Working Papers

Climate Policy and Sovereign Debt: The Impact of Transition Scenarios on Sovereign Creditworthiness, with Matt Burke, Matthew Agarwala, and Patrycja Klusak (December 2024).

Abstract: This paper links climate science with sovereign risk assessment to produce a single forward-looking measure of country-level climate change risk. We combine the Network for Greening the Financial System (NGFS) climate scenarios with a sovereign credit ratings model to simulate the impact of climate change on credit ratings, cost of debt and probability of default. For the first time, we extend beyond the physical risks of extreme weather events to explicitly incorporate risks associated with transitioning the global economy towards Net Zero. Across the sample of 48 countries and under a scenario of high (low) physical and transition risks, we find average downgrades of 3.9 (2.7) notches and mean increases in the cost of debt of 123 (76) basis points and default probability of 10.4% (6.2%). Counter-intuitively, ratings, default probability, and cost of debt appear insensitive to scenarios in some countries, with important implications for the usefulness of NGFS scenarios across central banks.
JEL Classifications: C53, E6, G20, H63, Q51, Q54.
Key Words: Sovereign debt, credit ratings, climate policy, transition risks, climate change.
Cambridge Working Paper Version: CWPE 2470.

How Air Pollution Makes Firms Less Innovative: Human Capital and Adaptive Strategies, with Tiago Cavalcanti, Hongyu Nian, and Haitao Yin (October 2024).

Abstract: This paper explores the long-term impact of air pollution on firm-level R&D human capital composition and innovation, as well as the strategies firms adopt to mitigate these effects. Using a spatial regression discontinuity design based on China’s Huai River heating policy and exploring a novel dataset with detailed information on firm-level R&D sector, we show that prolonged exposure to air pollution significantly reduces the proportion of R&D workers with advanced degrees, such as PhDs and master’s degrees. To counteract these challenges, firms in polluted areas increase their reliance on external strategies, such as acquiring technology and collaborating with universities, and adopt internal measures, including enhanced welfare subsidies for R&D staff and greater investment in experimental instruments. Despite these efforts, firms in polluted areas still produce lower R&D value compared to those in cleaner regions. Our results highlight the key importance of internal human capital in complementing external technological investments..
JEL Classifications: O15, O30, O44, Q51, Q56.
Key Words: Air pollution; R&D human capital composition; innovation; adaptive strategies; firm value.
Cambridge Working Paper Version: CWPE 2466.

Rising Temperatures, Melting Incomes: Country-Specific Macroeconomic Effects of Climate Scenarios, with Mehdi Raissi (June 2024).

Abstract: We estimate country-specific annual per-capita GDP losses from global warming using the most recent climate scenarios of the Intergovernmental Panel on Climate Change (IPCC) under different mitigation, adaptation, and climate variability assumptions. Our results indicate that without significant mitigation and adaptation efforts, global GDP per capita could decline by up to 24 percent under the high-emissions climate scenarios by 2100. These income losses vary significantly across the 174 countries in our sample, depending on the projected paths of temperatures and their variability.
JEL Classifications: C33, O40, O44, Q51, Q54.
Key Words: Climate change, economic growth, mitigation, adaptation, counterfactual analysis.
Cambridge Working Paper Version: CWPE 2429.
Income Losses from Climate Change: We make all of the 174 country-specific estimates of annual income losses available to download from here.
Media Coverage: This paper has been covered extensively in major international news outlets including the Financial Times, the i, La Repubblica, and in work by the Boston Consulting Group.
Video: What is the economic impact of climate change? Which countries and sectors will be worst affected? To find out, check out this video.
University of Cambridge News: The paper was highlighted by the University of Cambridge and Insight from the Judge Business School.

Climate Change and Sovereign Risk: A Regional Analysis for the Caribbean, with Matthew Agarwala, Matt Burke, Jennifer Doherty-Bigara, and Patrycja Klusak (April 2024).

