cHapTer 3 Policy Conclusions chapter summary Public policies facilitating FDI and FDO, as well as their spillover benefits, contribute more generally to real economic growth. Best practices encompass improving infrastructure, investing in education, and promoting the capacity of domestic firms to use new technology. National and sub-national governments both have an interest in facilitating foreign direct investment (both inward and outward), as well as in leveraging the spillover efficient benefits from foreign direct investment. In fact, policies that promise to facilitate FDI and FDO, as well as their spillover benefits, are largely consistent with public policies that are recommended more generally for improving productivity and economic growth. For example, improving the physical and communications infrastructure of a country or region, raising the education and skill level of the workforce, and encouraging innovation-related activities are important components of best practice policies to encourage foreign direct investment. In broad terms, best FDI practices can be seen as “framework” policies. That is, they contribute to an increased production capacity of the national or local economy. It is less clear from the available evidence that policies targeted specifically at foreign investors Find this report and other Conference Board research at www .e-library .ca can fit the description of best practices. For example, financial subsidies to foreign investors might attract some FDI, at the margin; however, the impact of those subsidies seems to weaken over time. Moreover, if the subsidies, intentionally or unintentionally, encourage investment outside concentrated “centres of excellence,” the spillover benefits to domestically owned firms are likely to be negligible. However, foreign investment promotion agencies can be effective instruments to encourage inward direct investment, particularly if they focus on mitigating administrative costs and delays that confront foreign investors. in broad terms, best Fdi practices can be seen as “framework” policies—i .e ., they contribute to an increased production capacity of the national or local economy . It is obvious that restrictions imposed specifically on foreign investors, particularly limitations on foreign ownership, will discourage inward foreign direct investment. Supporters of foreign ownership restrictions sometimes argue that such restrictions encourage foreign investors to take on domestically owned partners, and that such shared ownership promotes spillover benefits from FDI. In fact, there is no consistent evidence supporting this presumption. Moreover, requirements imposed on foreign-owned firms to source more inputs domestically or to export more do not seem to increase the benefits of FDI to the host economy. Hence, such targeted policies seem inadvisable.
Government subsidies to foreign investors will increase inward foreign direct investment, at the margin, presuming that they are not matched by other governments. Given the existence of spillover benefits to FDI, targeting subsidies to potential foreign investors would seem to be an advisable policy; however, extending such subsidies is not necessarily an element of best practices. For one thing, if subsidies are linked to investing in “have not” locations, the spillover benefits to the host economy are likely to be severely compromised. For another, the fiscal burden of significant investment subsidies implies either that taxes must be increased to pay for the subsidies or that government expenditures in other areas, including possible expenditures on public services, must be reduced. Either of these initiatives will discourage inward direct investment. On balance, national, but particularly sub-national, units might be more effective in attracting FDI, and in leveraging the benefits of FDI and FDO, by emphasizing governance and infrastructure improvements, rather than fiscal subsidies to foreign investors. Tax policies are, perhaps, the most controversial aspect of best practices. Popular opinion, as well as anecdotal evidence, suggests that lowering tax rates should encourage increased investment, including investment by foreigners. However, difficulties in accurately measuring effective tax rates, particularly at the sub-national level andfor specific industries and companies, limit rigorous empirical examination of the relationship between tax rates andforeign investment. Furthermore, since taxes help fund the provision of public goods, and since the supply of public goods encourages investment, the The Conference Board of Canada | 19 full impact of lowering tax rates might be to discourage investment, if the supply of public goods is diminished as a consequence. Since public sector investments are moderated by a broad range of social considerations, there may be no policy inferences that apply uniquely to best practices for promoting foreign investment. However, it seems fair to argue that investments focused on improving the efficient operations of government, modernizing and enhancing physical infrastructure capacity, and improving innovation capabilities are particularly relevant components of best practices. Good framework policies encourage both increased Fdi and greater spillover benefits from that Fdi . The available evidence is much more conclusive for best practices for FDI than for FDO. In particular, the available evidence suggests that good framework policies encourage both increased FDI and greater spillover benefits from FDI. While it is plausible that those same policies promote increased home-country spillover benefits from FDO, there is simply not enough evidence to support or disprove this presumption. While more research on the home-country spillover benefits from FDO is clearly desirable, there is no basis for imposing policies that discourage FDO at the margin. Both FDI and FDO are modes through which international production becomes more specialized geographically, and the benefits to production specialization are very wellestablished. Framework policies that encourage FDI will, over time, also encourage increased FDO. Find this report and other Conference Board research at www .e-library .ca