The effect of climate fluctuation on output in developing countries

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIET NAM THE NETHERLANDS VIET NAM – THE NETHERLANDS PROGRAMME FOR MASTER IN DEVELOPMENT ECONOMICS - THE EFFECT OF CLIMATE FLUCTUATION ON OUTPUT IN DEVELOPING COUNTRIES By NGO KHANH LIEN HUONG (VIETNAM) Academic supervisor Dr PHAM KHANH NAM This paper was submitted in partial fulfillment of the requirements for Master’s degree in Development Economics Ho Chi Minh City, July 2012 UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIET NAM THE NETHERLANDS VIET NAM – THE NETHERLANDS PROGRAMME FOR MASTER IN DEVELOPMENT ECONOMICS - THE EFFECT OF CLIMATE FLUCTUATION ON OUTPUT IN DEVELOPING COUNTRIES By NGO KHANH LIEN HUONG (VIETNAM) Academic supervisor Dr PHAM KHANH NAM This paper was submitted in partial fulfillment of the requirements for Master’s degree in Development Economics Ho Chi Minh City, July 2012 ACKNOWLEDGEMENTS This paper has could not be started and completed without the help of several individuals who supported me directly and indirectly First of all, I appreciate my supervisor Dr Pham Khanh Nam so much for his enthusiastic assistance He has not only given me genuine intellectual guidance in academy but also encouraged me a lot through the analysis process It is so hard for me to complete this research without his profound advice Thus, I am very grateful to him I am also thankful to Dr Nguyen Trong Hoai for sharing his knowledge and practice experiences in researching which are very useful for this study I also thank all my classmates in class MDE17 for sharing their advantage discussions on econometric techniques, especially Nguyen Thi Thuy Thanh Last but not least, I would like to thank my parents, and all my other family members for their concern and invaluable moral support ~ i~ ABSTRACT Climate change is one of the critical problems in recent years on over the world It impacts on many aspects of human life, that has a lot of researches and evident This paper has analysis the effect of climate change on the aggregate output particularly with two typical elements: temperature and precipitation in developing countries Besides, control variables proxy unobserved effects at country level and country fixed effects are also counted in the relationship of temperature and precipitation with the country’s output The finding shows that both temperature and precipitation have significant influence on the GDP of developing countries It is specially that temperature affects the GDP in U-shaped, while precipitation affects the GDP in hump-shaped Moreover, this paper also conducts the relationship of temperature and precipitation with the output by two characteristics: “hot country” and “agricultural country” The results are also significant; however, the relationship share cannot be identified Further, this research suggests some adaptive recommendations for production to changing of climate Key word: climate change, output, panel data, developing countries ~ ii~ TABLE OF CONTENTS CHAPTER 1: INTRODUCTION……………………………………………………….1 1.1 Problem statement……………………………………………………………… 1.2 Research Objective……………………………………………………………….4 1.3 Chapter summary……………………………………………………………… CHAPTER 2: LITERATURE REVIEW………………………………………………6 2.1 The theory……………………………………………………………………………6 2.2 Empirical studies……………………………………………………………… …7 2.3 Conceptual framework……………………………………………………… …17 2.4 Chapter summary…………………………………………………………… …19 CHAPTER 3: METHODOLOGY…………………………………………………….20 3.1 Econometric model………… ……………………………………………………20 3.2 Data…………………………………………………………………………… …24 3.3 Chapter summary…………………………………………………………… …27 CHAPTER 4: RESULT…………………………………………………………… …28 4.1 Descriptive statistics………………………………………………………………28 ~ iii~ 4.2 Non parametric analysis…… ………………………………………… ………30 4.3 Econometric analysis…………………………………………………… ………33 4.4 Chapter summary……………………………………………………… ……….44 CHAPTER 5: CONCLUSION………………………………………………….…… 45 5.1 Conclusion…………………………………………………………………………45 5.2 Recommendation…………………………………………………………… ……47 REFERENCES…………………………………………………………………….……49 APPENDIX………………………………………………………………………… …52 ~ iv~ List of Tables Table 3.1: Variable descriptions…………………………………………………………26 Table 4.1: Descriptions Statistic…………………………………………………………29 Table 4.2: Correlation matrix…………………………………………………………….30 Table 4.3: Temperature and Precipitation - Estimation Result…………………… ……37 Table 4.4: Estimation result with hot countries dummy………………………… …….40 Table 4.5: Estimation result with agriculture countries dummy……………………… 42 List of Figures Figure 2.1: The way climate fluctuation affects the country’s output………… …… 18 Figure 4.1: Histogram of temperature – precipitation – GDP per capita………….