Effectiveness and Economic Impact of Tax Incentives in the SADC ...

2-2 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
improved nutrition—to augment labor productivity. Broad-based human capital investment
is also essential for poverty reduction because it directly enhances capabilities and
opportunities for the poor.
The productivity effect is often referred to as technical change. In fact it refers to any source of
overall efficiency enhancement. A better label is total factor productivity (TFP) growth, which
measures the difference between actual output growth and that which would be explained by
increases in factor inputs (capital and labor) alone. In addition to technology, TFP growth also
stems from structural changes that shift resources to more productive sectors, the elimination
of impediments to competitive markets, stronger financial markets, and improved
management techniques.
Recent models of economic growth focus on the sources of productivity growth. These
theories emphasize determinants such as knowledge externalities, economies of scale in
production, and a “catch-up” effect.
Knowledge externalities arise when knowledge-building activities not only enhance
productivity for the immediate production unit, but also create diffuse, lasting, and
cumulative efficiency benefits for the economy. When these spill-over effects are significant,
private decision makers will systematically under invest in knowledge-building activities
because investors have no incentive to take into account the gains that accrue to others. In
effect, advances in knowledge are a type of public good. This provides a justification for cost-
effective interventions to strengthen the incentives for knowledge-generating activities such
as investments in science and technology, education and training, capital investment to
upgrade production facilities, or foreign direct investment involving technology transfer.
The importance of scale economies has been understood for centuries, but only recently has it
been incorporated into formal growth theory. For many (though not all) production
processes, a larger scale yields lower unit costs, higher productivity, and greater
competitiveness. This is an important reason for pursuing outward-looking strategies,
particularly in low-income countries where the domestic market is very small compared to
vast opportunities in regional and global market.
Finally, the catch-up effect suggests that poor countries ought to have the best prospects for
rapid growth. This is ironic because most poor countries have not achieved rapid growth.
(Otherwise they would no longer be poor!). The basis for the idea is that poor countries can
benefit from a deep pool of existing knowledge. They can also supplement domestic resources
with foreign capital and know-how, and take advantage of large global markets. Statistical
evidence strongly confirms the validity of the idea, and reveals that poor growth performance
in poor countries stems largely from policies and institutions that inhibit investment and
undermine productivity. With appropriate and consistent policies and institutions, poor