Climate effects on the diversification strategy of export firms: Evidence from China

strategies should aim to assist these firms in enhancing worker conditions, upgrading produc- tion equipment with advanced technologies such as digitization, and instituting monitoring systems to decrease machinery sensitivity to temperature. Such measures will foster the evolu- tion of green and sustainable production practices. Impact of regional financial development Access to finance is pivotal for firms seeking to bolster their resilience against extreme climate events [41,42]. In regions with immature financial systems, financing channels are often lim- ited, the cost of borrowing for firms is higher, and the amount of financing available is lower. These constraints make it harder for firms to get the support they need to cope with sudden economic pressures, such as those caused by extreme climate events [43]. Furthermore, finan- cial constraints may prevent timely adjustments to production processes or supply chains, lim- iting their ability to maintain or expand a diverse range of products and services in the face of extreme temperature changes. In addition, these financial constraints may limit the ability of firms to develop new products or services to respond to market shifts, thereby reducing their adaptability and survival in extreme climatic conditions. However, the extent and speed with which firms can access finance is influenced by a number of factors, of which the external financial environment is a key one. The local financial environment has a direct impact on the efficiency and economy with which firms can secure external finance. Regions with more

advanced financial systems often have a larger number of financial institutions and more robust capital liquidity, offering firms more efficient and cost-effective financing options. As a result, we expect the negative impact of extreme temperatures on firms’ diversification strate- gies to be less pronounced in cities with mature financial systems. To empirically examine this hypothesis, we employ the ratio of city commercial bank branches to total financial institution branches as an indicator of a city’s financial development level. City commercial banks reflect the maturity of urban financial systems in three ways: First, they possess greater autonomy than larger banks in approving loans to small and micro firms, which aids in expanding credit supply and equalizing the distribution of financial resources, thus reducing financing costs; Second, as local financial institutions, they have a deeper understanding of local economic conditions and market situations, effectively reducing information asymmetry and providing higher quality credit services; Third, the competition they introduce stimulates the financial industry, enhancing the availability of financing chan- nels for firms and alleviating capital constraints. Based on the median level of financial devel- opment, cities are divided into two categories: those that are less developed (Underdevelope group) and those with advanced financial systems (Advance group). A regression analysis is then carried out (as shown in columns (3) and (4) of Table 5-I). The results show that in cities

with less developed financial systems, extreme temperatures significantly inhibit the firms’ diversification strategies in export markets. In contrast, this negative effect is significantly reduced in cities with a mature financial infrastructure. This finding highlights the importance of local financial development in enhancing firms’ strategic flexibility and risk management in the context of climate change, particularly in terms of resource allocation and mitigation of economic shocks. Impact of economic development level and energy usage The previous analysis has shown that a higher level of financial development in cities can enhance firms’ adaptability to extreme temperatures by providing greater access to capital and more sophisticated financial services. However, a potential concern is that financial develop- ment may be closely related to the city’s economic development, potentially masking the PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 17 / 28

effects attributed to the financial system alone. To investigate this, the sample is segmented into less developed cities (Developing group) and developed cities (Developed group) based on the median gross domestic product (GDP) of the firms’ locations, and regressions are run for each group. The results are shown in columns (1) and (2) of Table 5-II. The regression results indicate that firms in developed cities are more likely to reduce the diversity of export products under extreme temperatures, while those in less developed cities tend to maintain or even increase their diversification strategies, with some temperature conditions promoting a posi- tive effect. This suggests that the positive moderating role of financial development is not driven by the level of economic development. Conversely, economic growth does not seem to improve the adaptability of local firms to extreme disasters. To clarify why firms in more developed cities are more affected, the sample of these cities is further divided into low-energy consumption cities (Lenergy group) and high-energy con- sumption cities (Henergy group), using the median of energy consumption per unit of GDP as a criterion. This indicator is derived from provincial energy consumption divided by provin- cial GDP, reflecting energy consumption per unit of economic output. Since adaptation to extreme temperatures for businesses and residents often relies on energy-intensive tools such as air conditioning or heating systems, it was hypothesized that higher energy consumption

