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A Climate Theory of Economic Development

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A Climate Theory of Economic Development

By Noel Brodsky

Department of Economics

Eastern Illinois University

Charleston, IL 61920

Abstract: It is well known that few countries in the tropics are developed. It
is also true that few countries in the temperate zones are undeveloped. The
relationship between climate and economic development is explored, and a
streamlined development model is suggested. Early development is typically
in the labor-intensive industries, most prominently textiles, which has large
corresponding demand in the temperate zones, and lacks such demand in the
tropics. The next stage of development is often led by petrochemicals, and
again the temperate zones have a large demand through its need for heat,
whereas the tropics do not. A dataset is constructed to test this, using the
GHCN-D temperature data and per capita GDP; the results are consistent with
the idea that temperature standard deviation and temperature minimum
average are indicators of economic development.

1. The Theory

Paradise can be Hell. If you happen to live between the Tropic of Cancer and the
Tropic of Capricorn you live in, for the most part, what most people call paradise. This is
particularly true if you live on an island far from a continental land mass. The land is
verdant, and the climate features warm and consistent temperatures throughout the year.
You might be subject to the occasional hurricane, tsunami or other natural disaster, but
nature is typically kind to you. You also live in the poorest region of the planet, with
unchecked diseases, poor nutrition, and low levels of education, low levels of output and
income and lower life expectancies. You live in economic Hell.

But go just a few degrees north of 23 degrees 26 minutes N or just a few degrees
south of 23°26’ S, and things change. The climate features seasons, with stronger effects
the further you are away from the tropics. There are cold, snowy winters and hot
summers, with a few months in between that are moderate. The land is green some of the
time and barren others. Rainfall can be sporadic and untrustworthy. Weather can be
violent as well. And yet if you happen to live in such a place, there’s a good chance that you

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live in one of the wealthiest places on the planet. You have high incomes and output, good
health care and nutrition, high levels of education and high life expectancy. You live in
economic paradise.

One of the fundamental facts of economic development over the past 250 years, that
is the modern experience of development, is that it is almost entirely confined to the
temperate zones of the planet. Why would the development process occur in such a way?
There are two salient differences between the temperate and the tropical zones: the
average temperature is lower and the temperature variance is greater in the temperate
zone over the year.

It is the proposition here that what counts is not just the first moment of
temperature distribution (the mean) but its second moment (the variance) as well.
Seasons matter, and the strength of those seasons count too. When there is a large
variation in temperature people deal with it by developing industries that address basic
issues of life; how do I stay warm on cold days? How do I stay cool on warm days? They
initially deal with this by using the most available resources they have, mostly land and
labor. Under reasonable conditions, they will develop capital, once this has happened,
there is a pretty good chance they will become a developed country.

The idea that climate might be related to development goes back at least as far as
1750 with Montesquieu (1750: p.427) “The empire of the climate is the first the most
powerful of all empires.” Lee (1957) noted the relationship in a geographic setting. Gallup,
Sachs and Mellinger (1999) go further and suggest that tropical diseases play a role in
diminishing development. They also point to other aspects of geography, like access to
ports, as a positive component.

We are going to ignore the physical characteristics of a country and concentrate the
focus on climate exclusively. Why would climate matter to such a high degree? Climate
sets the conditions for specific market demand which allows supply to flourish. How does
this happen? In order to answer that question we need to retool our language. We need
to distinguish between “needs” and “wants.”

Economists have been uncomfortable differentiating between needs and wants,

preferring to take it that they are essentially the same. For our purposes, it would be
better to define needs as those things that are essential for life; they have a large and
consistent demand over entire societies as well as time. These are staples, with low income
elasticities, but with a large physical demand. Wants can come and go, may exist for social
groups, and replaced by evolving technology or trends. Fresh water is a need. Barbie
dolls are a want.

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When a society exists in the temperate zone, it must adapt to four distinct seasons.
It some places, like North America, these seasonal variations are quite wide, and require a
larger clothing wardrobe and sleeping materials than say Sub-Saharan Africa. The need
for a large and vibrant textile industry is clear in North America, whereas such an industry
would have limited demand in African tropics. Temperate zone’s residents also need more
energy per capita than do those in the tropics; staying warm during cold periods is a need.
This leads us to infer that temperate zones have a well-defined demand for energy, in its
simplest form as heat. These are at least two industries that separate the temperate from
the tropical zones.

To tell this story in a simple but clear way, we redefine the stages of development.
Rostow (1960) suggested five stages marked by a variety of factors involving capital
formation and relatively free markets. His arguments were both economic and socio-
political. But the pattern doesn’t fit all countries, and defies econometric support. In a very
different research stream, Kuznets (1971) and Chenery (1999) used econometric data to
define what development looks like in numbers. There is indeed a pattern to development,
and the truth may lie somewhere between Rostow and Kuznets/Chenery.

