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Incentivizing embedded investment: Evidence from patterns of foreign direct investment in Latin America

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Abstract

Governments frequently offer tax incentives to induce localized investments. This is puzzling because previous research finds tax incentives are rarely decisive factors in firms’ locational decision-making. Some argue incentives reflect hyper capital mobility, which strengthens multinational enterprises’ bargaining leverage vis-à-vis governments that wish to attract investment. Others emphasize the domestic political institutions and electoral considerations that incentivize politicians to publicly court investors. We argue that firms’ leverage over governments stems from investment characteristics associated with governments’ broader development objectives. We test our argument on deal-level data on investment incentives in Latin America from 2010 to 2017. Our results indicate firms are more likely to receive incentives when they are already embedded in local markets and when they exhibit characteristics associated with low ex post mobility. These results challenge widely held beliefs over what provides firms political power in an age of globalization, and suggest that governments use incentives primarily to fulfill their economic and political objectives rather than because globalization destroys states’ capacity to tax mobile capital.

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Notes

  1. See UNCTAD’s Investment Policy Monitory http://investmentpolicyhub.unctad.org/IPM,

    accessed September 16, 2020.

  2. James (2013), see also Tavares-Lehmann et al. (2016) for a review.

  3. Remarks made by James Zhan, UNCTAD at the World Investment Conference in Istanbul, Turkey, October 18, 2016.

  4. The idea that capital mobility is central to explaining the firm/government bargaining dynamic is central to contemporary mainstream IPE. Building from insights that financial liberalization has decreased partisan differences in macroeconomic management (e.g. Boix (2000)), scholars frequently point to asset mobility as key to explaining a wide variety of outcomes including firm valuation (e.g. Pond and Zafeiridou (2019)), why and when governments commitment themselves to investor-state dispute settlement (e.g. Simmons (2014)), and the emergence of tax incentives for foreign investment (e.g. Morisset (2003)). The International Business literature has taken a more eclectic view of the factors that influence this bargaining dynamic (e.g. Eden, Lenway, and Schuler (Eden et al. 2005)), and we view our findings are complementary to that line of research.

  5. But see Graham, Johnston, and Kingsley (Graham et al. 2017), who argue democracies still engage in

    expropriating behavior, just more opaquely.

  6. However, EU members frequently circumvent these rules; See Rickard (2018).

  7. We thank an anonymous reviewer for making this connection explicit.

  8. as of July 24, 2017

  9. t = −0.27, df = 454.1, p value = 0.78

  10. χ2 = 0.04, df = 1, p value = 0.89

  11. χ2 = 0.94, df = 1, p value = 0.33

  12. The online appendix is available at the Review of International Organization’s website.

  13. See, for example, Gupta (2005).

  14. We compute our alternate measure of capital intensity using data from the Bureau of Economic Analysis to compute the share of Net Property, Plant, and Equipment over Total Assets. A summary of the values for this measure is available in the appendix (A19). We prefer the measure reported in our main models because the PPE-based measure places all intangible assets such as intellectual property, trademarks, and brands in the denominator. This has the effect of deflating the PPE ratio of many industries since MNEs tend to be very large firms with highly-valued global brands. However, as reported in A20, our results are robust to this measure.

  15. Most of our data display little missingness (for example, Growth had 1.25% missingness prior to imputation). In supplementary materials, we confirm our results retain when using unimputed data (A3)

  16. Assessing bivariate relationships is important because inclusion of control variables can often induce statistical significance. See Lenz and Sahn (2020).

  17. See also Pinto and Pinto (2015), who argue investment decisions follow partisan business cycles, largely because left governments provide more incentives to investors who will generate substantial employment opportunities. They argue that such incentives are forward looking compensation for the likelihood that future right-leaning governments will treat such investors less kindly.

  18. We urge caution in interpreting these models since our temporal coverage is limited.

  19. We thank an anonymous reviewer for making this point.

  20. We again thank an anonymous reviewer for making this point.

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Authors and Affiliations

  1. Indiana University Bloomington, 355 N Jordan Ave, Bloomington, IN, 47401, USA

    Sarah Bauerle Danzman & Alexander Slaski

  2. Leiden University, Leiden, Netherlands

    Sarah Bauerle Danzman & Alexander Slaski

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  1. Sarah Bauerle Danzman
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Correspondence to Sarah Bauerle Danzman.

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The authors would like to thank Indiana University’s Tobias Center for Innovations in International Development for support as well as Carrington Houser and Jared Schwartz for excellent research assistance.

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Danzman, S.B., Slaski, A. Incentivizing embedded investment: Evidence from patterns of foreign direct investment in Latin America. Rev Int Organ 17, 63–87 (2022). https://doi.org/10.1007/s11558-021-09418-0

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