……28 Figure 4.2: Average temperature trend……………………………………………… …31 Figure 4.3: Average precipitation trend……………………………………………….…31 Figure 4.4: Average temperature vs Average GDP per capita………………………… 32 Figure 4.5: Average precipitation vs Average GDP per capita…………………………33 ~ v~ CHAPTER 1: INTRODUCTION 1.1 Problem statement Increasing output is one of the most important targets of most of the countries, especially developing countries The output of a country has been identified in the function of elements such as human capital, physical capital, and technology However, the changing of climate belongs to environment elements in recent years, which is considered that it has a critical effect on country’s output Further, the climate change has economically effected on human health, life and production in agricultural countries, which makes the studies more attractive and interesting Human activities have already changed the atmospheric characteristics such as rainfall, global warming, sea level rise, increasing global carbon dioxide (CO2) emissions and the thinning of ozone layer Those climate changes happening constantly as a big problem all over the world have impacted upon many aspects of human life such as natural ecosystem, biodiversity, human health, landscape, socio-economic, etc There are obvious evidences that climate change affects human life (IPCC 2007) For example, expanding water stress, increasing temperature but reducing the rainfall has caused a decline in agricultural production in Asian developing countries while demands for production are increasing more and more Climate change has affected the supply, demand, and quality of water resources For instance, Northern Pakistan has been facing water shortages because of expanding winter period over the Himalayas during last 40 years; China is facing up to the drying up of rivers and lake in the dry weather while water need is increasing Likewise, In India, Bangladesh, and Nepal, water shortage is aggravated by climate change; consequently it has leaded to rising urbanization, and using water inefficiently Contrary to the water shortage, glaciers are melting rapidly in Central Asia, which has threatened human settlement, cities, forest ecosystem, and the rising of water level caused the disasters of landslides The 1997/98 El Nĩno event in Philippines and Indonesia fired around million of peatlands, 9.7 million hectares of forest (IPCC 2007) That is the extreme climatic event caused substantial fatalities and economic losses Climate change puts over 50% biodiversity of the Asia at risk, so many species could be fragmented or extirpated such as pine forest in Korea or beech tree in Japan (IPCC 2007) Other critical sector relating to climatic influence is human health Siberia has been reported a big number of deaths associated with heatwaves, while there is a spreading disease like diarrhoeal, cholera, malaria, etc due to poor drinking water and sewerage system in flood season Malnutrition and Diarrhoeal are posed as substantial risk of human health in year 2000 at Bangladesh, India, Nepal, Maldives, and Myanmar under climate change (IPCC 2007) Specially, the effects of climate change on the countries having high temperature climate and agriculture share has been considered profoundly Those heavy effects are explained that hot climate countries are sensitive to any small change of temperature, while agricultural countries are sensitive to the changing of precipitation Development activities of human are continuously creating greenhouse gas, one of the causes of climate chance, although they also contribute to enhancing adaptation greatly and decreasing vulnerability of vulnerable sectors to the changing of climate In general, climate change affects human life through different channels such as societal (e.g migration, civilization, culture), psychological (e.g mental illness, cognition), physiological (e.g nutrition, starvation), and economic (e.g energy, manufacturing) aspect In recent years, there are a lot of researches working on influences of climate change The most interesting sector is the climate change’s economic consequences Climate change is the result of greenhouse gas emission from human activities Hence, finding out the relationship between climate change and output will help suggest the policies or adaptation strategies in socio-economic sectors to control the effects of climate change within each country Furthermore, we can adjust the changes of climate at our will toward increasing output For instance, the Kyoto