Good uses for public money

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Coming up is spring meetings week for the IMF and World Bank, which means the great and the good of economic policymaking will soon be assembled in Washington. In the run-up, the fund begins to release its reports, chapter by chapter, which are always worth keeping an eye on as they tend to take the pulse of where mainstream economic policy thinking is placed and where influential decision makers would like that thinking to move. Below I consider one of the first reports out.

In a chapter of its Fiscal Monitor, published yesterday, the IMF has taken on industrial policy. Its stated motivation is a little curious: that it is necessary for every country to boost productivity, and the way to productivity growth is through more innovation, so we should look at how industrial policy can boost innovation. I say “curious” not because this is a bad reason, but because the renewed interest in industrial policy — the return of the state in steering how the economy develops — has generally been motivated by quite different things. In particular, leaders have focused on their goal of getting net carbon emissions to zero to address climate change, and on the imperative of reducing economic dependence on strategic goods and services in countries that are geopolitical adversaries.

This might seem to make the report, while useful on its own terms, too narrow to be relevant to today’s policy debates. Happily, however, the focus on innovation aligns nicely with the concerns more immediately on governments’ minds. The carbon transition is, after all, largely about changing the technologies we use for energy, movement and production — that is to say, innovating and technologically upgrading our way to a better economy.

Dig into the report, and this connection emerges clearly from the fund’s research. Target fiscal support for research and development could increase output by 2 per cent in a large country. The effect more than doubles, to 5 per cent, for a country that directs its innovation incentives to green sectors — because this helps address the economic damage from pollution and climate change, and because the ability to measure emissions can make for more precise targeting of funds than more nebulous policy criteria.

The fund would not be the fund if it did not warn about how everything can go wrong. So it points out that if business lobbies influence the politics of subsidies, misallocation can quickly turn a net gain into a net loss. Moreover, small open economies get most of their innovation benefit from outside anyway, and their own innovation policies would mostly benefit countries. This does not mean small economies should not boost innovation subsidies, but that they should do so in co-ordination with one another — like EU member states do through common programmes. As EU countries approach decision time for the bloc’s next budget (see “Other readables” below), they should take note of this argument for jumping together.

The IMF identifies some useful targets for innovation-focused public spending. Basic research has a high rate of return. But so, too, does spending that increases the diffusion of frontier technology across borders and from leading companies to the rest of the economy.

On the first count, raising the population’s education level and improving digital infrastructure are good ways to boost services imports and foreign direct investments, both important channels for technology diffusion. (More spending on education, for example, can boost an emerging or developing country’s national income by nearly twice as much.) The fund cites research that corporate tax rates have little effect on investment allocations, and proposes that developing countries could remove tax breaks for companies and invest in skills and connectivity instead. Not exactly your old Washington consensus.

As for technology diffusion within countries, the fund wants governments to focus on start-ups and smaller companies, which may often be more innovative than the established giants that are likely to gobble up all the public support if they get the chance. The solutions include more inclusive procurement policies, lower industry barriers to entry and generous loss carryforward policies — which are particularly helpful for start-up companies that still have a way to go before making any taxable profits. That holds for refundable tax credits as well, which the IMF also duly recommends. It bears noting that refundable tax credits are the backbone of the US’s Inflation Reduction Act.

But beyond the detailed prescriptions, the overall message is that fiscal spending on innovation can pay for itself. That is excellent news. Yet the fund can’t help itself: it worries about high-debt countries running out of “fiscal space” and so having to reprioritise other spending. I have written before that the whole notion of fiscal space borders on incoherence. But let’s suppose it here just means a risk that a government becomes unable to borrow money to spend. If so, then the fund’s boilerplate warning means something truly worrying: that financial markets cannot provide a government with the liquidity to do something that more than pays for itself (ie spending that improves rather than worsens its public finances). That would be a profound dysfunction of private markets and something that policy thinkers, including at the IMF, should clearly take on and think about how to fix — rather than just telling governments not to go there.

It also leaves me wondering: what about monetary policy? This is a report only about fiscal policy, of course, but what the best fiscal policy is both determines and depends in part on what the best monetary policy is. And the simple fact is that the way we do monetary policy now has meant that investing in green tech is a lot more expensive today than it was for a decade until three years ago. If we are serious about decarbonisation, we should really think hard about whether we have the right set-up for monetary policy.

Central bankers have been thinking about this, but so far their moves towards “greening” their policies have been minimal in terms of impact. Should they do more? I was struck by my colleague Zehra Munir’s reporting on French President Emmanuel Macron’s musings on the need for a green interest rate to be distinguished from a “brown” rate. She suggests some central bankers may be thinking about using the next rate-cutting cycle to introduce instruments that lower the financing cost of green projects more than brown ones — and it seems to me that central banks whose instruments work primarily through the banking system, such as the European Central Bank, are particularly well placed to make this happen.

Mobilising the powers of monetary policy looks overdue. I already wrote about the need to target the “green spread” four years ago. And as a recent article in Nature shows, our legacy financial system seems to be biased in the opposite direction: because historical risk data shows carbon-intensive projects to be safer investments than innovative green tech, regulatory requirements make the former cheaper to finance. Of course, the best way to fix this is to update our regulatory system. But even if that were done — and certainly while it isn’t — the second-best package of policy would seem to include more activist fiscal and monetary policy alike.

Other readables

The EU’s pandemic recovery fund is already shaping the bloc’s future, including by restarting economic convergence between south and north.

The fugitive executive of Wirecard, the fraudulent fintech giant, seems to have been a Russian intelligence asset in Europe.

And about that . . . Bulgaria’s prime minister tells the FT that corruption is a prime vehicle for Russian influence operations.