Investment Linkages and Incentives IN FOCUS Promoting Technology Transfer and FINANCE, COMPETITIVENESS & Productivity Spillovers from Foreign INNOVATION Direct Investment (FDI) INVESTMENT CLIMATE Yassin Sabha, Yan Liu, and Wim Douw © 2020 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non- commercial purposes. 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The authors are all working with the Investment Climate Unit within the Equitable Growth, Finance and Institutions Practice Group of the World Bank Group. They would like to thank the following colleagues: Thomas Farole, Hania Kronfol, Peter Kusek, Ulla Heher, Ivan Nimac, and Christine Zhenwei Qiang for their valuable inputs and contributions. Editing: Nancy Morrison Design and Layout: Aichin Lim Jones Photo Credit: Shutterstock.com Table of Contents THE RATIONALE FOR PROMOTING BACKWARD LINKAGES AND THE KEY CHALLENGES 4 HOW POLICY MAKERS CAN USE INVESTMENT INCENTIVES AND OTHER TOOLS TO PROMOTE BACKWARD LINKAGES 4 HOW COUNTRIES HAVE USED INVESTMENT INCENTIVES TO PROMOTE BACKWARD LINKAGES 7 HOW EFFECTIVE HAVE INVESTMENT INCENTIVE PROGRAMS BEEN IN PROMOTING BACKWARD LINKAGES 10 CONCLUSION AND POLICY RECOMMENDATIONS 11 REFERENCES 13 INVESTMENT LINKAGES AND INCENTIVES | 1 T his note seeks to provide an overview of investment incentive policy as a tool for Governments seeking to promote technology transfer and productivity spillovers by multinational enterprises (MNEs) in the host economy to local firms and suppliers. It summarizes international experiences to demonstrate what has worked and what has not worked, as well as the advantages and disadvantages of different investment incentive schemes. Evidence suggests that backward linkages between MNEs and local suppliers are the most important channels for technology and productivity spillovers to local firms (Jordaan et al, 2020). Furthermore, backward linkages offer an important avenue for ambitious local firms to integrate into Global Value Chains (GVCs). However, several market failures and challenges often prevent backward linkages from materializing. Policy makers can use investment incentives and other policy tools to help address these challenges. This note highlights examples of investment incentive schemes used by Governments, as well as their pros and cons. When using investment incentives as a tool for complex and costly for Governments to administer, promoting linkages, it is important to be aware particularly financial investment incentives. Third, of the costs and shortcomings compared to other investment incentives need to be compliant with policy tools. First, investment incentives represent international obligations, such as rules on State Aid public expenditures that affect fiscal revenues. in the European Union and rules on performance For developing countries with particularly scarce requirements by the World Trade Organization resources, this can be a challenge. Therefore, (WTO). Governments need to make sure incentives are targeted to specific objectives and market failures The note focuses on the role of both investment and the costs and benefits are analyzed and incentives and other policy tools in encouraging MNEs monitored. Second, investment incentives can be to develop supplier relationships with local firms. The structure of the note is presented in figure 1. Figure 1. Structure of In Focus Note The Rationale for The Use of Specific Country Evidence ol Promoting Incentives as a Examples of Outcomes Backward Linkages Policy Tool Incentives Used and Impact INVESTMENT LINKAGES AND INCENTIVES | 3 The Rationale for Promoting The FDI linkages policy agenda straddles multiple Backward Linkages and the Key ministries and agencies and touches on policies related to FDI attraction, industrial development, Challenges access to finance, small and medium enterprise The presence of foreign firms in the host (SME) development, innovation, trade, and labor economy can become a major driver of local firm policy. However, without effective coordination, productivity growth and offers opportunities these policies might contradict one another, with for local firms to integrate in international unintended adverse effects on the host economy. For production networks. Backward linkages between example, investment incentives extended to attract MNEs and domestic suppliers can promote the FDI can have adverse effects on the formation of diffusion of knowledge, spread good management local linkages. A clear example is the exemption practices, and help domestic suppliers upgrade on customs duties for the import of foreign inputs. their technical and quality standards (Du, Harrison, This policy is aimed at attracting FDI in specific and Jefferson 2011; Javorcik and Spatareanu locations—often Special Economic Zones (SEZs). 