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This paper analyzes how investment incentives may or may not be used to foster private investment, particularly in developing countries. As practitioners and policymakers can attest, political economy exerts a powerful influence on incentives. Many incentives especially generous ones have persisted because of lobbying by special interests and politicians' need to curry favor. Yet little research has been done on how political economy affects incentive policy. Second, the paper sheds light on the role that political economy plays in the popularity of incentives and the related shortcomings. Incentives are sometimes used to dole out favors to investors, so investors who benefit from incentives resist attempts to eliminate them. This paper suggests a way to tackle such problems. Third, the paper compiles good practices on managing and administering incentives in developing countries, drawing on government and private sector experiences. Finally, the paper provides policymakers with a framework for analyzing the efficacy of investment incentives based on the sector and level of development involved, and suggests reforms for moving toward best practice.

Recent decades have seen a dramatic rise in an array of costly government incentives used to attract FDI. Yet while use of incentives by both national and sub-national governments around the world is ubiquitous, with few exceptions little is known about their prevalence, distribution, effectiveness and impacts. For the most part, the use of investment incentives has thus far escaped systematic monitoring, reporting, analysis and regulation. But this may be changing. Certain types of incentives—especially fiscal, financial and regulatory—have increasingly been discouraged by international organizations and experts as they are costly, potentially harmful to sustainable development, and often economically inefficient, resulting in increased inequality rather than inclusive growth. Moreover, it is widely acknowledged that companies may seek—and governments may offer—incentives beyond those that may be needed to attract an investment. Other aspects of incentive packages (such as public investments in infrastructure and/or training) may be more effective but under-utilized. Given the potentially large costs and benefits of investments and investment incentives for countries, this background paper, prepared for the VCC Conference on the same topic on November 13-14, 2013, aims to advance our understanding about the role that incentives have played in attracting and retaining foreign direct investment; the policy rationales supporting or discouraging various types of incentives; the strategies that may be more effective at achieving the objectives of host governments; and the potential for future coordinated action on these issues.

This Public Expenditure Review (PER) takes stock of fiscal developments and institutions and analyzes the key issues that bear on the level, composition, challenges, and effectiveness of government spending and the stance of fiscal policy. Understanding these issues is essential, as new fiscal pressures are emerging in the process of economic transformation and as citizens demand higher quality of education and other public services. The fiscal reform agenda remains extensive but working on it will provide an opportunity to strengthen the effectiveness of government and boost inclusive economic growth. In the process of ongoing economic transformation, the government is facing several challenges in fiscal policy, for which this PER has developed policy options.