Climate physical risks refer to the potential impacts that climate change-induced extreme weather events and chronic changes have on the economy. These risks have direct effects, e.g. the destruction of livelihoods and productive capacity from a flood, and indirect effects. One of such indirect effects, the propagation of physical risks through supply chains, is an important but still understudied channel of transmission. Recent studies show that trade linkages generate complex patterns of amplification of climate physical risks. Understanding these mechanisms is important to build economic, social and financial resilience in the face of advancing climate change. In the following we review four recent papers that contribute to a better understanding of the transmission of physical risks across supply chains.
The globalization of climate change physical risks
Fahr et al. (2023) study the still relatively little researched role of global supply chains in transmitting climate-related physical risks to the euro area as well as other country regions around the globe. While direct climate change impacts are expected to hit regions outside the euro area more severely than within the euro area, the consequent disruptions in global supply chains can lead to significant economic losses also for the euro area. Developing a novel global Input-Output (IO) model, the paper integrates country-level GDP-at-risk estimates from SPGlobal with OECD data on international trade flows to quantify spillover effects. The IO model was developed so that climate shocks can spread both via supply and demand channels in the trade network. The findings suggest that, under a severe climate scenario (RCP 8.5), direct GDP-at-risk numbers can severely underestimate the ultimate impact of physical risk: trade effects can lead to losses that are up to 30 times higher in the euro area than what looking at the direct impacts would suggest. However, trade can also mitigate losses if country-sectors are able to restructure their input sourcing to avoid bottlenecks.
Climate change and firms’ adaptative behaviour in global supply networks
Pankratz and Schiller (2024) study whether firms adjust their supply-chain networks in response to perceived increases in their suppliers’ heat exposure. To do so, they combine firm-level supply-chain data for 5,600 supplier firms and 8,200 customer firms across more than 90 countries from 2003 to 2016 with historical temperature information. The paper provides three key insights. First, exposure to extreme heat events deteriorates the financial performance of supplier firms. Second, customer firms have a higher chance of terminating relationships when adverse weather at the locations of their suppliers becomes more frequent. Lastly, customers are shown to switch to replacement suppliers with lower expected and realized heat exposure. The highlighted effects are also evidenced in the study of flood events. These findings suggest that firms are adapting their supply chains in response to perceived increases in climate risk, which could have significant implications for global production networks and economic development in climate-vulnerable regions.
Transmission of climate shocks in firm networks
De Spiegeleer et al. (2024) develop an agent-based model (ABM) to investigate how physical climate shocks impact firm defaults through supply chain disruptions. The modelling framework explores how climate events reduce firms’ production capacity, which lead to a reduced asset value in a Merton model and generate ripple effect via both demand and supply side transmission in the supply chain. The model is initialised with a network of ~5000 firms belonging to the S&P500 using FactSet Supply Chain Relations data. Results indicate that doubling the frequency of storms can raise default rates by 16.3%, while floods and droughts increase defaults by 13.6% and 8.1%, respectively. Moreover, the paper shows that adaptation measures can significantly mitigate defaults. The study emphasizes the critical role of supply chains in transmitting climate risks, with sectors like transportation and energy minerals being especially vulnerable. It also highlights the need for adaptation strategies tailored to specific climate risks to maintain financial stability.
Assessing the vulnerability of food supply chains to climate change-induced disruptions
Tchonkouang et al. (2024) conduct a systematic review of the literature on vulnerabilities of food supply chains to disruptions caused by climate change. The paper surveys 67 publications and provides evidence of a weakening in the food supply chain due to climate change and extreme weather events. Extreme temperatures and droughts constitute the biggest risk factor for the food supply chain. Countries in the Global South, especially in tropical and subtropical regions, are expected to face more severe impacts on agricultural yields and food prices, which could trigger ripple effects along the supply and demand sides of the supply chains. The paper also highlights that disruptions in the food supply chain could lead to shock transmission both in terms of quantity produced as well as in terms of prices. Building resilience in food supply chains could prove vital for global economic stability in the face of future climate change scenarios.