Consider the following production function:

Y = f (N,L,K,H)

Where Y = output

N= Land (or Natural resource) input

L = Labor input

K = Physical capital input

H = Human capital input

The production function may take on the Cobb-Douglas form: 𝑌 = 𝑎𝑁 𝛼 𝐿𝛽 𝐾 𝛿 𝐻 𝜔

The layout and order is intentional, as this reflects the general pattern that we see in
development. Stage zero, the initial stage, is when output is dominated by Natural
resources. This would typically be called an underdeveloped country, with output in
agriculture and/or resource extraction. This tends to make the economic system stagnant,
as resources tend to be handed down through heredity. It also tends to make income and
wealth concentrated, with resource ownership being the primary determinant of economic
status. The “curse of natural resources” also fits this story, as a country could fall back into
this stage, or not be able to get out of it. The stage is very much like Rostow’s traditional
society.

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Stage one would be output dominated by labor as an input. The country is still
underdeveloped, but it would be clear that significant changes in output, income, income
distribution, profiles of production and consumption are present. Output would be mostly
in the light industrials; textiles, woodworking and other labor intensive goods. A large
unskilled population would need be present to provide the necessary input, but there
would also have to be a large correspondent demand for the output occurring at the same
time. Temperate climate provides support for this demand in textiles (and tropical zone
climates do not).1 The large scale use of labor also provides a widening of the income
distribution. As labor acquires skills and increases in labor productivity create higher
incomes, this leads to the creation of a middle class. This could be thought of loosely as
Rostow’s precondtions and takeoff stages.

Stage 2 would be output dominated by physical capital as an input. We would

recognize the country as attaining the status of developed, though perhaps not fully
developed by today’s standards. The use of physical capital would alter the economic
structure again, this time with rising incomes for a large number of people as capital acts as
a complement to labor, raising labor productivity sharply and thus real wages. This stage
would have output mostly in the heavy industrials, chemicals, steel, automotive and
appliance industries. Note that energy plays a significant role in this stage, and temperate
zones again have an advantage as such an industry would already be in the nascent stage as
a country entered stage 2. Increasing levels of technology are present as problems can be
solved with new ideas. Both education and entrepreneurship emerge major drivers of
economic expansion to develop new markets. Industries emerge to deal with climate
issues (like air conditioning) or physical geography (like railways, aircraft).

Our last stage, at least for now, stage 3, is where output is dominated by human
capital as an input. This transformation requires a country to be in a fully developed
structure as education is required to create the human capital input. Output tends to be
dominated by intangibles, and diminished in the light and heavy industrials, as a highly
skilled labor force is not well suited for labor intensive jobs. This stage has its output
mostly in goods and services like financial services, technology, software, movies, and
games. There may be more stages beyond this, but there is little information to guide us in
deciding how to define it.

This approach suggests that supply requires balancing demand. For there to be a
dynamic textile industry, so too, there must be a corresponding demand for the textiles
produced. Temperature variation provides the demand side of the market for textiles. This
is also true about energy markets at least in their early stages two centuries ago. The idea

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Textiles are particularly important in the early development process in developed country’s histories. Mantoux
(1928) provides a detailed account of textiles in Great Britain in its earliest stages.

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that physical geography plays a role in what industries develop is also part of this idea. It
doesn’t seem likely that a geographically small country will develop airplane technologies,
but large ones do have a balancing demand. So Switzerland, Honduras and Singapore have
no aeronautics industry; the USA, Russia, and the UK (which had parts of its empire
scattered across the globe) will. It is not to say that demand creates supply, but rather that
both must exist simultaneously or else no market will exist. This idea is related to
Rosenstein-Rodan (1961) and the idea of the “big push.”

Hidden in this idea is that one of the hallmarks of early development is the altering
of the distribution of income and wealth. Highly concentrated incomes and wealth that are
typical of natural resource based economies imply a profile of production and consumption
that satisfy the existing structure. When labor intensive production begins to take over,
incomes are spread in a less concentrated way, and this changes production and
consumption structures. This implies that highly concentrated incomes and wealth are a
detriment to development. However, historical evidence suggests that when income
and/or wealth distributions are sharply altered by political processes, the results are also
detrimental to development.