2009; Javorcik and Li 2013). Supply chains of Nevertheless, such investment incentives can put MNEs—notably, backward linkages through local local suppliers at a cost disadvantage with respect sourcing— offer the most direct channel for positive to foreign suppliers because of the value added tax FDI spillovers and technology transfer for local charged on their local products. The remainder of firms in developing countries (Jordaan et al, 2020; this In Focus note will focus on the role of incentives Farole and Winkler, 2014). The presence of MNEs as a key policy instrument in promoting linkages can have positive spillovers on the quality of exports between FDI and local firms. by domestic firms, as Bajgar and Javorcik (2019) show, using data on Romanian manufacturing How Policy Makers Can Use sector. This occurs via backward vertical spillovers, as MNEs demand inputs at international quality Investment Incentives and Other standards from domestic firms. Moreover, MNEs Tools to Promote Backward consider the presence of competitive local suppliers Linkages important for their locational decisions. A survey of This section uses concrete examples to demonstrate MNEs found that 61 percent of respondents consider what kinds of incentives policy makers can consider linkages to be important or critically important in addressing the market failures and constraints their location decisions (World Bank 2018, p. 32). hindering backward linkages. The potential for MNEs to source inputs locally Investment incentives are one of the tools depends on several factors. Evidence from the available to Governments to influence MNEs’ literature and years of observation as practitioners sourcing decisions, together with other programs, show that the creation of linkages and technology such as matchmaking services, supplier transfers between MNEs and local firms does not development programs, and local supplier happen automatically. The FDI characteristics, databases. Investment incentives are typically host country characteristics, as well as local firm defined as “measurable economic advantages that absorption capacity all play a key role. Furthermore, Governments provide to specific enterprises, with policy coordination failures on the part of the goal of steering investments into favored sectors Government, information asymmetries and weak or regions (locational investment incentives), or local firm capacity are among the most common of influencing the character or impact of such market failures and barriers to be overcome in order investments (behavioral investment incentives)” to improve linkages outcomes.1 More on this is described in the accompanying InFocus note with summary of FDI linkages literature review (Jordaan et al, 2020). 1 4 | INVESTMENT LINKAGES AND INCENTIVES (James 2009). Behavioral investment incentives can financial investment incentives (that is, cash be used to influence FDI sourcing behaviors and grants or cost-sharing schemes) for upgrading thus to promote linkages with local suppliers. This local suppliers. However, providing cash grants note focuses on behavioral investment incentives or cost-sharing schemes is typically used more targeting change in sourcing behavior by FDI in the in middle-income or developed countries and host economy that work to increase the integration less so in developing countries, due to resource of local firms in their supply chains. Demand- constraints and the political economy issues driven investment incentives and linkages programs around providing investment incentives to MNEs. appear the most successful in promoting backward FDI can also be exempted from paying VAT on linkages, as opposed to schemes primarily targeting local inputs, especially if located in SEZs. More local firms, such as more generic small and medium common, especially in developing countries, are enterprise development schemes. investment incentives provided to local suppliers as part of SME development schemes. On the Investment incentives, and complementary other hand, governments (often investment government support schemes, can help address promotion agencies) also provide complementary some of the key challenges and market failures programs to FDI. These include: development hindering backward linkages development by of supplier databases; provision of matchmaking MNEs in the host economy. For instance, MNEs services; and implementation of targeted supplier can be exempted from paying value added tax (VAT) development programs. A survey of MNEs found on local inputs. On one hand, in situations where that 61 percent of respondents rating supplier foreign inputs are exempted from customs duties, upgrading important, either in the form of direct VAT exemptions can help compensate for the cost- financial incentives for companies to invest disadvantage of local products compared to foreign in supplier development or government’s own supply. On the other hand, in situations where MNEs initiatives (World Bank 2018, p. 32). already receive customs duty exemptions (such as duty drawback schemes or