WORLD TRADE
ORGANIZATIONWT/WGTI/W/100
2 April 2001
(01-1643)
Working Group on the Relationship
between Trade and InvestmentOriginal:  English
COMMUNICATION FROM THE OECD
Reproduced hereunder is the statement made by the observer representative of the OECD at
the meeting of 7 and 8 March 2001.
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Summary of OECD Work on Issues Related to Investment Policy Analysis
1. Following the successful Review of the OECD Guidelines for Multinational Enterprises ,
which was the subject of a presentation to the WGTI last year [WT/WGTI/W/93], the OECDCommittee responsible for International Investment and Multinational Enterprises (the CIME) was
eager to complement this work with analysis of other issues.  To this end, it set up three ad hoc
working groups on the following:  "The Benefits and Economic Impact of FDI", "FDI and New
Technology", and "Policy-Based Competition to Attract FDI".
2. Among the issues with respect to the Benefits and Economic Impact of FDI that the ad hoc
group has indicated it would like examined are:  to identify with greater specificity the benefits and
costs of FDI on home and particularly host countries, whether in terms of macroeconomic impacts(economic growth, poverty alleviation, employment, balance of payments or exports), or
microeconomic evidence in areas such as technology transfer, competitiveness, firm-level
productivity, environmental impacts, human capital improvement, and corporate governance
standards.  In this vein, one question that could then be asked would be:  what have home and host
governments done to maximize the net benefits of FDI?  In addition, a fuller understanding of thisissue would be obtained by addressing whether and how differences in perception  concerning FDI
activity in developed and developing countries affect investment behaviour.  A full examination of
these issues could encompass examination of the behaviour of individual firms.
3. The FDI and New Technology group is particularly interested in examining the significance
of such recent phenomena as the growth in importance of intangible assets such as human capital andfirm-level know-how which have resulted from technological change.  Another phenomenon that
could merit examination is the apparent paradox of the global corporation, facilitated by technological
developments affecting data and information exchange while at the same time complicating its
management.  In addition, what are the macroeconomic effects of these qualitative changes in the way
firms can operate with respect to FDI flows and strategy.  How can the gains from innovation bedisseminated?
4. Finally, the ad hoc group on Policy-Based Compe tition for FDI has indicated that it would
like to focus on two aspects of this issue at the outset:  financial incentives, and "rules-based
competition", in so far as they concern environmental and labour standards in particular.  (FiscalWT/WGTI/W/100
Page 2
incentives can not be disregarded of course, and the OECD will integrate expertise in this domain into
the investigation as well.)
5. Work with respect to this latter project will draw on a recently published OECD Development
Centre study on the subject.  An annex, below, provides greater detail on its contents, and includes an
executive summary, and findings and conclusions.  Reflecting the Development Centre's links, anumber of individuals and institutions from developing countries contributed to the analysis and
provided comments.
6. Highlights of the study of relevance to the work of the ad hoc group on Policy-Based
Competition for FDI include the following:  The first part of the study looks at the debate over
incentives and rules-based competition, including the "positive sum game" and "negative sum game"
hypotheses.  Among the findings in this regard are, not surprisingly, that incentives based competition
for FDI is a global phenomenon, and furthermore than their significance may be increasing as otherbarriers to FDI fall and the benefits of FDI are in creasingly realised by governments.  Nonetheless,
competition for FDI is more intensive in some industries than others.
7. A number of examples are examined from both developed and developing countries.  While
not containing a comprehensive examination of all programmes, the study does echo UNCTAD's
findings that developed counties tend to rely on financial rather than fiscal incentives.  Caution shouldbe exercised in interpreting results with respect to  drawing any conclusions with respect to investment
incentives, however, since among other problems meas uring the costs and benefits of FDI is difficult,
particularly net benefits to a host economy.  Finally, while the study finds little evidence of a "global
race to the bottom" in labour and environmental standards, the widespread use of investment
incentives in both developed and developing countries is arguably bad for both transparency ingovernment and accountability.  For most industries in most countries, the best investment incentive
continues to be good economic and political fundamentals, including with respect to infrastructural
arrangements and a smoothly functioning ma rketplace for both inputs and outputs.
8. It could be added that more research is needed into these and related questions, including the
efficacy of both financial and regulatory investment incentives, and the ad hoc group at the OECD hasexpressed some interest in doing so.  It is also evident that as the OECD intensifies its analysis into
