Climate change recalibrating FDI

Governments and companies are trying to evaluate and anticipate the risks of the effects of global warming in an uncertain world

Every year Kearney conducts a survey of global business executives that ranks markets that are likely to attract the most investment in the next three years－the Kearney Foreign Direct Investment Confidence Index. The findings this year are indeed striking. Although the novel coronavirus has killed more than 800,000 people and brought the global economy to a standstill, it shows climate change is the main concern for the majority of investors.

Climate change considerations are playing a significant role in foreign direct investment decisions and are set to grow as a priority. Notably, 85 percent of investors say that the environmental impact of potential foreign investment targets is important to them. Importantly, 77 percent of investors say that climate-related risks are likely to affect their investment decisions over the next three years.

Also they anticipate further climate regulations and worsening climate risks in the years ahead. More than half of investors expect financial losses as a result of climate change. To maximize gains, investors will need to calibrate their investment decisions to match the climate-driven shifts in their operating environments. A significant number of companies, then, are vulnerable to climate risks－and are aware of their exposure. This high level of awareness likely reflects the rise of global efforts to mitigate climate change before the COVID-19 pandemic. It may also suggest that companies have undertaken efforts to understand and analyze their existing climate risk vulnerabilities.

In addition, research has shown that there are linkages between infectious diseases and higher temperatures. Among other factors, the shifting of animal habitats due to higher temperatures and the destruction of nature caused by human activities increase the proximity between humans and animals, facilitating pathogen transmission. It was also recently discovered that there is a correlation between coronavirus deaths and pollution. Such findings may inspire environmentally conscious lifestyle changes among consumers and may also increase public support for renewable and cleaner energy sources in general. Broadly, these findings indicate that investors worried about the impact of climate change are more likely to favor the destinations that are more interested in mitigating the impacts of climate change.

Extreme temperature is the climate change risk that is of most concern. Investors in all regions rank extreme temperatures as the biggest climate risk today and over the next three years. The impact of extreme temperatures and climate risks in general on the global economy are considerable. According to estimates, climate change risks will threaten as much as 30 percent of global GDP by 2025, double the amount in 2008.

The effects of extreme weather can be profound and destructive. In the United Kingdom, roads liquified when the temperature reached 33 C. In India－where the average temperatures are 1.2 C higher than they were a century ago－heatwaves are now melting roads every summer. And Qatar－one of the hottest countries on the planet－will require more than double its current cooling infrastructure by the end of the 2020s. Extreme heat also lowers labor productivity. Factories and manufacturing or other physical assets are therefore particularly vulnerable.

The second-biggest climate risk currently facing investors is wildfires, and the third is droughts and water shortages. Wildfires are global phenomena that result in significant economic losses. In 2019, wildfires struck many countries－including Spain, the United States and Australia, among others. The Australian wildfires in 2019 and 2020 inflicted damages worth $110 billion. In California, the 2019 wildfire losses were $80 billion. There is a heavy price tag for countries experiencing droughts as well. In the US alone, losses from droughts amount to an estimated $9 billion yearly. On a regional level, Europe-based investors cite similar levels of concern about the longer-term trend increase in aggregate temperatures－perhaps a reflection of increased climate change efforts in that region. It is an area where investors appear to be displaying a higher level of foresight.

Global investors rate melting glaciers and diminishing snow cover as the least impactful climate risks in shaping their investment decisions. This ranking likely reflects the fact that few investors have physical assets in close proximity to these phenomena. They may also perceive these challenges as more long-term and abstract relative to the others.

Nonetheless the challenges that climate change would trigger means governments, enterprises and investors need to react right now.

So far, 124 state and regional governments in 35 markets have declared climate action goals. As of April, carbon pricing initiatives covering 46 national and 31 sub-national jurisdictions had been implemented or were scheduled to be implemented. China plans to gradually roll out a nationwide carbon cap-and-trade program in 2020, which is slated to be the biggest emissions-trading scheme in the world. It is broadly expected to incentivize power companies to make their operations more environmentally friendly when implemented. And the European Union－the region consistently dominating the index and the home of the majority of the most desired FDI markets－has proposed a Carbon Border Adjustment, which would tax imports from countries without a carbon pricing plan and is expected to lead to a reduction of carbon emissions globally as more countries adopt similar legislation.

In the future, climate change mitigation efforts and related regulations may be set to intensify following the eventual economic recovery from the pandemic.

Encouraging the development of infrastructure that is both sustainable and resilient to climate change will be a future trend of responsible governments.

It is unsurprising that the environmental impact of potential FDI targets is a factor for the overwhelming majority－85 percent－of investors. They anticipate further climate regulations and worsening climate risks in the years ahead. As a result, they are recalibrating their investment decisions accordingly.

The author is a global partner of Kearney and head of Kearney Greater China Government & Economic Development Practice. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.