bonded regimes), VAT There are several pros and cons to using exemptions on local sourcing can be used to level investment incentives. In terms of fiscal (tax) the playing field. In addition, rewarding MNEs for investment incentives, corporate income tax training or upgrading the quality of local suppliers holidays and concessionary rates tend to be the can change the cost and risk calculation for MNEs most common. These investment incentives in terms of technology transfer and sourcing locally are easy to communicate to investors and allow versus relying on their trusted foreign suppliers. for less interaction with tax authorities, which By the same token, sharing the cost of MNEs can be particularly useful in contexts where tax developing local suppliers through training services administration is less efficient. On the other hand, and technology upgrades can help close the gap long-term investors that have no profits or losses on QCDTF2 issues and overcome coordination in the first years of operations do not reap much problems. In practice, no individual MNE buyer benefit from such investment incentives. Moreover, would have the incentive to fully bear the costs of when tax holidays liberate investors from meeting upgrading local suppliers because this would pose tax obligations, it makes it much more difficult to the risk of other buyers free riding. track the benefits and costs of investment incentives, affecting transparency. In addition, tax holidays are Several types of incentives are given by granted without a direct link to desired outcomes, governments to FDI to promote backward such as investment, jobs, or domestic value added. linkages. On one hand, FDI can receive corporate Finally, this type of investment incentives can create income tax incentives for local sourcing, or opportunities for tax avoidance and profit shifting. Quality, Cost, Delivery, Technology and Flexibility 2 INVESTMENT LINKAGES AND INCENTIVES | 5 Other common fiscal investment incentives focus instruments allow investors to access credit for on indirect taxes such as value added tax (VAT) specific activities, such as purchasing equipment, and customs duties on imports. These investment while maintaining private sector ownership, by incentives relieve inputs used in the direct setting a matching contribution (such as 50-50 or production of exports from the burden of indirect 80-20). In addition, cost-sharing schemes allow taxation. However, these investment incentives governments to better target their investment can be prone to leakages if imported goods are incentives. However, they are more difficult to diverted to other purposes. They can also risk administer and can require a substantive financial distorting competition, putting domestic suppliers disbursement. Cost-sharing schemes can also at a cost disadvantage versus foreign inputs and crowd out private investment or promote nonviable undermine backward linkages formation. Finally, firms. Tables 1 and 2 summarize the most common these investment incentives also have no direct link investment incentives and policy tools in support to desired outcomes. of backward linkages provided by governments to MNEs, along with their main pros and cons, In terms of financial investment incentives, based on a review of the available literature and governments often use cost-sharing schemes, such institutional websites. as matching grants, to promote linkages. These Table 1. Examples of Investment Incentives to Promote Backward Linkages Investment Incentive Pros Cons Investment Incentives Promoting Upgrading of Local Suppliers Corporate income tax incentives • No direct disbursement • Public expenditure through fiscal revenue contingent on local sourcing • Easier to administer compared to financial foregone (such as tax credits, reductions, incentives • Ineffective if no capable supplier exists deductions, capital allowances) • Link to desired outcomes • More difficult to target compared to matching grants and cost-sharing schemes Matching grants and cost- • Can stimulate beneficiary’s sense of • Public expenditure through financial sharing schemes in support of ownership through matching contribution disbursement local firm upgrading and cost-sharing • Administrative burden for government • Easier to target compared to corporate agencies to manage the program income tax incentives • Compliance cost for private sector (application process, reporting) • Potential market distortions, such as promoting nonviable suppliers, misallocating scarce resources; crowding out private investment Investment Incentives to Address Coordination Failures Value added tax (VAT) • No direct disbursement • Public expenditure through fiscal revenue exemption on purchase of inputs • Level the playing field if foreign inputs are foregone from local firms exempt from VAT • More difficult to target compared to matching • Easier to administer compared to financial grants