Does Climate Change Constitute a Financial Risk to Foreign Direct Investment? An Empirical Analysis on 200 Countries from 1970 to 2020

Abstract

Abstract In this paper, we study the role of climate change as a financial risk for foreign investors. Multinational enterprises seek to internationalize where financial risk is at the minimum level, including the climate change risk on profitability and productivity. Thereby, we conducted an empirical analysis of the effect of climate change on inward foreign direct investment (FDI) net inflows using data from 200 countries and times series from 1970 to 2020 and employing two categories of climate change indicators: Climatology and climate-related natural hazards. Using the estimation methods of fully modified ordinary least squares and robust weighted least squares, we concluded that the rise of climatology indicators (mean annual temperature and precipitations) negatively impacts inward FDI. Second, we conclude that most climate-related natural hazards (coastal/rural/urban floods, landslides, and cyclones) deter FDI while extreme heat and wildfires show no significant effect. In addition, the results show that the negative impact of climate change is more severe when the host economy depends on agricultural activities and there is no significant investment in research and development as compared with countries that depend on service and manufacturing activities and are more innovative and invest in technology infrastructure. Furthermore, we conclude that poorer host countries experience more severe effects of climate change on FDI than rich countries in terms of GDP per capita. Significance Statement The purpose of the paper is to investigate the effect of climate change on inflows of cross-border capital in 200 countries. In other words, we see if rising temperature and natural hazards related to climate change affect the decision of firms to invest in a given country. The results show that global warming and unstable meteorological indicators deter firms from investing abroad. Equally, natural hazards linked to climate change (coastal/rural/urban floods, landslides, and cyclones) constitute an investment risk. The finding suggests that the deterring effects of climate change are less severe when a given country depends less on agriculture and more on industrial sectors and when that country is more developed and technologically advanced.