Investment Incentives: Evaluating the Impact Aaditya Mattoo Development Economics Research Group, World Bank November 25, 2013

Three questions I.What do we want to know? I.What do we know? II.How can we find out?

What do we want to know? Investment incentives Investment flows Outcomes like productivity Empirically: Do investment incentives enhance FDI flows? Does FDI create spillover benefits? Do conditional incentives modify investor behavior to enhance the benefits of FDI? Theoretically: Case for unconditional incentives when market failure so that the social benefit of investment is greater than the private benefit Case for conditional incentives when market failure so that the social benefit of modified behavior is greater than the social cost

Valuation versus Attribution Investment takes place in a noisy environment: –many firms, many countries, many products, infrequent lumpy investments, non-incentive reasons for changes in investment. Valuing the impact of investment requires –Determining which changes in the world are due to the incentives (attribution) Attribution is the primary purpose of impact evaluation efforts –Attaching a dollar value to the attributed changes (valuation) A complete method requires both. Credibility will depend on the joint credibility of both activities.

The data needs Investment incentives Investment flows Outcomes like productivity Policy data Restrictions (entry, ownership, operations) Subsidies Tax holidays Local content requirements Export obligations Investment data Total flows (extensive and intensive margins) Greenfield/ acquisition Source country Destination sector Outcomes Welfare Productivity (same sector, upstream, downstream) Employment Exports + control variables (income, size, business environment, endowments, infrastructure…)

Credible identification Investment incentives Investment flows Outcomes like productivity Omitted variable bias: availability of data by country (or state), sector and time helps Reverse causality: evidence of exogenous variation in investment incentives helps

How far has the chain of causality been established? Investment incentives Investment flows Outcomes like productivity Existing literature focuses mostly: On the first link OR the second link but not the entire chain On unconditional incentives (designed to attract investment) and not on conditional incentives (designed to modify investment behavior)

Example 1: Roll out the red carpet and they will come (Harding and Javorcik, 2011) Investment promotion Investment flows 2005 census of investment promotion agencies with time varying information on priority sectors Promotion works through information provision and assistance with bureaucratic procedures Country-year, country-sector and sector-time fixed effects FDI inflow cit =  +  Post-targeting cit +  ci +  ct +  it +  cit Investment promotion leads to higher FDI flows in countries in which red tape and information asymmetries are severe

In recent years, India has radically reformed its services sectors Example 2: Services reform and manufacturing productivity (Arnold, Javorcik, Lipscomb and Mattoo, 2012)

India’s services reform has boosted not only productivity and exports in services, but also the performance of downstream manufacturing industries New study based on panel data for 4,000 Indian firms for the period finds that banking, telecommunications and transport reforms all have significant positive effects on the productivity of manufacturing firms Source: Arnold, Javorcik, Lipscomb and Mattoo (2012). Services reform as industrial policy New work would help policy-makers understand the implications of alternative sequencing of reforms in goods and services.

Emphasis of trade policy and World Bank assistance to trade is changing Trade Competitiveness: pro-active industrial policies for productive capacity building and export promotion To equip agricultural, manufacturing, and services producers to export Trade Facilitation and Logistics: customs reforms and infrastructure improvements To reduce trade transactions costs and delays World Bank Group Trade Portfolio (WB/IFC commitments FY2008 ) A widely-felt need for more credible evaluation methodologies

What can we learn from past evaluations of World Bank trade-related projects? Of the 85 World Bank trade-related projects initiated between 1995 and 2005, only 3/4 were evaluated; most by non-rigorous methods; and less than 5 had a meaningful impact evaluation involving a control group Subjective “While the impact on the firms assisted had not yet been determined, a visit to two beneficiaries by a supervision mission confirmed that there had been an impressive impact on the firms' quality of products and skills.” Simple before-after comparison “The achievement of the overall goal of the project was measured in terms of increases in exports' share of GDP and greater diversification, compared with the initial year of the project.”

Example 3: CAN EXPORT PROMOTION ASSISTANCE LEAD TO OVER-DIVERSIFICATION? Preliminary results suggest that Tunisian firms receiving FAMEX assistance are encouraged to introduce new products and sell to new markets with a consequent short-run boost to exports But the boost to exports may not be sustainable Source: Gourdon, Cadot, Fernandes and Mattoo (2010) The consequences of export assistance provided under FAMEX 2005