Protocol’s main target is to balance greenhouse gas emission (CO2, CH4, N2O, SF6…) in our environment to prevent dangerous effects from harming the existence and improvement of the human beings This required developed countries to reduce greenhouse gas, and submit annual activity reports; meanwhile, developing countries are encouraged to joint this protocol Existing studies about the relationship between climate change and the aggregate output have been quite rare until now Most of them were conducted for the countries of OECD (Organization for Economic Cooperation and Development), which are strongly impacted by temperature because they belong to the relatively low temperature areas For some other countries, studies mainly focused on the suffering of separate sectors under climate change such as food production, fish catching, forest, or agriculture Moreover, other published researches estimate the effect of climate change on economic growth According to this study’s result I define that temperature and precipitation have a significant influence on country’s output; and it is robustness with altered specifications Although this analysis produced findings which are in line with the results of previous literatures in this field, it still has got some contradictions with them Whereas the finding about hump-shaped relationship between temperatureprecipitation with GDP per capita is definite as Nordhaus (2006), and John (2009), the measuring is not the same Perhaps, the previous papers conducted all countries on over the world include hot and cold countries, which is different from my study having just considered the developing countries which have an enormous number of tropical countries Tol 2002 mentioned that the low income countries could be reduced output easily by changing of temperature and precipitation as they depend on agriculture which is very sensitive to climate change with a huge extent Moreover, they are lack of capacities and alternatives to deal with climate problems In addition, developing countries move toward to be more agricultural and hotter Hence, to test whether developing countries representative for these two characteristics, I add two dummy variables: hot country dummy and agricultural country dummy into the regression (3) like Dell et al (2008) to answer the second question First, hot country dummy is defined as countries belong to tropical climate Summarizing the full description result is presented in table 4.4 Hot country dummy is denoted “1” for tropical countries; and “0” for others The coefficient of hot country 38 dummy, interaction between “hot dummy” and temperature, interaction between “hot dummy” and precipitation are significant at 1% and 5% in both model 4-1 and model 4-3, indicating that there is substantial variance impact of temperature – precipitation on GDP per capita between hot and cold developing countries Although the sign of coefficients changed when I expand observations by adding control variables and country fixed effects in model 4-3 which is more robustness, the negative effect of temperature and precipitation on the country’s output is confirmed The hump-shaped relationship of precipitation and GDP per capita is also approved In hot countries, the GDP per capita increases 1.011% when precipitation increases 1%; and at turning point the GDP per capita decrease 0.106% when precipitation increases 1% Further, it is apparent that the effect of precipitation on country’s GDP per capita in tropical countries is lower than other countries The regression added hot country dummy, however, did not show clear result about the hump-shaped or U-shaped relationship of temperature and GDP per capita as the coefficient of the interaction between hot country dummy and temperature square is not significant 39 Table 4.4: Estimation result with hot countries dummy Model 4-2 Model 4-1 Coeff Constant Std.Error Model 4-3 Coeff Std.Error Coeff Std.Error 7.399 0.085*** 5.188 0.228*** 5.188 0.028*** 155.299 42.734*** -20.948 48.919 -20.948 6.159*** -98.209 29.759*** 8.905 30.367 8.905 3.823** -1.260 0.481*** 1.011 0.711 1.011 0.089*** squarex Hot country 15.568 4.672*** -0.954 4.735 -0.954 0.596 0.058*** -0.106 0.087 -0.106 0.010*** Population density 0.001 0.000** 0.001 4.19*** Urban population 0.038 0.002*** 0.038 000*** 0.013 0.012 0.013 0.001*** Unemployment 0.015 0.008* 0.015 0.001*** Inflation -0.000 0.000 -0.000 4.63*** Hot country dummy Ln(Temperature)x Hot country dummy Ln(Precipitation)x Hot country dummy Ln(Temperature) dummy Ln(Precipitation) square x Hot country 0.201 dummy GDP per capita growth rate Fixed effect