Global temperature, R&D expenditure, and growth

Highlights: • We use a VAR to quantify the effect of a temperature shock on R&D expenditure growth. • Temperature shifts negatively influence R&D expenditure growth in G7 countries. • We use a DSGE to evaluate three theoretical channels of the negative temperature effect. • Temperature risk generates welfare costs of 93.14% of lifetime utility in the DSGE model. • Government can offset welfare costs of temperature risk with subsidies or with taxes. We shed new light on the macroeconomic and financial effects of rising temperatures. In the data, a shock to global temperature dampens research and development (R&D) expenditure growth. This novel empirical evidence is rationalized within a stochastic endogenous growth model. In the model, temperature shocks undermine economic growth via a drop in R&D expenditure. We examine three theoretical channels of the negative R&D expenditure effect of rising temperatures: the patent obsolescence channel, the labor productivity channel, and the capital quality channel. Temperature risk generates welfare costs of 93.14% of lifetime utility in this benchmark model. Moreover, the government can offset these welfare costs by subsidizing investment with 7.04% or R&D expenditure with 3.81% of total public spending, respectively. Alternatively, it can levy a lump-sum tax on households which finances 6.90% of total public spending, reduce corporate taxes by 3.62 percentage points, or increase labor taxes by 2.80 percentage points.