DFID-IMF Workshop on Globalisation and Revenue MobilisationAbuja, Nigeria, 27 February 2008

Conclusions

Are incentives effective?

Country experience

What are FDI incentives?

Incentives are policy measures specifically designed to increase the nominal rate of return of a particular FDI undertaking or to reduce (or redistribute) its costs or risks

Incentives are available to domestic and foreign investors who otherwise qualify

Incentives are offered at all levels of government -- national, regional and local

Fiscal incentives

Financial incentives

Other incentives

tax holidays reduced rates on taxes of all kinds

(e.g. sales tax, social security)exemptions from customs dutyaccelerated depreciation

Tax holidays are most popular, available in 71 % of Sub-Saharan Africa

government grantssubsidized creditgovernment equity participation insurance at preferential rates

Financial incentives involve upfront disbursement of public funds and are not usually offered by developing countries.

subsidized , dedicated infrastructuremarket preferencespreferential treatment on foreign

exchange

Free zones are popular, available in 38 % of Sub-Saharan Africa

Incentives may be conditional (upon performance requirements)

Incentives may be automatic or discretionary

Awards may be up front or after conditions are met

Investors prefer incentives that are awarded upfront, automatically and unconditionally

to reflect positive externalities to develop comparative advantage in

an expanding industry to encourage investors to carry

certain public costs to compensate investors for lost

return due to other government interventions

can distort production structure can favor large companies over

small enterprisescosts can outweigh benefits investors might invest in the

absence of incentivespolitical pressures hard to monitor

What are FDI incentives?

Conclusions

Are incentives effective?

Country experience

proliferation of incentives since the mid-1980s more countries, offering more types of

incentives developed countries offer more financial

incentives developing countries rely more on fiscal

incentives easy to rationalize: “if the incentives were

not offered, then the investment would not take place and there would be no tax to collect anyway.”

regional development (popular in developed countries)

exporting (most frequent objective in developing countries)

manufacturing sector a main focus jobs, training, R&D, environmental

protection and infrastructure projects tax incentive schemes have become

increasingly specific, in terms of qualifying conditions.

tax holidays (5 years; up to 25) tariff concessions (5-10 years; 15-25

for major projects)grants for worker training loan guarantees rebates on electricity, water and

sewage services (up to 15 %)export-processing zones, science

parks

What are FDI incentives?

Conclusions

Country experience

Are incentives effective?

95% of the changes in FDI laws in last decade were towards greater liberalization: Entry and ownership requirements relaxed Protection against nationalization and expropriation Recognition of national treatment Provision for settlement of disputes Guarantees for repatriation of funds Benefits of bilateral investment & double tax

treaties Investment agencies shifted from FDI approval to

FDI facilitation and promotion. They provide incentives.

Incentives do not rank high among the many determinants of FDI company decisions rest on economic and

long-term strategic considerations relating to inputs, production costs and markets.

Investors are also averse to risk and favor a stable, transparent and predictable regulatory environment.

But as policies converge to global best practice, the role of incentives gains importance.

At the margin, tax incentives can trigger an investor’s final choice among alternate locations, particularly for investments that are cost-oriented and mobile.

Export-oriented investors also value infrastructure zones and access to world markets (e.g. AGOA).

But mobile investors are footloose.

Use of incentives to promote infant industry has been mixed. FDI assembly operations created

domestic value-added, but gained competitiveness after protection levels and incentives were reduced.

Benefits take time to emerge.

Tax incentives for industrial upgrading and training have had some success, particularly when combined with partnership schemes that foster linkages between manufacturers and suppliers.

Regional incentives can influence choices within the same market.

Tax incentives for innovation, research and development and technology transfer are common in Asia and Europe. However, evidence suggests that granting tax holidays and “pioneer status” does not result in significant technology transfer.

But reduction of restrictions on imports and the hiring of expatriate employees, funding of enterprise zones and research parks can attract high technology manufacturing.

FDI

FDI /GDP

Note: Assets owned by US firms in 1999 in 60 countries grouped into four governance categories. Source: Dhammika Dharmapala and James R. Hines Jr. , “Which Countries Become Tax Havens?” (2006).

Incentives +

governance works

Incentives attracted FDI in natural resources.

