April 2016 IMF Fiscal Monitor: Acting Now, Acting Together

Wednesday, May 4

Victor Lledo, Senior Economist, International Monetary Fund

Global fiscal developments and the associated risks and policy options, as well as the relationship between fiscal policy, innovation, and economic growth were the key topics of the April 2016 Fiscal Monitor. On May 4, Mr. Victor Lledo, an IMF senior economist, presented this flagship IMF publication at the JVI.

Mr. Lledo began on a sobering note, stating that downside risks had materialized since the October 2015 issue of the Fiscal Monitor. The April issue therefore now projects a higher public debt path for all major groups of economies, with the revision being relatively mild for advanced economies but quite substantial for emerging markets and middle-income economies.

These less favorable debt dynamics reflect both policy choices and adverse external developments. On the policy side, many advanced economies are confronted with the triple threat of low inflation, slow growth, and high debt. As a result, after four years of fiscal consolidation, adjustment efforts have stalled. For example, Germany and the Baltic countries relaxed their fiscal stance and Portugal slowed the pace of consolidation. External factors included falling oil prices and decelerating growth, which have pushed down revenues in emerging markets, especially among commodity exporters. And low-income economies must deal with far less favorable financing costs.

The challenges facing countries are diverse, so that there can be no “one-size-fits-all” approach to policy recommendations. The IMF sees merit in a continuing accommodative monetary stance in advanced economies. It is also crucial that fiscal policy address the two-fold task of supporting recovery and incentivizing structural reforms that promote long-term growth. To this effect, it will be paramount to ensure a coordinated response across both countries and policies. For oil exporters, mobilizing and diversifying revenue must continue to be a priority. Fiscal sustainability in China will depend on enhancing transparency, incorporating off-budget transactions into the budget, and managing the fiscal risks of nonviable state-owned enterprises. Low-income countries need to build up their tax capacity because too little tax revenue means that public investment is not sufficient and constrains long-term growth.

Mr. Lledo said the second chapter of the Fiscal Monitor, on policies for innovation and growth, identifies three pillars of innovation that can benefit from fiscal policy support:  research and development (R&D), technology transfer, and entrepreneurship.

Both public and private investment in R&D has high returns and should be given fiscal incentives. Public investment should complement private investment and encourage closer collaboration between universities and private firms. Private R&D investment would greatly benefit from fiscal stabilization, because that would reduce the costs of external financing for firms. The Fiscal Monitor reports that allocating about 0.4 percent of GDP in R&D tax credits and subsidies could help reduce R&D costs by about 40 percent and induce a 40 percent expansion in private R&D investment. The ultimate benefit could be additional economic growth of as much as 5 percent in the long run.

The design of incentives to encourage R&D, foreign direct investment, and entrepreneurship is critical to their effectiveness. As an example, Mr. Lledo noted that tax exemptions for intellectual property income are common, but not particularly efficient because they often lead to cross-country tax competition rather than rewarding R&D; it would be more effective to offer targeted exemptions or subsidies to R&D expenditures.

To promote growth, countries attract foreign investment, often by creating an incentive package that includes preferential tax treatment. New IMF staff estimates suggest, however, that such measures are far less important than economic and political stability, transparent laws, and the availability of skilled labor. Hence, improving institutions and spending more on education would be advisable.

Finally, fiscal policy should do more to support entrepreneurship. One current trend is to offer tax incentives to small businesses. However, these firms are usually neither new nor innovative. Tax incentives, then, can create a “small-business trap,” do not enhance the environment for creative destruction, and impede firms’ and wider economic growth.

After Mr. Lledo’s presentation, the audience raised a number of questions, for instance: should fiscal policy really be concerned with designing incentive packages when the risk of getting the design wrong is high, fiscal space is limited, and stabilization is a priority? How might higher aging-related spending further affect public debt trajectories? Are there still reasons to keep simplified taxation for small firms? Mr. Lledo reaffirmed that sustaining the recovery remains a priority, that there is no “one-size-fits-all” solution, and that even countries with little fiscal space can achieve a lot by restructuring their budgets accordingly. In the medium-term, he stressed, all countries should strive to enhance the resilience of public finances, among other things, to aging-related spending pressures and to foster sustainable growth. To achieve the latter, he concluded, fiscal policies should pay greater attention to incentivizing innovation.

Mikhail Pranovich, Economist, JVI


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