Background Paper on Investment Incentives: The good, the bad and the ugly: Assessing the costs, benefits and options for policy reform

Recent decades have seen a dramatic rise in an array of costly government incentives used to attract FDI. Yet while use of incentives by both national and sub-national governments around the world is ubiquitous, with few exceptions little is known about their prevalence, distribution, effectiveness and impacts. For the most part, the use of investment incentives has thus far escaped systematic monitoring, reporting, analysis and regulation. But this may be changing. Certain types of incentives—especially fiscal, financial and regulatory—have increasingly been discouraged by international organizations and experts as they are costly, potentially harmful to sustainable development, and often economically inefficient, resulting in increased inequality rather than inclusive growth. Moreover, it is widely acknowledged that companies may seek—and governments may offer—incentives beyond those that may be needed to attract an investment. Other aspects of incentive packages (such as public investments in infrastructure and/or training) may be more effective but under-utilized. Given the potentially large costs and benefits of investments and investment incentives for countries, this background paper, prepared for the VCC Conference on the same topic on November 13-14, 2013, aims to advance our understanding about the role that incentives have played in attracting and retaining foreign direct investment; the policy rationales supporting or discouraging various types of incentives; the strategies that may be more effective at achieving the objectives of host governments; and the potential for future coordinated action on these issues