the subject areas of all three ad hoc groups, the Organisation will need to consult widely with
developing countries, including organizations such as the WTO, UNCTAD, and regional groupings.
The OECD looks forward to doing so wherever opportunities for productive dialogue present
themselves.WT/WGTI/W/100
Page 3
ANNEX
Executive Summary and Further Information
OECD Development Centre
POLICY  COMPETITION
FOR
FOREIGN  DIRECT  INVESTMENT
A Study of Competition among Governments to Attract FDI
by
Charles P. Oman
March 2000WT/WGTI/W/100
Page 4
Contents
AcknowledgementsPrefaceExecutive SummaryChapter 1:  The Phenomenon, The Debate
Two Interpretations
Positive-sum-game hypothesis
Negative-sum-game hypothesis
       Incentives-based and Rules-based Competition
Chapter 2:  Incentives-based Competition
The UNCTAD Report   
  I. Incentives-based Competition in Developing Countries
Brazil
Argentina
Malaysia
Singapore
ChinaIndia
 II. Incentives-based Competition in OECD Countries:  an Overview
United States
Western Europe
Canada
III.  Summing Up the Evidence
Chapter 3:  Rules-based Competition
I. Environmental Standards
II.  Labour Standards and Export-Processing Zones
III.  More Effective Rules-based Policies to Attract FDI
RegionalisationPrivatisation, and the Need for Competition Policy
Accountability and Rules-based Governance
Chapter 4:  Conclusions
Is the Competition Intensifying?The Effects of Policy Competition
Effects on Investment Decisions
Effects on Policy Making
Economic Effects
Positive-sum game or Negative-sum game?
Policy Implications
 Summing Up
BibliographyWT/WGTI/W/100
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 Acknowledgements
The Development Centre and the author are particularly grateful to participants in the
Centre’s November, 1998, meeting of experts on Polic y Competition and Foreign Direct Investment,
who provided valuable comments on a draft of this study, and to the authors of the country- and
region-specific analyses on which this study relies heavily:
- John Bachtler and his team at the University of Strathclyde’s European Policies Research
Centre (Europe)
- Jaime Campos, Executive Director, Fundación Invertir  (Argentina)
- Edward K. Y. Chen, President, Lignan College, Hong Kong (China)- Chia Siow Yue, Director, Institute of Southeast Asian Studies (Singapore)
- Jack Donahue, Professor, John F. Kennedy School, Harvard University (United States)
- Hu Angang, Chinese Academy of Sciences (China)
- Weng-Jeng Kuo and Shin-Horng Chen, Chung-Hua Institution for Economic Research
(Chinese Taipei)
- Michael Mortimore and Wilson Peres, UN Ec onomic Commission for Latin America and the
Caribbean (Caribbean Basin)
- Pedro Noyola and Enrique Espino sa, SAI Law and Economics (Mexico)
- André and Françoy Raynauld (Canada)
- Sieh Lee Mei Ling, Professor, University of Malaya (Malaysia)- R. Venkatesan and colleagues at the National Council of Applied Economic Research (India)
- Pedro da Motta Veiga and Roberto Iglesias (Brazil).
They are grateful to Dale Weigel, General Manager of the Foreign Investment Advisory
Service (World Bank Group), Anne Houtman, Head of  State Aids policy at the Commission of the
European Communities, and André Raynauld, Emeritus Professor of Economics at the University of
Montreal, for their detailed comments on the manuscript, and to colleagues in the Trade Union
Advisory Committee’s Secretariat and in the OECD Directorates for the Environment, for Education,
Employment, Labour and Social Affairs, and for Financial, Fiscal and Enterprise Affairs for their
comments on and contributions to the study (whose responsibility nevertheless remains that of the
Development Centre).
Thanks also to Gauri Sikri for her invaluable research assistance, and to Teresa Wells and
Sandra Lloyd for processing the manuscript.WT/WGTI/W/100
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Preface
Globalisation poses numerous challenges for policy makers both in developing countries and
emerging economies and in OECD Member countries.  One of these challenges stems from awidespread concern that as governments in developing and emerging economies move to adopt more
open and market-friendly policy regimes, and seek more actively to attract the foreign direct
investment which they see as vital to strengthening the ability of their economies to compete in global
markets, they may stimulate or reinforce a global process of competition among governments to
attract FDI that has undesirable effects.  Of particular concern is the danger that such competition may
lead governments to engage in “bidding wars” that drive up investment subsidies to exorbitant levels,
and/or drive down public measures that are needed to protect the environment and/or workers’ rightsand labour standards.
This study seeks to address those concerns, and to shed light on the implications for
developing and emerging economies of competition among governments, worldwide, to attract FDI.
It argues that although such competition is indeed widespread, and can be very intense in particularindustries or for particular investment projects, overall the competition for real long-term corporate
investment has both positive and negative effects, and it is important not to overstate its net effects —
in either direction.  While the inherent difficulty to obtain reliable data particularly on the subsidies
that investors actually receive makes any conclusion  tentative (neither the governments that provide