Abstract: Climate change is an existential threat to the world economy, with complex, evolving and nonlinear dynamics that remain a source of great uncertainty. There is a bourgeoning literature on the economic impact of climate change, but research on how climate change affects sovereign risks is limited. This paper provides forward-looking regional analysis of the effects of climate change on sovereign creditworthiness, probability of default and the cost of borrowing for the Caribbean economies. Our results indicate that there is substantial variation in the sensitivity of ratings to climate change across the region which is due to the non-linear nature of ratings. Our findings improve the identification and management of sovereign climate risk and provides a forward-looking assessment of how climate change could affect the cost of accessing international finance. As such, it leads to a suite of policy options for countries in the region.
JEL Classifications: C33, C53, G10, G18, H63, O44, O54, Q51, Q54.
Key Words: Sovereign credit rating, climate change, counterfactual analysis, climate-economy models, sovereign debt, physical risks, fiscal policy, transition risks, Latin America, Caribbean.
Inter-American Development Bank Working Paper Version: IDB-WP-1574

Air Pollution and Firm-Level Human Capital, Knowledge and Innovation, with Tiago Cavalcanti, Hongyu Nian, and Haitao Yin (January 2023).

Abstract: This paper investigates the long-run effects of prolonged air pollution on firm-level human capital, knowledge and innovation composition. Using a novel firm-level dataset covering almost all industrial firms engaged in science and technology activities in China, and employing a regression discontinuity design, we show that prolonged pollution significantly diminishes both the quantity and the quality of human capital at the firm level. More specifically, we show that air pollution affects firm-level human capital composition by reducing the share of employees with a PhD degree and master’s degree, but instead increasing the share of employees with bachelor’s degree. Moreover, the difference in the composition of human capital materially change the knowledge and innovation structure of the firms, with our estimates showing that pollution decreases innovations that demand a high level of creativity, such as publications and inventions, while increasing innovations with a relatively low level of creativity, such as design patents. Quantitatively, on the intensive margin, one μg/m3 increase in the annual average PM2.5 concentration leads to a 0.188 loss in the number of innovations per R&D employee. Overall, we show that air pollution has created a gap in human capital, knowledge, and innovation between firms in the north and south of China, highlighting the importance of environmental quality as a significant factor for productivity and welfare.
JEL Classifications: O15, O30, O44, Q51, Q56.
Key Words: Pollution, human capital, knowledge, innovation, and China.
Cambridge Working Paper Version: CWPE 2301.
University of Cambridge News: The paper was highlighted by Insight from the Judge Business School.

People-centric Emission Reduction in Buildings: A Data-driven and Network Topology-based Investigation, with Ramit Debnath, Ronita Bardhan, Darshil U. Shah, Michael H. Ramage, and R. Michael Alvarez (December 2021).

Abstract: There is a growing consensus among policymakers that we need a human-centric lowcarbon transition. There are few studies on how to do it effectively, especially in the context of emissions reduction in the building sector. It is critical to investigate public sentiment and attitudes towards this aspect of climate action, as the building and construction sector accounts for 40% of global carbon emissions. Our methodology involves a multi-method approach, using a data-driven exploration of public sentiment using 256,717 tweets containing #emission and #building between 2009 - 2021. Using graph theory-led metrics, a network topology-based investigation of hashtag cooccurrences was used to extract highly influential hashtags. Our results show that public sentiment is reactive to global climate policy events. Between 2009-2012, #greenbuilding, #emissions were highly influential, shaping the public discourse towards climate action. In 2013-2016, #lowcarbon, #construction and #energyefficiency had high centrality scores, which were replaced by hashtags like #climatetec, #netzero, #climateaction, #circulareconomy, and #masstimber, #climatejustice in 2017-2021. Results suggest that the current building emission reduction context emphasises the social and environmental justice dimensions, which is pivotal to an effective people-centric policymaking.
JEL Classifications: C63, Q54.
Key Words: Emission, climate change, building, computational social science, people-centric transition, Twitter.
Cambridge Working Paper Version: CWPE 2202.

Greenovate for a Better Environment and Economy, with Zeina Hasna and Henry-James Hatton (October 2021).

Abstract: Climate change is the most severe threat facing the planet today and countries all over the world are gathering for COP26 with ambitious and extremely time-sensitive plans to reduce carbon emissions. In the race for progress, this paper investigates whether increased innovation among greenrelated activities can combine environmental breakthroughs with future economic prosperity. Drawing on patent data from the last three decades for 43 OECD and BRICS countries, we find that a doubling of green patent filings, if sustained, will lead to a significant increase of 4.8 percentage points in real GDP growth. This is particularly noteworthy when compared with a GDP gain of 3.4 percentage points if non-green patents alone are doubled yearly. We also show that the impact of green patent filings on growth is mostly channelled via the services sector. Finally, we document the vital success stories we are witnessing among major innovating countries and renewable-energy businesses, and the instructive role that governments can play in driving progress for our planet’s environmental and economic future.
University of Cambridge News: The paper was highlighted by Insight from the Judge Business School.

