The Adaptive Investment Effect: Evidence from Chinese Provinces

A paper of mine, “The Adaptive Investment Effect: Evidence from Chinese Provinces“, co-authored with Dr Kamiar Mohaddes, has recently been published in Economic Letters.

In the paper, we outline that the Adaptive Investment Effect (AIE) is the diversion of investment resources from productive to adaptive capital in response to the effects of climate change. We would expect this diversion to reduce the productivity of investment on economic growth.

For instance, we can imagine that climate change might increase temperatures in some areas. It is well known that higher temperatures reduce labour productivity and so to ameliorate this loss in productivity, firms might invest in air-conditioning units in offices. This wouldn’t have been necessary in the absence of climate change. The funds used to finance this air-conditioning (adaptive capital) could instead have been used for other purposes (investment in productive capital) such as building new factories or investing in more machinery.

We then set out to test whether the AIE actually has an effect in the real world, using data from Chinese provinces. Essentially, we split the provinces into those which have seen the largest increase in temperature with those that see a lesser increase. Within each category we further split the provinces into those which have invested in adaptive capital (proxied by air-conditioning) and those which haven’t. Therefore, we have 4 groups: hotter provinces which have adapted, hotter provinces which haven’t adapted, colder provinces which have adapted, and colder provinces which haven’t adapted. With the hot and cold sub-groups, we then compare whether the economic impact of investment is lower for provinces in the adapt group, relative to provinces in the don’t adapt group. We find that this is the case.

Moreover, we find that provinces which adapt, are better able to withstand the effects of rising temperature, suggesting that adapting is indeed successful in mitigating against climate change.

Overall, our findings lend evidence to the Adaptive Investment Effect, whereby provinces which adapt have a lower impact of investment by around 27-37%. This suggests that there are large benefits to mitigation policies designed to reduce global warming and thereby reduce the costs associated with the AIE.

We recommend that policymakers invest further in such mitigation policies and encourage them to take steps to reduce carbon emissions and other global warming gases.

The paper is available here (working paper here).

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