IMF update

 

Dear MARIA, We just published a new blog—please find the full text below.  Industrial Policy Is Not a Magic Cure for Slow Growth (Credit: olaser/iStock by Getty Images) By Era Dabla-Norris, Daniel Garcia-Macia, Vitor Gaspar, Li Liu Many countries are ramping up industrial policy to boost innovation in specific sectors in the hope of reigniting productivity and long-term growth, amid security concerns. Major initiatives are springing up around the world, such as the United States’ CHIPS and Science Act, which will fund domestic research and semiconductor manufacturing, the European Union’s Green Deal Industrial Plan, which supports the bloc’s transition to climate neutrality, the New Direction on Economy and Industrial Policy in Japan, or the K-Chips Act in Korea, alongside longstanding policies in emerging market economies like China. Industrial policy, in which governments support individual sectors, can drive innovation if done right. But striking the right balance is a crucial consideration, as history is full of cautionary tales of policy mistakes, high fiscal costs, and negative spillovers in other countries. This recent turn to industrial policy to support innovation in specific sectors and technologies is not a magic bullet, as we show in a chapter of the April 2024 Fiscal Monitor. Instead, well-designed fiscal policies that support innovation and technology diffusion more broadly, with an emphasis on fundamental research that forms the basis of applied innovation, can lead to higher growth across countries and accelerate the transition to a greener and more digital economy. Our assessment of how fiscal support for innovation should be targeted to specific sectors shows that pursuing such policies generate productivity and welfare gains only under stringent conditions: When targeted sectors generate measurable social benefits, such as lower carbon emissions or higher spillovers of knowledge to other sectors; When policies do not discriminate against foreign firms; and When the government has strong capacity to administer and implement such a policy. Most industrial policy relies heavily on costly subsidies or tax breaks, which can be detrimental for productivity and welfare if not effectively targeted. This is frequently the case, as for example when subsidies are misdirected toward politically connected sectors. In addition, discriminating against foreign firms can prove self-defeating, as such policies can trigger costly retaliation and most countries—even major advanced economies—rely on innovation done elsewhere. In some cases, industrial policy can be justified, such as when it supports sectors that generate strong knowledge spillovers to the domestic economy (for example, in the semiconductor industry). Another important use case is driving green innovation—reaching net zero emissions will require technologies that do not yet exist. But subsidies to green innovation should be transparent, focused on environmental objectives, and complemented by robust carbon pricing to minimize fiscal costs. More generally, governments deploying industrial policies should invest in technical capacity, recalibrate support as conditions change, and act in line with open and competitive markets. They need to design policy with a view to avoiding wasteful spending and protectionist measures that could further fragment global trade. Pro-innovation policy mix Technologically advanced economies would do well to choose a policy mix that supports innovation more broadly, especially because fundamental research with wide applications is usually underfunded. A cost-effective way to boost innovation and growth is implementing a complementary mix of public funding for fundamental research, research and development grants for innovative start-ups, and tax incentives to encourage applied innovation across firms. We estimate that increasing spending on these policies by 0.5 percentage points of gross domestic product—or about 50 percent of the current level in OECD economies—could raise GDP by up to 2 percent for the average advanced economy. That level of spending on innovation could even reduce the debt-to-GDP ratio over the long term. But design matters. Grants are most useful if targeted to earlier stages of the innovation lifecycle, for example, while tax incentives must be easy to access if they are to benefit more than just the large established firms. While supporting innovation can pay off in the long term, countries with limited fiscal space may need to reprioritize other spending and raise more revenue in the short term. Priorities differ for less technologically advanced countries. Their governments can obtain larger productivity dividends with policies that promote the diffusion of technologies developed elsewhere. But they must invest in human capital and strategic infrastructure to reap the full benefit of technology inflows. For all countries, closer international cooperation and greater exchange of knowledge are critical to accelerate the green and digital transformations and achieve a more prosperous future. Inward-looking policies diminish the world’s innovative potential and slow the diffusion of technology, especially to the countries that need it the most. —This blog is based on Chapter 2 of the April 2024 Fiscal Monitor. World Must Prioritize Productivity Reforms to Revive Medium-Term Growth (Credit: olaser/iStock by Getty Images) By Nan Li, Diaa Noureldin The world economy faces a sobering reality. The global growth rate—stripped of cyclical