UNCTAD releases today a study on Incentives and foreign direct investment , which proposes ways to limit excessive incentives competition to attract FDI. The study, updates a report prepared in 1995 for the UNCTAD Commission on International Investment and Transnational Corporations (see TAD/INF/2530). It surveys FDI incentives programmes in over 100 countries from all regions. The overall number and range of incentives available for foreign investors, and the number of countries that offer incentives, have increased considerably since the mid-1980s. In fact, international competition for FDI with fiscal, financial and other incentives is pervasive, and it is even more intense now that it was some ten years ago. Countries have deliberately changed their FDI regimes in light of actions taken by neighbouring countries.
The study proposes that the effectiveness of national incentive programmes be reviewed. Conditional incentive-limitation clauses in bilateral investment and double taxation treaties could be negotiated and the levels of investment incentives packages could be limited through regional undertakings. At the multilateral level, international hearings could be held to find ways of improving reporting, assessment methods and policy approaches, and to encourage governmental pledges to reduce the level of incentives. In all these efforts, the dynamic effects of incentives, as well as the particular needs and constraints of developing countries, in particular those of the least developed countries, need to be taken into account.
Incentives are less often used now to attract FDI flows in general than in the past; rather, they tend to be aimed towards achieving specific purposes. Countries very often offer a number of incentives linked to different objectives, thus further multiplying the number of incentives programmes available to transnational corporations (TNCs). Developed countries tend to prefer financial incentives over fiscal ones. However, this pattern is reversed in developing countries, presumably because these countries lack the resources needed to provide financial incentives. Fiscal incentives continue to be the most widely used type of FDI incentive in developing countries, as they lack resources for providing financial incentives. Competition with incentives is not only strong among countries, but also among subnational authorities within states. This is so regardless of whether the countries involved are large or small, rich or poor, developed or developing.
Competition with incentives is strong despite of the fact that a review of the empirical evidence suggests that incentives play a relative minor role in the locational decisions of TNCs relative to other locational advantages, such as market size and growth, production costs, skills levels, political and economic stability and the regulatory framework. However, the impact of incentives is not negligible. In particular, when all other factors are equal, incentives can induce foreign investors towards making a particular locational decision by sweetening the overall package of benefits, and hence tilt the balance in investor´s locational choices. With respect to different types of incentives, in general, fiscal and financial incentives seem to run pari pasu in terms of FDI preferences. Among FDI incentives packages, those geared to promoting exports have proven to be most effective. There is often a trade-off between incentives that are targeted to achieve specific policy goals and more general investment incentives. The more targeted an incentive, the greater its impact -- but also the greater the chance that it leads to biases and distortions that impose economic costs on the economy.
Proposed action
No general discipline exists at the multilateral or regional levels to deal with incentives that affect FDI flows and the locational decisions of TNCs, although some limited intergovernmental commitments exist. Containing excesses in competition with incentives requires national as well as international approaches at bilateral, regional and multilateral levels, all of which can be pursued simultaneously. UNCTAD´s suggested programme of action involves the following:
- National initiatives: Governments could undertake national incentive reviews to determine the complete array of FDI incentive instruments -- including discretionary incentives and to assess whether any of these incentives are redundant or can be eliminated or a ceiling placed on them. Such reviews could include the benefits and costs of the incentives for the local economy, and explore whether a proper balance is being maintained between investment incentives and other promotional activities.
- Bilateral initiatives: Noting that some countries have used bilateral investment treaties to curtail the use of performance requirements, the study suggests that it may be possible to negotiate a conditional incentive-limitation clause in bilateral investment or double taxation agreements that would only become operative if a specified number or set of countries adopted the clause.
- Regional initiatives: Efforts at the regional level to curtail excessive incentives could involve agreeing on overall ceilings on investment incentives packages; on criteria to phase out the most distorting incentives; and on prior approval of incentives programmes by the competent regional organization.
- Multilateral initiatives: Multilateral efforts are in their infancy and need to be expanded. To assist this process, UNCTAD proposes that an International Group of Eminent Persons could hold hearings on FDI incentives, with the participation of the private sector as well as national and international institutions.
Based on the experiences with the effectiveness of incentives the Group could explore ways and means of:
- improving transparency regarding FDI incentives;
- further clarifying and documenting the costs and benefits of FDI incentives;
- identifying a limited number of particularly distortive incentives, with a view towards dealing with them first;
- elaborating a check list of points that governments should take into account in their incentive policies.
The group could conclude its work with a "challenge" round of pledges by countries to reduce the level of incentives by some fixed amount over a time period. A demonstration that such a pledge might be feasible could enhance the willingness of governments to seek a multilateral agreement on FDI incentives.
Just as the international community has begun to deal successfully with subsidies that distort trade, it many be possible, step by step, to make similar progress towards dealing with incentives that distort international investment flows, the study concludes.
