Investment incentives: A waste of public money?

Investment incentives: A waste of public money? Steven Mere ; Pursuing a PhD in Business, Human Rights and the Law (International Law) at SOAS, The University of London, UK

JAKARTA POST, 24 Oktober 2012

The Organization of Economic Cooperation and Development (OECD) has recommended that Indonesia reconsider its decision to grant an investment incentive through tax holidays to some pioneer industries in order to maximize the country’s economic growth. The reason is that the provision of investment incentives for a long period will weaken the structure of tax revenue as the basis for maximizing economic growth. Speaking to the media, Finance Minister Agus Martowardojo, however, argues that investment incentive is necessary to lure foreign investments to Indonesia.  Under Article 2 of Ministry of Finance Regulation No. 130/PMK.011/2011 on Provision of Tax Holiday or Reduction Facility, an investor can be granted a tax holiday for a period of between five and 10 years, beginning from the commencement of its commercial production. After the expiration of the tax holidays, the investor will be entitled to an income tax reduction of 50 percent for a further two years. Thanks to the regulation, Indonesia enters an incentive race (bidding war) with other countries that use tax holidays and other incentives as competing tools to attract foreign direct investment (FDI).  The question now is whether the investment incentive will be effective as an attracting tool, particularly in connection with the decision on the FDI destinations is generally claimed. Or, is it just a waste of state revenue?  The rationale of this question is that it incentives are not always the determining factor in the selection of a host country as the destination of FDI.  Foreign investors have their own determinant motives and criteria, which are not necessarily similar, and even often contradictory, to those of the host state, on where to invest.  John Dunning (1993:56-61) identifies four motives (criteria). First is the need for specific resources. These include physical resources (minerals, raw materials and agricultural products), cheap labor, technological capabilities, management and organizational skills.  Second is the opportunity to supply goods or services to the host state’s market, and this will demand an appropriate market size and its growth prospects, cheap production and transaction costs and cooperative action of the host government.  Third is efficiency in business by way of rationalizing “the structure of established resource base” in order to produce standardized goods. The last motive is to secure an asset that can maintain advancement in the face of long-term market competition.  These considerations imply that the FDI is mainly attracted to a particular destination, not only because of the provision of generous investment incentives, but by what Blomstrom and Kokko (2003:4) call “strong economic fundamentals” in place in the host countries.  These fundamentals include market size, level of real income, basic skill level (knowledge), availability of infrastructure, accessibility of resources, socio-political stability and investment policy.  In this regard, whether the host state provides investment incentives or not, as long as the conditions in host state meet at least one of the investor’s motives, that state will be chosen as destination of FDI.  The problem arises when a host state that fulfills at least one of the criteria provides investment incentives to foreign investors who would actually invest in its country anyway. In this context, the incentives, such as tax holidays, are nothing to do with locational attraction for FDI. They are indeed a waste of public money.  This is the reason why the Indonesian government needs to reconsider its tax-holiday and other investment incentive policies. Some critical considerations need to be taken into account.  First, it is necessary for the government to clarify whether the proposed investment is a resources-seeking, market-seeking, efficiency-seeking, strategy-seeking or capability-seeking investment.  We also need to identify which category can be claimed as our strength and advantage.  As a country with a strong advantage in resources, for instance, it is not necessary for us to provide expensive incentives only to attract FDI, if we know in advance that our foreign counterpart is a resources-seeker.  There is no point in attracting FDI by means of incentives if we are sure that our resources have been the determinant factor for the decision to invest in our jurisdiction. Second, the clarification of motives for investment is also significant in identifying the opportunistic tactic of taking advantage of our investment incentives by rent-seekers, whose main motive is to exploit our costly incentives without making any positive contribution to domestic economic growth. It is worth noting that this opportunistic tactic is employed not only by foreign rent-seekers, but also by corrupt officials and business agents.  So, creating transparency may help to prevent such an opportunistic tactic in the investment process. This transparency includes the disclosure of the cost of providing incentives and the expected benefits from the investment spillovers.  It has to be ensured that the spillovers’ value to the domestic economy exceeds the cost of providing incentives. If what is happening is the other way around, then the incentive is a waste of public money.  Third, in cases where the effectiveness of investment incentives depends on whether there are positive spillovers or not, priority must lie with the development of “strong economic fundamentals” as mentioned previously and the promotion of business sectors that create a potential for spillover such as training and research and development (R&D).  This is because they are not only the determinant factors behind the investors’ motives to choose this country as the destination location of their FDI, but also necessary for positive contributions toward spillover value for the domestic economy once our foreign counterparts begin to invest in our jurisdiction. ●