Supply chain transmission of climate-related physical risks

Summary

Focus

We use data on Brazilian municipalities between 2012 and 2019 to study how supply chains propagate shocks to economic growth from unusually dry or rainy periods. Climate-related physical risks can result in significant economic losses where they hit, but details about the transmission of shocks are still largely unknown.

Contribution

Brazil's continental size allows us to focus only on firm pairs located hundreds of kilometres from each other. Since climate conditions are local, we identify the effect on economic growth from climate anomalies that occur on customers and suppliers in other municipalities. We use sectoral data for each municipality to evaluate how economic sectors might respond differently to supply chain issues.

Findings

Climate anomalies depress growth in the location where they happen, and the shock is sufficiently material to propagate through trade linkages. Specifically, dry spells at municipalities with customer firms lead to lower growth, less demand for foreign trade and depressed labour markets. The data suggest that a meaningful portion of the effect is due to moderate, not intense, shocks. Agriculture and to a lower extent also manufacturing are more sensitive to supply chain shocks than services. We estimate also that supply chains contributed to transmitting climate shocks due to climate change.

Abstract

How do climate anomalies affect GDP growth, and how do trade connections help understand this impact? We address these questions exploring local fluctuations in temperature and precipitation coupled with data on supply chain linkages between municipalities in Brazil. GDP growth falls with local anomalous dry spells and to a lower extent, also wet spells. Much of this effect is attributable to moderate levels of climate anomaly. This impact is sufficiently material to transmit across supply chain connections to other municipalities. Focusing on pairs of distant municipalities to avoid common climate shocks, municipalities whose customer firms suffer dry spells have between 1 and 2 percentage points (p.p.) lower GDP growth. This supply chain shock also leads to lower import growth and weaker labour market metrics, suggesting an overall lower level of economic activity. We also examine the major economic sectors separately and find that agricultural activity is more sensitive to supply chain transmission of physical shocks, including moderate ones, than manufacturing (which responds mainly to intense supply chain shocks) or services. This suggests that the local economic mix can be a potentially important driver of effect heterogeneity. Using a counterfactual analysis, we estimate also that supply chain spillovers from climate change varies substantially over the years but can lead to 1 p.p. lower growth on average.

JEL classification: E32, L14, Q54, R15

Keywords: climate-related physical risks, precipitation anomalies, supply chains, GDP growth