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AN INVESTMENT PERSPECTIVE ON GLOBAL VALUE CHAINS
Investment incentives Governments use investment incentives to attract foreign firms and encourage specific behavior. Many governments offer tax concessions intended to steer investment into preferred sectors or specific regions or to enhance the investment’s development effects (James 2014). However, tax incentives come at the expense of forgone revenue and should be seen as a type of government subsidy or a form of state-directed “investment” in a company’s future. Tax incentives are justified only if they generate positive externalities that compensate for their present social costs (Harrison and Rodríguez-Clare 2010; Margalioth 2003; Wade 1990). Tax incentives are often used to meet two types of objectives (figure 4.5): 1. Locational incentives hope to generate positive externalities by attracting MNCs that will provide new GVC opportunities and raise domestic firms’ productivity and sector competitiveness. Because FDI is highly mobile across countries, attracting MNCs may require offering reduced tax rates or other incentives. This is a classic case in which incentives can lead to net social benefits (Margalioth 2003). 2. Behavioral incentives aim to generate positive externalities by stimulating specific firm behavior (such as innovation) that will yield high social benefits. Temporary support can help improve firms’ long-term productivity. For such interventions to enhance welfare, they must pass two tests: the supported firms should eventually be able to survive international competition without the incentives, and the expected future benefits should compensate for the present subsidy costs. In practice, it is extremely hard to identify firms that would exhibit such spillovers if supported, let alone to identify the incentives that would pass a cost-benefit assessment (Harrison and Rodríguez-Clare 2010). Developing countries are increasingly using tax incentives as part of their industrialization strategies. Andersen, Kett, and von Uexkull (2018) find that, for the period FIGURE 4.5 Locational and behavioral incentives have different aims and expected benefits
Objectives
Objective type
Attract new investment
Grow strategic sectors
Create jobs
Promote R&D and innovation
Promote exports
Locational objectives (Attract new firms)
Behavioral objectives (Shift firm behavior)
Incentive aim
Raise firms’ expected profitability • Effect on tax risks (transparency) • Effect on profits
Lower user cost of specific behavior • Effect on input cost • Effect on output cost
Incentive success
New firms locate in the country or region as a result of incentives
Firms use inputs more or produce more output as a result of incentives
Incentive failure
Firms receiving incentives would have located there anyway
Firms receiving incentives do not change behavior or would have changed their behavior anyway
Source: Kronfol and Steenbergen 2020. Note: R&D = research and development.