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© 2021 International Monetary Fund
WP/21/193
IMF Working Paper
Strategy, Policy and Review Department
How do Climate Shocks Affect the Impact of FDI, ODA and Remittances on Economic Growth?
Prepared by Alassane DRABO1
Authorized for distribution by Johannes Wiegand
June 2021
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Abstract
The three main financial inflows to developing countries have largely increased during the last two decades, despite the large debate in the literature regarding their effects on economic growth which is not yet clear-cut. An emerging literature investigates the dependence of their effects on some country characteristics such as human and physical capital constraint, macroeconomic policy and institutional capacity. This paper extends the literature by arguing that climate shocks may undermine the effect of Foreign Direct Investment (FDI), official development assistance (ODA) and migrants’ remittances on economic expansion. Based on neoclassical growth framework, the theoretical model indicates that FDI, ODA, and remittances improve economic growth, and the size of the effect increases with good absorptive capacity. However, climate shocks reduce this positive effect of financial flows in developing countries. Using a sample of low and middle-income countries from 1995 to 2018, the empirical investigation confirms the theoretical conclusions. Developing countries should build strong resilience to climate change. Actions are also needed at global level to reduce greenhouse gases emissions, and build strong structural resilience to climate shocks especially in developing countries.
JEL Classification Numbers: F3, F4, 04, Q5.
Keywords: Financial flows, Climate shock, economic growth, absorptive capacity
Author’s E-Mail Address: alassanedrabo@hotmail.com
Table of Contents
Abstract
I. Introduction
II. Theoretical background: capital flows and climate shocks in neoclassical growth model
III. Financial flows, economic growth and climate shocks
A. How climate shocks may affect the financial inflows-economic growth nexus
B. Climate shocks and economic growth
IV. Empirical investigation
A. Empirical Models
B. Estimation strategy
C. Data
V. Results
VI. Robustness checks
VII. Concluding remarks
References
Figures
1. Financial Flows to Developing Countries in 2017
2. Financial Flows Trends in Developing Countries in 2017
3. Financial Flows in Developing Countries by Income Group
4. Financial Flows in Developing Countries by Region
5. Evolution of Precipitation Shocks Per Income Group
6. Evolution of Temperature Shocks Per Income Group
7. Correlation Between Absorptive Capacity and Climate Shocks
Tables
1. Effect of ODA, FDI and Remittances on Economic Growth
2. Absorptive Capacity Conditional Effect of ODA, FDI and Remittances on Economic Growth
3: Role of Average Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth
4. Role of Weighted Average Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth
Appendix 1: Tables
A1. List of Countries
A2. Data Sources
A3. Role of Climate shocks on the Effect of Financial Flow on Economic Growth Without Human Capital
A4. Role of Climate Shocks on the Effect of Aggregate Financial Flow on Economic Growth
A5. Role of Maximum and Minimum Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth
A6. Role of Natural Disasters on the Effect of ODA, FDI and Remittances on Economic Growth
A7. Role of Average Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth Using Three-year Time Periods
A8. Role of Average Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth According to Development Level
A9. Role of Average Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth According to the Period
A10. Impact of Climate Shocks on the Effect of ODA, FDI and Remittances on Economic Growth According to the Period: Role of Absorptive Capacity
We would like to thank Roland Kangni Kpodar, Vimal Thakoor, Wei Guo, Gregor Schwerhoff, Zamid Aligishiev, Giovanni Melina and Augustus Panton from the International Monetary Fund (IMF) for their relevant and valuable comments. This research is part of the IMF-FCDO project on Macroeconomic Research in Low-Income Countries (Project id: 60925) supported by the UK’s Foreign, Commonwealth and Development Office (FCDO). The views expressed in this paper are those of the author and do not necessarily represent the views of the International Monetary Fund (IMF) or FCDO.