Climate-change adaptation: The role of fiscal policy

Climate change and natural disasters have important consequences on fiscal sustainability, especially for developing countries with limited financial resources and underdeveloped institutions. The paper contributes to shed light on the role of fiscal policy in climate-change adaptation, which aims at containing the economic damage of climate change. We use an overlapping generations (OLG) model for a small open economy in which adaptation reflects the extent to which public policies reduce the negative influence of climate change on the capital depreciation rate. Adaptation includes both preventive measures, i.e. investment in infrastructure, and remedial measures, i.e. post-disaster relief and reconstruction. Through model simulations we assess the costs and benefits of both remedial and preventive actions. We find that preventive intervention leads to higher GDP growth rates than either taking no action or waiting until remedial action is necessary. However, the evidence shows that, due to high costs of early adaptation and budgetary constraints, countries tend to focus on late corrective actions, also relying on international assistance. Given the expected increase in climate-related risks, a comprehensive strategy including both preventive and corrective actions would be desirable to strengthen resilience to shocks and alleviate the financial constraints, which particularly affect small countries.