Simpler technologies tend to dominate early in the development process. While this
seems to a simple matter of historical fact it goes beyond that. Technologies that utilize the
factors that are in relative abundance at the time are also typically going to be the cheapest.
Because cost drives price, and incomes tend to be low during early development, the lowest
cost producers tend to be the most successful. As development continues, more complex
(and often more expensive) technologies can survive as incomes grow. Consider the use of
ice during the 1800s in the United States. Steven Johnson (2014) suggests that the
technology to make ice appears in the south during the civil war, but the use of ice from
storage in the north remained dominant until after the war.

Acemoglu, Johnson and Robinson (2002) describe a “reversal of fortune” where

countries in the tropics were generally wealthier than those in the temperate before 1500.
They note climate and geography as one possible explanation, but reject it in favor of
institutions. The idea of climate having an impact on “work effort and productivity” is
short of what climate does to a country’s economy. Demand matters too, and when Europe
experienced a dramatic increase in population in the years leading up to the first industrial
revolution, her climate would have provided the demand for textiles. Increases in
population in the tropics, part of the evidence of increasing resources, could not be
sustained without corresponding increases in demand. An increase in labor resources is
best applied to labor intensive industries (like textiles); in Europe this market is large, in
the tropics it is not. As a result the reversal of fortune need not depend on institutions as
much as climate for the demand side of the economy.

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2. The Data

There are three data sets in use for the econometric analysis. The first is familiar to
economists, GDP per capita from the World Bank. To supplement World Bank data,
Maddison (2001) is used to obtain per capita income for 1950. The third is less familiar;
the GHCND (Global Historical Climatology Network Daily) data set from NOAA. This is
daily climate data from every reporting station in the world, which is currently 75,000
stations in 180 countries. Each observation gives the station identification, date and
includes information on temperature maximums and minimums, as well precipitation,
snowfall and snow depth. There are also flags for data quality. The data for this analysis
uses only the temperature minimums, and calculates the mean and variance (to get
standard deviation) for one data station in each country for the decade years and year
2014. The minimum temperatures reflect the argument that temperature variation, and in
particular significant cold periods, generate demand for textiles and rudimentary energy
markets (for heat). As a result, we use only the minimums for our analysis. We should
expect any tropical zone country, or any country that is a small island, to have smaller
temperature variance than countries in the temperate zone. It is also well documented that
mean temperature tends to be lower in temperate zones than the tropics.

The selection process was to get each country’s capital data if possible, or its largest
population center, or a data station that was close to these geographically. Some data
stations provided limited data, and some did not consistently report minimum
temperatures. Selecting a single data station might seem a poor representation of an entire
country, but in fact, it does remarkably well. Most countries are small enough that one data
station covers the typical population centers. For large countries, one data station seems
to capture temperature distribution for a large section of a country. For example,
Washington DC does an acceptable job of estimating the northern tier states. The
temperature data set was then matched to the World Bank GDP per capita data set, and
countries were eliminated if they could not be matched. For example, for the 2014 data set
this process left 105 observations for the temperature minimum data set. The number of
temperature observations did vary from country to country, but only countries that
reported data throughout the year were included.

It is possible to get very high resolution data for some countries, especially the
United States. The theory laid out in this paper does not rely on high resolution, rather
implies a general relationship between climate and development. These relationships
might exist at higher resolution, but that is beyond the scope of this analysis. To see how
higher resolution data might fit, see Nordhaus (2006). Using a single reporting site for each
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country is clearly not going to capture a large country’s climate experience. For example,
the United States was observed in this data as just Washington DC’s National airport. A
more thorough approach was taken by Dell, Jones and Olken (2012), using geospacial
software to compensate for a country’s size and weighting the data by population sizes,
with very similar results to those presented here in mean temperature (though not
including the standard deviation of temperature). They find that at least in poor countries,
a 1 degree centigrade increase in temperature decreases GDP growth by 1.3%, in average.

3. The Results

The first regression uses OLS to establish the basic idea that climate matters in
economic development, using the 2014 data set. Log GDP per capita (LGDP) is run with
mean temperature minimum (Tmin) and standard deviation of temperature (SDTemp) as
independent varaibles. The results are below, with p-values in parenthesis:

LGDP = 10.189 - .0979Tmin - .6602SDTemp

(.001) (.364)

We find the results that are similar to past research with regards to mean temperature.
For each increase in mean minimum temperature by 1 degree Celsius, GDP per capita falls
by .12 percent. The mean temperature data carries a negative significant coefficient, which
implies that increases in mean temperature decrease per capita GDP. Temperature
standard deviation is not significant when run jointly with temperature. This is probably
due to the very high collinearity between temperature and temperature standard deviation
(their r is -.76). When run alone, temperature standard deviation is positive significant, but
with a p-value of 0.5%, it is slightly less than robust as temperature.

