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Welfare Loss And Incentives-Based FDI Competition

Just how effective are incentives when it comes to attracting FDI and what downsides are associated with this form of investment attraction?

Corporate taxation has implications for international investment allocation. From the global minimum tax debate to the argument for more inclusive economic systems, tax competition remains one of the most important credos of orthodox macroeconomic policy. As the ongoing accelerated pace of digitisation continues, the subject of international mobility of productive capital is back on the front burner of policymaking in many jurisdictions interested in attracting foreign direct investment (FDI).

Insofar as the location choices of potential investors are driven by varying degrees of institutional quality and corporate tax rates, governance infrastructure will continue to be critical vis-à-vis the sensitivity of FDI inflows to host country tax rates.

FDI flows and the global North-South divide

The debate gets even more interesting when viewed through a global North-South lens. The issue of asymmetries in the impact of corporate tax differentials on FDI between developed and developing countries features prominently in economic development policy and practice. In the advanced industrial nations, governance infrastructure – via stable and transparent regulatory and policy regimes – is generally conducive to FDI inflows. However, due to a wide range of political economy factors, the effect of the institutional dimensions of governance on inward FDI is more nuanced in developing countries – partly because this could present a ‘double whammy’ whereby lower tax rates do not significantly increase foreign investment, while higher rates deter new capital inflows.


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