Wednesday, October 7, 2009

Investment incentives in Southeast Asia

Recent decades have seen a proliferation of investment incentives around the world as governments seek to attract increasingly mobile foreign direct investment (FDI) in the hope of spurring economic growth, raising employment and bringing technology and know-how to the country. Southeast Asia is no exception to this trend. The region has seen substantial growth in FDI inflows over the last three decades, reaching US$60 billion in 2007, a 15-fold increase compared to FDI substantial inflows in 1987. All Southeast Asian countries have offered incentives to foreign investors over the years, although the timing and extent of investment promotion has differed among the countries.
The most widely available incentives in Southeast Asian countries are tax incentives—usually granted for a defined period and with certain eligibility criteria—and reduced duties on capital goods and raw materials used in export-oriented production. Moreover, all Southeast Asian countries have set up designated zones where investors can benefit from special tax benefits, infrastructure and streamlined administrative procedures. In addition to attracting FDI overall, many incentives provided by Southeast Asian countries aim to meet other development objectives, such as promoting investments in underdeveloped regions or attracting investments to certain types of industries and sectors. While the use of investment incentives is widespread in Southeast Asia, their actual impacts on foreign investors’ decisions about where to invest, in what and how much remain poorly understood. More importantly, the quantity of investments is not a sufficient indicator to judge the success of incentives. Instead, it is necessary to assess the impacts of incentive-induced FDI on the countries’ policy objectives
related to economic growth, social development and environmental sustainability.
Understanding such impacts can be challenging due to difficulties in assessing the costs and benefits of investment incentives and isolating the role of incentives from other factors. However, experiences in Southeast Asia have also shown that incentives are certainly not a sufficient condition for attracting FDI and a number of other factors—such as political stability, social and physical infrastructure, cost variable, the macroeconomic environment and institutional development—will be
equally if not more important in shaping FDI decisions.
For instance, political and economic instability in the Philippines and Indonesia in the 1980s and late 1990s respectively has deterred foreign investors despite
the availability of investment incentives. A number of studies have shown redundancy rates (i.e., would investments have been made anyway in the absence of incentives?) of somewhere between 70 and 80 percent in Vietnam, the Philippines and Indonesia.
The environmental impacts of investment incentives are seriously under-researched. Such impacts can occur where investment incentives increase the level of production or where the FDI projects themselves negatively affect the environment, such as in large-scale hydropower, mining or industrial agriculture projects. A FDI-induced growth in manufacturing industries, notably the electronics industry in Thailand and Malaysia, has raised serious environmental concerns related to pollution, high energy consumption and hazardous electronic waste. Concerns have also been raised that foreign enterprises may be attracted to an investment location to take advantage of lax environmental standards or that host governments may lower their environmental standards or fail to enforce them to attract foreign investors. Overall, however, there seems to be growing consensus that for most sectors, environmental standards play a less significant role in influencing FDI decisions than other cost factors.
No systematic studies have been carried out to assess the impacts of incentive-based competition on FDI diversion across the Southeast Asian region. A general comparison of FDI sectors, source countries, types of investors, investors’ motivations and the broader investment environment among the Southeast Asian countries suggests that incentives could play a role in diverting FDI between Singapore and Malaysia for high-tech industries as well as among Malaysia, Thailand, Indonesia, the Philippines and Vietnam for manufacturing components and medium-tech products for export. The region’s least-developed countries Cambodia and Laos (as well as Vietnam to a lesser extent) would likely compete for low-tech
assembly industries and FDI in natural resource extraction and large-scale agricultural production.
Similarly, evidence on the actual impacts of incentive-based competition on socio-economic and environmental progress is still inconclusive, both globally and for Southeast Asia. Some have argued that competition for mobile capital can be healthy, facilitating the efficient allocation of investment and encouraging governments to improve the investment environment more generally. More commonly,
however, concerns have been raised that competition can lead to “bidding wars” that will leave all bidders no better or even worse off in the end. While the proliferation of incentives in Southeast Asia highlights the role that investment competition can play, it is still unclear whether this trend has had positive or negative impacts on the sustainable development of these countries.

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