ISLAMABAD: Most governments in developing economies are facing enormous fiscal constraints to implement industrial and innovation policies due to elevated levels of debt, rising debt servicing costs, and significant output losses from the pandemic crisis, the United Nations said.

The November edition of the ‘World Economic Situation and Prospects’ released by the UN Department of Economic and Social Affairs (UN-DESA), said over fifty developing economies spend more than 10 per cent of their revenues on interest payments, and 25 countries spend more than 20pc.

Additionally, many economies face rising social and development needs. Consequently, most governments lack fiscal space and financial resources for industrial and innovative policies. Low-income countries are in the direst situation, as many of them are in debt distress or at high risk of debt disaster.

This situation is further compounded by structural factors in developing countries. Institutional capabilities are weak, and innovation policies have generally suffered from lack of political commitment, the report says.

Increasing social and development needs strain fiscal resources

Furthermore, these countries have a limited scientific community and low labour force skills. Innovation activity is concentrated in low-tech sectors, leading to low research and development investments, limited participation of private firms, and a lack of interactions with universities.

Given the current economic conditions and industrial policy trends, most developing economies will encounter enormous difficulties to strengthen their productive and technological capacities in the coming years.

The resurgence of industrial policy in the developed economies, along with the ongoing political fragmentation of the world economy and the on-shoring and re-shoring of manufacturing away from many developing countries, could imply less foreign direct investment (FDI) and fewer technology transfers and diffusion to the developing countries.

These trends will inevitably widen the technological divide between developed and developing economies. Moreover, there are rising risks that the technological divide and the divergence of research and development (R&D) investments could expand further, even among the developing countries. Amid a high risk of debt distress, low-income countries will remain severely constrained in implementing industrial and innovation policies to strengthen their productive capacities and foster the green energy transition.

The UN report suggested that many of the developing countries are holding on to their static comparative advantages and failing to build innovation and technological capabilities and target and pursue their dynamic comparative advantages. Well-designed and well-funded industrial policies, including the strategic use of conditionalities, can bridge the gap between static and dynamic comparative advantages.

A usual counter-argument emphasises that developing economies, especially the least developed countries, still need to enhance their capital stock before focusing on innovation. However, innovation is a cumulative learning process that should be enhanced to avoid situations of “lock-in” and “path dependency” in commodities and low-productivity sectors, which traps these countries into a vicious cycle of underdevelopment.

Published in Dawn, November 6th, 2023