The International Monitory Fund (IMF) in a recent study of Fiscal Monitor says that global recovery is still weak and policymakers have not been able to address the issue effectively pushing the global economy to more and more risks. The fiscal policies are expected to address this situation with immediate effect in order to reduce vulnerabilities. Since April 2015, fiscal situations have worsened mainly in middle income economies and emerging markets reaching the levels of previous global financial catastrophe, the situation has pushed public debt ratios upward in these economies. Oil exporters in the Middle East and North Africa would be in difficult situations. The advanced economies also may face vulnerable situations due to low inflation, slow growth, and high public debts. It is understood that bold policy decisions are needed to address this situation, but the political pressure does not allow corrective remedies to take place in most of the major economies.
The key challenges in emerging and developing economies would be to provide budgetary provisions to cater rising demand for public services including health, education and infrastructure. The IMF says oil importing countries with large fuel subsidies can use savings of lower oil prices to support growth-enhancing reforms at the same time the economies should develop a risk management framework to reduce the high exposure.
Deteriorating monetary trends
Commodity exporters in emerging and developing economies experienced a considerable decline in their financial positions, where commodity importers have not been able to absorb the benefits of the same. Whilst advanced economies suffering due to high debt, low inflation, and low growth, decline in commodity prices, slowdown in trade, declining capital inflows to emerging and developing economies were also clearly observable.
Innovation and growth
The private sector of advanced economies is expected to invest 40% more in R&D which will have a positive impact on the GDP growth. It will have a positive impact on the global economy by way of spillover effect. Most of the firms find it difficult to find finances for the R&D investments due to the fact that R&D involves high risks and returns could be expected only in the mid- or long-term. However, the returns depend on human capital base of those countries, if the workforce is educated and has the capacity to absorb technological advances. China is a good example for high return on R&D efforts. Corrective Fiscal Instruments should be used to avoid any under investments in R&D. In other words, firms should be encouraged by offering tax credits and direct subsidies etc. The IMF report suggests that increasing private R&D could generate a significant growth dividend for the economy. It is estimated that boosting 40% of R&D investments may bring in approx. 5% GDP growth in the long run.
Encouraging technology transfer
It is noteworthy that more than 60% of the global R&D is taking place in G7 countries and absorbed in to other emerging and developing economies. It is through international trade and Foreign Direct Investments (FDI) that technology be transferred. Businesses can obtain technological knowledge by importing technically advanced capital equipment and intermediate goods or learn by importing technologically advanced products.
It is the practice of emerging and developing economies, setting up investment zones to attract FDIs and introduce tax holidays where the economy can get the best benefit by having high quality jobs, high productivity and much needed investment funding. The studies conducted in Africa Asia and Latin America reveals that tax incentives offered have very little impact on investment decisions of multinationals. Attracting FDIs to emerging and developing economies have other concerns such as Institutional quality, knowledge and infrastructure.
As per the IMF report, it is not only the large companies that should be invested in R&D, but also the small startups that should engaged in experimentation and risk taking. It is a known fact that large firms would tend to look at incremental development of their innovations, whereas startups are more radical in technical innovations and make the environment more competitive.
So it is very important to ensure institutional support for business entry growth and exit as well. Access to finance is one key issue faced by entrepreneurship, where the support can be extended through seed capital, early stage financing and venture capital, etc., other issues that affecting the entrepreneurship which are considered as non-fiscal – Permits, licenses, bankruptcy laws and unfavourable labour laws.
To ensure productivity growth and to promote innovations it is vital to pay attention to following aspects through fiscal policies. Promoting R&D will be a key aspect for the economy and even through recessions, firms should be able to keep on spending for R&D activities. The expectations from the governments are also of great significance, and reiterate the fact that pushing 40% more on R&D investments in advanced economies will have an impact of 5% GDP growth in the long run. This will certainly bring positive impact on other economies through spillover effect.
While designing fiscal incentives to support private R&D, governments are supposed to spend more on public R&D such as scientific research that would facilitate more towards the private sector R&D. The emerging and developing economies are saddled with a challenge of absorbing technology in to the economy, and all possible steps should be taken to attract FDIs. These countries are expected align policies to have better institutions, education and infrastructure and improving human capital base is also of paramount importance. Furthermore, tax preferences should be targeting the new firms entering the business promoting entrepreneurship.
Reference – IMF Fiscal Monitor April 2016
(The writer is the Secretary General/CEO of the National Chamber of Commerce of Sri Lanka)