Extreme high temperatures, firm dynamics and heterogeneity, and aggregate productivity: The case of Chinese manufacturing

Abstract

We investigate how extreme (high) temperatures impact firm dynamics—specifically entry, exit, and aggregate productivity—in China's manufacturing sectors. While existing studies primarily focus on the effects of extreme temperatures on incumbent firms (intensive margin), we examine their influence on firm entry and exit (extensive margin) and the resulting implications for aggregate productivity. Extreme temperatures reduce the productivity of incumbent firms (productivity effects) but also select for higher-productivity firms to survive (selection effects). Leveraging a unique dataset containing registration information for the universe of firms, we document a novel general equilibrium mechanism: resources released by the exit of low-productivity firms are reallocated to higher-productivity firms. As a result, the combined effects on aggregate productivity are muted, challenging the prevailing consensus that extreme temperatures universally worsen productivity and economic outcomes. Using a heterogeneous firm framework à la Melitz (2003), we quantify these effects, providing valuable insights into the role of firm dynamics in shaping effective climate policies.