and cost-sharing schemes incentives 6 | INVESTMENT LINKAGES AND INCENTIVES Table 2. Other Policy Tools to Promote Backward Linkages Policy Tool Pros Cons Policy Tools to Promote Quality, Cost, and Delivery Reliability of Local Suppliers Systematic Supplier • Can be very company or sector • Complex to manage and implement Development Programs (SDP) targetedProven approach with strong track • Costly to implement record of success • Opportunity to start with small pilot and expand when successful proof of concept Policy Tools to Address Information Failures Matchmaking services • Not costly to implement Simple to • Works only if there is an appropriate domestic administer supplier base • Requires a minimum level of institutional capacity of IPA or other entity in charge MNE and local supplier • Relatively basic but effective tool for • Costly to implement and maintain up-to-date databases overcoming information failures • Works only if there is a sufficient size and quality domestic supplier base Note: MNE = multinational enterprise. How Countries Have Used in the computation of corporate income tax. Large Investment Incentives to Promote industrial firms in Malaysia also receive corporate income tax relief of 5 percent if they buy primary Backward Linkages products from national SMEs. Supplier firms The discussion that follows presents eight examples enjoy either Pioneer Status, with income tax of countries using investment incentives directed exemption of 100 percent of statutory income for to MNEs to promote backward linkages and ten years, or an investment tax allowance (ITA) productivity spillovers, often in combination with of 100 percent qualifying capital expenditure other policy tools. However, it is important to note for five years. Moreover, in conjunction with that, while the examples present some positive these incentives, the private sector pursued its lessons learned for developing countries, the global own initiatives to upgrade local skills. Hewlett- experience on investment incentives has been mixed Packard, Intel, and Motorola joined forces with in this space. the Penang Development Corporation as early as 1989 to create the Penang Skills Development Over the years Malaysia has used several Center (PSDC). The three MNEs formed the types of investment incentives to strengthen steering committee to create a tri-partite PSDC linkages between MNE and domestic firms structure, combining government, academia, and (Ruffing 2006; InvestPenang website). Since industry. They persuaded 24 electronics investors 1980s, various behavioral incentives have been to contribute equipment for the new PSDC introduced to improve linkages and upgrade campus and led the group in assigning executives the technical capacity and quality of domestic to teach the skills needed to design and produce suppliers. To encourage large companies to sophisticated electronic subassemblies and final participate in its current Industrial Linkage products (PSDC; Athukorala 2017). Program (ILP), expenditures incurred in training of employees, product development and testing, Early on in its FDI success, Singapore introduced and factory auditing to ensure the quality of the Local Industry Upgrading Program (LIUP) vendors’ products, will be allowed as a deduction to support the transfer of technology, marketing, INVESTMENT LINKAGES AND INCENTIVES | 7 and business process knowledge from MNEs South Africa’s Strategic Investment Program to domestic SMEs (Perry, Tan Boon Hu, (SIP) offers an initial capital allowance (ICA) of 1998; Coe and Perry 2004). The LIUP provided 50 percent or 100 percent for foreign companies investment incentives for MNEs to upgrade their that extend linkages to domestic firms. Creation of local suppliers through a relationship of long-term linkages with South African SMEs is a prerequisite mentorship. Through the program, local suppliers to benefit from ICA. Another tax allowance developed new products and processes and engage investment incentive (12I TAI) supports greenfield in joint research and development (R&D) with and brownfield investments for capital investment the MNE mentor (UNCTAD 2011). As part of the and training. It offers an additional investment LIUP, the Economic Development Board (EDB) allowance of R350 million–R900 million for covers part of the salary of an MNE manager or greenfield and brownfield projects, an additional engineer who works with the local supplier in order training allowance of R36,000 per employee, and a to transfer knowledge and build their capacity. As maximum additional training allowance per project a result of the program, several Singaporean firms of R20 million. To qualify for this allowance, have become efficient suppliers, transitioning projects should provide general business linkages, from low-wage, labor-intensive activities into acquire goods and services from SMEs, create more capital- and knowledge-intensive industries