Transmission of Real and Financial Spillovers to and from Japan, with Paul Cashin and Mehdi Raissi (November 2019).

Abstract: This paper develops a quarterly macro-econometric model for Japan over the period 1981Q2–2018Q2 and integrates it within a compact model of the world economy (including the global oil market). This framework enables one to study the size and speed of the international transmission of stress in global financial markets, growth shocks emanating from China, Europe, or the United States, as well as a global growth slowdown. It also allows one to investigate outward spillovers from a GDP shock in Japan to the rest of the world and how they have changed over time. Spillovers are transmitted via trade, financial, and commodity price linkages. The results show that all regions are more sensitive to developments in China than to shocks in the Euro Area or the United States, in line with the direction of evolving trade patterns and the emergence of China as a key driver of the global economy. Stress in global financial markets can amplify spillovers from growth shocks in systemic economies. While outward spillovers from Japan have reduced over time, they are likely to be stronger in its immediate geographical proximity.
JEL Classifications: C32, F44, O53
Key Words: Japan, international business cycle, and Global VAR.

Debt, Inflation and Growth: Robust Estimation of Long-Run Effects in Dynamic Panel Data Models, with Alexander Chudik, M. Hashem Pesaran, and Mehdi Raissi (November 2013).

Abstract: This paper investigates the long-run effects of public debt and inflation on economic growth. Our contribution is both theoretical and empirical. On the theoretical side, we develop a cross-sectionally augmented distributed lag (CS-DL) approach to the estimation of long-run effects in dynamic heterogeneous panel data models with cross-sectionally dependent errors. The relative merits of the CS-DL approach and other existing approaches in the literature are discussed and illustrated with small sample evidence obtained by means of Monte Carlo simulations. On the empirical side, using data on a sample of 40 countries over the 1965-2010 period, we find significant negative long-run effects of public debt and inflation on growth. Our results indicate that, if the debt to GDP ratio is raised and this increase turns out to be permanent, then it will have negative effects on economic growth in the long run. But if the increase is temporary, then there are no long-run growth effects so long as debt to GDP is brought back to its normal level. We do not find a universally applicable threshold effect in the relationship between public debt and growth. We only find statistically significant threshold effects in the case of countries with rising debt to GDP ratios. 
Arabic Abstract: Click here for the Abstract in Arabic. 
JEL Classifications: C23, E62, F34, H6.
Key Words: Long-run relationships, estimation and inference, large dynamic heterogeneous panels, cross-section dependence, debt, inflation and growth, debt overhang. 
CAFE Research Paper: No. 13.23.
Matlab Codes for the CS-DL Estimators: Click here for the Matlab codes for the cross-sectionally augmented distributed lag (CS-DL) Mean Group and Pooled estimators developed in Chudik et al. (2013).
Data and Stata Do File: Click here for the data as well as the Stata do files needed to transform the data and compute the statistics and results in "Debt, Inflation and Growth: Robust Estimation of Long-Run Effects in Dynamic Panel Data Models".
YouTube Video: Click here for a video recording of a lecture given by M. Hashem Pesaran based on "Debt, Inflation and Growth: Robust Estimation of Long-Run Effects in Dynamic Panel Data Models".

Institutions and the Volatility Curse, with Weishu Leong (July 2011).

Abstract: This paper revisits the resource curse paradox and studies the impact of resource rents and their volatility on economic growth under varying institutional quality. Using five-year non-overlapping observations between 1970 and 2005 for 112 countries, we find that while resource rents enhance real output per capita, their volatility exerts a negative impact on economic growth. Therefore, we argue that volatility, rather than abundance per se, drives the resource curse. However, we also find that higher institutional quality can help offset some of the negative volatility effects of resource rents. Therefore, resource abundance can be a blessing provided that growth and welfare enhancing policies and institutions are adopted.
JEL Classifications: C23, F43, O13, O40.
Key Words: Economic growth, resource curse, institutions, resource rent, and commodity price volatility. 
Cambridge Working Paper Version: CWPE 1145.