Aligning climate & socio-economic governance within the European Semester

Introduction

As the world heads towards 2.7°C of warming by the end of the century,^[1] the security implications of climate change are becoming an increasingly important dimension of EU policy. The costs of inaction are projected to exceed the costs of shielding citizens and businesses from climate risks, which are estimated to be higher than USD 1.266 trillion.^[2] These costs represent an increasingly insurmountable burden for public budgets, undermining the ability of governments to sustain their lending capacity and service their debt. The current trend is largely driven by insufficient investment and persistent delays in implementing adaptation and mitigation policies.^[3] In these circumstances, the only responsible approach to fiscal policy is to invest in climate change mitigation and adaptation, and support social measures to avoid the spiralling and unmanageable level of public debt down the line.

At the European level, climate governance – the processes coordinating and monitoring implementation of the EU Climate law, intermediary targets, and the Paris Agreement – remains fragmented from the socio-economic governance, which coordinates and monitors Member States’ macroeconomic and fiscal policies. Yet, adaptation and mitigation policies have direct implications for Member States’ budget and fiscal trajectories. This position paper aims to address this gap to ensure EU socio-economic viability, along with the long-term sustainability of public finances.

I.  The need for public finance in a just transition

A. The limitation of private finance to tackle the just transition

It is widely recognised that private finance alone cannot deliver a just and sustainable transition. In 2020, only one in three assets worldwide was managed under a so-called “sustainable” strategy, within a global asset management industry valued at USD 103 trillion.^[4] Asset managers’ investments in fossil fuels were still roughly double those directed towards clean energy.^[5] Moreover, in 2024, the world’s 65 largest banks channelled USD 869 billion to companies linked to fossil fuel activities.^[6]

There are several reasons why private finance alone cannot provide sufficient investment for a just transition. These challenges are often summarised under the concepts of “bankability” and “negative externalities”. The structure and culture of our economic system are not aligned with the long-term consequences of climate change. In this sense, investment horizons remain largely short-term, and the reliance on probabilistic assumptions biased towards the near future makes it difficult to integrate sustainability considerations into investment decisions.^[7] The dominant narrative at the EU level has also evolved to frame climate action as a burden for companies, portraying it as a source of competitiveness challenges in a globalised economy (see Annex 1). For this reason, Finance Watch, in its July 2024 report, called for improving the current “hybrid” economic system, in which private actors capture most of the gains while society bears the risks. In short, the current system is not adequate for protecting people from the risks associated with climate change. A key part of the solution is to strengthen the role of the state in imposing conditionalities for public spending and in steering strategic investments.^[8]  Public and private financing must work hand in hand, complementing each other to close the investment gap, which is estimated to exceed the trillion range.^[9]

B.    Public investment needs for mitigation and adaptation

As private finance remains constrained to support a just transition, stronger public-sector intervention is necessary. Indeed, climate change exposes the economy to significant disruption risks, that is, systemic threats capable of altering or even undermining fundamental societal structures. These disruptions carry far-reaching consequences for economic stability and the financial system.^[10] For this reason, both mitigation policies aimed at limiting global warming to prevent catastrophic outcomes, and adaptation measures, designed to address the already pressing socio-economic impacts of climate change are essential. Particular attention must be paid to shielding people and businesses from these risks through policies that ensure a just transition.

The EU adopted its first Adaptation Strategy in 2013 and updated it in 2021. This overarching program outlines EU policies to address climate change, and, despite its name, also includes mitigation measures, as the EU Climate Law is considered the foundation of the Union’s adaptation efforts. The strategy focuses on three key objectives: improving knowledge of climate impacts and developing solutions; reinforcing planning, implementation, and climate risk management; and strengthening climate resilience globally.^[11] Achieving these aims requires substantial public investment, estimated at 2% to 6% of EU GDP annually.^[12] Due to insufficient investment in adaptation and mitigation, the EU remains behind its objectives.^[13]

To address this investment gap, the first step should be to bridge socio-economic and climate governance at the EU level. Integrating climate risks into the European Semester would showcase the budgetary implications of unabated climate change and unlock the necessary fiscal space required. This would pave the way for mitigation, adaptation and related social policies through greater flexibility and targeted fiscal support, which are also critical to the long-term stability of public finances.

II. The European Semester, a framework for socio-economic and climate coordination

A.  Disconnected governance: the “Great Fragmentation”

European socio-economic governance is based on a framework for coordination and surveillance established during the Eurozone crisis, known as the European Semester. Within this annual cycle, the Commission monitors Member States’ compliance with the fiscal rules established in the Maastricht Treaty and the Stability and Growth Pact, namely a 3% deficit and 60% debt relative to GDP. The Semester also allows the Commission to issue recommendations and set the socio-economic priorities for the year, which are endorsed by the Council, the body responsible for discussion and final decisions.

Another mechanism that has gained momentum due to the Green Deal concerns energy and climate policies. The governance of the Climate and Energy Union is the EU’s framework for coordinating and monitoring progress towards the bloc’s climate and energy goals (facilitated by plans and reporting requirements) between Member States and the EU institutions.

The current European Semester continues to rely on a triptych of fiscal and budgetary surveillance, macroeconomic surveillance and social and economic coordination. Beyond occasional or abstract references in documents released throughout the Semester, climate governance remains largely fragmented from the socio-economic governance. In the latest Autumn Package (2026), references to the impacts of climate change remain largely anecdotal and are mostly linked to concerns related to employment, growth, social, market, expenditure, education, and poverty. References to climate appear only 18 times in documents related to fiscal, budgetary and macroeconomic surveillance, and fewer than 50 times in those related to socio-economic coordination. Socio-economic coordination covers a broad range of topics – mainly employment and labour-related issues such as housing – yet, given the overall volume of documents produced in the Package, climate considerations are marginal. Overall, public expenditure is predominantly discussed in relation to defence. In short, the 2026 cycle of surveillance and coordination remains largely focused on socio-economic governance, as if climate change were detached from economic and social policies.

