In December 2021, a typhoon caused what was described as “arguably the worst flooding in history” in some regions of Malaysia, displacing 60,000 people and killing 27. The flooding also severely damaged Klang, South East Asia’s second-largest port, where Taiwanese advanced microchips are routinely shipped for packaging at Malaysian factories. Meanwhile, BE Semiconductor, a Dutch supplier of chipmaking equipment with a factory in flood-affected Shah Alam, incurred losses to the tune of $28m (€25.98m) as it halted operations on product assembly lines. The result was a breakdown in the global semiconductor supply chain, causing some US automobile companies to suspend manufacturing.
Other instances of extreme weather affecting multinational companies’ foreign facilities include the flooding of Toyota’s manufacturing facilities in Thailand in 2018, a water shortage that shut down a Coca-Cola plant in India, and China’s seaport in Gwadar, Pakistan (part of the Belt and Road Initiative), which some experts claim could be underwater by 2060. Another major Chinese infrastructure project, the Maputo-Katembe bridge – the longest suspension bridge in Africa – is located in Mozambique, which is considered one of the world’s most vulnerable countries to the effects of climate change, experiencing frequent cyclones, droughts and storm-surge flooding.
A new direction in the study of FDI and climate change
To date, most academic research has focused on the impact of foreign direct investment (FDI) inflows on carbon emissions, with many studies exploring the so-called “pollution haven hypothesis”. However, a new spate of studies is now examining the exposure of multinationals’ FDI to physical climate risks, particularly as it relates to human-caused climate change.
Although there remains significant uncertainty within climate modelling (inter-model and intra-model variability, and internal climatic variability), scientists say that there is “substantive evidence” of the link between global warming and extreme weather events. Across more than 400 peer-reviewed “extreme event attribution” studies, 71% of 504 extreme weather events were found to be made more likely or more severe by human-caused climate change. Of the 152 extreme heat events assessed by scientists, climate change made the event or trend more likely or more severe in 93% of cases. For the 126 rainfall or flooding events studied, human activity made the event more likely or more severe in 56% of cases. For the 81 drought events studied, the figure was 68%.
At least anecdotally, multinationals seem aware of the climate risks associated with their investment decisions. In 2022, BlackRock CEO Larry Fink addressed senior business executives, telling them that “climate risk is financial risk”. He said: “Because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.” This, he added, will not only be the result of physical climate risk – which may cause an exodus of human capital, a deterioration of the macroeconomic environment and damage to infrastructure – but also due to new ESG and regulatory priorities.
Consumer-goods giant Unilever has also previously said that climate change disruption costs the company some €300m per year, while General Mills has reported that it loses a significant number of production days each year due to the effect of extreme weather on its supply chain and transportation. Indeed, companies such as General Mills are already devising supply chain resilience plans in the event of serious climate-related disruptions.
Do companies typically factor climate-related risks into their FDI decisions?
According to newly published research, company-level evidence suggests companies with high climate risk exposure are more likely to reduce FDI in response to the target country’s physical climate risks following the Paris Climate Accord in 2015. They also found that, at a country/industry-level, higher emission productivity – gross domestic product (GDP) per unit of emissions – leads to higher FDI inflows.
The research also found that advanced economies are more negatively affected by “transition risk” – that is, risks arising from the transition to a low-carbon economy – than is the case with emerging economies.
More generally, researchers discovered that multinationals’ awareness of climate-related risks started to increase following the Paris Climate Accord.
Another recent study found that the rise of climatology indicators (mean annual temperature and precipitations) negatively impacts inward FDI. However, while most climate-related natural hazards (floods, landslides and cyclones) deter FDI, extreme heat and wildfires show no significant effect.
The study also found that the negative impact of climate change on FDI inflows is more severe when the host country has a largely agriculture-based economy and receives no significant investment in research and development. In general, poorer host countries experience more severe effects of climate change on FDI than rich countries in terms of GDP per capita.
A 2021 working paper published by the International Monetary Fund also argues that while FDI improves economic growth in developing countries, climate shocks reduce the positive effect of financial inflows by reducing a country’s “absorptive capacity” – that is, the total amount of foreign capital that a developing country can use productively.
The most at-risk foreign investments and industries
Research found that the climate risks of a company’s overseas investments vary by industry: with access to Four Twenty Seven’s climate risk scores and facility statistics of 2,233 public companies, the study found that the three most at-risk industries were agriculture, forestry and fishing, mining and manufacturing, with the biggest risks being heat stress, water stress and flood risk.
Glenn Barklie, principal economist at Investment Monitor, says: “For many companies, climate risks will be a low FDI driver. For example, a software company opening an R&D centre in the UK is unlikely to have climate risk as a key investment driver. Alternatively, for sectors such as agriculture production, climate risk will be a more important factor – particularly in world regions or countries where risks are elevated.”
Moreover, the research found that overseas investments in the Caribbean, the Middle East and South East Asia face the highest climate risks.
And, according to descriptive statistics, Chinese foreign investments have higher aggregate climate risks across countries and industries compared with other countries with high FDI outflow stock. Overseas projects operated by Chinese companies tend to have higher water stress, flood and hurricane/typhoon risks.
Several possible explanations have been offered for this. For example, some Chinese foreign investments are primarily driven by political and strategic considerations (for example, projects under the Belt and Road Initiative), rather than profit-seeking ones; for this reason, decision-makers may be more likely to locate in countries with higher risks if it serves strategic interests. Further, China only began its aggressive foreign investment strategy in the early 2000s, possibly implying that Chinese companies had to invest in higher-risk countries because lower-risk ones were already ‘taken’.
An unclear picture?
Although current research suggests several identifiable trends, the aforementioned report in ScienceDirect notes that there is a lack of a sizeable and consistent response of FDI to climate shocks in the data. However, the researchers believe there is the potential for large and abrupt changes going forward, especially as countries begin to enact more stringent climate legislation.
Indeed, for the time being, climate change and natural catastrophes rank low on the list of business worries among risk management experts. According to Allianz’s 2023 Risk Barometer, concerns about natural catastrophes and climate change have slipped down the annual rankings (from third to sixth, and from sixth to seventh, respectively), to be overtaken by more immediate macroeconomic concerns such as inflation, financial market volatility and a looming recession, as well as the ongoing energy crisis.