Fiscal Policies for Innovationand Growth

CARLOS MULAS-GRANADOSINTERNATIONAL MONETARY FUND

ECFIN WORKSHOP

JANUARY 24TH, 2016

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Outline

Growth: a state of alert

Three pillars of innovation: a role for fiscal policyResearch & Development

Technology Transfer

Entrepreneurship

Key findings and policy recommendations

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Growth: a state of alertIn the long-term, is innovation what matters

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Potential output projections are disappointing

Source: IMF staff estimates.

4

Fiscal positions have worsened in the past yearRevisions to General Government Gross Debt-to-GDP Ratio, 2007–21

(Rebased debt ratio, index 2007 = 100)

Emerging Market and Middle-Income Economies, Excluding China Low-Income Developing CountriesAdvanced Economies

60

80

100

120

140

160

2007 09 11 13 15 17 19 21

20162013

2011

Spring 2007

2009 2015

60

80

100

120

140

160

2007 09 11 13 15 17 19 21

2016

20132011

2007

2009 2015

60

80

100

120

140

160

2007 09 11 13 15 17 19 21

2016

20132011

2007

2009

2015

Source: IMF staff estimates.

5

4,000

40,000

1929 1949 1969 1989 2009 2029

KeynesBands

US real GDP per capitaAnnual growth 2.1%Annual growth 1.4%

What can be done? let’s take a long term view

Sources: US Bureau of Economic Analysis, US Census Bureau, January 2016 WEO. Forecast using January 2016 WEO projections for 2016-2021.

United States Real GDP per Capita, 1929-2030(2009 dollars, logarithmic scale)

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R&D is key for innovation

Sources: US Bureau of Economic Analysis, US Census Bureau, January 2016 WEO. Forecast using January 2016 WEO projections for 2016-2021.

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Research & DevelopmentScope to do more

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R&D around the world

Sources: World Bank and IMF staff calculations.

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Total R&D is too low

Private R&D, “underinvestment” due to:

Credit constraints – especially prevalent during recessions

Spillovers to the wider economy – textbook solutionPigou’s price correction: fiscal incentives to efficiently address externalities

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Fiscal Stabilization can promote R&D in Bad Times

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Aghion et al: Fiscal stabilization affects TFP growth, as R&D is impaired during recessions due to credit constraints

Using a panel of 24 countries (c), 16 industries (j) and 38 years (t),

α γ β ϵ

Private R&D expenditure

External financial dependence cf. Rajan-Zingales

Measure of time-varying fiscal stabilization (from previous Fiscal Monitor)

• Diff-in-diff: interact Fiscal Stabilization with Industries’

Fiscal Stabilization can promote R&D in Bad TimesHigher fiscal countercyclicality increases private R&D expenditure.More in industries that are highly dependent on external finance

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Table. Impact of Fiscal Stabilization on Private Research and Development

Source: IMF staff calculations and estimates.Note: Estimates are based on equation (A2.1.3). The t-statistics based on clustered standard errors at country-industry level are reported in paren-theses. Country-time fixed effects are included in all regressions, industry fixed effects in (1) and (3), and industry-country fixed effects in (2) and (4). Differential in research and development computed for an industry with external financial dependence at the 75th percentile relative to the 25th percentile of the financial dependence distribution when the country increases fIscalstabilization from the 25th to the 75th percentile.*** p < 0.01.

R&D externalities justify a Pigouvian subsidy

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Domestic social returns are at least 2 x private returns

Correction ≥ 50% Today subsidies ≈ 10% Required effort ≈ 40%

Scaling up fiscal incentives can yield a major growth dividend

≈ 0.4 percent of GDP fiscal cost

40 percentcost reduction of extra R&D for firms

R&D Tax credits

R&D Subsidies

40 percentincrease in private R&D investment

Note: estimates are averages across OECD countries.

Effective Design Critical

5 percent higher GDP from domestic spillovers

8 percenthigher global GDP with cross-border spillovers

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Two key fiscal instruments to promote private R&D

Fiscal Support to Private R&D, 2013(percent of GDP)

Direct R&D subsidies

R&D tax incentives

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Examples of R&D tax incentives

Targeting small or new firms?

Small firms: Canada, the Netherlands, Norway, and the United Kingdom

New firms: Belgium, France, Italy, the Netherlands, and Portugal

Tax credits or Tax reliefs?

R&D Tax credits: refundable tax credits are more appropriate for start-ups

Tax relief from other taxes: Belgium, France, Hungary, the Netherlands, and Spain

Simple or incremental incentives?

Incremental: cheaper (Italy, Japan, Korea, Portugal, Spain, and the United States)

Simple: easier to monitor and don’t influence the timing of investment

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Which works better? Subsidies or tax incentives?

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Using firm-level (and sectoral) data, estimate a diff-in-diff:ΔLog ⋯ γ … .

Firm characteristics (size, sector)Fiscal support for private R&D

- Subsidies- Tax incentives

Mixed results on effect of subsidies versus tax incentivesMaybe tax incentives stronger effect

Which works better? Subsidies or tax incentives?

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Which works better? Subsidies or tax incentives?

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Mixed results on effect of subsidies versus tax incentives (as in literature)

Which works better? Subsidies or tax incentives?

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“Patent box”? No! Ineffective – no effect at all in two countries

Only effective where tax relief is large and link with R&D strong

Inefficient – as relief depends on income, not R&D

Negative international spillovers – focus is on attracting mobile IP income (aggressive tax competition)

Synthetic Control Estimation Results: Intellectual Property Box and Private R&D

(Log of real R&D spending)

-0.6

-0.3

0.0

0.3

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Reform

-0.6

-0.3

0.0

0.3

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Reform

-0.2

-0.1

0.0

0.1

0.2

0.3

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Reform

Actual Synthetic Control1. France

-1.6

-1.2

-0.8

-0.4

0.0

0.419

90

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Reform

2. Spain

4. Netherlands3. Belgium

IP box ineffective IP box ineffective

IP box effective, but costly IP box effective, but costly

Source: IMF staff estimates. Note: Estimates, based on the synthetic control method. The synthetic control mimics the R&D development in the country before the introduction of its IP box. The actual line shows how R&D deviates from the control after the introduction of the IP box. In France and Spain, there is no impact; in Belgium and the Netherlands, the impact of the IP box on R&D is positive, but the revenue cost quite significant.

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Key findings and policy recommendations

R&D – scope to do more and betterFiscal stabilization matters, also for long-run growthR&D incentives: GDP could rise by 5 percent; impact can be 8 percent if international spillovers are taken into accountBoth tax incentives and direct subsidies workDesign matters: e.g. no patent box

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THANK YOU!

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