LGDP = 7.8626 + 1.223SDTemp

(.005)

Why would this happen? The argument that temperature deviation creates markets
for the first stage of development would be overshadowed by subsequent development for
all well-developed countries. The fact that temperature mean is still significant is reflected
in the importance of the energy industries even today in those countries. But there is a way
to eliminate mean temperature from the data and pick up the echo of the past. This method
uses the instrumental variable approach.

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MVEA October 23, 2015 Climate / Brodsky

By using mean temperature as an instrument, we can take it out of the cross sectional
variation in log GDP per capita. We can then run temperature standard deviation in the
second stage to determine if it can explain the remaining variation. Indeed it does, carrying
a p-value of effectively 0, and a positive sign, which is what we would expect if the theory is
valid.

LGDP = 7.1890 + 2.573SDTemp (Tmin as instrument)

(.000)

The idea that temperature variance (or standard deviation) is a component of

climate-based development is supported by the data. In an ideal world of data, both
temperature and GDP per capita data would be available from the early 1800’s and this
could be tested directly. While there is some temperature data from that period as the data
goes back to 1763, it is very limited, and there is no corresponding data for per capita GDP.
The earliest year that both temperature data and per capita GDP can be matched up for
reasonable sample size is 1950; but that still suffers from the same problem that 2014 does
– the dominance of stage 2 industrialization.

To investigate the stability of these results, we start at 1950 and move forward by
each decade to 2000, and note the results for 2014 at the bottom of the table. The 1950
data uses the Maddison (2001) results for GDP per capita, corrected by the US GDP implicit
price deflator to attempt to make the coefficients more consistent with the rest of the data
that comes from the World Development Indicators (WDI). The earlier data samples are
considerably smaller in size, half as large as the later sample sizes; this may explain some of
the variation in the coefficients.

Table 1 Temperature mean and standard deviation to GDP per capita (U$S2005)

Year Temperature t-statistic Temperature t-statistic Correlation

Mean Standard deviation Tmin and TSD
1950 n=45 -0.12345 -6.605*** -0.082063 -1.427 -0.74497
-0.099271 -8.196***
0.15048 3.592***
IV 0.33695 4.401***
1960 n=43 -0.19455 -5.865*** -0.13330 -0.9761 -0.69939
-0.15838 -8.197***
0.21734 1.997*
IV 0.58355 4.003***
1970 n=50 -0.20863 -5.603*** -0.24011 -1.819* -0.79046
-0.13703 -6.524***
0.19703 2.132**
IV 0.45951 4.224***

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1980 n=75 -0.17423 -5.755*** -0.13801 -1.372 -0.70959

-0.13891 -7.711***
0.20481 2.969***
IV 0.54285 4.946***
1990 n=95 -0.14496 -5.778*** -0.16565 -2.091** -0.69282
-0.10468 -5.031***
0.12052 1.970*
IV 0.43054 4.269***
2000 n=94 -0.11201 -4.090*** -0. 12173 -1.570 -0.71419
-0.079384 -3.919***
0.091456 1.644
IV 0.29622 3.533***
2014 n=105 -0.97860 -3.522*** -0.66017 -0.9118 -0.76312
-0.77877 -4.540***
0.20481 2.899***
IV 0.25727 4.064***
* significant at the 10% level
** significant at the 5% level
*** significant at the 1% level

The six decades, plus the most current data are fairly consistent. Mean temperature
is negative significant at the 1% level in all of the data periods which is in agreement with
other research. Run alone, temperature standard deviation is positive significant, also at
the 1% level. When run together temperature mean dominates, leaving temperature
standard deviation either insignificant or negative significant. This is probably due to the
strong correlation between the two variables, and makes a strong case to deploy the
instrumental variable regression technique. Using temperature mean as the instrument,
temperature variance is always positive significant at the 1% level.

The relationship we see here is probably due to the time distance between when
temperature variance was important and now. Large variations in temperature generate a
large demand for textiles, a key industry in stage 1, the stage dominated by labor intensive
production. Low mean temperatures generate a large demand for energy, which is a key
industry for stage 2, or capital intensive output. Not only are we closer in time to stage 2,
but the income effects of stage 2 are more dramatic, and it dominates the regression. What
we can get, through the instrumental variables method, is an echo of the past, and once
temperature mean has been accounted fo,r the temperature variation is still clearly
important. These results are consistent with the model suggested earlier.

