Climate change is expected to reduce agricultural productivity in developing countries. Classic international trade and geography models predict that the optimal adaptation response is a reallocation of capital and labor from agriculture towards other sectors or regions gaining comparative advantage.
In the Barcelona School of Economics Working Paper “The Effects of Climate Change on Labor and Capital Reallocation,” Christoph Albert, Paula Bustos and Jacopo Ponticelli study the experience of Brazil to provide direct evidence on how capital and labor adjust to changes in climate.
Regions with higher excess dryness experience a large reduction in agricultural production.
Table 1 below reports the results of the impact of dryness on the productivity of land (Panel A) and the results of the long-run effects of average excess dryness relative to historical averages (Panel B). The magnitude of the coefficients reflects the effect of an increase in excess dryness from the median to the 90th percentile of the distribution of ∆Dryness.
A municipality moving from the median to the 90th percentile of excess dryness experiences an 8% decline in both area farmed and value of agricultural production (Panel A).
Meanwhile, a municipality moving from the median to the 90th percentile of excess dryness relative to its historical average experienced declines in agricultural area farmed of about 15% and in total value of agricultural production of more than 20% in the last two decades.
This large output reduction suggests a limited scope for adaptation responses within the agricultural sector, like adopting new technologies or changes in crop composition.
Notes: Controls include: the share of population living in rural areas, log income per capita, literacy rate, population density, deforestation, and changes in soy and maize potential yields.
The estimated effects are highly non-linear with sharp reductions in output in the top deciles of dryness but no significant effects of excess wetness (Figure 1).
Figure 1 shows that municipalities in the top decile of the distribution of excess dryness suffer a loss of 16% in the value of agricultural production relative to those in the middle of the distribution, while municipalities in the bottom decile experience no significant change.
In the short run, local economies insure themselves against negative weather shocks via financial integration with other regions.
The authors find that regions suffering droughts experience capital inflows and an increase in credit to the agricultural sector while financially connected regions reduce credit and experience capital outflows (Figure 2; panels (a) and (b)).
This finding suggests that banks smooth temporary income shocks by reallocating capital across regions where they have branches.
However, over the long run, persistent increases in dryness generate a sharp reduction in credit to all sectors.
First, with respect to the direct effect, the authors find that a municipality experiencing an increase in dryness from the median to the 90th percentile experiences a 15% decadal decline in lending originated by local branches to all sectors of the economy (Figure 2; panel (c)). That is, they find that capital reallocates away from both local agriculture and non-agriculture.
Second, with respect to the indirect effect, the authors find negative indirect effects on lending to all sectors in municipalities that are financially integrated with areas experiencing increases in dryness (Figure 2; panel (d)).
In addition, they find that this contraction in credit leads to a large reduction in manufacturing employment. Thus, capital market frictions appear to be a key constraint for optimal factor adjustment in response to climate change.
Dryness generates a large reduction in agricultural employment
The authors find that municipalities experiencing an increase in dryness from the median to the 90th percentile over the 2001-2010 period suffer a sharp reduction in employment in both agriculture (-6.9%) and services (-4.7%), and an increase in manufacturing employment (5.3%) (Figure 3). While local manufacturing absorbs part of the displaced workers, these regions experience large out-migration.
Municipalities integrated through past migrant networks with areas suffering droughts experience a large increase in migration inflows. However, regions receiving climate migrants expand employment in agriculture and services, but not in manufacturing. In other words, there is only local reallocation towards manufacturing in regions directly hit by excess dryness.
Using social security data, the authors provide evidence that labor market frictions direct migrants to firms connected to migrants’ social networks, which are mostly disconnected from manufacturing firms at destination.
In sum, this paper’s findings suggest that abnormal dryness affects the structure of the local economy. Local labor reallocation across sectors is relatively unconstrained while spatial reallocation from agriculture to manufacturing is subject to labor market frictions. And, in the long run, affected regions experience large declines in agricultural production and significant capital outflows consistent with a permanent decrease in investment opportunities.
Overall, the evidence suggests that frictions in the interbank market and spatial labor market frictions constrain the reallocation process from agriculture to manufacturing.
