Climate Change and Fixed Capital Dynamics: Evidence from Manufacturing Plants in Indonesia

Authors
Azhar Hussain

Climate change can have dramatic effects on the spatial and temporal distribution of future economic growth. As Indonesia has historically been affected by frequent flooding episodes, sea-level rise can exacerbate coastal flooding. This is especially dangerous since the major population centres are located on the islands of Java and Sumatra, where the main economic activities are concentrated on the coasts. The costs of flooding are two-fold: first, there could be loss of land due to inundation; second, there could be dynamic losses resulting from the accelerated depreciation of existing buildings and other man-made structures. This project will address the following research question: how do the changes in fundamentals due to rising sea-levels affect the distribution of economic activity and the growth path of Indonesian regions?

To answer this question, the researcher will estimate a dynamic spatial general equilibrium model by using a variety of granular datasets that come from both surveys and satellite observations. Using land inundation simulations from the Digital Elevation Model, the researcher will estimate total capital depreciation accounting for capital growth, which is important to get to the overall cost of capital destruction due to sea-level rise. In the literature, the impact of sea-level rise has been modelled as reducing land availability, but to measure its impact on firms, this simple model is not suitable because in aggregate firms occupy very small share of total land area. Therefore, the researcher will include capital dynamics to capture costs for the non-agricultural sector, while keeping land inundation channel active for the agricultural sector. The model will be estimated at the level of regencies, which are administrative level-2 regions in Indonesia.

This project is relevant for providing policy guidance on long-term climate adaptation. It will shed light on two adaptation channels: the first involves relaxing sector-region migration costs for workers, which in low-income countries tend to be hindered by credit and liquidity constraints. The governments can remove some constraints through public funding of skill development programs and aiding citizens to sort across regions in a forward-looking manner. The second adaptation channel involves choosing optimal locations for the establishment of economic zones, such that the new design takes future sea-level rise into account. This will require maximising the present discounted value of present and future benefits net of costs to mitigate the economic impact of sea-level rise.
 

Authors

Azhar Hussain

London School of Economics (LSE)