4. An Echo of Institutional Effects

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Part of the literature related to climate and development relates to the effect of
institutions on markets. The importance of institutions can be traced back to at least
Machiavelli (1519), and the argument remains vibrant today. In the area of climate and
development the two sides can be seen in Rodrik, Subramanian, and Trebbi (2004), Sachs
(2003) and Acemoglu, Johnson and Robinson (2002). The analysis here provides a hint
that institutions matter when we split the sample to exclude communist and post-
communist countries. Once excluded, the regression results change, though standard
deviation of temperature is still insignificant in the joint model.

LGDP = 4.50 - .1196Tmin + .0759SDTemp

(0.000) (.344)

However, in both the joint model and the standard deviation of temperature by
itself, the coefficients are higher, which infers that communism interfered with the natural
advantage of temperature variation in temperate zone countries. Taking this further, the
institution of communism disrupts a country in stage 1 development, making it difficult for
it to form the basis of labor intensive output, namely textiles. Of course it should also be
noted that communist countries did not put maximized per capita GDP on their priority list,
and labor markets were treated very differently from capitalist countries.

LGDP = 7.3506 + .2881SDTemp

(.000)

Using instrumental variable regression, the analysis remains the same as before, but
with a coefficient for standard deviation of temperature that is more than twice as large.
We infer that for non-communist countries, a one degree increase in temperature standard
deviation can lead to a 0.5% increase in per capita GDP cross sectionally, taking into
account the temperature mean.

LGDP = 6.3685 + 0.533SDTemp (Tmin as instrument)

(.000)

5. Conclusions

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The differences between countries based on their climate in the tropical versus
temperate zones can be established. The idea that temperature mean and standard
deviation matter in explaining the variations in per capita income appears to be correct.
While it has been documented in prior research that temperature mean is important, we
add temperature standard deviation as relevant in this story.

To connect these climate differences to economic development, we apply a new

general model of production that relies on input intensities. Temperature standard
deviation is critical for the development of the textile industry – a key industry in early
development that is highly labor intensive. Temperature means that are lower are crucial
for the development of an energy industry – one of key industries for the second stage of
development that is highly capital intensive. There are other important industries, both of
these industries have been very important historically, and are different for tropical and
temperate zones.

Trade economists have long argued that trade acts as a substitute for the lack of
mobility of resources. But it goes beyond that – trade also acts as substitute for the lack of
domestic demand. A tropical country may lack demand for a wide variety of textiles, as a
result it cannot sustain sufficient demand locally for a vibrant textile industry. However, if
a tropical country were to partner with a temperate zone country in trade, the lack of
demand locally can be substituted away. This may be one of the keys to successful
development in the tropics.

Where do we go from here? One thing that can be done is fill in all the years for
which data is available. The data on per capita GDP seems to be the limiting factor, as
temperature data goes back to the 1700’s, though that data is quite limited as well. Given
how relatively stable the coefficients are for each of the decades after 1960, it seems likely
the results will not change much. What would be ultimately useful is to get data before
1880, the usual marker for the second industrial revolution in the United States and
Europe. If the analysis here is correct, pre 1880 data should show significance for
temperature standard deviation with less emphasis on temperature mean.

It is also possible that regional analysis might work to explain differences within
countries. It is well known that the southeastern United States was slower to develop
relative to the north. There is the possibility that this was the result of climate related
differences. Such analysis could also be applied to other country’s regional differences.

All of this suggests that economic paradise is possible everywhere. Those countries
that find themselves without the natural advantage of large demand for textiles and energy
can substitute away the problem by partnering with countries in the temperate zone. Once
they achieve stage 2 (the capital intensive process dominance stage), they should be able to
develop without the need for a partner. However, due to the income distribution effects on
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the profiles of consumption and production, it does not appear that stage 1 (the labor
intensive process stage) can be skipped.

References

Acemoglu, Daron, Simon Johnson and James A. Robinson, “Reversal of Fortune: Geography
and Institutions in the Making of the Modern World Income Distribution, Quarterly Journal
of Economics, 2002.

Dell, Melissa, Benjamin F. Jones and Benjamin A. Olken, “Temperature Shocks and
Economic Growth: Evidence from the Last Half Century,” American Economic Journal:
Macroeconomics. 2012;4(3):66-95.

Chenery, Hollis B., and Moshe Syrquin. (1989) “Patterns of Development, 1950 to
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Gallup, John Luke, Jeffrey D. Sachs and Andrew D. Mellinger. 1999. “Geography and
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National Oceanic and Atmospheric Administration. (NOAA). Global Historical Climatology

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Nordhaus, William D, “Geography and macroeconomics: New data and new findings,”
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Rodrik, Dani, Arvind Subramanian, and Francesco Trebbi, “Institutions Rule: The Primacy
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Rosenstein-Rodan, Paul “Notes on the Theory of the Big Push”, in Ellis, editor, Economic
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