could facilitate adaptation to extreme temperatures, potentially offsetting the negative regula- tory effects of temperature impacts on economically advanced cities. Specifically, regressions were run separately for high and low-energy consumption cities within the developed city cat- egory. The results, presented in columns (3) and (4) of Table 5-II, show that in areas with lower energy consumption, the diversification of firms’ export products decreases signifi- cantly, while the opposite is true for areas with higher energy consumption, suggesting that energy consumption enhances the ability of firms to adapt to extreme temperatures. Impact of firms’ location Scholars generally believe that short-term impacts can be mitigated in the long term through behavioral adjustments of economic agents, leading to adaptability (Hornbeck, 2012). This study delves into the development of temperature adaptability across different regions in China, a nation characterized by substantial latitude and temperature gradients. Specifically, we scrutinize whether northern China, which experiences lower average temperatures and fre- quent cold weather, has greater adaptability to low-temperature shocks, and whether southern China, with its higher average temperatures and frequent hot weather, is more adept at coping with high-temperature shocks. Our analysis classifies Chinese cities into southern and northern regions based on eco- nomic geography. The southern regions include Shanghai, Jiangsu, Zhejiang, Anhui, Fujian,

Jiangxi, Hubei, Hunan, Guangdong, Guangxi Zhuang Autonomous Region, Hainan, Chong- qing, Sichuan, Guizhou, Yunnan, and Tibet Autonomous Region. The northern regions include Beijing, Tianjin, Hebei, Shanxi, Inner Mongolia Autonomous Region, Liaoning, Jilin, Heilongjiang, Shandong, Henan, Shaanxi, Gansu, Qinghai, Ningxia Hui Autonomous Region, and Xinjiang Uygur Autonomous Region. This analysis excludes Hong Kong, Macau, and Tai- wan. We then conduct grouped regressions, as shown in Table 5-Ш. Column (1) shows results for firms in northern cities, where both low and high temperatures exert insignificant impacts. Column (2) presents results for firms in southern cities, which are the epicenter of China’s trade firms and the primary driver of our findings. High temperatures are found to signifi- cantly diminish the diversity of export products, suggesting that southern cities have not yet achieved effective adaptation to high temperatures. Considering China’s current economic geography, marked by a more robust southern region and a relatively weaker northern PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 18 / 28

counterpart, this conclusion underscores that even firms in developed regions are poorly adapted to climate shifts. Southern cities, being vital to China’s foreign trade, ought to priori- tize strategies for preparing for escalating temperatures and increasing extreme heat events. This can be accomplished by investing in climate-adaptive infrastructure and guiding firms to enhance their production environments, thereby promoting sustainable development. Our findings are in harmony with those of Zhang and Li (2023) and Burke et al. (2015), who observed that regions with warmer climates or higher economic wealth have not implemented substantial adaptive measures, with economic indicators remaining sensitive to high-tempera- ture shocks. Furthermore, aligning with the methodology of Zhang and Li (2023), we categorize cities as historically hot or cold based on their average annual temperature from 1970 to 1999. Cities that surpass the national median temperature are designated as hot, while those below it are labeled as cold, with regressions conducted for each group. Columns (3) and (4) of Table 5-Ш reveal that in historically hot cities, an upsurge in the frequency of high-temperature days is significantly associated with a reduction in export product diversity. Conversely, in historically cold cities, an increase in the frequency of low-temperature days tends to reduce export prod- uct diversity, although this effect does not achieve statistical significance. These results are con- sistent with those of columns (1) and (2), indicating that Chinese export firms have not yet

implemented significant adaptive adjustments to temperature fluctuations. As climate change intensifies and high temperatures, particularly extreme heat, become more prevalent, southern Chinese cities are poised to confront more severe repercussions. It is imperative that govern- ments and firms in these regions prioritize strategic adjustments to augment their climate adaptability. Structural factors in export diversification decline In this section, we analyze the factors that influence the reduction in the variety of product cat- egories exported by firms due to extreme temperatures. We adopt a dynamic perspective, focusing on three key aspects: product entry, survival, and exit. Specifically, the number of product categories exported by firms can be decomposed into two main components: Diversityit ¼ X pNewipt þ X pExistipt ð13Þ Where i, p, and t denote the firm, product, and year respectively. Diversity reflects the export product categories of the firms. Newipt is equal to 1 if product p belongs to a new cate- gory. Otherwise, it is equal to 0. Here, new category denotes products that were absent in the previous year but are present in the current year. Existipt is equal to 1 if the product p belongs to an existing category. Otherwise it is equal to 0. Where, exist category refers to products that exist in the previous year and continue to exist in the current year. Eq (13) expresses that the total number of product categories exported by a firm in a given year is equal to the sum of the

