Multi-year droughts and their compounding economic impacts in Europe

Climate change is intensifying the frequency and severity of droughts, posing significant risks to regional economies, water resources, and food security. While the direct impacts of droughts on agricultural output and water availability are documented, their medium and long-term economic consequences across multiple sectors remain underexplored. In particular, drought effects may accumulate over time, with multi-year drought conditions potentially compounding economic impacts and creating lasting disruptions to different industries, labour markets, and public services. Given the spatial heterogeneity of drought exposure and economic structures, a fine-grained regional analysis is necessary to understand varying vulnerabilities and adaptation capacities. Using NUTS 3 regional economic data and firm-level metrics across Europe (1995-2022), combined with high-resolution climate data from EOBS, we employ Local Projection fixed-effects models to examine how drought duration and severity affect various economic outputs like production, productivity, investment, capital stock, and employment. We assess droughts using SPI and SPEI indices at 3, 6, and 12-month accumulation periods and analyze both their contemporaneous and lagged effects on economic outputs at fine spatial level. By combining high spatial resolution drought indices with comprehensive economic data and local projection methods, we capture heterogeneous regional responses that can be masked in national-level analyses. Specifically, we examine cumulative drought impacts over multiple years (1-4 years) to understand how multi-year drought conditions compound their economic consequences, providing insights into the medium-term persistence of drought-induced economic disruptions. This analysis provides crucial information for designing targeted adaptation policies and assessing climate risks at the regional level.