Why climate costs keep mounting: A blind spot in Europe’s public finances

Today, it is no surprise that lives and livelihoods are under threat from climate change. From wildfires to floods, climate disasters are a frequent fixture of Europe’s news. 

This summer, two out of every three heat-related deaths in Europe were caused by human-made global warming. The economic costs are staggering, too. According to the European Environment Agency, climate-related disasters in Europe incurred losses of over €162 billion between 2021-2023. That’s a quarter of all climate-related losses since 1980 in just three years, and the insurance sector cannot cope. Europe’s largest insurer, Allianz, already estimates that approximately 60% of natural disaster losses are not insured and that additional investments of over €300 billion per year are needed to strengthen resilience to natural disasters.

Europe is already living with climate disruption. And the trajectory is clear: tipping points and feedback loops are no longer abstract warnings. Climate change is accelerating, bringing higher costs and deadlier consequences. 

So what is being done? Is Europe prepared for an escalating climate crisis? The short answer is no. 

Fiscal space 

Europe’s response depends upon an arbitrary but decisive factor. Fiscal space. 

Fiscal space is the wiggle room governments have to spend, for example, on climate resilience, like flood defences, wildfire prevention, and transport resilience. In Europe, this capacity to spend is artificially limited by two things.

1. National fiscal rules

EU countries face strict limits on how much they can borrow and spend relative to debt and GDP. These rules make little distinction between wasteful spending and long-term investment. As a result, governments are discouraged from investing in climate resilience, even when it would save billions in the future.

2. The EU budget

At the European level, fiscal space is tiny. Even with the new multiannual financial framework, the EU budget represents just 1.3% of the Union’s economy, compared to around 23% for the US federal budget. Contributions are set by Member States and defined by narrow national interests. As a result, the capacity to pursue common priorities, like climate resilience, at the European level is extremely limited. 

Institutional stalemate

Europe faces a political impasse. The Commission restricts Member States from spending enough on climate at the national level. And Member States restrict the Commission from expanding the collective budget and increasing investment at the EU level.

But the climate crisis doesn’t recognise this institutional stalemate. Governments will have to spend. Europe can invest now in climate mitigation and adaptation or pay many times over as the climate crisis intensifies. Like a house with a leaky roof, repairing it today may be costly, but waiting means paying far more in water damage, ruined furniture, and structural repairs. If Europe doesn’t do the same and build, for example, flood defences, it will spend significantly more on emergency responses as the climate crisis intensifies. This is the cost of action vs inaction. 

Where will the money come from? 

Addressing climate change will require upfront investments in the order of 5% to 10% of EU GDP per year. At just 1.3% for all EU budgetary expenditure, the current MFF is structurally incapable of bridging this investment gap, and Finance Watch research shows it cannot come from private capital alone. Even under the most optimistic assumptions, private markets can only match one-third of the EU’s essential investment needs. The rest must come from the public purse. 

The good news is that the rules which currently restrain public budgets are not laws of nature. They are arbitrary political choices. They were written down decades ago, and are subject to change whenever crises generate the political will. 

When COVID struck, the European fiscal rules were suspended. When energy prices soared, new EU budget facilities were created. Today, as the US retreats from European security, governments are suddenly given room to invest in defence. Each time, what was once called ‘rigid’ has proven flexible. When governments flip the switch, money arrives. It seems the rules work to pursue European priorities best when they are suspended. 

A new approach to fiscal discipline 

So what routes are available now? Finance Watch has a clear recommendation: the EU should incorporate future climate risk into the way it calculates and enforces fiscal rules. Integrating climate governance into the macroeconomic and fiscal framework is not merely a technocratic adjustment but a political necessity, since climate investments depend on economic and fiscal policy. 

In the private sector, banks and insurers routinely quantify climate risk, integrating it into investment and lending decisions to protect profits. Governments should do the same to protect people and public finances. It’s quite possible to integrate the future costs of climate change into calculations which define what ‘sustainable debt’ looks like. 

The fiscal rules should recognise the difference between spending that adds to long-term debt and investments that reduce future liabilities. This shift can be built directly into the existing machinery of the EU’s economic governance. The Commission’s Debt Sustainability Analyses, which guide the application of fiscal rules, already model debt paths decades into the future based on demographic change and growth assumptions. Yet they fail to include the fiscal costs of climate disruption, from floods to crop losses to infrastructure damage. The methodology can and should be updated to integrate climate scenarios.

The same applies to the European Semester, where governments receive Country-Specific Recommendations on spending and reform priorities. These recommendations could anchor climate investment needs in fiscal governance by linking them to national energy and climate plans. In practice, that would mean treating spending on resilience as a frugal investment. 

Fiscal space can be created for green investment; it already is for countries that want to increase defence spending. 

Illustration of the Finance Watch report “Fiscal Mythology Unmasked – Debunking eight tales about European public debt and fiscal rules“

Europe’s choice 

Europe can continue patching its fiscal framework with short-term fixes, stumbling from one crisis to the next. Or it can face reality: climate change is here, the costs are mounting, and only public investment at scale can build resilience. 

The rules are arbitrary, and they can change. The question is whether they are changed in time. Because with climate change, just like with a leaky roof, the cost of action is far lower than the cost of inaction. The Commission and Member States must stop treating climate resilience as optional and rewrite the rules before costs spiral out of control.

Max Krestchmer, Finance Watch

This Finance Watch opinion piece was originally published in the Deutscher Naturschutzring, accessible here in German