor of environmental economics in UCSB’s Bren School of Environmental Science & Management and the Department of Economics, said. “It is well-documented that when it’s hot, people work less productively.”
What motivated their study was the fact that the design of climate change adaptation policy requires an understanding of the mechanisms responsible for these temperature-driven output losses. If the problem is costly factor reallocation, adaptation investments should focus on lowering factor adjustment costs. If temperature is directly related to productivity, investments should prioritize reducing the sensitivity of productivity to temperature.
To find the mechanism responsible, the researchers began by conducting the first joint empirical analysis of temperature effects on total factor productivity (TFP) and factor inputs and output using firm-level data. Specifically, they estimated the effects of temperature on manufacturing activity using year-to-year variation in a firm’s exposure to the annual distribution of daily temperatures.
Additionally, they used a detailed dataset covering the near-universe of Chinese manufacturing plants during 1998 and 2007. They found an inverted U-shaped relationship between temperature and TFP with particularly negative effects at high temperatures. In their benchmark specification, a day with a temperature above 90°F decreases TFP by 0.56 percent, relative to a day with a temperature between 50-60°F.
“In one particularly striking result, we separately examine temperature sensitivity between low and high-tech industries in China,” Olivier Deschenes, a professor of economics at UCSB, said. High-tech industries include those that produce medical supplies, aerospace equipment and computer equipment. “We typically think of these sectors as being capital-intensive with indoor production facilities that tend to operate with air conditioning. We find that these industries are just as sensitive to extreme temperature as low-tech industries.”
Compared to a day with a temperature between 50–60°F, a day with a temperature above 90°F lowers manufacturing output by 0.45 percent, or by $8,160 in 2007 dollars for the average firm. In contrast, temperature effects on labor and capital inputs are less responsive. This implies that TFP losses in response to high temperatures is the primary channel through which temperature alters manufacturing output in our setting.
According to Meng, the results suggest that if we are to reduce the negative impact of climate change on manufacturing output, adaptation measures should not focus solely on reducing the sensitivity of workers to extreme heat but also that of factory machines.
Examining TFP allows the researchers to look at the combined effect of labor and capital productivity. High temperatures could reduce labor productivity by causing discomfort, fatigue and cognitive impairment in workers.
Additionally, high temperatures could affect machine performance and lower capital productivity. Previous studies have largely focused on labor productivity, without examining capital productivity, but results suggest that high temperatures affect both labor and capital productivity.
“More broadly, our paper introduces a new cost of climate change that hasn’t been documented before,” Meng said. “China is already doing a lot to reduce its emissions. These existing policies were put into place even without this new evidence on manufacturing sector losses. Given the importance of manufacturing for China, we hope our findings will help lead to more stringent Chinese climate policy.”