them nor the investors that receive them readily supply such information), the most damaging overalleffects appear to stem less from the direct financial cost to governments of investment subsidies paid
out, or from any lowering of environmental or labour standards, than from the lack of policy
transparency and government accountability that the process of competition for FDI tends to
engender.  This lack of policy transparency and accountability creates significant possibilities for graft
and corruption, and for rent-seeking behaviour more broadly, which can in turn be highly detrimentalto the processes of developing competitive markets and sound policy-making — processes which are
fundamental to development itself.
From a policy perspective, the study thus argues for the importance of encouraging
governments to move away from incentives-based means of competing to attract FDI in favour of
greater concentration on rules-based means of competing that do not weaken environmental and
labour standards.  It calls for national and international rules (the latter at the regional and perhapsmultilateral levels)  that create more stable, predictable and transparent rules for investors and
governments alike.  These rules should help gove rnments collectively to overcome the “prisoner’s
dilemma” nature of policy competition, and the “fr ee rider” problem associated with it, and should
favour policies that work to enhance productivity growth in developing and emerging economies in
ways that promote sustainable development and im proved working conditions in those countries.
Undertaken as part of the follow-up to the Development Centre’s work on globalisation, this
study further highlights the fact that just as globalisation creates major challenges for policy makers in
both developing countries and OECD countries, so is it important for governments in the two groups
of countries to work together in responding to those challenges.  Promoting stable, predictable andtransparent rules to enhance the fl ow of FDI to developing countries is one important way to do that.
Ulrich Hiemenz
DirectorOECD Development Centre
October 1999WT/WGTI/W/100
Page 7
Executive Summary
Globalisation, and in particular the move by many developing and emerging economies in
recent years to seek more actively to attract foreign direct investment, is raising policy makers’concern that intensifying global competition among governments to attract FDI may have undesirable
effects.  The main concern is that global “bidding wars” to attract FDI may be producing an
uncontrolled upward spiral in costly “investment incentives” that weaken public finances while
introducing market distortions in the allocation of real  investment, and/or that such “wars” are putting
excessive downward pressure on global standards of protection of the environment and/or of workers’
rights (the so-called “race to the bottom”).
Intensifying global competition among governments to attract FDI could also, however,
produce beneficial effects.  These effects may include inducing governments to strengthen their
economies’ “fundamentals” (e.g., by pursuing policies to enhance the supply of modern infrastructure
and appropriately trained workers, by achieving greater macroeconomic and political stability, by
improving long-term economic growth perspectives) which should in turn promote economicdevelopment — almost independently of their impact on FDI flows per se .  Another effect may be to
increase the global supply of FDI, to the benefit of investors and host economies alike.
The actual degree of global competition to attract FDI is not known, moreover, and while
there is considerable evidence that such competition is widespread, involving sub-national as well asnational governments both in OECD countries and in developing and emerging economies, it is
difficult to predict whether that competition will intensify in the coming  years.
It is against this backdrop that the present study addresses three sets of questions:     (i) To
what extent do governments — national and sub-national governments in OECD and non-OECDcountries — actually compete with one another to at tract FDI;  to what extent is that competition
intensifying, or likely to intensify;  and what are the principal policy instruments or means by which
governments compete to attract FDI?   (ii) What are the effects of that competition — on FDI flows,
on policy-making more broadly, and on the economy?   and (iii) What are the implications for policy
makers?  The study addresses these questions from the dual policy perspective of enhancing economic
and social development in the developing and emerging economies, and of strengthening relations
between those economies and OECD Member countries.
Chapter 1 lays out the policy and conceptual issues and the working hypotheses that guide the
study.  Chapters 2 and 3 present the evidence.  Chapter 2 looks at governments’ use of financial and
fiscal incentives (“incentives-based competition”) while Chapter 3 focuses on governments’ use of
“rules-based” means of competing to attract FDI — means such as environmental and labour
standards, export-processing zones, international regional-integration agreements, privatisation of
state-owned enterprises and strengthened judicial systems.  Chapter 4 concludes with a presentation of
the overall findings and policy conclusions.
Those findings and conclusions may be summarized as follows:
− Incentives-based competition for FDI is a global phenomenon:  governments at all levels
(national and sub-national) in both OECD a nd non-OECD countries engage in it world-wide.
 
