The economics of international investment incentives
The attitude towards inward foreign direct investment (FDI) has changed considerably over the last couple of decades, as most countries have liberalised their policies to attract all kinds of investment from multinational corporations (MNCs). On the expectation that MNCs will raise employment, exports, or tax revenue, or that some of the knowledge brought by the foreign companies may spill over to the host country private sector, many governments have also introduced various forms of investment incentives, to encourage foreign owned companies to invest in their jurisdiction. These include OECD country governments, which, from a developing country viewpoint, have sometimes been considered as discouraging FDI flows toward less developed economies. The most powerful arguments in favour of such incentives are based on the prospect for knowledge spillovers. Since technology to some extent is a public good, foreign investment can result in benefits for host countries even if the MNCs carry out their foreign operations in wholly-owned affiliates. These benefits take the form of various types of externalities or " spillovers ". For instance, local firms may be able to improve their productivity as a result of forward or backward linkages with MNC affiliates, they may imitate MNC technologies, or hire workers trained by MNCs. The increase in competition that occurs as a result of foreign entry may also be considered a benefit, in particular if it forces local firms to introduce new technology and work harder. However, the foreign MNCs will not include these spillovers in their private assessment of the costs and benefits of investing abroad, and may therefore invest less than what would be socially optimal. If, on the other hand, the benefits of FDI are adequately reflected in the private return accruing to an investment, market incentives ensure that this investment effectively takes place and no special government incentives should be necessary. The motive for public subsidies to foreign investors is to bridge the gap between the private and social returns, thus promoting larger inflows of FDI.