direct employment, and provide skills development (McKendrick, Donner, and Haggard 2000). For within South Africa. South African’s Ministry of example, STMicroelectronics received financing Trade and Industry also provides targeted grants under the LIUP. The company sent a manager to support the growth and development of the to train local manufacturers on issues related to automotive sector. The Automotive Investment large-scale production processes, quality control, Scheme rewards investments in new/replacement standard setting, and the broader needs of the models and components that will increase plant MNE buyer. This helped result in nine indigenous production volumes, sustain employment, and companies becoming significant international strengthen local automotive value chain. It provides players (UNCTAD 2011). The LIUP also provided for a grant of 20 percent to 30 percent of the value training investment incentives for Singaporeans of qualifying investment in productive assets (Invest to pursue their studies in and enter selected areas South Africa; Barbour 2005). of expertise. It helps local firms improve their operational efficiencies, capabilities, and capacity In Taiwan, China, a Center-Satellite (CS) to develop new products and services. One of the Factory System was launched in 1984 already most renowned examples is the partnership between to organize and integrate satellite factories that Hewlett Packard Singapore and its local supplier, FJ serve a central factory. The program identifies Industrial. In addition, the government introduced the potential central firms, whether they are receiving Partnerships for Capability Transformation (PACT) FDI or not, and seeks to persuade them to establish in 2010. PACT works with large MNEs and local a Center-Satellite factory system. The arrangement companies to identify and implement collaborative helps address coordination failures and reduce the projects between the large organization and local central firm’s operating costs and offers a wide range SMEs in areas of knowledge transfer, capability of vendor assistance and productivity enhancement upgrading, and the development and test-bedding of programs. Companies in special zones also enjoy innovative solutions. Like the LIUP, PACT operates a fiscal investment incentive (zero percent value on a cost-sharing basis. SMEs whose projects are added tax) for purchases of raw materials, fuel, approved are eligible for up to 70 percent funding supplies, semi-finished materials, and machinery support for qualifying development costs. from areas outside of the special zones in Taiwan, China (Battat, Frank, and Shen 1996). 8 | INVESTMENT LINKAGES AND INCENTIVES The government of Thailand has introduced 2003, 57 percent of participating suppliers recorded merit-based investment incentives to attract and higher value added content, and participating MNEs stimulate investment in projects or activities increased local sourcing from 0 percent–5 percent that benefit the country or a targeted industry at to 2.5 percent–30 percent. Czech Republic also large. Specifically, the Board of Investment (BOI) offers financial support to broader manufacturing offers competitiveness enhancement investment sector, technology centers, and business support incentives to MNEs that develop local suppliers with services centers. Eligible firms enjoy corporate at least 51 percent of Thai shareholding. MNEs that income tax relief for 10 years, receive cash grants provide advanced technology training and technical for job creation up to approximately US$25,000 per assistance receive additional corporate income job, and cash grants for training and retraining up tax exemptions of up to 200 percent of eligible to 50 percent of training costs. Strategic investment expenditures (Thailand Board of Investment). projects also receive cash grants for purchase of fixed assets up to 10 percent of eligible costs. To Chile has used financial investment incentives address information asymmetry between MNEs to promote backward linkages and productivity and local firms, CzechInvest also built a database spillovers in strategic sectors. To attract high- containing standardized profiles of more than tech FDI in sectors with high value added, Chile’s 3,400 Czech manufacturing and ICT companies by investment promotion agency (InvestChile) offers a subsector to connect foreign investors to domestic wide range of tax incentives and subsidies to cover suppliers. pre-investment studies, acquisition of fixed assets, staff training, and R&D activities, in addition to In Ireland, the National Linkage Program (NLP) broader marketing and pre-investment services. The provided financial investment incentives to FDI Integrated Promotion Initiatives (IFI) support the together with quality upgrading services to implementation of new technological investment local suppliers (Görg, Hanley, and Strobl 2011; projects or the expansion of