# **I. INTRODUCTION**

1. The gradual elimination of barriers to global capital and trade flows and the increasing mobility of international firms have stimulated competition among countries for foreign direct investment, often through the use of tax incentives (Morisset, 2003). From tax holidays and import duty exemptions to investment allowances and accelerated depreciation, the global phenomenon of using fiscal incentives to attract multinational corporations, with the resultant technology and knowledge spillovers, appears to have strengthened since the early 1990s. However, the debate over the outcomes of tax incentives is not settled.  A number of studies have shown that tax incentives are not the most influential factor for multinationals in selecting investment locations. Factors such as basic infrastructure, political stability, and the cost and availability of labor seem to be more important. Still many other cases (e.g. Ireland or tax havens in the Caribbean and South Pacific) suggest that tax incentives did play a relevant role in attracting foreign investment. The literature suggests several interesting corollaries. For instance, tax incentives affect the composition of foreign direct investment more than on its level.  Also, large foreign companies – such as those in the automobile sector – are generally in a better position to negotiate special tax regimes and thus extract rents from host governments (Oman 2000). Furthermore, survey evidence (James 2010) suggests that export oriented investors are much more responsive to incentives than investors oriented towards the domestic market.

2. Mainstream economics cautions us about the use of industrial policies that target sectors, firms and regions. In addition, the implementation of WTO-consistent policy and incentive frameworks is shifting the emphasis from tax benefits towards infrastructure and regulatory frameworks. The Agreement on Subsidies and Countervailing Measures (SCM), for instance, prohibits subsidies that are conditional on exports. Countries subject to these WTO rules<sup>2</sup> , will in principle need to revise their incentive regimes to avoid being subject to potential legal challenges from other WTO members.

3. Certainly, tax incentives are costly. The first and most direct costs are those associated with the potential loss of revenues for the host government. Other possible economy-wide distortions include distortions in the allocation of resources and the cost and difficulty of administering the incentive scheme effectively. A cost-benefit analysis can help evaluate the full impact of the MIDP program. Such an exercise is however beyond the scope of the present analysis. In this paper, we contribute to the ongoing debate on the outcomes and effectiveness of tax incentives by examining the case of the automobile industry in South Africa and, particularly, by investigating to what extend the program was effective in improving South Africa‟s automotive exports.

4. In 1995, the South African government implemented the Motor Industry Development Program (MIDP) with the main objective of improving the international competitiveness of firms in the South African automobile industry, enhancing growth through exports, and stabilizing employment levels. In order to achieve these aims, a series of export-oriented tax incentives were introduced, coupled with a reduction in

> 2 The WTO subsidy disciplines apply to WTO members who have a GNI per capita of more than US$ 1,000.

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