How do extreme heat waves affect the economy’s overall productivity? New research published by the European Central Bank (“Climate change, firms and aggregate productivity“) suggests that for every 2°C increase in average annual temperature, overall productivity is expected to decline by 1.68%. The impact is even more pronounced for a 4°C increase in temperature, with productivity losses increasing to around 6.8%.
The findings of the new research are much more pessimistic than those of previous studies, which only considered the direct effects of climate change on productivity at the firm level, without taking into account economic factors such as distortions in the allocation of resources.
The second worrying conclusion, the analysts point out, is that climate change could exacerbate existing regional inequalities, widening the North-South economic gap. This dimension is particularly critical for the Greek economy, which already lags significantly behind the EU average in productivity.
What solutions are proposed?
But it is not all black. The economic cost of extreme climate events can be mitigated if appropriate policies are implemented, depending on the needs of each region. Particular emphasis should be given to investments in climate change adaptation technologies: means of protection against natural disasters, efficient use of resources (energy, water), resilience of infrastructure, etc. According to researchers, the adoption of adaptation technologies can mitigate the economic damage from extreme climate events by 20% to 30%.
For Greece, this would mean that it must become independent of the “monoculture” of tourism and real estate, and emphasize productive investments: in industry, innovation, the knowledge economy, but also in the long-suffering primary sector, instead of illegally distributing subsidies to “cronies” of the ruling parties, as was done with the OPEKEPE scandal.
Direct and indirect consequences on productivity
One of the effects of climate change is the increase in global temperatures due to the increase in carbon dioxide emissions. This trend imposes direct productivity losses on businesses, as extreme heat reduces employee efficiency and negatively affects the performance of machinery.
Although the direct effects are significant, there are indirect effects that are equally serious, but often overlooked, the research highlights.
Indirect impacts stem from the limited ability of businesses to effectively adapt their inputs (raw materials, energy, machinery, labor) to climate shocks.
Productivity reduction of up to 10%
An example given by the ECB’s economists is as follows: Suppose we have a heat wave that affects half of a country, causing its businesses to remain out of operation for 20% of the time, resulting in a 20% reduction in output.
In a frictionless economy, where businesses have no input adjustment costs and can operate with constant returns to scale, total productivity would remain the same, as inputs and outputs would shrink by the same amount.
However, if unaffected businesses can increase their output while affected businesses cannot adjust their input use, the economy experiences a misallocation of resources.
The result is a reduction in overall productivity due to an indirect effect, that is, inputs are allocated inefficiently among firms.
In the above scenario, this reduction would be about 10%.
The above example highlights how firm-level frictions can magnify the overall economic consequences of climate shocks. This is also important for integrated assessment models, which often remove microeconomic details, potentially underestimating the true economic costs of climate change, analysts note.
The Italian example
The authors of the study examined the direct and indirect effects of extreme temperatures on business productivity across Italy, based on high-resolution meteorological data from the European Copernicus program. The choice of the country is not accidental: “Italy’s diverse climatic and economic geography – stretching from the industrial centers of the Alps in the north to the warmer, less industrialized regions in the south – constitutes an ideal natural laboratory for studying the economic consequences of temperature change,” they note.
What is the impact of temperature on business performance?
Periods of very high temperatures reduce sales by about 0.8%, with each additional day above 40°C equivalent to almost two days of lost sales. In response, businesses significantly reduce their workforce and raw materials, but do not adjust their capital use.
For example, a factory is found to significantly reduce its production activity during periods of extreme heat. To cope with this reduction in production, it shortens employee shifts and temporarily limits purchases of raw materials.
However, its machinery, cooling systems, and physical infrastructure remain unchanged. Adapting or moving these capital assets is expensive, and as a result, they remain underutilized. As a result, the factory’s capital is not utilized efficiently, and its return on investment – its marginal productivity – decreases.