new categories added and the number of categories surviving from the previous year. There- fore, on the basis of Eq (13), we will examine how temperature affects the number of new prod- uct categories and the number of existing product categories in the export of firms. We replaced the dependent variables in Eq (11) with the number of newly added and exist- ing product categories in firm exports, respectively, for the regression analysis, yielding the results shown in Fig 4. Solid circles indicate the effect of temperature on newly added product categories, while triangles indicate its effect on existing product categories. The shaded area includes the 90% confidence interval, with blue and grey shading indicating the confidence intervals for newly added and existing product categories respectively. The regression results PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 19 / 28

show an inverted U-shaped relationship between temperature and both newly added and exist- ing product categories. The results suggest that extreme temperatures reduce the product diversification of firms’ exports by reducing the variety of both newly added and existing prod- ucts. Looking at the marginal effects, temperature bins have a more pronounced negative effect on newly added product categories than on existing ones. The addition of new products, which indicates positive development and expansion, is hindered by unfavorable tempera- tures, which poses a challenge to the long-term sustainable growth of firms. In addition, a dynamic decomposition of changes in the number of product categories exported by firms can be expressed in the following formula: DDiversityi;t ¼ X pNewip;t X pExitipt ð14Þ Where Exitipt equals 1 if the product p belongs to an exit category, otherwise it is 0. Exit cat- egory refers to products that were present in the previous year but are absent in the current year. The remaining variables are consistent with the above context. Eq (14) shows that the change in the number of product categories this year is equal to the number of new product categories minus the number of exiting product categories. This dynamic change in product exits, as indicated by Eq (14), influences the second-order changes in the number of product categories exported by firms. In this section, we examine the impact of temperature on product exits in firms’ exports using two different approaches.

We use Eq (11) to regress the influence of temperature on the number of product categories that firms exit from the export market, represented by the blue dots in Fig 4. These dots repre- sent the impact of the temperature bins on the exiting product categories. In particular, tem- peratures above the optimal range tend to increase the number of product categories exiting Fig 4. Temperature and dynamics of firm exported products. Solid circles indicate the effect of temperature on newly added product categories, while triangles indicate its effect on existing product categories. The shaded area includes the 90% confidence interval. https://doi.org/10.1371/journal.pone.0308391.g004 PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 20 / 28

the export market, while the opposite trend is observed when temperatures fall below the opti- mal range. However, the effects in the lowest and highest temperature bins lack statistical sig- nificance. Consequently, there is no conclusive evidence indicating that extreme temperatures reduce the number of exported product categories by encouraging product exits. In addition, we examine this issue in more detail using data at the firm-product level. We build the following econometric model: Exitipcrt ¼ a þ X m6¼5bm 1 Tbinm crt þ d1Xcrt þ gi þ gpt þ grt þ εipcrt ð15Þ Where, Exitipcrt indicates whether product p of firm i has exited the export market in year t. If the product has exited, the value of Exitipcrt is 1; otherwise it is 0. The other variables retain their meaning from the previous context. The regression results, shown by the black triangles in Fig 5 (corresponding to the right axis), indicate the influence of temperature bins on the probability of products exiting the export market. The results are consistent with the effect on the number of exiting product categories. Specifically, temperatures above the optimal range tend to increase the probability of products exiting the export market, while the opposite is observed for temperatures below the optimal range. However, statistically, the effects in the low-temperature bins lack significance below a 10% threshold, while the effects in the high- temperature bins show some significance. Overall, temperatures above the optimal range mod- erately increase the likelihood of products leaving the export market.

Extensive research In the benchmark regression, our focus is on assessing the influence of temperature on firms’ export product diversification. Another important aspect of diversification in export strategies Fig 5. Temperature and product exits. The dots depict the impact of the temperature bins on the exiting product categories, corresponding to the values on the left-hand axis. The triangles. depict the impact of the temperature bins on the probability of products exiting the export market, corresponding to the values on the right-hand axis. https://doi.org/10.1371/journal.pone.0308391.g005 PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 21 / 28

is the diversification of export destinations [44]. Given the increasingly complex global politi- cal and economic landscape, strategic decisions regarding the international distribution of sales networks have become paramount. Like product diversification, export destinations diversification serves as a crucial risk mitigation strategy for firms [45]. However, due to the associated entry costs, firms face limitations in expanding their export destinations. Typically, firms with higher productivity are better able to cover market entry costs, allow- ing them to develop additional export markets. Conversely, as productivity declines, firms may choose to minimize costs by abandoning certain export markets. Building on previous studies [27], we expect that deviations from the optimal temperature, which tend to reduce firm productivity, will lead firms to reduce their export destinations, resulting in a lower degree of diversification. We then empirically test this hypothesis using the following econo- metric model. Countryicrt ¼ a þ X m6¼6bm 1 Tbinm crt þ d1Xcrt þ gi þ grt þ εicrt ð16Þ The variable Countryicrt denotes the number of destinations of the firms’ exports, while the other variables retain their meanings consistent with the previous context. We refer to the tem- perature bin 13~18˚C as the baseline group for the regression, as the empirical analysis identi- fied it as the optimal category. The regression results are presented in Fig 6, where the solid dots represent the regression coefficients for each temperature bin, accompanied by their

