Fiscal Policy and Economic Growth Vitor Gaspar Director, Fiscal Affairs Department International Monetary Fund Peterson Institute for International Economics June 3, 15
Background The study draws on an extensive review of the literature and a three-pronged analytical approach: Nine in-depth country studies Analysis of 14 growth acceleration episodes in 11 countries Model simulations Country studies apply a novel statistical technique (the synthetic control method); and cover a diverse set of cases. Based on these complementary techniques we try to infer the ingredients of a successful fiscal reform strategy.
The global recovery remains weak and potential growth estimates have fallen 11 18 Real GDP, 3Q4-15Q1 (Index, 7Q4=1) 115 11 15 Advanced Economies (Index of Real GDP, 7=1) 1 14 1 Euro Area United States Japan 1 95 9 85 1 8 4 8 1 1 14 1 98 9 1 14 Emerging Markets (Index of Real GDP, 7=1) 94 1 9 1 9 8 Dec-3 Aug-4 Apr-5 Dec-5 Aug- Apr-7 Dec-7 Aug-8 Apr-9 Dec-9 Aug-1 Apr-11 Dec-11 Aug-1 Apr-13 Dec-13 Aug-14 4 8 1 1 14 1 Source: Haver Analytics, WEO, and IMF staff estimates. Fall 7 Fall 8 Spring 15 3
Fiscal stabilization is associated with lower output volatility and higher medium-term growth 8 Fiscal Stabilization, Output Volatility, and Growth: Cross-Country Correlations, 198 13 Fiscal Stabilization Coefficient versus Output Volatility 8 Fiscal Stabilization Coefficient versus Real GDP Growth Output volatility (percent) 7 5 4 3 1 Correlation =.4 Significant coefficients Insignificant coefficients -.5..5 1. 1.5. FISCO (fiscal stabilization coefficient) Sources: IMF, Fiscal Monitor, April 15, and IMF staff estimates Real GDP growth rate (percent) 7 5 4 3 1 -.5..5 1. 1.5. FISCO (fiscal stabilization coefficient) 4
Fiscal stabilization is more widespread in advanced economies Advanced Economies Emerging Markets and Low-Income Countries Number of countries 1 1 8 4 Median coefficient (.7) Number of countries 35 3 5 15 1 Median coefficient (.3) 5 -... 1. 1.4 1.8 Stabilization coefficient Insignificant Significant -. -... 1. 1.4 1.8. Stabilization coefficient Insignificant Significant 5
The paper analyses four key transmission channels of structural fiscal policies to growth Labor supply Human capital Physical capital Innovation
There is a broad menu of growth-friendly fiscal reform options Structural fiscal reforms can help build sound, growth-friendly, fiscal institutions. Both tax and expenditure policies can be made more growthfriendly. Labor supply: Improving the design of labor taxes and social benefits strengthens work incentives. Human capital: More equitable access to education and health care can contribute to human capital accumulation. Physical capital: Reforming capital income taxes to tax rents reduces distortions and encourages private investment. Productivity/innovation: Well-targeted tax incentives and efficient public investment in infrastructure can raise the economy s productive capacity. 7
Example 1: Improve efficiency 45 4 35 3 5 15 1 5 Advanced Economies Public Expenditure, 14 (Percent of GDP) Emerging Markets Low-Income Countries Public Expenditure Composition, 7-13 (Percent of total) 1 9 8 7 5 4 3 1 Advanced Economies 43% Emerging Markets Investment Social Benefits and Subsidies Goods and Services Compensation of Employees Low-Income Countries 8
Example : Strengthen work incentives 7 Advanced Economies 7 Emerging Markets and Low-Income Countries Tax Wedge (Percent of Labor Costs) 5 4 3 1 GRC ITA ESP BEL DEU FRA PRT CZE FIN EST LVA SVK SVN GBR JPN IRL USA AUT SWE NOR DNK NLD CAN AUS KOR ISR NZL CHE ISL Tax Wedge (Percent of Labor Costs) 5 4 3 1 ZAF TUR HUN BGR ARG COL NIC ROU UKR LTU UZB POL HND RUS TJK IND MEX CHL IDN BRA CHN KAZ BOL PER 4 5 7 Employment (Percent of Working-Age Population) 38 48 58 8 78 Employment (Percent of Working-Age Population) Source: IMF staff calculations. Note: the black lines show an ordinary least squares (OLS) regression line. 9
Example 3: Encourage private R&D R&D Expenditure and Growth, 1-1 Average Real GDP Per Capita Growth 1 1 8 4 - -5 5 1 15 Average Real R&D Expenditure Per Capita Growth Source: World Development Indicators Note: Excludes countries with fewer than five observations during the considered period. 1
Evidence from Country Studies Estimated Growth Gain (Percent, GDP per capita, 1-year average 1/ /) 5 4 Advanced Economies Emerging Markets Low-Income Countries 8 7 5 Long-Term Growth Post-Reform (Percent, GDP, 1-year average) TFP Labor Capital 3 1 Average EME and LIC Average, AE (excluding Ireland) 4 3 1 Total Advanced Economies Emerging Markets Low-Income Countries Source: IMF staff calculations. 1/ 5-year averages for Germany and Poland. / Chile (1) refers to the first reform episode (1974); Chile () to the second reform episode (1983); Australia (1) to the first reform episode (1985); and Australia () to the second reform episode (1998). 11
Evidence from Growth Acceleration Episodes 5 Fiscal Reforms and Conditional Probability of Growth Accelerations (Percent) 4 3 1 Personal income taxes Health spending Social security contributions Corporate income taxes Consumption taxes Education spending Transport and communication spending Property taxes Capital spending 1
Design Matters: Complementary reforms help maximize growth gains 8 7 5 4 3 1-1 - Ireland: Tax Cuts and Wage Moderation (Percent) -3 1971 197 1981 198 1991 199 1 11 7 5 55 5 45 4 35 3 5 Real Wage Growth (3-Year Moving Avg.) Personal Income Tax Rate (RHS) Source: IMF staff calculations. 13
Design Matters: Public support helps deepen and sustain reform efforts.5 Cumulative Change in the Public Wage Bill (Percent of GDP) -.5-1 -1.5 - t t+1 t+ t+3 t+4 t+5 t+ t+7 t+8 t+9 t+1 Social Dialogue Little Social Dialogue Source: IMF staff calculations. 14
Design Matters: Equity-efficiency trade-offs can be avoided Net Inequality 1/ (1-year avg. post-reform minus 1-year avg. pre-reform) 1 Chile (1) Increase in inequality Change in Gini Coefficient - Australia (1) Germany Australia () Poland Netherlands Chile () Ireland Malaysia - Decrease in inequality 1 3 4 5 7 8 Estimated Growth Gain Advanced Economies Emerging Markets Source: IMF staff calculations, SWIID 5.. 1/ Refers to Gini coefficient after taxes and transfers. 15
Conclusion Fiscal reforms make a difference for long-term growth: Evidence shows that growth increased by ¾ pp in advanced economies and by even more in developing economies. Reforms should be tailored to country-specific conditions. But their design matters: they are more effective when they are mutually reinforcing they are complemented by structural and macroeconomic policies they enjoy broad public support for their implementation they contain measures to avoid equity-efficiency trade-offs 1
Thank You! 17