Yes countries Adjusted R2 0.1414 0.488 0.503 Observations 891 299 299 Dependent variable: ln(GDPPC); *** is significant at 1%; ** is significant at 5% 40 Second, testing that agricultural economy suffers climate shock more than other economy as Dell et al (2008) is also applied in this paper Agricultural dummy is defined as countries which agricultural value added country’s GDP is above mean agriculture GDP share in 2000 (Source: http://data.worldbank.org/indicator/NV.AGR.TOTL.ZS) Agricultural dummy is denoted “1” for countries have agricultural share is equal or bigger mean agriculture GDP share; and “0” for others The reason I used agricultural share data in 2000 because data from previous years is scattered Summarizing the full description result is presented in table 4.5 Once again, the coefficient of agricultural dummy is significant at 1% in both model 5-1 and model 5-3, indicating that there is stable heterogeneity of temperature – precipitation on GDP per capita between agricultural developing countries and others The finding pointed out that the higher temperature in agricultural countries, the lower GDP per capita when the interaction between “agricultural” and temperature is significant at 1% However, the shape of the relationship between temperature and precipitation on GDP per capita cannot be satisfied in this case 41 Table 4.5: Estimation result with agriculture countries dummy Model 5-2 Model 5-1 Coeff Coeff Std.Error Coeff Std.Error 0.044*** 6.372 0.192*** 6.372 0.242*** 5.645 1.725*** -3.145 4.246 -3.145 0.534*** -3.323 1.246*** 1.092 2.901 1.092 0.365*** -1.581 0.540*** -0.102 1.343 -0.102 0.169 0.643 0.250** -0.137 0.575 -0.137 0.072* 0.193 0.066*** 0.007 0.167 0.007 0.169 Population density 0.001 0000*** 0.001 3.71*** Urban population 0.023 0.002*** 0.023 000*** 0.002 0.010 0.002 0.001 Unemployment 0.011 0.007 0.011 0.000*** Inflation -0.000 0.000 -0.000 3.86*** Constant Agricultural dummy Ln(Temperature)x agricultural dummy Ln(Precipitation)x agricultural dummy Ln(Temperature) square x agricultural dummy Ln(Precipitation) square x agricultural dummy 7.400 Std.Error Model 5-3 GDP per capita growth rate Fixed effect countries Yes Adjusted R2 0.394 0.643 0.654 Observations 891 299 299 Dependent variable: ln(GDPPC); *** is significant at 1%; ** is significant at 5%; * is significant at 10% 42 The overall findings are not the same with Dell et al (2008), which has no evidence with hot country dummy and agricultural dummy for all countries on over the world as it could be different data collection between the whole world and developing countries Another possibility may be that the adaption theory mentioned in Dell et al (2008) According to this theory, in the long run, regions might change to adapt to climate change, for example, switching or diversifying appropriate crops, applying technologies, moving far from tough environment While Dell et al (2008) conducts the effect of climate change from the last half century, my study just considers developing countries in short time by 17 years from 1990 to 2006 Thus, the adaptation might not appear in my result Generally, the damage of climate fluctuation with temperature and precipitation on the output of developing country is proved Although it is impossible to make conclusion about the hum-shaped relationship of rising temperature and precipitation with the country’s output, until now my consequences about the relationship between temperature – precipitation and output is negative It is also similar results to literature Besides, it is impossible to think that the country’s output could be increased or decreased by decreasing or increasing temperature and precipitation because there are uncertainties of time frame, poor information, etc Nevertheless, the damages of climate shock are irreversibility; thus policies or strategies to reduce the damage of climate shock on the economy could not be postponed 43 4.4 Chapter summary This chapter has described statistic and examined the relationship between temperature, precipitation and the country’s GDP Description statistic shows the trend of temperature tends to increase; but the trend of precipitation tend to decrease It also pointed out clearly that there is negative relationship between rising temperature and GDP The regression result has indicated that both temperature and precipitation have significant effect on the aggregate GDP of developing countries However, temperature affects the GDP in U-shaped, while precipitation affects the GDP in opposite dimension Likewise, this paper also conducts the relationship between temperature, precipitation