affiliates, and they have a 0.9 percent lower return on assets. Tax effects are particularly strong in Europe, where 10 percent higher tax rates are associated with 7.7 percent lower FDI and a 1.7 percent lower returns on assets. In developing countries, Klemm and Van Parys (2012) find that a 10 percentage point increase in corporate income tax rates lowers FDI by 0.31‐0.32 percentage points of GDP. These numbers are small relative to those for OECD countries.

Further, the effects of tax incentives also seem to vary across types of FDI. Efficiency‐seeking FDI—where foreign multinationals locate segments of their production chains in different countries in search of greater competitive production strategies—tends to be more responsive to tax incentives than other types of FDI. Azémar and Desbordes (2010) proxy FDI flows with sales by affiliates of multinational enterprises. They find that a 10 percentage point drop in a host country’s average effective tax rate is associated with 7.7 percent higher sales by American multinational affiliates in the United States, in contrast to 1.2 percent higher sales by local affiliates. These findings suggest that tax incentives have a bigger effect on vertical, export‐oriented FDI rather than on horizontal, market‐seeking FDI.

Evidence regarding the role of financial incentives in attracting FDI is relatively limited. It focuses on sets of regional development grants—rather than individual instruments—in developed countries. Such programs have been in place in the European Union, the United States, and many other developed countries for decades, with considerable spending. Despite the ubiquity of these programs, microeconomic evidence on their effects is limited. The United Kingdom is an exception, and shows the complexity of evaluation—mainly due to data access and difficulty with a clear identification strategy— as well as the potential tradeoffs of such programs.

Devereux, Griffith, and Simpson (2007) analyze how grant offers under a major UK business support program, the Regional Selective Assistance scheme, affect location decisions for greenfield investments by foreign and domestic multi‐plant groups in different counties. The authors match data on manufacturing plants and grants in the late 1980s and the 1990s. They find that grants are poor predictors of firm location choices relative to agglomeration effects, and that a £100,000 increase in the expected grant raises the probability of a greenfield locating in an assisted area by 1 percent. Further, firms are more attracted to industrially diversified locations, but seek proximity to other foreign‐owned plants in the same industry. For example, an increase of 10 foreign plants increases the probability of location by 1.032 percent. These results imply that larger grant offers are needed to attract greenfield entrants to locations where industry agglomeration or natural resource benefits are weaker.

Wren and Jones (2011) address the problems of matching grant and plant data in the previous study. They analyze policy effects at the regional level over a longer period (1985‐2005). They find that every £25 million in grants given by a UK region could increase the regional share of FDI by 1 percentage point or, equivalently, six additional inward FDI projects assessed to generate, on average, 150 jobs (equal to £4.12 million). This effect is highly significant but small relative to the UK’s inward investment. The authors recommend further research using more disaggregated spatial data to confirm the results.

15