Climate change and institutional change: what is the relative importance for economic performance?

A growing empirical literature attempts to assess the effect of climate and institutional quality (measured by e.g. economic freedom) on economic growth, both being important fundamental growth conditions. So far, these conditions have been studied apart, even if they from a theoretical point of view are non-exclusive and could both be important. This study investigates their interaction and relative importance, using dynamic panel models. Both global warming and declining institutional quality affect growth adversely. A permanent negative shock of one unit to institutional quality (on a 0–10 scale) is associated with a 10.4% lower long run GDP per capita. In our preferred model, the adverse growth effect of global warming is significant and large compared to the literature, implying a 3.4% drop in global GDP from a 1 °C temperature rise. The effect is quadratic. For 79% of the World the adverse effect of a one-point fall in institutional quality dwarfs the effect of a temperature rise of one degree. Our study suggests that policies to reduce global warming should not be at the expense of policies to enhance institutional quality, which are more important for long time growth.