Fiscal crises and climate change

Abstract

Climate change adaptation depends crucially on the fiscal space of countries. The historical accumulation of high debt levels among emerging and low-income developing countries, which are disproportionately affected by climate change, poses a significant concern. In light of this issue, we empirically examine the potential trade-off between reducing vulnerability to climate change and maintaining fiscal stability. Our findings indicate that governance, as a measure of institutional quality, is the key determinant of both fiscal stability and climate change preparedness. Thus, there is no inherent trade-off between the two aims. Higher levels of institutional quality result in increased preparedness for climate hazards and a lower likelihood of fiscal crises. However, our survival analysis also highlights that fiscal stability is contingent upon the debt burden, particularly the interest paid on that debt. This could potentially result in fiscal instability. In light of these findings, international efforts to address the consequences of climate change should aim to maintain relatively constant interest payments on debt among emerging and low-income countries during their ecological transition. Our results further suggest that enhancing human habitat conditions, while considering the role of governance, is the most effective means of simultaneously reducing the likelihood of a fiscal crisis and increasing preparedness for climate hazards. A reduction in the human habitat vulnerability index by one unit results in approximately a 40% decrease in the probability of a fiscal crisis, while an equivalent increase in governance reduces the probability by 55%.