The (Mis)Allocation Channel of Climate Change: Evidence from Global Firm-level Microdata

An extensive literature has documented the negative effect of global warming on TFP, but we know little about the micro origins of this relationship. This paper examines a novel channel: the impact of temperature extremes on capital misallocation. Using global firmlevel microdata from 32 countries, we provide causal evidence that a day with extreme heat (>30°C) increases the dispersion of marginal revenue products of capital (MRPK) by 0.31 log points, implying a 0.11% annual aggregate TFP loss for an average region-sector. Notably, this effect is more pronounced in hotter and more economically developed regions. Our estimates, taking future adaptation and development into account, suggest a global aggregate TFP loss of 35.4% from the misallocation channel at the end of the century under the SSP3-4.5 scenario. In light of these findings, we develop a firm dynamics model with varying sensitivity to temperature across firms to examine the mechanisms behind temperature-induced misallocation. The model reveals that greater temperature forecasting errors and increased productivity volatility from extreme climates both exacerbate the dispersion in MRPK. Our results uncover the critical role of the misallocation channel and the necessity of considering firm heterogeneity in climate policies. In addition to mitigation policies, we also highlight improving mid-range weather forecast accuracy as a key adaptation policy to improve investment efficiency.