Incentives for Attracting FDI in South Asia

Abstract

Incentive offers along with performance requirements are a notable feature of the Foreign Direct Investment (FDI) policies of South Asian countries after they opened up to trade and investment in the 1990s. Since FDI operates in an imperfect market environment, a government policy that tries to counter this imperfection by insisting on performance requirements could well improve welfare. Incentives are then offered to soften the impact of performance requirements. There are no systematic studies to assess the cost and benefits of these incentives offered competitively in South Asian countries. Often, the purpose of these incentives may have been to generate funds for side payments to the bureaucracy of host countries. Incentives seem to affect mainly footloose FDI or, at best, lead to relocation of FDI within a region. This latter advantage disappears when countries of a region tend to compete in incentives. The limited number of studies on the South Asian region that are available seem to identify an increase in employment and/or wages, reduced prices or improved product quality, more revenues for the government and indirect benefits through professionalism, learning and technology diffusion as benefits. The impact of providing facilitation to foreign investors on national savings, deterioration in trade conditions and balance of payments are cited as the cost of incentives. Coordination in FDI policy making among South Asian countries is the main policy prescription that emerges out of this study.