Developing Countries in Competition for Foreign Direct Investment

Transcription

1 Seinar in International Econoics 5 Marc 2015 Developing Countries in Copetition for Foreign Direct Investent oran Vukšić Institute of Public Finance, Zagreb Tis seinar series is an activity in te fraework of FIW 'Forscungsscwerpunkt Internationale Wirtscaft', wic is a project designed to build a center of excellence in researc on International Econoics, funded by te Austrian Ministry of Science, Researc and Econoy BMWFW.

2 Developing Countries in Copetition for Foreign Direct Investent oran Vukšić Institute of Public Finance, Zagreb WIIW, Marc 2015

3 Wy copetition? FDI ay bring ore to ost countries tan just additional financial capital: broader tax base increased eployent enanced anageent skills new tecnologies iger wages access to export arkets, etc. Benefits fro FDI depend on types of investent and on ost countries policies. Tese effects are especially iportant in te context of econoic developent reason wy countries engage in copetition for FDI Question: Wen can a less developed country win in copetition for FDI?

4 Soe iplications fro epirical researc Intensity of te copetition for FDI as increased as a consequence of fallen barriers to international investent, and of reduced iportance of arket size due to globalization of te world econoy. Tax incentives are one of te ain instruents for attracting FDI, but tey cannot copensate for all drawbacks of soe copeting country. Te ost iportant oter factors considered by te investors: predictable and non-discriinatory regulatory environent and an absence of excessive adinistration including transparent public sector and effective syste of courts and law enforceent. stable acroeconoic environent including access to international trade. sufficient and accessible resources relevant infrastructure and uan capital. Policies to influence investors decision witout giving subsidies.

5 Fiscal policy tools Copeting countries can influence FDI flows up to a certain level by using fiscal policy instruents as strategic tools. Tax incentives and/or iger supply of public inputs? Bot of tese policies need to be financed by a iger tax burden on doestic producers te use of public resources for tax incentives tends ore to copete tan to augent te use of public resources for providing additional public inputs. owever, wile only foreign copany benefits fro tax incentives, additional public inputs increase te output of doestic copanies as well. One needs to odel te copetition for FDI in wic governents ay coose between tese two instruents.

6 Asyetric countries I Most of te odels on tax copetition, and on copetition for FDI are in syetric settings te results do not say anyting about te allocation of FDI aong countries at different stages of developent. Countries are different in respect to any aspects wic are iportant for location decision of foreign investor FI: arket size arket access, transportation costs intensity of copetition wages or oter production costs available infrastructure pysical and institutional + uan capital

7 Asyetric countries II Te attractiveness of a country as an investent location increases, ceteris paribus, wit: a larger arket better arket access b lower intensity of copetition on local arkets c lower wages/production costs d iger supply of public inputs infrastructure a & b sufficiently explored tis paper concentrates on c & d. Can it be stated in advance tat, according to above criteria, developing countries are ore attractive for foreign investors? Developing countries arkets are usually saller, but wit lower intensity of copetition. Also, te wages in developing countries are lower, but te supply of relevant infrastructure and oter public inputs is saller.

8 Deterinants of optial policy toward FDI Te situation witout FDI can be described as initial incoe. Incoe wit FDI ust be copared wit te initial incoe in order to define net gains fro FDI. Country can offer e.g. subsidies to foreign investor as long as te net gain fro FDI is positive, wic defines a country s axial bid. In situation wit asyetric countries, initial incoe as well as te axial bid of individual countries will norally differ. Wit a possibility of increasing te supply of public inputs along/instead offering tax subsidies axial bid is not to be understood as axial subsidy, but as best possible conditions for FI given te positive net gain fro FDI.

9 Assuptions of te odel Two countries copete for a single FDI. FI will invest in te country in wic e akes iger profits. Markets of two countries, as well as of te rest of te world are assued to be perfectly integrated wit tariffs and transportation costs equal to zero. Doestic copanies in two countries produce a oogenous product for wic tere is an exogenously given deand. Doestic firs are price takers on te world arket, wic is separate fro te arket of foreign investor. overnents use capital tax to finance teir expenditure public inputs and/or subsidies and tey ust run balanced budget. Tere is an eployent creation effect due to FDI in bot countries and no spillover effects.

10 Copeting econoies and differences I Tere are n copanies in eac copeting econoy, engaged in perfect copetition n is noralized to 1. Tey produce a single good and teir tecnology is described by te production function wit tree arguents: capital, labor and public inputs: F,, g in, wit positive first, and negative second derivative of g. and te assuption tat capital is te liiting factor in te production of doestic firs. In addition, te analysis starts wit assuption of an adinistrative iniu wage causing uneployent and an infinite labor supply at iniu wages denoted wit w.

11 Copeting countries and differences II Doestic firs are not obile, i.e. te capital eployed in tese copanies represents an iobile tax base. Te only difference between countries is tat local producers in ore developed country use ore capital in te production, i.e. tat: were stands for ig developed country and for underdeveloped country. Te above inequality leads to: It is also assued tat: w w

12 overnent overnent levies capital tax in order to finance te supply of public inputs: T wit,t 0 were T denotes tax rate. overnent axiizes its residents' real disposable incoe denoted by W: W F,, T g T Optiality condition witout FDI is: g 1 Te above condition defines: T T, and Witout FDI, tere is iger supply of public inputs and iger incoe in ig developed country. W W

13 Foreign investor Te profit of FI is given by: wit and, were and stand for capital and labor eployed by te FI, is te tax rate for FI, and r is exogenous cost of capital. Te residents incoe wit FDI equals: But now tere is a possibility of tax discriination and we ave: Two regies will be analyzed: witout and wit tax discriination. w T g W,, T r w F T T T g F ], in[,,