existing projects, it UNCTAD 2006). In the early 1980s, the Irish offers up to 30 percent of investments implemented Industrial Development Agency introduced the during the first two years of projects, worth over US National Linkage Program to address both demand- 2 million dollars, provides training of specialized side and supply-side constraints. On one hand, the human capital, and promotes supplier development program supported the upgrading of local suppliers (InvestChile). in targeted sectors. The program worked closely with over 250 MNEs to identify high potential The Czech Republic has used financial investment local suppliers. Once part of the scheme, firms incentives in combination with a broader were monitored for technology improvements, supplier development program (Malinska and quality, cost, and service requirements. On the Martin 2016; OECD 2001; World Bank 2019). other hand, the NLP provided grants to MNEs to The Czech Pilot Supplier Development Program encourage them to link with local suppliers. The operated from 2000 to 2002. Czech’s investment two key criteria for MNEs to benefit from the grant promotion agency, CzechInvest, administered a 95 were employment and local content. The results percent matching grant awarded to local suppliers were startling. As a result of the program, many to participate in the “intensive support phase.” local SMEs became suppliers to international firms Local firms were closely advised by Czech and such as IBM, Apple, and Dell. Ireland also offers international consultants to upgrade their offering financial investment incentives to companies that to meet MNE’s demands. The program also tackled carry out in-house R&D projects and collaborative information asymmetries through the funding of projects with industrial partners and third-level databases and matchmaking services. A dozen institutes such as universities and research institutes. MNEs were involved throughout the project and Training grants are available across the country to 45 SMEs received targeted training based on needs develop the competitive capabilities of companies uncovered during business reviews. The program already located in Ireland. led to US$46 million in new business contracts by INVESTMENT LINKAGES AND INCENTIVES | 9 How Effective Have Investment In Taiwan, China, the Center-Satellite Factory Incentive Programs Been in System has been instrumental in establishing 139 CS factory systems comprising 2,075 Promoting Backward Linkages firms and accounting for more than one- Recent empirical evidence indicates the third of the value of the island’s output in the potential that investment incentives and other manufacturing sector. Most of the systems are complimentary policy instruments can offer in concentrated in three sectors: electronics, metal stimulating backward linkages (Jordaan et al, engineering, and motor vehicles. The electronics 2020). In Ireland, empirical evidence shows that industry, particularly the semiconductor sector, financial incentives (grants) to foreign MNEs have has formed a major part of Taiwan, China’s succeeded in forming linkages with suppliers in economy and export base since 1980s. In 2007, certain cases (Görg, Hanley, and Strobl 2011). the semiconductor industry overtook that of the In Chile, the program combining matchmaking United States, to become second only to Japan services with a financial incentive (subsidized (Battat, Frank, and Shen 1996). credit) was found to significantly increase sales, employment, and the sustainability of SMEs In Malaysia, the Penang Skills Development (Arráiz, Henriquez, and Stucchi 2013; Guimon Center (PSDC) has become one of the most et al, 2017). In Czech Republic, the Supplier successful Workforce Development Institutions Development Program, which combined financial in the world. Over the past four decades, Penang investment incentives (matching grants) with has grown to become a major export production hub other policy instruments, was found to increase with more than 250 branch plants employing over sales for about one-third of all participating firms 250,000 workers. The MNE-local firm partnership and helped one-fifth of firms initiate exports or strengthened over time, resulting in a large pool of obtain contracts of higher value-added content local electronics and equipment firms (Athukorala (Mariscal and Taglioni 2017; Javorcik, B. S., and 2017). The electrical and electronics (E&E) industry M. Spatareanu. 