Targeting FDI
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Targeting FDI Ben Ferrett1,2 · Ian Wooton3,4,5 Accepted: 28 August 2020 © The Author(s) 2020
Abstract We study the tax/subsidy competition between two countries to attract the FDI projects of two firms. We assume that governments lack the capacity to target every potential inward investor such that each can only bid for a single firm. When the characteristics of the two countries are common knowledge, subsidy competition never arises in equilibrium. Both governments may target the same firm if there is uncertainty as to the more profitable location for that firm’s plant, such that both governments believe they may win the competition. We also explore how such uncertainty affects the firms’ after-tax profits. Keywords Foreign direct investment · Tax/subsidy competition · Efficiency JEL Classification F12 · F23 · H25 · H73
1 Introduction Attracting inward FDI is an important goal of government policy, given the perceived benefits that it generates in terms of employment (more and better jobs), technological spillovers to indigenous firms, increased demand for local services, etc. Consequently, a country may be willing to spend resources trying to persuade firms to locate their plants within its national frontiers. As production becomes increasingly mobile, countries will face an increasingly wide choice of which firms to target with their fiscal incentives.
* Ben Ferrett [email protected] 1
School of Business and Economics, Loughborough University, Loughborough LE11 3TU, UK
2
GEP, University of Nottingham, Nottingham, UK
3
Department of Economics, University of Strathclyde, Glasgow G4 0QU, UK
4
CEPR, London, UK
5
CESifo, Munich, Germany
13
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B. Ferrett, I. Wooton
Our analysis begins from the assumption that governments are constrained in the number of potential inward investors they can, in fact, target with investment incentives. If incentive packages typically take forms that are specific to the FDI projects concerned (e.g. the provision of certain types of infrastructure that would complement the MNE’s plant), then it seems natural that a public bureaucracy should be constrained in terms of the number of such packages that it can devise annually.1 Most obviously, such constraints might arise for administrative reasons. For example, decisions taken this year to hire specialised public servants to research and negotiate firm-specific incentive packages create an administrative-capacity constraint in future years (given that recruitment of highly specialised workers is often a lengthy process).2 We assume that such a “targeting constraint” on government behaviour is binding. Consequently, it is infeasible for a national government to develop a projectspecific incentive package for every potential inward investor. In this environment, we seek to answer the following two questions. First, which firm (or firms) will a government choose to target? Secondly, in what circumstances will more than one government compete to attract a particular firm’s production facilities? We e
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