14 Case witout tax discriination sing only single tax rate, applicable to all copanies te governent axiizes residents disposable incoe, subject to: non-negative supply of public inputs profit of FI ust be iger tan in oter country tere is a non-negative net gain fro FDI, Forally: s.t. ax W T g T w W T ~ W 0

15 cont. In te situation wit FDI tere is a new optial supply of public inputs deterined by te following condition: 1, wic defines T, and W g owever, fro te perspective of FI, te optial supply of public inputs ust fulfill te following condition: 1, wic defines T, and W Tis aount of public inputs is denoted by attainable for copeting countries. Tis depends on weter: W W. and it ay, or ay not be

16 ,W W W2 W W W 1 ax ax

17 Te copetition Strategy spaces are: [, in [, ax, ax, in ] ] for for and Best response functions are: set set s.t. s.t. ess developed country wins if: or, if is not attainable wen: ax ax, in

18 Wic country wins? If is attainable for bot countries, te difference between foreign investor s profit in two countries equals: In te case witout tax discriination and wit attainable : if wages were equal in bot countries, te ig developed country would always receive te investent; te underdeveloped country will receive te investent if te difference in wages between two countries is sufficiently ig: ] [ w w T T ] [ T T w w

19 An iplication and te role of public inputs ess developed country as better cances of winning in te case of labor intensive project greater difference in labor costs, wile oter variables are not affected. In te absence of taxes wit being soe exogenous variable tat cannot be affected by te policy, less developed country wins if: If following inequality olds: ten consideration of public inputs ay increase te less developed country s cances of winning te FDI. w w ] [ T T

20 Case wit tax discriination Maxiization proble is: s.t. ax W g T, T T w T ~ T W T W T 0

21 Optial supply of public inputs In te situation wit FDI, te optial supply of public inputs is always iger tan in a regie witout FDI. Te optial supply of public inputs denoted by is defined by te following condition: owever, te above condition does not define individual tax rates for doestic and foreign copanies. Rearranging te first order conditions of te axiization proble yields: 1 g Ĝ w r T / ~ ˆ ˆ w r T / ~ ˆ ˆ ˆ ~ ˆ ˆ ˆ ˆ r g W

22 Iplications and te copetition Fro above equations it can be seen tat residents incoe wit FDI, as well as te tax rate on foreign capital, is negatively related to profit tat foreign investor can ake in te oter country. Te opposite olds for tax rate on doestic capital. Te strategy spaces are T, T R and R suc tat governent s budget is balanced. Te best response functions are: set ˆ and set T Tˆ s.t. ˆ ˆ, T, T set ˆ and set T Tˆ s.t. ˆ ˆ, T, T

23 Wic country wins? Fro te condition of non-negative net gains fro FDI, it is possible to find expression for axial subsidy, wic can be plugged into FI s profit function to express te axial profit tat FI can ake: wit: FI s decision is deterined by te sign of te following expression: r F F ax g g F ˆ ˆ ax ax F F F F F ˆ

24 A F E D C B i g, g g Ĝ Ĝ g 1 g 1

25 Solution It turns out tat ig developed country always wins te investent wit tax discriination. Te reason is tat wage rates do not play any role ere, since additional labor cost for te FI is equal to additional gains fro FDI for te governent, so tat ig developed country can copensate tis difference in labor costs to FI. Tis is not canged even in te set up wit labor arkets clearing wages, i.e. witout adinistrative iniu wages creating uneployent. If labor supply curve is upward sloping, te assuption of cleared labor arkets increases te cance of less developed country winning te investent, in te case witout tax discriination.

26 Conclusions Witout tax discriination, less developed country can win te FDI if wage differential is sufficiently ig and depending on te responsiveness of foreign and doestic copanies affecting attainability to canges in te supply of public inputs. Including public inputs in te odel ay increase te cances of less developed country, as copared to considering anoter location deterinant tat cannot be affected by policy. In eac case, witout tax discriination, te cances of less developed country are better wit labor intensive FDI. If tax discriination is peritted, bot countries optially raise te supply of public inputs, but ig developed country always wins te investent. Qualitatively, te results do not cange if cleared labor arkets are assued instead of adinistrative inial wages causing uneployent unless soe doestic copanies are forced to exit te arket.

27 Iplications overnents of less developed countries ay ave an incentive to work on an international agreeent to disallow tax discriination, i.e. subsidies, unless tey are convinced tat te gain fro FDI in teir countries is sufficiently iger tan in ig developed countries and tat tis difference is not reflected in different costs for foreign investor. Suc easure is not identical to abolising tax copetition for FDI in general. Even if governents are not allowed to discriinate, tey ay still deviate fro teir optial taxation and supply of public inputs in order to attract FDI as long as te residents incoe wit FDI exceeds teir incoe witout FDI. Teory on copetition for FDI and related epirical researc sows tat public policy atters for te location decision of investors. Fiscal policy could ave kept ore capital in te developed world by using subsidies, tan te neoclassical teory would predict if fiscal policy were neglected.

28 iterature Barros, P.P. and Cabral,. 2000, Copeting for Foreign Direct Investent, Review of International Econoics 8, pp Bjorvatn,. and Eckel, C. 2006, Policy copetition for foreign direct investent between asyetric countries, European Econoic Review 50, pp Fuagalli, C. 2003, On te welfare effects of copetition for foreign direct investents, European Econoic Review 47, pp aaparanta, P. 1996, Copetition for foreign direct investent, Journal of Public Econoics 63, pp aufler, A. and Wooton, I. 1999, Country size and tax copetition for foreign direct investent, Journal of Public Econoics 71, pp Oan, C. 2000, Policy Copetition for Foreign Direct Investent, Developent Centre Studies: International Developent, OECD.