Incentives also attracted efficiency-seeking FDI (to special economic zones and for market access, e.g. via AGOA). Examples also of failure.

Studies of positive externalities from FDI in Africa suggest that spillovers are limited and tend to occur when there is a vigorous domestic private sector.

The capacity to execute incentives measures varies widely.

The capacity to monitor is particularly weak in some developing countries.

Good practice: legislation should clearly define purpose,

criteria and procedure for obtaining incentives. Coordination among government agencies. Monitoring ensures projects deliver on benefits.

incentives can attract investment to one country, away from another

other countries might therefore respond

there will be a tendency to overbid "victor" is likely to be party with the

"deepest pockets" the poorer countries are relatively

disadvantaged

Attempts to harmonize tax incentives at the regional and multilateral levels have made slow progress. But some success: European Union in manufacturing sector. European Commission over State-aid policy. Caribbean countries agreed to limit rivalry

for FDI but implementation left to individual discretion.

Asian countries cooperate on all but incentives.

Rethinking of tax incentives given overall trends in fiscal policy: Lower corporate tax rates in all regions.▪ Average rates fell during 1990-2005 from 45% to 33% in

Sub-Saharan Africa. Broadening of the tax base.▪ Corporate contributions to tax revenue low but

increasing in Sub-Saharan Africa. More widespread use of VAT, partly to

replace trade taxes. Improved tax administration.▪ Long-term challenge, the impact on revenue has

been modest in Sub-Saharan Africa.

Governments are revisiting tax incentives: Mauritius has rationalized its multiple

incentives schemes and put in place:▪ Corporate tax rate reduced from 22.5% to 15% ▪ Advance payments system to align tax payments

flow with profits flow▪ Tax amnesty▪ Simplified tax methods, electronic filing▪ Business facilitation (clear statement of investment

rules, regulations and administrative procedures)

Governments are revisiting tax incentives: Zambia has revised its mining code:▪ Increasing the corporate mining tax from 25% to

30%,▪ Raising the mining royalty fee to 3% from the

current 0.6%, and ▪ Imposing a 25% windfall tax on companies mining

copper and other base metals. ▪ The new tax regime is expected to generate

additional revenue of US$415 million, with no loss of investor confidence.

What are FDI incentives?

Country experience

Are incentives effective?

Conclusions

Investment incentives involve gains as well as losses for the countries that grant them.

Incentives are minor in decisions of investors relative to other factors (e.g., market size, costs, skills, stability and regulatory framework).

The best incentive is the removal of disincentives to investment.

Tax incentives can be helpful for targeting specific investments.

How incentives are offered is as important as whether they are offered.

There are alternatives to tax incentives that can be conducive to investors and advantageous for domestic revenue mobilization.

Economic growth of 6% in 2007. Export revenue grew 15% in 2006. FDI inflows at highest levels ever

($38 billion in 2006, 27% growth). Contribution of the corporate sector

to public revenue needs to keep pace with the growth in economic output, and this warrants a broadening of the tax base.

Evidence shows that rates of return on FDI in Africa are much higher than on investment in developed, or even other developing countries.

Between 1995 and 1998, US companies registered returns of almost 23 per cent on their investment in Africa, while in Asia and Oceania the figure was 13 per cent. Similar findings for Japanese affiliates abroad confirm that Africa is a very profitable location.

To enhance the benefits from investment and trade in extractive industries.

To diversify industrial and export base.

To attract FDI into infrastructure, manufacturing and services.

To create linkages between FDI and domestic investment.

carefully targeted, strategic incentive packages may be relevant and useful.

Investment climate

Strategic FDI

attraction

Strengthening

absorptive capacity

Source: Altenburg, 2005.

Development strategy and policy coordination

SME support & Linkages

programmes

• Establish an enabling environment for investment and private sector activity.

• Integrate FDI promotion with trade facilitation and export development, in overall development strategy.

• Provide incentives to encourage TNCs to invest in strategic activities, taking due account of WTO rules. Involve TNCs in the upgrading of human resources.

• Invest in infrastructure. Involve TNCs (e.g., public-private partnerships).

• Support the development of domestic suppliers and clusters. Involve TNCs (e.g., linkages).