Strong and Equitable Growth: Fiscal Policy Can Make a Difference

SUMMARY

Amid a recovery from the financial crisis that continues to disappoint and growing fear that the global economy is entering a prolonged period of mediocre growth, a new IMF study says that fiscal policy can actually lift potential growth.

 
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  • Fiscal policies can help boost countries’ long-term growth prospects
  • Complementary structural reforms magnify growth dividends
  • Social dialogue and attention to equity key to building public support for reform
  • The study finds that fiscal reforms, especially when complemented with supportive changes in other economic policies (structural reforms), can support strong and equitable growth. It draws on the lessons from nine country case studies (Australia, Chile, Germany, Ireland, Malaysia, the Netherlands, Poland, Tanzania, and Uganda), as well as an analysis of growth accelerations (defined as increases of at least 1 percentage point in five-year average growth following fiscal reforms).

    Although the precise effect of fiscal policy is difficult to measure accurately, average growth increased substantially during the decade following reforms in most countries studied: by about ¾ percentage point on average in advanced economies (excluding Ireland) and by even more in emerging markets and low-income countries (Chart 1). Analysis of growth acceleration episodes in 112 countries confirms this encouraging result, by finding that such accelerations occurred significantly more often when countries had implemented fiscal reforms.

    Anatomy of successful fiscal reforms

    Fiscal reforms can influence growth through four main channels, according to the study:

    Employment. A number of fiscal policy measures can promote employment and thus increase the contribution of labor to growth. For instance, cutting labor taxes, especially when they are high, increases take-home pay—and thereby increases incentives to work. Improving the design of social benefit programs and active labor market programs can strengthen work incentives and better assist job seekers. Germany, for example, increased its labor force participation by 8 percentage points between 2000 and 2013 through active labor market programs and other labor market reforms. Targeted measures to support labor market participation of specific groups, such as women, youth, older workers, and low-skilled workers, are often important tools. For instance, India applies a lower effective tax rate on women’s labor income, and most advanced economies subsidize the hiring of unemployed youth.

    Investment. Investment is a key driver of growth, and tax policies, in particular, can influence private investment decisions. For example, Ireland saw investment surge after it streamlined and reduced its corporate income...

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