A recent report released by the World Meteorological Organization paints a devastating picture of extreme weather events and the effects of climate change in Latin America and the Caribbean. Throughout the region, floods, droughts, heat waves, and hurricanes are killing hundreds of people, inflicting severe damage on infrastructure, and displacing population.
The situation is dire. Human activities are responsible for an average global temperature rise of approximately 1.1 °C above pre-industrial levels. While countries that are parties to the Paris Agreement have pledged to reduce emissions, these commitments are not enough to meet the Agreement’s targets.
Governments reached further agreements at the 2021 United Nations Climate Change Conference (COP26), but the situation remains precarious. Taking into account national climate commitments and other mitigation measures, the world is now on track for a global temperature rise of 2.7 °C by the end of the century. Such a rise could have an unprecedented impact on human and environmental systems, destroying ecosystems, displacing hundreds of millions of people, and generating enormous costs for the world’s economies and public finances.
If we want to combat climate change, one key step is to make sure all public and private financial flows are in line with the international objectives set out in the Paris Agreement. This will require developing funding mechanisms and information systems to identify, prioritize, and evaluate countries’ climate finance efforts, which hinges on first identifying and evaluating public spending on climate change in national budgets.
Classifying and identifying climate expenditures—a crucial step for countries
Identifying and tracking public climate expenditures helps ensure that such expenses are well managed in the first place. How so? Classifying climate expenditures reveals how much is being spent and on what. It also makes it easier to monitor and evaluate climate management, providing key information used to analyze fiscal risks tied to climate impacts and the transition to net-zero economies. Additionally, it is essential in order to slash public spending with negative or potentially negative climate impacts. What we need then is a consistent and coherent methodology that can be used to hold countries to their international commitments, evaluate the impacts of government action on climate change, and boost access to timely financing.
As great as this sounds, international policymakers have yet to agree on a methodology for identifying spending to address climate change. What’s more, efforts to regularly classify such spending are stymied by the limitations of countries’ public expenditure management and classification systems, as well as by the growing demand for information for sustainable development that adds complexity for data collection and classification.
For this reason, any proposed methodological framework must be compatible with the standard budget agency practices in the region. The ability to merely identify and classify climate expenditures is not enough—the methodology must also ensure that data is internationally comparable.
Being able to classify budget expenses and environmental activities is key to tracking information on public activity resources and expenditures. While countries in the region organize and classify statistical information using systems with varying levels of sophistication and specificity, all take their cues from international statistical standards for environmental and fiscal information, such as the System of National Accounts (SNA), the System of Environmental Economic Accounting (SEEA), and the IMF’s Government Finance Statistics (GFS) framework.
One highly useful standard is the Classification of the Functions of Government (COFOG), which can be used to analyze spending trends by purpose. Included in the IMF’s 2014 Memorandum of Economic and Financial Policies, the COFOG breaks down data on government expenditure into ten main categories according to their function, or purpose. It can thus serve as an analytical framework to assess how governments respond to society’s needs through public spending. However, we still lack a sufficiently detailed functional classification to identify all climate-related public spending, due to the cross-cutting nature of climate issues.
Climate public expenditure: a definition
Generally speaking, climate public expenditure can be defined as spending that seeks to address climate change or its impacts through actions such as mitigation or adaptation. In other words, climate spending is any spending that is mainly or ultimately aimed at responding to the climate crisis. But there are other expenditures whose main purpose isn’t to address climate change, but which—due to the technical nature of the activities implemented—nonetheless have significant impacts on climate management. There are also expenditures that respond to major climate impacts such as natural disasters associated with extreme weather events. We can consider the latter two as indirect climate expenditures, or expenditures with knock-on effects on climate policy.
This brings us to a fundamental methodological dilemma at the heart of countries’ climate action and systems for classifying expenditures by function. The current classification system fails to capture indirect or secondary actions or expenditures whose main objective isn’t climate change mitigation or adaptation—such as investments in renewable energies or public transportation—but which are nonetheless important for policymakers.
What we need is a methodology capable of identifying and classifying climate expenditures according to the logic of current classification systems and compatible with these systems, but that can also provide policymakers with climate spending information that isn’t boxed in by strict definitions based on main purpose or ultimate motivation.
A new IDB methodology to identify and classify climate public expenditure
With this objective in mind, the IDB recently developed a methodology for classifying climate expenditures that is both in line with international standards and compatible with the budgeting practices of countries in the region. Specifically, the methodology proposes grounding climate expenditure classification in the current structure of the COFOG system by using a double-entry functional classification matrix that takes into account both the primary and secondary purpose of climate expenditures, following the analytical approach of satellite accounting.
Under this methodology, countries design their own classification systems to obtain the inputs needed to track climate spending, evaluate it, and provide feedback on their budget formulation processes in order to optimize climate spending effectiveness and efficiency. The IDB has had success applying this methodology in Costa Rica, the Dominican Republic, and Jamaica, which we cover in other posts on this blog.
The methodology is just one of the spokes of the IDB’s institutional strategy to accelerate the region’s economic recovery through fiscal policies that increase its resilience to extreme weather events and attract green investment. As part of this effort, the IDB and the German government launched a $20 million fund at COP26 to strengthen green fiscal policies in Latin America and the Caribbean.
The methodology developed by the IDB was carefully designed to supply policymakers with the information they need to promote green fiscal policies. While climate change presents enormous challenges for the countries of Latin America and the Caribbean, the ability to identify and monitor public spending on climate change will be an invaluable tool for improving climate management and, above all, putting a price tag on what inaction would mean for the region.
Download the Conceptual Framework for Classifying Public Spending on Climate Change in Latin American and the Caribbean [Spanish only]
Learn more about the IDB’s work on fiscal management and climate change.
Related blog posts
Five reasons why COP26 is an important event for finance ministers [Spanish only]
What are the fiscal risks of extreme climate events and how to we address them? [Spanish only]
Climate Change Public Budget Tagging: Connections across Financial and Environmental Classification Systems
Fiscal Policy and Climate Change: Recent Experiences of Finance Ministries in Latin America and the Caribbean
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