“Temperature Effects on Productivity and Factor Reallocation: Evidence from a half million Chinese manufacturing plants”

Peng Zhang, The Hong Kong Polytechnic University

Junjie Zhang, Duke University

Olivier Deschenes, UCSB, IZA, and NBER

Kyle Meng, UCSB and NBER

Understanding the relationship between temperature and economic growth is critical to the design of optimal climate policies. A growing body of literature has estimated a negative relationship between these factors using aggregated data. However, the micro-mechanism remains understudied; thus, its usefulness in shaping adaptation policies is limited. This paper uses detailed firm-level production data derived from nearly two million observations of the Chinese manufacturing sector over 1998-2007 and documents the relationship between daily temperature and four components in a standard Cobb-Douglas production function: output, total factor productivity (TFP), labor, and capital inputs. We detect an inverted U-shaped relationship between daily temperature and TFP, and the reduction in TFP in response to high temperatures is the primary driver behind output losses. A medium-run climate prediction indicates that climate change will reduce TFP annually in China by 4%, and result in output losses of 6%. These annual losses corresponds to CNY 208 billion (USD 33 billion) in 2013 values. Given that TFP is invariant to the intensity of use of labor and capital inputs, the Chinese manufacturing industry is unlikely to avoid climate damages simply by reallocating factors across sectors.