and the output by two characteristics: “hot country” and “agricultural country” The results are also negative significantly; but the relationship shape cannot be identified 44 CHAPTER 5: CONCLUSION 5.1 Conclusion The effect of climate change on many sectors of human life has expanded on over the world in recent years The consequences of the climate change on separate aspects as agriculture, water resources, energy, urbanization, health, etc are also different Externalities included such as temperature, precipitation, sea level rising, etc of the climate change have severe influences on the activities belong to the economy specially the aggregate output, which has attracted more and more researches The target of this research is generally conducting the short-run economic impact of climate fluctuation on country’s aggregate GDP in some individual national aspects Furthermore, I also conduct the effect of climate fluctuation on countries with two special characteristics: “hot” and “more agriculture” This paper is the first to analysis the effect of climate change on the aggregate output of developing countries by observed data from 1990 to 2006 To investigate the impact of temperature and precipitation on GDP per capita, I conduct the panel analysis with applying approach from top to bottom I did analysis at national level through three models The first model was used to test how temperature and precipitation affect on GDP The second model was added control variables such as inflation, GDP per capita growth, population density, urban population, and unemployment which are representative for unobserved factors impact GDP The last 45 model is the full model to examine how temperature and precipitation affect the aggregate GDP with both control variables and country fixed effects The finding shows that both temperature and precipitation have non-linear effect on the developing country’s output It is significant that decreasing temperature at 1% will lead to increase 2.629% GDP per capita until turning point then GDP per capita will decrease 0.644% if temperature continues to decrease 1% Nevertheless, it is completely different from the effect of precipitation on GDP per capita When precipitation rises 1%, the GDP per capita will also rise 1.872%; but at turning point rising precipitation at 1% makes GDP per capita decreases 0.222% As developing countries move toward to be more agricultural and hotter, the second question was answered by adding two dummy variables: hot country dummy and agricultural country dummy into the regression In hot countries, the GDP per capita increases 1.011% when precipitation increases 1%; and at turning point the GDP per capita decrease 0.106% when precipitation increases 1% However, the hump-shape of the relationship between temperature and precipitation on GDP per capita cannot be satisfied in both cases The limitations of this paper are also further issues First, the assumption that same slope between countries is not reality For example: Indonesia is a group of islands, so will suffer more from precipitation Further, I disregard catastrophes and natural disasters in specific years which have influence temperature, precipitation, control variables Fourth, the observed data is not update and restricted 46 5.2 Recommendation The effect of climate change on human life, in particular the output of developing countries is obviously However, it is more important to get adaptation and mitigation policies to narrow down negative profound influences of climate change on production The Kyoto protocol which requests carbon quota or emissions permits is one of typical examples There are other proposed recommendations to reduce the developing country’s vulnerability under climate change such as development education, increasing technology or technical skills, promotion distribution of public food, management disaster preparedness and health care system, etc In this part of the paper, I just recommend some adaptation strategies in agriculture which relate to rising output under climate change mainly and directly Agriculture has taken a critical role in the economy of developing countries as it is the most capacity sector of them Thus, rising adaptive capacity of agriculture to climate change means increase the country’s income The strategy should be intended to invest more into infrastructure and technology; thus step by step modify crop shock and farming practices The infrastructure must be accounted for are equipment, irrigation and production system to mitigate changing of temperature and precipitation in different seasons as dry or wet season