Does climate aid reduce perceived climate risks to foreign direct investors?

Studies show that climate risks are deterring multinational companies (MNCs) from making foreign investments in developing countries. This is worrisome, as foreign direct investment (FDI) is one of the key ingredients for generating economic growth and development in low- and middle-income nations. Investment avoidance is largely driven by concerns that adaptation costs will be left to MNCs. Therefore, they may not withhold investments when host states absorb those costs for them. Yet many developing countries lack the resources to do so. The international community is attempting to bridge this gap through the provision of climate aid. Aid inflows may signal to MNCs that a potential host state has the resources to address key climate risks, leading them to follow through on investments. This paper tests this argument by investigating whether climate aid reduces MNCs’ anxieties about investing in climate-vulnerable countries. Empirical results suggest that climate risks deter MNCs from investing in countries that receive low levels of climate aid. However, this effect vanishes as climate aid inflows rise. These findings indicate that foreign aid donors can play a productive role in ensuring ongoing inflows of FDI to developing countries, even in the presence of climate risks.