Climate Change Impacts on Economic Growth

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Abstract

This paper develops a theoretical model of endogenous growth where both human and physical capitals depreciate due to environmental pollution by extending the framework of Bretschger and Valente (2011). The model allows for adaptation to environmental effects triggered by climate variation. We characterize the socially optimal path of an economy in which pollution is generated by physical capital accumulation, which affects the depreciation rate of both the types of capital. The harmful effects of pollution might be severe for countries vulnerable to climate change. Solving for the social planner’s equilibria, we find that along the optimal path, economic growth is lower when the efficiency loss in physical and human capital stock due to climate change is higher; when the pollution intensity of physical capital is higher, the vulnerability of a country to climate change is higher or the adaptation efficiency of the country to climate change is lower. These results are tested empirically for a balanced panel of sixty-two countries, including both developing and developed countries for a time spanning 1995–2016. We capture the vulnerability of human capital and physical capital of a country to climate change through environmental health index (EHI) and CO2 intensity respectively. The empirical results based on the system-GMM method shows that increase in environmental health index (EHI) has a positive impact, whereas increase in CO2 intensity has a negative impact on the GDP growth rate of the country, as well as the different sectors of the economy. Moreover, special efforts should be made to improve human health; efforts to reduce pollution could possibly be viewed as an investment in human capital, and this directly affects the output growth rate. This linkage between environmental pollution and human capital investment matters because if environmental pollution reduces human capital investments, economic growth will also reduce.