Investment incentives

Investment incentives play a paradoxical role when it comes to attracting investors. They are rarely relevant in the investor’s decision making process, but hardly any location can afford not to use them.

Incentives are most commonly conceptualized in the context of attracting foreign investors. The following tables give an overview of types of incentives in this perspective. However, many of these incentives are also applicable when it comes to attracting domestic companies, or even in cases where local companies have enough bargaining power to force government to come up with incentives.

Main types of fiscal incentives for Foreign Direct Investment

Profit-based	Reduction of the standard corporate income-tax rate; tax holidays; allowing losses incurred during the holiday period to be written off against profits earned later (or earlier).
Capital investment-based	Accelerated depreciation; investment and reinvestment allowance.
Labor-based	Reductions in social security contributions; deductions from taxable earnings based on the number of employees or on other labor-related expenditure.
Sales-based	Corporate income-tax reductions based on total sales.
Value-added-based	Corporate income-tax reductions or credits based on the net local content of outputs; granting income-tax credits based on net value earned.
Based on other particular expenses	Corporate income-tax deductions based on, for example, expenditures relating to marketing and promotional activities.
Import-based	Exemption from import duties on capital goods, equipment or raw materials, parts and inputs related to the production process.
Export-based	Output-related, e.g., exemptions from export duties; preferential tax treatment of income from exports; income-tax reduction for special foreign-exchange-earning activities or for manufactured exports; tax credits on domestic sales in return for export performance. Input-related, e.g., duty drawbacks, tax credits for duties paid on imported materials or suppliers; income-tax credits on net local content of exports; deduction of overseas expenditures and capital allowance for export industries.

Source: UNCTAD, Incentives and Foreign Direct Investment, New York and Geneva 1996

Main types of financial incentives for FDI

Government grants	A variety of measures (also loosely referred to as "direct subsidies") to cover (part of) capital, production or marketing costs in relation to an investment project.
Government credit at subsidized rates	Subsidized loans; loan guarantees; guaranteed export credits.
Government equity participation	Publicly funded venture capital participating in investments involving high commercial risks.
Government insurance at prefential rates	Usually available to cover certain types of risks such as exchange-rate volatility, currency devaluation, or non-commercial risks such as expropriation and political turmoil (this type of insurance is often provided through an international agency).

Source: UNCTAD, Incentives and Foreign Direct Investment, New York and Geneva 1996

Main types of other incentives for FDI

Subsidized dedicated infrastructure	Include provision, at less-than-commercial prices, of land, buildings, industrial plants, or specific infrastructure such as telecommunications, transportation, electricity and water supply.
Subsidized services	Services offered may include assistance in identifying finance; implementing and managing projects; carrying out pre-investment studies; information on markets, availability of raw materials and supply of infrastructure; advice on production processes and marketing techniques; assistance with training and retaining; technical facilities for developing know-how or improving quality control.
Market preferences	Preferential government contracts; closing the market for further entry; protection from import competition; granting of monopoly rights.
Preferential treatment on foreign exchange	Special exchange rates; special foreign debt-to-quity conversion rates; elimination of exchange risks on foreign loans; concessions of foreign exchange credits for export earnings; special concessions on the repatriation of earnings and capital.

Source: UNCTAD, Incentives and Foreign Direct Investment, New York and Geneva 1996

Explaining foreign-direct-investment motivations

The key factors that influence the decisions of TNCs fall under three broad categories (in the terminology of John Dunning, one of the most prominent researchers in the field):

1. firm specific (or ownership) advantages, which give a firm competitive advantages in global markets (these include, for example, technological assets, product differentiation, management skills, production efficiencies, size and concentration)

2. internalization advantages, which exist when the internalization of cross-border transactions with in a firm becomes a more efficient form of servicing markets than arm’s length transactions

3. locational advantages, which occur when the local conditions of potential host countries make them more attractive sites for FDI operations than the home country, taking also into account how these conditions combine with the ownership and internalization advantages of the firm. Locational determinants include natural factors (e.g., market characteristics, natural resource availability), political and economic stability, economic conditions (e.g., production costs, transport costs, exchange rates) and policy factors (such as trade barriers, openness to foreign ownership, fiscal regimes or investment incentives)

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