When temperatures matter: Extreme heat and labor share

While prior literature has demonstrated the negative effects of extreme heat on labor productivity, empirical evidence remains limited on its implications for labor share. This study employs a rich dataset of Chinese manufacturing firms spanning the years 1998 to 2007 to examine the impact of extreme heat on labor share in the context of climate change. Our empirical analysis reveals a statistically significant reduction in labor share triggered by extremely high temperatures. Specifically, an additional day with temperatures above 90 °F leads to a 0.129 percentage-point decrease in labor share. We extend our inquiry to discern the underlying mechanisms and find that the capital-labor substitution channel principally drives the observed decline in labor share. Importantly, our analysis indicates that the manufacturing sector does not provide an employment buffer for workers migrating from the agriculture sector due to temperature-related productivity shocks, thereby exacerbating the detrimental effects on labor share. The findings highlight the policy relevance of enhancing labor market flexibility to mitigate the adverse consequences of extreme heat on labor share.