Moreover, it is necessary to diversify crop to narrow productivity losses in uncertainty changing of climate Although taking a long time and a lot of cost, improving education, information, and awareness of local people about weak water-use planning, and inefficient land using, improving pest disease management, 47 benefits of crop yield change, etc need to be paid attention (Nicholls and Tol, 2006; Tan and Shibasaki, 2003) Expressing that awareness through communication programmes, government institutions, and policies for local people to understand vulnerabilities or how to cope with climate change is very important It is also effective way to enhance people’s adaptive capacity 48 REFERENCES Aslanidis, N.2009 Environmental Kuznets Curves for carbon emission: A critical survey FEEM Working Paper 336 Conrad J Choiniere and John K.Horowitz 2006 Aproduction function approach to the GDP-Temperature Relationship SSRN Working papers series Dijkgraaf, E and H.R.J Vollebergh 2005 A test for parameter heterogeneity in CO2 panel EKC estimations Environmental and Resource Economics 32, 229-239 Intergovernmental Panel of Climate Change 2007 Climate change 2007: Working Group II: Impacts, Adaption and Vulnerability John K.Horowitz 2009 The Income-Temperature Relationship in a Cross-Section of Countries and its Implications for Predicting the Effects of Global Warming Environ Resource Econ 44:475-493 Maddison, D J 2003 The Amenity Value of the Climate: The Household Production Function Approach Resource and Energy Economics 25(2): 155–75 Mankiw NG, Romer D, Weil D 1992 A contribution to the empirics of economic growth Q J Econ 107:407-437 Melissa Dell, Benjamin F Jones, and Benjamin A.Olken 2008 Climate change and economic growth: evidence from the last half century Nber working paper series 14132 Mendelsohn 2000 Comparing impacts across climate models ISSN: 1389-5176 49 Nicholls, R.J and R.S.J Tol, 2006: Impacts and response to sea-level rise: a global analysis of the SRES scenarios over the 21st Century Philos.T.R.Soc.A., 364, 1073-1095 Nordhaus, William D 1994a Managing the Global Commons: The Economics of Climate Change.Cambridge, MA: MIT Press Nordhaus, William D 1994b Expert Opinionon Climate Change American Scientist, 82(1):45–51 Nordhaus, William D 2006 Geography and Macroeconomics: New Data and New Findings Proceedings of the National Academy of Science,103(10): 3510–17 Rehdanz, K., and D.J Maddison 2005 Climate and Happiness Ecological Economics, 52 Pp 111-125 ISSN 0921-8009 Samuel Fankhauser, and Richard S.J.Tol 2004 On climat change and economic growth Resource and Energy Economics 27 (2005) 1-17 Tan, G and R.Shibasaki, 2003: Global estimation of crop productivity and the impacts of global warming by GIS and EPIC integration Ecol Model., 168, 357-370 Tol, R.S.J 2002a Estimates of the Damage Costs of Climate Change-Part 1: Benchmark Estimates Environmental and Resource Economics 21(1): 47–73 Tol, R.S.J 2002b Estimates of the Damage Costs of Climate Change-Part II: Dynamic Estimates Environmental and Resource Economics 21(2): 135–60 Tol, R.S.J 2009 The economic effects of Climate change Journal of Economic Perpectives 23 (2): 29-51 50 Thomas, J.M., and S.J Callan 2007, Environmental Economics Applications, Policy, and Theory, Thomson South-Western William A.Masters and Margaret S.McMillan 2001 Climate and Scale in Economic growth Journal of Economic Growth Volume 6, Number (2001) 167-186, DOI: 10.1023/A:1011398431524 51 APPENDIX List of developing countries Afghanistan Equatorial Guinea Mauritius Togo Angola Eritrea Mexico Trinidad and Tobago Argentina Ethiopia Morocco Uganda Armenia Gabon Mozambique Vietnam Bangladesh Gambia Nepal Yemen Belize Ghana Nicaragua Zambia Cambodia Guinea Nigeria Cameroon Guyana Pakistan Cape Verde Indonesia Sao Tome and Principe Chad Jamaica Senegal Chile Kenya Sierra Leone China Lebanon South Africa Colombia Liberia St Vincent and the Grenadines Comoros Malawi Suriname Dominica Mali Tanzania Dominican Republic Mauritania The Bahamas 52 ... especially in the aspect of the output The aim of this paper is conducting the research on the impact of climate fluctuation on the aggregate output of the developing countries, then answering two... certainly offensive in the condition of climate variables The cross-sectional data of 60 countries is used to examine the climate role in determining consumption then calculate price for a climate. .. INTRODUCTION 1.1 Problem statement Increasing output is one of the most important targets of most of the countries, especially developing countries The output of a country has been identified in the