As climate policies increasingly affect Member States’ budgets and fiscal capacities, synergies between climate and socio-economic governance need to be strengthened. The Commission’s Adaptation Strategy emphasises that “National fiscal frameworks in the EU include climate change and natural disaster fiscal risk only to a limited extent,” highlighting the “need to manage the risks to long-term public debt sustainability.”^[14]

Similarly, the Draghi Report highlights that fragmented governance is a major drag on the competitiveness of the EU economy. The report criticises the current design of the European Semester, which focuses on the coordination and surveillance of socio-economic policies but “does not entail the EU-wide coordination of policies.” It underscores the inefficiency of the current architecture, noting that “the established processes have so far proven to be largely bureaucratic (mainly producing reports) and ineffective in delivering relevant reforms at the EU level, favouring national initiatives under a common framework over true EU-wide coordination.”^[15] Taken together, these institutional assessments call for a reconsideration of the European Semester’s architecture and offer momentum to broaden its scope by integrating climate governance. Competitiveness is also an important notion to include in the Semester, although its interpretation remains ambiguous in EU policies and communications. Whilst a more specific discussion of the term is beyond the scope of this paper, Finance Watch considers competitiveness as the ability of the economy to efficiently allocate resources, maintain productivity and guarantee the well-being of its citizens, while remaining resilient to shocks such as climate change. In this sense, competitiveness requires robust governance and coordination mechanisms.

B.    Adapting the European Semester: towards a broader framework for surveillance and coordination

The most recent reform of the fiscal rules, adopted in April 2024, did not foresee any meaningful changes to the architecture of the European Semester. In the absence of political appetite for a comprehensive reform better accounting for the future needs of European society, including addressing climate risks and improving the coordination of socio-economic and climate policies, this proposal relies on using the full flexibility of existing legislation to integrate both socio-economic and climate governance. This approach does not require substantive legislative change. Moreover, it would enable more effective coordination between socio-economic and climate policies, supporting a just transition and enhancing competitiveness of the EU economy. In practice, the current timing of the Semester would be preserved (see Annex 2), with the Commission releasing its Autumn Package in November, Member States submitting relevant reports and data for surveillance and coordination in April, and the Commission concluding the Semester with its Spring Package in June.

Figure 1. The European Semester structured around three Pillars

This proposal to adapt the European Semester follows the Draghi Report’s recommendations on the coordination of competitiveness policies, as it recognises the need for the EU to establish a framework for the wide-ranging coordination of strategic policies.^[16] In this context, Finance Watch proposes to reconceive the European Semester as a framework for coordination and surveillance built around three pillars:

1. Fiscal climate and macroeconomic surveillance – processes related to the implementation of fiscal rules (draft budgetary plans, medium-term fiscal structural plans, reports in accordance with Article 126 TFEU, post-programme report); the monitoring of macroeconomic imbalances (the Alert Mechanism Report, European Macroeconomic Report, and in-depth reviews); and climate transition processes (National Energy and Climate Plans, National Long-Term Strategies, Social Climate Plans).
2. Socio-economic and climate coordination – the Commission’s assessment of socio-economic and climate performance (Country Reports, Joint Employment Report (JER)) as well as its recommendations (Annual Sustainable Growth Survey, Recommendation on the economic policy of the euro area, Country Specific Recommendations, Employment guidelines).
3. The Commission’s recommendations aimed at enhancing competitiveness (Annual Sustainable Growth Survey, Country Specific Recommendations) and any new coordination tools established at the EU level, such as the governance of the potential Competitiveness Fund.

The rationale behind the proposed change is to enhance the effectiveness of the EU’s surveillance and coordination processes. This would ensure that Member states’ fiscal and budgetary policies are aligned with the EU’s climate ambitions and the goal of strengthening the bloc’s competitiveness. Although it is true that certain documents produced under the current architecture of the European Semester already include (limited) links to climate policies (e.g. Annual Sustainable Growth Survey, Country Specific Recommendations), Finance Watch proposes adapting the framework to substantially strengthen these connections. Moreover, there is a clear need for rationalisation and simplification through the merging of overlapping documents and by turning the Semester into a true framework for EU-wide coordination, as advocated by the Draghi Report. Bridging the gap between climate and socio-economic governance would ensure that discussions and decisions regarding Member States’ progress on milestones and compliance with rules account for all relevant variables that may affect a country’s ability (or inability) to meet its obligations. Finally, stronger coordination around competitiveness is also essential, as it helps ensure the quality of public spending and supports a just transition.

Conclusion

A robust system of public finance governance is needed to ensure the resilience, sustainability and competitiveness of the EU economy – all of which are inseparably connected. Such a system requires, most notably, addressing climate change and the associated challenge of a sustainable and just transition. Yet, in the EU, fiscal, macroeconomic and socio-economic governance are fragmented from climate policies and do not take into account the growing impact of climate change and environmental degradation on public finances.

Finance Watch proposes bridging this gap by creating an integrated system of governance under the European Semester process. The proposed single framework for coordination and surveillance aims at addressing the interdependencies between different processes, aligning governance with EU priorities, whilst making the framework simpler and more efficient. The adaptations can be implemented within the existing legislative framework.