respective 90% confidence intervals. The results show that the regression coefficients for all temperature bins are negative, implying that destination diversification has an inverted U- shaped relationship with the temperature bins, suggesting that as temperatures deviate further from the optimal range, there is a greater reduction in the number of destinations for firms’ exports. In particular, the impact of extremely low temperatures is more pronounced and eco- nomically significant than that of high temperatures. Fig 6. The effects of temperature on firms’ export destination. https://doi.org/10.1371/journal.pone.0308391.g006 PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 22 / 28

Further analysis examines the influence of temperature on the diversification of firms’ export relationships. The diversification of relationships is defined as the number of country- product pairs for exports. When this variable is substituted into Eq (16) for the regression, the results presented in Fig 7 show an inverted U-shaped pattern. In contrast to the effect on export destinations, the high-temperature bins yield more significant coefficients, indicating a significant reduction in firms’ export relations as the positive deviation from the optimal tem- perature increases. In the low-temperature bins, only the coefficient for -2~3˚C passes a 10% significance test. The above results suggest an inverted U-shaped relationship between temper- ature and the diversification of firms’ export destinations and relationships, but characterized by an asymmetric effect between high and low temperatures. Discussion Previous studies have revealed a nonlinear, inverted U-shaped relationship between tempera- ture and economic output at both macro and micro levels. Specifically, micro-level research indicates that extreme temperatures reduce industrial firms’ output, productivity, export vol- umes, and product quality. Using non-parametric models, this paper examines how tempera- ture influences export firms’ diversification strategies. Unlike prior research that focused on the scale of firms or economies, this study delves into how extreme temperatures affect the variety of exported products, export partners, and relationships. This provides a deeper under-

standing of the multidimensional impacts of extreme temperatures on economic behavior and their profound economic implications. The findings reveal that export firms adjust their diver- sification strategies in response to frequent extreme temperatures, affirming the inverted U- shaped relationship between temperature and export diversification. Our study complements previous micro-level climate economics research by emphasizing export diversification. These Fig 7. The effects of temperature on firms’ export relationship diversification. https://doi.org/10.1371/journal.pone.0308391.g007 PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 23 / 28

findings have significant practical implications for enhancing firms’ export market diversity and competitiveness and promoting climate adaptability among firms and society. Our research uncovers that temperature shocks, both high and low, are associated with a diminution in the variety of export products among firms. Specifically, for a prototypical firm, an increment of one day with temperatures below -2˚C is correlated with a decrement of 0.22 in the count of export product categories, aggregating to a yearly reduction of 2.94 categories. Similarly, an increment of one day with temperatures at or above 28˚C results in a 0.09 decrease, culminating in an annual reduction of 4 categories. These results demonstrate robustness after accounting for endogeneity concerns, utilizing alternative methodological approaches, addressing outlier effects, refining the hierarchy of standard error clustering, and reconfiguring temperature bins through diverse methodologies. By dynamically decomposing products, our findings indicate that extreme temperature shocks reduce the number of export product varieties primarily by decreasing the number of new and continuing product varieties. However, the exit of products does not emerge as a predominant catalyst. Positive deviations from the optimal temperature marginally enhance product exits, thus diminishing export product diversity. In contrast, negative deviations do not incite product exits and exert a dampening influence under certain temperature conditions. Furthermore, we also find that

temperature exhibits an inverted U-shaped relationship with both the number of export desti- nation countries and the number of export relationships. Upon delving deeper into the types of firms that exhibit climate adaptability, our research indicates that general trade firms are more resilient to extreme temperatures compared to pro- cessing trade firms. This enhanced resilience may stem from their robust profitability, elevated wage structures, and substantial investment in research and development (R&D), which col- lectively enable them to furnish superior working conditions and allocate resources towards climate adaptation initiatives. Firms located in regions with developed financial markets dem- onstrate greater adaptability to extreme temperatures. However, a higher level of economic development in a city does not necessarily enhance firms’ adaptability unless accompanied by high energy use. Finally, our findings suggest that firms have not yet fully adapted to the local climate conditions, implying that climate adaptation strategies are not integrated into firms’ decision-making frameworks. Furthermore, there may be an absence of adequate climate adaptation infrastructure within certain cities. This disparity is particularly pronounced in southern Chinese cities, which play a pivotal role in export trade and are frequently subjected to high temperatures. Despite this, the firms in these regions have not demonstrated a suffi- cient level of adaptability to thermal extremes. The study has some limitations that need to be further explored in the future. Firstly, our

