The positive but insignificant result for the impact of fiscal balance on diversification shows that macro stability plays a role for the success of diversification efforts. At the same time, a proactive fiscal policy, especially in terms of promoting public investment, can support efforts towards diversification. In that respect, the results with regard to fiscal balances and diversification suggest that a conservative economic policy, or fiscal conservatism for that matter, may not be good for a country that is planning to achieve a diversified economy. It should be noted that expansionary fiscal policies are only as good for diversification as the absorptive capacity of the economy and the requisite fiscal discipline that ensures that fiscal spending is directed at building economic production capacities.
The success of an expansionary fiscal policy, assuming an optimal tax regime, depends to a large extent on the way the deficit is financed. Financing options such as domestic borrowing (assuming an illiquid money market) or using credit from the central bank are likely to have the undesirable effect of putting pressure on domestic interest rates. This situation would undermine the investments that are important to diversification. Yet, where domestic money markets are liquid with minimal risk of crowding out private investments, public investment expenditure can be expanded through domestic borrowing that allows for higher fiscal deficits without any detrimental effects on the economy.
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