ups and downs—has slowed steadily since the 2008-09 global financial crisis. Without policy intervention and leveraging emerging technologies, the stronger growth rates of the past are unlikely to return. Faced with several headwinds, future growth prospects have also soured. Global growth will slow to just above 3 percent by 2029, according to five-year ahead projections in our latest World Economic Outlook. Our analysis shows that growth could drop by about a percentage point below the pre-pandemic (2000-19) average by the end of the decade. This threatens to reverse improvements to living standards, and the unevenness of the slowdown between richer and poorer nations could limit the prospects for global income convergence. A persistent low-growth scenario, combined with high interest rates, could put debt sustainability at risk—restricting the government’s capacity to counter economic slowdowns and invest in social welfare or environmental initiatives. Moreover, expectations of weak growth could discourage investment in capital and technologies, possibly deepening the slowdown. All this is exacerbated by strong headwinds from geoeconomic fragmentation, and harmful unilateral trade and industrial policies. However, our latest analysis shows that there’s hope. A variety of policies—from improving labor and capital allocation across firms to tackling labor shortages caused by aging populations in major economies—could collectively rekindle medium-term growth. The key drivers of economic growth include labor, capital, and how efficiently these two resources are used, a concept known as total factor productivity. Between these three factors, more than half of the growth decline since the crisis was driven by a deceleration in TFP growth. TFP increases with technological advances and improved resource allocation, allowing labor and capital to move toward more productive firms. Resource allocation is crucial for growth, our analysis shows. Yet, in recent years, increasingly inefficient distribution of resources across firms has dragged down TFP and, with it, global growth. Much of this rising misallocation stems from persistent barriers, such as policies that favor or penalize some firms irrespective of their productivity, that prevent capital and labor from reaching the most productive companies. This limits their growth potential. If resource misallocation hadn’t worsened, TFP growth could have been 50 percent higher and the deceleration in growth would have been less severe. Two additional factors have also slowed growth. Demographic pressures in major economies, where the proportion of working-age population is shrinking, have weighed on labor growth. Meanwhile, weak business investment has stunted capital formation. Medium-term pressures Demographic pressures are set to increase in most of the major economies, according to United Nations projections, causing an imbalance in world labor supply and dampening global growth. The working-age population will increase in low-income and some emerging economies, whereas China and most advanced economies (excluding the United States) will face a labor squeeze. By 2030, we expect the growth rate of the global labor supply to slide to just 0.3 percent—a fraction of its pre-pandemic average. Some resource misallocation may correct itself over time, as labor and capital gravitate toward more productive firms. This will go some way toward mitigating the TFP slowdown even as structural and policy barriers continue to slow the process. Technological innovation may also lessen the slowdown. But overall the pace of TFP growth is likely to continue to decline, driven by challenges such as the increasing difficulty of coming up with technological breakthroughs, stagnation in educational attainment, and a slower process by which less developed economies can catch up with their more developed peers. Absent major technological advances or structural reforms, we expect global economic growth to reach 2.8 percent by 2030, well below the historical average of 3.8 percent. Reviving global growth Our analysis evaluates the impact of policies on labor supply and resource allocation, set against the backdrop of the rapid advance of artificial intelligence, public debt overhang, and geoeconomic fragmentation. We examine scenarios featuring ambitious, but achievable, policy shifts that address resource misallocation by improving the flexibility of product and labor markets, trade openness, and financial development. We also consider policies aimed at enhancing labor supply or productivity by reforming retirement and unemployment benefits, supporting childcare, expanding re-training and re-skilling programs, and improving integration of migrant workers, as well as the removal of social and gender barriers. Our findings indicate that the benefits of increasing labor force participation, integrating more migrant workers into advanced economies, and optimizing talent allocation in emerging markets are comparatively modest. By contrast, reforms that enhance productivity and fully leverage AI are key for reviving growth in the medium term. Our analysis suggests that focused policy actions to enhance market competition, trade openness, financial access, and labor market flexibility could lift global growth by about 1.2 percentage points by 2030. The potential of AI to boost labor productivity is uncertain but potentially substantial as well, possibly adding up to 0.8 percentage points to global growth, depending on its adoption and impact on the workforce. In the long run, innovation-driven policies will be crucial to sustaining global growth. —This blog, based on Chapter 3 of the World Economic Outlook, “Slowdown in Global Medium-Term Growth: What Will it Take to Turn the Tide?”, reflects research by Chiara Maggi, Cedric Okou, Alexandre B. Sollaci, and Robert Zymek.  