Public subsidies are often offered to businesses to encourage them to invest in a particular region. Governments provide these subsidies in the form of economic development incentives to either mitigate risk or operational difficulties that the firm may see as potentially problematic or decrease the cost the business may otherwise incur in selecting a particular location.
Subsidies are generally categorized as either
Financial: tax abatements and credits or grants or loans made directly to the firm and realized as an asset on the firm’s financial statement. Sometimes referred to as ‘direct’ incentives because the subsidy goes to the business’ financial statement directly.
Non-financial: support provided indirectly through an intermediary delivering an in-kind service to the firm (e.g., funding for customized training at a community college or infrastructure improvements made near a selected facility). ‘Non-financial’ in this context means that the funds do not go to the business’ financial statement.
Whether the subsidies and/or services are provided directly to the company or indirectly through a third-party intermediary, they always have a cost to the region, even if it’s the staff time to provide the help.
Business' goal: leverage incentives to mitigate risks and lower costs
Firms expanding a facility or relocating an operation face significant costs associated with the location decision and a risk that the decision will not reap the benefits anticipated, that costs will exceed expectations, or that the investment could have a significant short-term negative impact on the firm’s bottom line.
Firms conduct analyses that examine a variety of location factors and how well those align with the company’s needs. Many factors, such as physical proximity to suppliers and customers, access to the appropriately trained workforce, available infrastructure, and other regional assets or even quality of life advantages, influence the FDI decision.
Region's goal: leverage investments to generate benefits
For regions, the goal is to leverage these investments to generate positive economic or fiscal benefits for workers, companies, and the entire region that otherwise may not have happened.
Regions conduct due diligence on potential investors and conduct their own analyses at two levels. First, the region’s representatives estimate the relative costs of the firm’s decision to locate locally as compared with elsewhere to determine whether an incentive is needed and how much might be required to make the region competitive with other locations. Second, the region’s representatives then assess whether the amount required provides positive economic benefits and reflects a fiscally sound decision.
Our research suggests that FDI-related incentives are essentially the same as those provided to attract domestic attraction because the business and regional goals are similar in both cases. While some foreign direct investments occur without incentives, many prospects require regions to offer them as catalysts to (1) generate interest in the state or region, (2) demonstrate a region’s willingness to negotiate, and (3) close a deal. Incentives are viewed as a cost of doing business in today’s competitive marketplace.
This section of the toolkit identifies approaches to operating an effective business incentives program that reflects the unique needs of foreign direct investment efforts.
Assessing the Need for Incentives
Designing Effective Incentives for FDI