− As barriers to international investment have fallen over the last two decades, the significance
of competition for FDI has increased.
 WT/WGTI/W/100
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− Incentives-based competition can be intense, but the evidence — which is insufficient to draw
more than tentative inferences — suggests that the competition tends to be quite intense only
in particular industries (e.g. automobiles) or for particular investment projects (especially
large ones) and in some industries is intense only during particular periods.
 
− Most incentives-based competition is effectively intra-regional, since much of the real
investment for which national and sub-national governments compete is investment the
investor intends in principle to locate in a particular region.
 
− While the evidence does not clearly point to any inexorable tendency towards global “bidding
wars” among governments in their competition to attract FDI, the “prisoner’s dilemma”nature of the competition creates a permanent danger of such “wars”.
 
− Data on the direct financial and/or fiscal ‘cost-per-job’ of incentives received by investors in
the automobile industry reveal similar orders of magnitude of that cost in OECD and indeveloping and emerging economies (a cost that often exceeds $100 000).
 
− Evidence of the effects of incentives on corporations’ real investment-location decisions,
particularly for major new investment projects, is consistent with the view that the decision is
normally a two-stage (or multi-stage) process in which investors first draw up a short list of
acceptable sites on the basis of the economic and political “fundamentals” of alternative sites,largely irrespective of the availability of fiscal and financial incentives from potential hostgovernments, and only later, after the short list is drawn up on the basis of the investment
“fundamentals”, do investors consider — and often seek out — investment incentives,sometimes playing one government off another at this stage of their location decision.
Incentives and other discretionary government policies to attract FDI can thus be decisive in
investors’ location decisions, despite the much greater overall importance investors attach tothe “fundamentals”.
 
− There is little evidence that increasing global competition for FDI over the last two decades
has contributed in any significant way to the major growth of global FDI that has occurredover the same period.  Rather, any relationship of cause and effect between the two
phenomena appears more to work in the opposite direction:  as the global supply of FDI hasrisen significantly, governments have intensified competition with one another to attract
“their share” of that growth.  (Several factors have stimulated the growth of FDI, including
Europe’s Single Market and Maastricht Accords and other regional phenomena, e.g.,
NAFTA, as well as world-wide economic policy liberalisation and market deregulation and
the globalisation of corporate activity and competition.)
− Even in the absence of global bidding wars for FDI, the distortionary effects of incentives  —
which tend to discriminate against smaller firms, against local firms ( de facto , though rarely
on a de jure basis) and against firms in sectors or types of activity that are not targeted — can
be significant.
 
− It can be counterproductive for a government to  offer costly investment incentives if the
“fundamentals” of the potential investment sites within its jurisdiction fail to meet seriouslong-term real investors’ basic requirements, because the incentives — in addition to the
distortions they inevitably introduce —  will tend to attract the “wrong kind” of investor.
They also tend to render the broader policy-making process more vulnerable to rent-seeking
behaviour, perhaps including corruption, which can be very costly — and can even spreadand become quite destructive for the economy, for democracy and the development of a
modern state, and thus for the very process of development.WT/WGTI/W/100
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− Undiscerning use of investment incentives and other discretionary policies by governments to
attract FDI can have a negative effect on FDI inflows, in part because the incentive
programmes and policies tend to be seen by investors as unsustainable.
 
