Building Resilient Businesses in the Face of Climate Shocks: A World Bank Study

The study by the World Bank reveals that extreme weather events, particularly dry spells, significantly reduce firm performance, especially in developing economies and smaller businesses. Firms with innovation and digital connectivity show greater resilience, highlighting the need for policy interventions and infrastructure investments to combat the growing impact of climate change.

The World Bank’s Policy Research Paper authored by Roberta Gatti, Asif M. Islam, Casey Maue, and Esha Zaveri, explores the impact of extreme weather shocks on firms worldwide. This research, conducted by the Office of the Chief Economist of the Middle East and North Africa Region and the Planet Vice Presidency, leverages global data from the World Bank’s Enterprise Surveys, which contain precise geolocation of firms. The study focuses on the effect of dry spells and precipitation shocks on firm performance, particularly in terms of sales and market exits. It finds that extreme weather events, specifically dry days, have a significant negative impact on firms, with smaller businesses and those located in developing economies being the most vulnerable. For example, for every additional extreme dry day, firm sales drop by approximately 0.6%. On average, firms in areas that experience extreme dry days see a sales reduction of 3.8%, and in the most severe cases, firms facing up to 86 dry days, or about three months of drought, could suffer a loss of nearly 48.6% in sales.

Developing Economies Bear the Brunt

The study reveals that firms in developing economies, particularly in Latin America and the Caribbean, are more severely affected by these shocks compared to high-income economies. In fact, firms in Latin America show the most significant losses, while those in regions like East Asia, Sub-Saharan Africa, and the Middle East and North Africa are also impacted, though to a lesser extent. Notably, smaller firms and those in the service sector are particularly vulnerable, compared to larger firms or those in manufacturing sectors. This vulnerability stems from several factors, primarily related to infrastructure and labor productivity. The research highlights that dry spells disrupt key services such as water and power, which in turn negatively affect firm productivity. These disruptions are particularly harmful to smaller firms that may not have the resources to cope with such challenges. Firms that face frequent water shortages or power outages, which are exacerbated by dry spells, often experience greater operational difficulties, further contributing to their sales decline. Labor productivity also takes a hit during extreme weather events, with workers either being less productive due to the harsh conditions or being absent more frequently. This effect is especially pronounced in hot climates, where extreme temperatures further diminish the efficiency of the workforce.

Access to Finance Worsens the Impact

Access to finance is another key challenge for firms facing extreme weather shocks. The study finds that during periods of precipitation shocks, firms are less likely to secure loans or overdraft facilities. Banks, anticipating higher risks due to the unpredictable nature of these shocks, often raise interest rates or reduce the availability of credit, further straining the financial health of firms. Firms that are unable to access sufficient financing to weather these shocks often struggle to stay afloat, with some ultimately being forced to exit the market. The research indicates that the probability of a firm exiting the market increases significantly in regions experiencing extreme dry spells. However, the study also uncovers an additional, less expected channel: exposure to corruption. Firms located in areas suffering from severe water shortages or droughts report higher instances of bribery as they navigate the increased difficulty of obtaining critical resources.

Innovation and Digital Connectivity Offer a Lifeline

Interestingly, the study finds that not all firms are equally affected by extreme weather. Firms that are digitally connected, innovative, or export-oriented show greater resilience to these shocks. For instance, firms that own a website, engage in process innovation, or use technology licensed from foreign firms tend to experience less severe impacts on their performance. Exporting firms also display more resilience as they can rely on demand from foreign markets, which are less likely to be affected by localized extreme weather events. This suggests that digital technologies and innovation serve as a buffer against the negative impacts of climate shocks, helping firms adapt and maintain operations even in adverse conditions. However, the research also finds little evidence that firms respond to these shocks by adopting greener management practices or making green investments. Despite the growing emphasis on sustainability, firms exposed to extreme weather events do not appear to significantly increase their adoption of climate-friendly measures. One potential explanation is that firms may only adopt such practices after repeated exposure to shocks, or the adoption of such measures may be hindered by financial constraints or low-quality management practices.

Policy Interventions are Critical

The study underscores the urgent need for policy interventions to help firms, especially smaller ones in developing economies, build resilience against climate shocks. Investments in public infrastructure, particularly in water and power systems, are essential to help firms adapt to the increasingly unpredictable precipitation patterns caused by climate change. Moreover, fostering innovation and digital connectivity within firms could provide additional protection against weather-related disruptions. Finally, while the research highlights that firms are not necessarily adopting green practices in response to weather shocks, it suggests that other policy measures may be necessary to encourage sustainable investments and improve overall climate resilience.

A Call to Action for Policymakers

As climate change continues to intensify, the study offers valuable insights for policymakers aiming to mitigate the economic impact of extreme weather on the global private sector. This research reveals that firms, particularly in developing regions, are highly vulnerable to environmental shocks and may not necessarily adapt through greener practices unless incentivized through targeted policies. Therefore, building more resilient businesses will require a mix of infrastructural investments, financial support, and an emphasis on innovation and digital connectivity to protect firms from the growing threat of climate change.