Developing countries and the challenge of fiscal space

Developing countries, in general, are faced with a serious lack of fiscal space to make needed investments to reach a much-needed resilient economy in view of a fast-unfolding existential threat in the shape of climate change crisis, and the associated ‘Pandemicene’ phenomenon.

The Covid pandemic compounded the situation of fiscal space, given its recession-causing nature, and the global aggregate supply shock – along with strong indication of serious price gouging in general globally, including reportedly artificial oil-related supply cuts a number of times since the early stages of pandemic – contributing to not just high inflation levels, but also built up acute stagflationary headwinds, especially in developing countries.

Enhancing fiscal space required raising domestic resource mobilization effort at the local level, but traditionally weak democracies in a number of developing countries, including Pakistan, saw the absence of any meaningful public voice to push towards policies aimed at broadening the tax base, and enhancing tax progressivity as such.

Higher inflation, which due to perpetuation of neoliberal, and austerity policies increased all the more and remains stubborn at the back of high level of imported-, and cost-push inflationary channels.

This put additional burden on public expenditures, especially in terms of debt repayments, which, in turn, further squeezed fiscal space. Moreover, adoption of over-board monetary austerity policies by major central banks globally has also added significantly to external debt burdens facing developing countries in particular.

For instance, highlighting the unusually high extent of debt burden facing developing countries, a recent report ‘The worst ever global debt crisis’ by Development Finance International (DFI) pointed out: ‘The key findings of the 2023 database are that this is the worst debt crisis the Global South has faced since global records have begun.

The key ratio which the IMF [International Monetary Fund] and World Bank use to measure the debt service or “liquidity” burden of public debt is the debt service/budget revenue ratio, which shows each country’s fiscal capacity to pay it[s] debts. Debt service/revenue is currently averaging 38% of budget revenue (excluding grants) across the 139 countries, and 57.5% for low-income countries.’

Tax revenues also shrank due to tax avoidance/evasion in developing countries in particular due to a lot weaker economic institutional quality in these countries. In addition, a lacklustre global financial and tax architecture at the back of decades of neoliberal assault in terms of perpetuation of weak regulatory arrangements, did not allow for adequately checking against tax evasion practices.

For instance, in his recent Project Syndicate (PS) published article ‘Fixing global economic governance’, economics Nobel Laureate, Joseph E. Stiglitz, pointed out: ‘Consider the OECD’s Base Erosion and Profit Shifting framework.

The hope was that BEPS would make rich corporations pay their fair share of taxes in the countries where they operate. The prevailing “transfer price system” gives multinationals enormous leeway to report profits in whatever tax jurisdiction they prefer. But the proposed BEPS reforms – even if fully adopted, which seems unlikely – seem of limited effect and will provide developing countries with limited additional revenues at most.

Worse, the invidious Investor-State Dispute Settlement process – which allows multinationals to sue governments when they make regulatory changes that could harm profits – has further constrained the resources available to emerging markets and developing countries, even as it has hampered their efforts to respond to environmental and health challenges.’

Moreover, a recently released ‘Global tax evasion report 2024’ by ‘EU Tax Observatory’ pointed out ways to enhances taxes from the wealthy and multinationals as follows: ‘Specifically, we make 6 proposals: 1. Reform the international agreement on minimum corporate taxation… to implement a rate of 25% and remove the loopholes in it that fosters tax competition. 2. Introduce a new global minimum tax for the world’s billionaires, mimicking what was achieved for multinational companies. 3. Institute mechanisms to tax wealthy people who have been long-term residents in a country and choose to move to a low-tax country. 4. Implement unilateral measures to collect some of the tax deficits of multinational companies and billionaires in case ambitious global agreements on these issues fail. 5. Move towards the creation of a Global Asset Registry to better fight tax evasion. 6. Strengthen the application of economic substance and anti-abuse rules.’

For instance, the Report pointed out the benefit of both placing a rather small wealth tax on billionaires, and augmenting the ‘global minimum tax on multinational companies’ in terms of huge revenue potential as follows: ‘A key proposal is to institute a global minimum tax on billionaires, equal to 2% of their wealth. We provide a first estimation of the revenue potential of this measure, showing that it would raise close to $250 billion (from less than 3,000 individuals) annually.

A strengthened global minimum tax on multinational companies, free of loopholes, would raise an additional $250 billion per year. To give a sense of the magnitudes involved, recent studies estimate that developing countries need $500 billion annually in additional public revenue to address the challenges of climate change – needs that could thus be fully addressed by the two main reforms we propose.’

In parallel to tax related initiatives needed to enhance fiscal space, and reining in austerity policies to reduce the burden of interest payments, in terms of both external and domestic debt, there is an urgent need to drastically increase both lending capacity of multilateral development banks (MDBs), and much greater allocation of IMF’s special drawing rights (SDRs), and over a number of years, given the depth of polycrisis, especially the existential threats.

In the same article, for instance, Joseph E. Stiglitz not only challenged the neoliberal mantra that the government should mainly facilitate the private sector – where the writer of this article in Business Recorder believes, rather a balance needs to be brought in terms of public sector, MDBs, and the private sector all playing meaningful part in implementing investment – but also called for greater SDR allocation.

Hence, it was pointed out in this regard by Stiglitz as ‘But why should we expect the private sector to solve a long-run public-goods problem like climate change?The private sector is well known to be short-sighted, focusing wholly on proprietary gains, not social benefits.…It would be much better to use liquidity to strengthen multilateral development banks (MDBs), which have developed special competencies in the relevant areas. …Perhaps the single most important improvement to the global financial architecture would be an annual issuance of, say, $300 billion in special drawing rights (SDRs, the IMF’s international reserve asset), which it can “print” at will if advanced economies agree.

As matters stand, the bulk of SDR issuances go to rich countries (the IMF’s largest “shareholders”) that don’t need the funds, whereas developing countries could use them to invest in their future or to pay back debt (including to the IMF).That is why rich countries should recycle their SDRs by turning them into loans or grants for climate investments in developing countries.

While this is already being done to a limited extent through the IMF’s Resilience and Sustainability Trust, it could be scaled up massively and redesigned to achieve a bigger bang for the buck.’

Copyright Business Recorder, 2023