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Subsidies, tax breaks detrimental to production – IMF

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The International Monetary Fund (IMF), has said that most industrial policies rely heavily on costly subsidies or tax breaks, which could be detrimental to productivity and welfare if not effectively targeted.

The multilateral lender stated this in a new report titled ‘Industrial Policy Is Not a Magic Cure for Slow Growth’.

According to the global lender, Industrial policy, in which governments support individual sectors, can drive innovation if done right.

It said striking the right balance was a crucial consideration, as history is full of cautionary tales of policy mistakes, high fiscal costs, and negative spillovers in other countries.

The report also noted that many countries were ramping up industrial policy to boost innovation in specific sectors in the hope of reigniting productivity and long-term growth amid security concerns.

The report read in part, “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, 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.”

According to the report, the recent turn to industrial policy to support innovation in specific sectors and technologies is not a magic bullet.

“However, 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,” it noted.

It advised governments deploying industrial policies to invest in technical capacity, recalibrate support as conditions change, and act in line with open and competitive markets.

It added, “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 minimise fiscal costs.”

Since taking over the reins of power, the Bola Tinubu-led administration has embarked on widespread reforms premised on discontinuing subsidies that many analysts had blamed for Nigeria’s current economic woes

During his inauguration on May 29, 2023, President Bola Tinubu announced that the regime of fuel subsidy had come to an end for good.

Two weeks later, the Central Bank of Nigeria floated the local currency to allow it to find its true value.

The two major policy reforms, despite being met with criticism by some quarters of society, have received applause from international observers.

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In an earlier report released in January, the IMF had commended Nigeria and three other countries for recent subsidy reforms that would create space for development spending.

It said, “Building resilience in the face of these trends requires countries to act. Some countries have made progress— for instance, Angola, The Gambia, Nigeria, and Zambia have taken steps to implement significant energy subsidy reforms to create space for development spending.”

It, however, expressed worry that many countries were lagging, especially in efforts to increase revenues, such as broadening the tax base, reducing tax exemptions, and increasing the efficiency of tax administration.

 

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