− Many of the governments that are most successf ul in attracting FDI are also among those that
best meet the requirements for good governance (requirements that include sound public
finances because they lend credibility to incentives programmes in the eyes of investors, and
legitimacy in the eyes of voters, by making them likely to be seen as sustainable).
 
− There is little evidence to support the hypothesi s that intensifying competition to attract FDI
induces governments significantly to enhance local supplies of infrastructure and of skilled
labour;  one cannot reject the hypothesis that incentives tend more to compete with than toaugment the use of public resources to increase local productivity-enhancing human-capital
formation and the supply of modern infrastructure.
 
− Whether or not induced by competition to attr act FDI, policies to enhance local supplies of
human capital and modern infrastructure, if successful, can nevertheless be a powerful means
to attract FDI — as well as to promote economic development — if the other “fundamentals”
are sound.
 
− While governments often “justify” providing investment incentives with the argument that
they are needed to steer corporate investment to poorer areas within their economy, inpractice incentives are often of limited effectiveness in this regard (though there are
exceptions) and they sometimes actually reinforce inequalities instead.
 
− Competition for FDI among sub-national governments has been “activitated” by, but also
contributes to, a broader process of reform of policy-making which includes regulatory
reform, privatisation and liberalisation of trade and investment policies.  In addition to
strengthening market forces, this process tends to induce sub-national governments to
modernise and organise themselves better, and more flexibly, to enhance the competitiveness
of the economies under their jurisdiction.
 
− Investors often choose sites where the host government’s strategy to attract investors is part of
a broader process of mobilisation around a project of social and political reform in which thegovernment redefines its role, turning away from  rigid structures and exclusive relationships
with vested interest groups in favour of greater transparency, democracy and market
competition.  This process both enhances and is reinforced by growing exposure of local and
foreign firms in the domestic market to international competition.
 
− Policy competition raises the delicate question of how to ensure the accountability of
government officials, particularly those involved in the negotiation of discretionary incentive
packages, and points up the need for governme nts to be able to monitor their own use of
incentives.  That monitoring could in turn constitute the needed basis for co-operation among
governments to ensure that competition for FDI does not lead to beggar-thy-neighbour policycompetition and incentives “bidding wars”.
 
− There is little evidence in support of the stronger versions of the “race to the bottom”
hypotheses regarding governments’ defense of labour and environmental standards.  Theevidence cannot tell us, however, to what extent competition to attract FDI is inhibiting a
socially optimal raising of those standards, and the danger of such “races”— or at least of
increasing downward pressures on those standards — always exists.  There is, at the sameWT/WGTI/W/100
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time, evidence that competition to attract FDI can exert some upward pressure on those
standards, particularly by local governments.
 
− Policy makers must remain vigilant to ensure that competition to attract FDI does not lower
labour and environmental standards but works, if anything, in the opposite direction.
Governments and society would benefit in this regard from enhanced international policy co-ordination on environmental standards, perhaps also on core labour standards.
 
− International regional-integration agreements can be a powerful policy tool both for attracting
FDI (which requires relatively open  regional agreements) and for enhancing co-operation
among governments to limit the potential negative effects of policy competition — including
downward pressures on labour and environmental standards as well as costly beggar-thy-
neighbour policy wars and incentive wars.
 
− For developing and emerging economies, whose scarce financial resources often push them
into a heavy reliance on fiscal incentives to attract FDI, it is important to stress the value ofmoving away from discretionary incentives towards greater reliance on rules-based means of
attracting FDI — national and international rules that maintain or strengthen environmentaland labour standards and create stability, predictability and transparency for policy makers
and investors alike.  A strong rules-based approach, which should include a strong andindependent judiciary system, can also provide the policy transparency necessary to limit the
rent-seeking behaviour that can be very damaging to development.
 
− The prisoner’s-dilemma nature of competition for FDI creates a permanent risk of costly
beggar-thy-neighbour bidding wars and downwar d pressure on environmental and labour
standards that cannot be fully addressed by national governments in the absence ofstrengthened international policy co-ordination.
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