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Monday, January 2, 2012

Investment Incentives and the Global Competition for Capital

The Vale Columbia Center on Sustainable International Investment has just published my new article in its "FDI [foreign direct investment] Perspectives" series, "Investment Incentives and the Global Competition for Capital." This piece summarizes my book of the same name, and makes the following main points:

  • Investment incentives (subsidies designed to attract investment) are widely used around the world at all levels of government.
  • Incentives are expensive. As I have discussed before, the cost to U.S. state and local governments is $50-70 billion per year. In the Philippines, the cost has been estimated to equal 1% of gross domestic product.
  • Investment subsidies tend to be both economically inefficient and inegalitarian (average taxpayers pay subsidies to richer owners of capital), while some incentives subsidize environmentally harmful projects.
  • Companies have more information about governments than governments do about the companies with which they are bargaining ("information asymmetry"), leading to a tendency for governments to pay more for an investment than they need to.
  • Developing countries sometimes pay far more in incentives than developing countries do for a similar investment. Goias state in Brazil gave Usina Canada $125 million in tax breaks for a $25 million ethanol facility, for example.
  • The best control mechanism for controlling investment incentives exists in the European Union, where the "state aid" rules require advance notification of all subsidy programs and all large individual subsidies (which also provides the best transparency in the world), advance approval by the European Commission, aid limits no higher than 50% of the investment tied to specific regions' income per capita, and sharp reductions in the maximum aid available to projects over 50 million euro. As a result, large projects receive considerably less in the EU than they do in the United States.
  • Outside the European Union, transparency is the first important reform needed in most of the world.
The book, of course, goes into much greater detail on these and many more points I could not cover in the 850-word format of the Perspectives series. Thanks to Editor-in-Chief Karl P. Sauvant and Managing Editor Jennifer Reimer for their help in bringing this article to completion. You can browse the entire Perspectives series here.

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