How does climate change impact on international trade?

12 June, 2023

The Panama Canal. Photo: Rikin Katyal, Unsplash

Climate change is affecting prospects for trade and economic development around the world. Extreme weather can disrupt supply chains, damage the transport infrastructure necessary for trade in goods, and restrict people’s ability to travel. Changing climatic conditions and the policies introduced to address them are shifting the patterns of comparative advantage, creating risks for countries that rely on climate-vulnerable sectors but also new economic opportunities for countries with plentiful renewable energy sources such as wind, sunlight and minerals critical to the manufacture of clean infrastructure.

How does climate change disrupt trade?

The rising frequency and intensity and widening geographical spread of extreme and sudden weather events due to climate change, along with ‘slow-onset’ impacts including sea level rise, pose serious risks to the transport infrastructure necessary for the smooth and reliable operation of international trade routes. For example, hurricanes and floods can directly damage roads, bridges, ports and railway tracks and disrupt air transport. Policymakers’ awareness of these physical risks to trade have been heightened by recent crises such as COVID-19 and the war in Ukraine, as these have highlighted the vulnerability of transport infrastructure and international supply chains to risks emanating from outside the economic and financial system.

Maritime transport is particularly exposed to climate-related risks. Sea level rise represents a direct threat to the operation of ports, while changes in precipitation affect the viability of critical shipping hubs and passages. For example, the Panama Canal – which handles around 6% of global maritime commerce – directly depends on the availability of freshwater for its operation and is therefore highly vulnerable to changes in precipitation patterns and drought. The Canal authority has had to impose restrictions on the largest ships passing through because of falling water levels in nearby lakes. Low rainfall and heat-related evaporation have caused similar shipping disruptions in China’s Yangtze river. Both small island states and landlocked countries and regions are particularly vulnerable to this type of disruption given their reliance on a limited number of trade routes.

The complex and interconnected nature of global value chains that shape today’s international trade system also means that disruption in key locations can have an exaggerated effect for the global economy. This is particularly problematic when disasters hit regions that produce hard-to-replace, highly-specialised goods (for example, the production of electronics parts was disrupted during the Thailand floods of 2011).

Which traded sectors will be most adversely affected by climate change?

Agriculture

Changes in temperature, resulting in heatwaves and degraded land, and changes in precipitation levels, causing water stress and drought, can all damage agricultural output and drive up food prices. Heat stress also affects agricultural workers, impacting productivity. These factors affect the trade of food products and manufacturing sectors, such as food processing, that are dependent on climate-sensitive agricultural inputs. Developing economies in sub-Saharan Africa and South Asia are particularly vulnerable to this kind of damage, as they are heavily dependent on agricultural exports and large proportions of their populations are employed in the sector. Concerns about food insecurity exacerbated by climate change can cause countries to restrict crop exports in times of stress: for example, in May 2022 India, a major wheat producer, banned exports of the cereal on the grounds of protecting national food security during a heatwave.

Ocean warming and acidification associated with climate change are also negatively impacting fisheries, in turn affecting trade in ocean products and food security. This harms the livelihoods of rural, small-scale fishers and those involved in food supply chains in particular.

Manufacturing

As well as the disruption to manufacturing supply chains via problems caused to transport and agricultural inputs, temperature increases can result in productivity losses and the number of hours worked by exposing workers to heat exhaustion and causing equipment to malfunction, creating shortages in production and further damaging supply chains. High temperatures can also make trade more expensive by increasing the costs of cooling in storage facilities.

Tourism

Tourism can be severely disrupted by extreme climate and weather events, through both immediate damage to tourism infrastructure and gradual climatic changes that reduce the appeal of destinations over time (in addition to disrupting transport). For example, visitor numbers to Thailand dropped considerably in the aftermath of the 2003 tsunami, causing employment to decline. Portugal is an example of a country experiencing continued impacts on its tourism sector due to damage from wildfires. Gradual changes in temperature and rising sea levels can also affect tourism: for example, in ski resorts that rely on predictable and consistent snowfall, or in seaside resorts that attract visitors for natural beauty that is at risk from climate-related damage to ecosystems and biodiversity (such as Australia’s Great Barrier Reef).

Trade opportunities presented by the net zero transition and changing energy market

The energy transition from fossil fuels to renewables is shifting patterns of comparative advantage – that is, which countries and regions are best positioned to trade and manufacture certain goods the most efficiently. A greater focus on renewables, along with developments in energy technology such as energy storage and transmission, could radically transform global energy markets and trade. Places with the optimal combination of abundant renewable resources, land to accommodate solar or wind farms, and access to water can also benefit from developing hydrogen hubs that can export energy to large demand centres.

Comparative advantage in the old economy was shaped by endowment in fossil fuels. In contrast, the low-carbon transition will place greater importance on the availability of renewable energy sources such as wind and solar, which are much more universally abundant than fossil fuels (though still with a distinct geographical distribution). This means the emerging new global energy market has the potential to become more equitable and many emerging markets and developing economies are already capitalising on their potential for renewable energy production to achieve energy resilience and security. The Middle East and North Africa have established themselves as the most competitive regions, benefiting especially from their solar potential (e.g. Morocco’s Noor Ouarzazate Solar Complex and Egypt’s Benban Solar Park are currently the world’s largest). However, the high cost of capital in developing countries poses a barrier to their full participation in the new energy economy, even where renewable potential is high (for example, it costs three times as much to install a solar panel in Namibia than in Germany).

Major economies such as China, the EU and the US are also establishing themselves as big players in the future renewable energy market, with initiatives such as China’s 14th Five-Year Plan on Modern Energy System Planning, the EU’s Green Deal and the $1tn US Inflation Reduction Act. They benefit from large landmasses, enabling them to harness energy from a range of both sunny and windy climates, and access to low-cost capital.

The mining and production of ‘transition-critical minerals’ – used in the manufacture of renewable energy and also hydrogen and electric vehicle technologies – are unevenly distributed, meaning some countries will have a trade advantage over others in these materials. There could also be bottlenecks in their supply as demand increases, which would affect trade in both developed and developing economies and the pace of the transition overall.

Impacts of electrification on industry and productivity

The low-carbon transition opens up significant possibilities for the electrification of industrial processes. If energy-intensive industries such as steel, aluminium and base chemicals that currently emit significant amounts of CO₂ can be electrified, benefiting from cheaper energy from renewables, the result will be a different energy and industrial production map, no longer tied to fossil fuel access. Countries such as Chile, Brazil, Australia, Saudi Arabia, UAE, Mauritania, Namibia and Kazakhstan are already developing landmark projects through pilot investments across green hydrogen, green ammonia, green steel and low-carbon aluminium that could see them become strong players and early leaders in low-carbon industries.

The energy transition also has implications for productivity. Expanding (clean) energy to reach the over 700 million people in emerging markets and developing economies who still lack access to electricity would accelerate economic development given the criticality of energy to the agriculture, business, communications, education, healthcare and transportation.

Managed well by governments through domestic policies and through international cooperation, such changes in global patterns of trade and industry can diversify global supply chains and increase their resilience to shocks such as the physical impacts of climate-related disasters.

This Explainer was written by Danae Kyriakopoulou with Georgina Kyriacou and Natalie Pearson.