2009). remains the mainstay of Malaysian economy today. Penang has received global recognition as one of In Singapore, an evaluation of the Local the most dynamic industrial clusters in the world, Industry Upgrading Program (LIUP) found thanks to its world-class capabilities and efficient that suppliers in partnerships with large supply chain. firms improved productivity by 17 percent on average by the mid-1990s, while value added In Thailand, the merit-based incentives to per worker rose by 14 percent. By 1994, 180 promote supplier linkages has also proved SMEs and 32 buyer firms, including 28 MNEs, effective. Today, Thailand is the largest automobile formed a partnership under the program. By 1999, exporter in the Association of Southeast Asian the LIUP had 670 local vendors and 30 MNEs Nations (ASEAN), the third largest in Asia after participating (Battat, Frank, and Shen 1996). Case Japan and the Republic of Korea, and the seventh studies show that supplier upgrading through largest exporter in the world. More than 80 percent LIUP is limited in the electronics sector, but of total value is produced by local companies, which the horizontal partnership in the software sector represents the highest localization rate in Southeast yielded more benefits (Coe and Perry 2004). More Asia (World Bank 2016). than 40 suppliers have benefitted from PACT While some of these cases dates back to the 1980s since 2010, mostly from the oil & gas and medical or 90s, many of these programs or successive technology industry. Overall, PACT has been an iterations are still in place today and continue effective tool to deepen the FDI-SME linkages in to be useful tools for deepening linkages. For Singapore. (World Bank, 2019) 10 | INVESTMENT LINKAGES AND INCENTIVES example, Malaysia’s Industrial Linkages Program Conclusion and Policy is now tailored to local machinery and equipment Recommendations (M&E) players to promote collaboration between companies to further adopt advanced and new Investment incentives targeting MNEs can be a technologies (Malaysia Investment Development powerful tool for governments to influence MNE Agency). The program has successfully led to e sourcing behavior and promote backward linkages ongoing business and technical engagement on and technology transfer with local suppliers. They M&E between Malaysian companies and Italian can help overcome a specific market failure. For companies. The Penang Skills Development Center instance, investment incentives can help compensate continues to be the leading talent development for shortcomings in quality, cost, and punctual institution in Malaysia. It provides a wide range delivery of local suppliers that often prevent MNEs of training on engineering skills, digital skills, and from sourcing more from local firms. Moreover, business skills to meet changing business demands alignment of investment incentives may be needed (Penang Skills Development Centre). in some countries to help offset the cost disadvantage of potential local suppliers with respect to imports While most of the cases described are from by MNEs that enjoy customs duty exemptions on middle- and high-income countries, and imports of raw materials, inputs, and machinery. programs were designed at the time when FDI In practice, investment incentives are often used took off in these countries, they can provide good in combination with other policy tools, such as the insights and key principles for low-and middle design and implementation of targeted supplier income countries receiving FDI today. Many of development programs, provision of matching the economies had much lower income levels than making services by the national investment they have today when they initiated these programs promotion agency as part of its aftercare services (including Chile and Singapore). With the right to investors, and the development of high-quality policy instruments, government can strengthen supplier databases. The latter can be very helpful in backward linkages by combining public and private overcoming information asymmetries. resources to remedy market failures. Low-income countries can focus on improving local suppliers’ However, investment incentives have several capabilities through carefully designed supplier shortcomings and not all their programs end up development programs. This requires concerted being successful, including those targeting backward effort among different government institutions to linkages and technology transfer. Investment promote backward linkages in an outward-looking incentives (particularly financial investment and market-oriented approach. incentives) can be difficult to administer. They are very costly for public finances, so they should be Finally, the cases presented have achieved successful well targeted to address specific market failures results in promoting backward linkages also thanks in order to be effective. In addition, investment to effective targeting of the market failure and good incentives should be implemented in compliance administration of the programs. However, there with international obligations, such as WTO rules have also been many less successful examples in on performance requirements. Finally, due to public light of the many challenges associated with their resource constraints, low-income countries might implementation. 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