Temperature shocks and firm productivity
This ECB working paper by Andrea Caggese, Andrea Chiavari, Sampreet Goraya, and Carolina Villegas-Sanchez presents a comprehensive analysis of how temperature affects firm productivity and derives implications for aggregate economic damage from climate change. The authors develop a micro-to-macro framework using a general equilibrium model with heterogeneous firms to link firm-level climate impacts to aggregate productivity effects. Their approach employs:
- Theoretical framework: A monopolistically competitive model where firms produce with capital, labor, and materials, with temperature affecting both demand and productivity directly, plus indirect effects through input adjustment frictions.
- Empirical strategy: The study merges Italian firm-level data from Orbis (1999-2013) covering approximately 75% of Italy’s aggregate gross output with high-resolution daily climate data from Copernicus at 11×11 km grid resolution. Temperature effects are estimated using temperature bins methodology, with firms matched to climate data via postal codes.
Importantly, the framework distinguishes between direct effects (temperature impacts on productivity/demand) and indirect effects (arising when firms cannot efficiently adjust inputs due to friction).
Findings
- Firm-level effects: Temperature exhibits an inverted U-shaped relationship with firm outcomes. Extreme heat significantly reduces productivity – one additional day above 40°C decreases sales by 0.807% and revenue-based marginal product of capital (MRPK) by 0.578%. Cold extremes also have negative effects, with days below 0°C reducing sales by 0.094%.
- Input adjustment patterns: Materials and labor adjust relatively flexibly to temperature shocks, while capital adjustment is severely constrained. This creates the key indirect effect – when productivity falls but firms cannot reduce capital proportionally, MRPK declines due to excess capital, amplifying aggregate losses.
- Aggregate productivity damages: Under a 2°C warming scenario, aggregate productivity declines by 1.68%, with direct effects contributing 0.81% and indirect effects 0.87%. The relationship is highly non-linear – a 4°C increase causes 6.81% productivity loss, more than four times the 2°C impact.
- Comparison with existing approaches: The micro-founded approach reveals damages approximately four times larger than representative firm models that average firm-level losses without capturing allocative efficiency effects. This suggests traditional Integrated Assessment Models significantly underestimate climate damages.
- Regional heterogeneity: Effects vary substantially across Italian regions, with southern provinces facing larger losses due to greater exposure to extreme temperatures. This pattern suggests climate change will exacerbate regional inequalities.
- Adaptation effects: Analysis of historically adapted areas versus newly exposed regions indicates climate-resilient technologies can reduce damages by 20-30%.
Climate Change, Firms, and Aggregate Productivity
Authors: Andrea Caggese, Andrea Chiavari, Sampreet Goraya, Carolina Villegas-Sanchez
From: Universitat Pompeu Fabra, University of Oxford, Stockholm School of Economics, ESADE Business School
Heterogeneous climate impacts on European firms
The paper by Romano Tarsia employs a firm-level panel data analysis spanning 1995–2020 for European firms sourced from the Orbis Historical database, matched to high-resolution weather data (hourly temperature and monthly precipitation) from the ERA5-Land reanalysis product.
Economic outcomes—real gross output, value added, capital stock, employment, and total factor productivity (TFP, estimated via the Wooldridge 2009 method)—are transformed into yearly growth rates. Control variables include industry‐year and firm fixed effects, and financial variables are deflated to address price-level differences and outliers. Identification relies on exogenous variation in yearly average temperature shocks, modelled using a second‐order polynomial in contemporaneous and two lagged temperatures (and precipitation) to capture nonlinear and persistent effects.
Findings
- Inverted-U-shaped aggregate response
Pooled estimates for all European firms reveal an inverted-U relationship between temperature and economic outcomes but with statistically insignificant average marginal effects, suggesting aggregate insulation from temperature shocks. - Heterogeneity by productivity
– Low-productivity firms experience significant negative impacts from rising temperatures, especially in warmer regions, with growth rate declines of up to 12.8 percentage points for yearly TFP.
– High-productivity firms show positive or insignificant effects, benefiting from resource reallocation following low-productivity firm exits.
– Accounting for TFP heterogeneity significantly narrows confidence intervals, reducing uncertainty in climate damage estimates. - Firm exit dynamics
A Cox proportional hazards model indicates elevated exit hazards for firms exposed to higher temperatures two years prior (lag 2), especially among the least-productive firms in warm areas. Their 20-year survival probability falls to ~0.8, compared with >0.95 for other categories, explaining positive spillovers to surviving high-productivity firms. - Limited role of firm size
Size heterogeneity is only pronounced for small firms in warmer areas, which face negative growth effects; medium and large firms show no significant temperature sensitivity once productivity is controlled for. - Industry-level variation
– The wholesale, retail, transport, accommodation, food, and information sectors exhibit significant negative lagged effects in warm areas, reflecting both supply-side disruptions and demand reductions.
– Unexpectedly, agriculture, forestry, fishing, and construction sectors in warm regions show positive marginal effects, likely due to pre-existing adaptation investments and extended growing seasons in milder winters. - Policy implications
– The pronounced productivity heterogeneity underscores the need for targeted adaptation policies, such as support for low-productivity firms in warm regions and tailoring tax instruments to redistribute gains from temperature-resilient firms.
– Productivity-boosting policies yield dual benefits by both raising output and enhancing resilience to weather shocks.
Heterogeneous effects of weather shocks on firm economic performance
Author: Romano Tarsia
From: LSE