empirical study is constrained by the scope of available data, which encompasses the period from 2000 to 2016 and represents the most recent and extensive dataset of firm-level export information in China. However, given the rapid development of digital technology and artifi- cial intelligence, it is worth exploring whether the conclusions of this study remain valid or have been subject to considerable alteration. Future research would be enriched by accessing more current and granular data, allowing for a deeper investigation into these phenomena. Research efforts could concentrate on evaluating recent data to discern whether the influence of prevailing extreme temperatures has been exacerbated or ameliorated through the digital technology revolution or advancements in artificial intelligence. Undertaking such an updated analysis would not only deepen our comprehension of the impact of climate change but also guide the development of strategies that harness contemporary technology to adapt to these shifts. Secondly, our study shows that extreme temperatures affect firms’ diversification strate- gies and that certain factors could potentially augment firms’ adaptability to temperature changes, thereby reducing the impact. Future research could further systematically investigate PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 24 / 28

which factors play a more crucial role in enhancing the climate adaptability of firms and how they operate. Conclusion Building on a theoretical framework, this study investigates the relationship between tempera- ture and firm diversification in the export market using China’s daily meteorological data and detailed customs export data from 2000 to 2016. Employing a non-parametric model, we iden- tify an inverted U-shaped relationship between temperature and export product diversifica- tion. In the analysis of climate adaptability, general trade firms demonstrate greater adaptability to extreme temperatures compared to processing trade firms. Firms located in cit- ies with developed financial markets also tend to exhibit stronger adaptability to extreme tem- peratures. However, a high degree of urban economic development does not necessarily enhance local firms’ adaptability to extreme temperatures. Energy consumption, on the other hand, can enhance the adaptive capacity of firms in developed regions. Lastly, the study observes that firms have not yet fully adapted to local climatic norms, especially in southern regions, which serve as important trade hubs and remain highly sensitive to heat shocks. A dynamic decomposition of firms’ export products reveals that extreme temperatures reduce the variety of export products primarily by decreasing the number of newly introduced and existing product categories. Moreover, the research discerns an inverted U-shaped relationship between temperature and the diversification of both firms’ export destinations and relationships.

The findings of this study yield significant policy implications for both corporate entities and governmental bodies. Initially, there is an imperative for the establishment of capacity- building initiatives focused on fortifying the resilience of firms, with a particular emphasis on processing trade firms. This could encompass educational programs and training modules on the assessment and management of climate-related risks. At the onset of 2024, China’s Minis- try of Commerce, in conjunction with other governmental departments, introduced a suite of 12 measures to enhance the development of processing trade, aiming to create a "Processing Trade 2.0" and accelerate the transition of firms from OEM (Original Equipment Manufactur- ing) to ODM (Original Design Manufacturing) and OBM (Original Brand Manufacturing). Processing trade firms should leverage these policy initiatives to gradually upgrade and trans- form, providing more competitive work environments and salaries for labor, focusing on green and sustainable development, and proactively investing in climate adaptability. This will enable them to achieve greater autonomy and strategic flexibility in international competition. Secondly, the government needs to accelerate the construction of climate-adaptive cities, particularly implementing high-temperature adaptation measures in southern cities. This ini- tiative should encourage the southern regions to invest more in infrastructure designed to withstand extreme heat and gradually increase fiscal expenditure on high-temperature adapta-

tion. It should also use financial mechanisms to incentivize firms to contribute to climate resil- ience. For example, Encouraging green finance initiatives can help direct capital towards sustainable practices and technologies. This could involve creating financial instruments that favor environmentally friendly investments. Policies should support R&D in climate-resilient technologies and practices. This could include public-private partnerships to innovate in areas such as energy efficiency, sustainable materials, and smart logistics. Lastly, cognizant of the inherently global dimensions of trade, international cooperation is essential to address climate change. Policies should support global initiatives aimed at reducing emissions and promoting climate adaptation. By considering these policy implications, gov- ernments can play a proactive role in helping their economies transition to a more climate- PLOS ONE Climate effects on the diversification strategy of export firms PLOS ONE | https://doi.org/10.1371/journal.pone.0308391 August 16, 2024 25 / 28

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