Rising Cyber Threats Pose Serious Concerns for Financial Stability (Credit: Altayb/iStock by Getty Images) By Fabio Natalucci, Mahvash S. Qureshi, Felix Suntheim Cyberattacks have more than doubled since the pandemic. While companies have historically suffered relatively modest direct losses from cyberattacks, some have experienced a much heavier toll. US credit reporting agency Equifax, for example, paid more than $1 billion in penalties after a major data breach in 2017 that affected about 150 million consumers. As we show in a chapter of the April 2024 Global Financial Stability Report, the risk of extreme losses from cyber incidents is increasing. Such losses could potentially cause funding problems for companies and even jeopardize their solvency. The size of these extreme losses has more than quadrupled since 2017 to $2.5 billion. And indirect losses like reputational damage or security upgrades are substantially higher. The financial sector is uniquely exposed to cyber risk. Financial firms—given the large amounts of sensitive data and transactions they handle—are often targeted by criminals seeking to steal money or disrupt economic activity. Attacks on financial firms account for nearly one-fifth of the total, of which banks are the most exposed. Incidents in the financial sector could threaten financial and economic stability if they erode confidence in the financial system, disrupt critical services, or cause spillovers to other institutions. For example, a severe incident at a financial institution could undermine trust and, in extreme cases, lead to market selloffs or runs on banks. Although no significant “cyber runs” have occurred thus far, our analysis suggests modest and somewhat persistent deposit outflows have occurred at smaller US banks after a cyberattack. Cyber incidents that disrupt critical services like payment networks could also severely affect economic activity. For example, a December attack at the Central Bank of Lesotho disrupted the national payment system, preventing transactions by domestic banks. Another consideration is that financial firms increasingly rely on third-party IT service providers, and may do so even more with the emerging role of artificial intelligence. Such external providers can improve operational resilience, but also expose the financial industry to systemwide shocks. For example, a 2023 ransomware attack on a cloud IT service provider caused simultaneous outages at 60 US credit unions. With the global financial system facing significant and growing cyber risks from increasing digitalization and geopolitical tensions, as shown in the chapter, policies and governance frameworks at firms must keep pace. Because private incentives may be insufficient to address cyber risks—for example, firms may not fully account for the systemwide effects of incidents—public intervention may be necessary. However, according to an IMF survey of central banks and supervisory authorities, cybersecurity policy frameworks, especially in emerging market and developing economies, often remain insufficient. For example, only about half of countries surveyed had a national, financial sector-focused cybersecurity strategy or dedicated cybersecurity regulations. To strengthen resilience in the financial sector, authorities should develop an adequate national cybersecurity strategy accompanied by effective regulation and supervisory capacity that should encompass: Periodically assessing the cybersecurity landscape and identifying potential systemic risks from interconnectedness and concentrations, including from third-party service providers. Encouraging cyber “maturity” among financial sector firms, including board-level access to cybersecurity expertise, as supported by the chapter’s analysis which suggests that better cyber-related governance may reduce cyber risk. Improving cyber hygiene of firms—that is, their online security and system health (such as antimalware and multifactor authentication)—and training and awareness. Prioritizing data reporting and collection of cyber incidents, and sharing information among financial sector participants to enhance their collective preparedness. As attacks often emanate from outside a financial firm’s home country and proceeds can be routed across borders, international cooperation is imperative to address cyber risk successfully. While cyber incidents will occur, the financial sector needs the capacity to deliver critical business services during these disruptions. To this end, financial firms should develop, and test, response and recovery procedures and national authorities should have effective response protocols and crisis management frameworks in place. The IMF actively helps member countries strengthen their cybersecurity frameworks through policy advice, for example as part of the Financial Sector Assessment Program, and through capacity-building activities. —This blog is based on Chapter 3 of the April 2024 Global Financial Stability Report, “Cyber Risk: A Growing Concern for Macrofinancial Stability.”   Jeff Kearns Managing Editor IMF Blog jkearns@IMF.org   Thank you again for your interest in IMF Blog. Read more of our latest content here. Take good care!