The Effect of Climate Change on Economic Growth in Iran

The increase in greenhouse gases has affected global weather, resulting in changes in climate zones. Climate change is mostly characterized by changes in temperature. There is strong evidence showing that climate change will adversely affect the world especially developing countries in the following decades. Agricultural activities are more vulnerable to climate change as they are more dependent on water resources and temperature. Moreover, damages to agricultural activities may contract output in other sectors as well. Given the importance of the issue, Iran is a prominent example since it is located in an arid and semi-arid region, and its average annual precipitation is less than one-third of the global precipitation. In addition, there is a large body of literature indicating an increase in average temperature of Iran over the last decades. Therefore, this study aims to investigate the effect of climate change on the economic growth in Iran.

The Solow-Swan growth model was applied to investigate economic growth under climate changing environment. The growth models were estimated using time series data of 1350-1395 (1971-2016). In the growth model, a damage function, change in which damage is a function of temperature, was applied to examine the effect of climate changes. The growth model determinants are physical as well as other types of capital including human, social and environmental capitals. Internet access and phone access were used as proxies for social capital. Also, literacy rate, primary school enrolment rate, and university students were applied as proxies for human capital. Agriculture, mining, and oil and gas production were considered as proxies for natural and environmental resources. Another proxy for environmental capital was the value of natural resources marginal product. This variable is defined as the ratio of CO2 damages to GDP. Trade impact on economic growth was also investigated through using Foreign Direct Investment (FDI) and trade openness variables. Also, to examine the trend of temperature, an ARMA model was used. GDP is technically considered as an endogenous variable so Generalized Method of Moments (GMM) method is applied.

The specification of ARMA model revealed two significant moving average trends including five-year and nine-year. These trends indicate an increasing average for temperature, leaving less doubt about the phenomenon of climate change. Our results showed that the increase in temperature will negatively affect economic growth. It was also found that one-degree increase in average temperature is expected to reduce Iranian GDP by 5-6.6 percent. Physical capital showed the highest contribution to Iranian GDP. Its contribution to the economic growth, in terms of elasticity, was found to be 0.08-0.16. The corresponding values for human and social capital were 0.02-0.06 and 0.03-0.08, respectively. However, environmental capital failed to affect the economic growth significantly. Among the variables applied for human capital, university students were found to play a more significant role. The insignificant effect of environmental capital on economic growth may be attributed to its nature that is used as a public good, resulting in intensive as well as irrational use. Among the variables applied for environmental capital, the value of natural resources marginal product showed a slightly strong effect, needing to be considered as a proxy for environmental capital. Also, FDI showed an insignificant effect; however, trade openness was found to affect economic growth positively.

The general trend of the economic growth in Iran is far from what is expected. In addition, this trend is threatening by, among the others, climate change which is characterized by increasing average temperature as well as decreasing precipitation. Also, as far as the capital is considered, economic growth in Iran is highly dependent on physical capital while the contribution of other types of capital including human, social and environmental capital is not significant. However, it is worth noting that environmental capital seems to be used intensively while for human capital reasons like inappropriateness of labor quality and education system is more acceptable. Even for physical capital, higher contribution is expected since the Iranian economy enjoys lower capital accumulation. It was also found that removing trade barriers and being more connected with the global economy may provide more opportunities to enjoy higher growth.