چگونه منافع داخلی از سرمایه گذاری های خارجی را به حداکثر یرسانیم : اثر برگشت ناپذیری و عدم اطمینان

When a foreign monopolist facing uncertain future demand can either export to a host country or serve the market by undertaking an irreversible foreign direct investment, the host government maximizes net domestic benefits by nearly fully subsidizing the investment cost in combination with taxing away benefits that exceed the gains from exporting. Without the subsidy, maximization of domestic benefits leads to underinvestment from a world welfare point of view.

Host governments often lure foreign investors by large investment grants. Backward regions in Europe, for example, may use the EC’s Structural Funds Program to cover up to 62% of the investment cost. Though literature shows that the optimal corporate tax rate in a small and open economy is zero when capital is mobile (Gordon, 1992), multinational firms are typically exposed to the corporate tax rate that prevails in the host country after having undertaken the investment. In a recent survey, Morisset and Pirnia (2000) find that Western-European countries rely more on incentives that reduce the fixed cost of investment than on incentives that reduce the effective corporate tax rate such as tax holidays. Even though the average statutory tax rate in the EU fell by more than 13 percentage points between 1985 and 1999 (Haufler, 2001), it is still 35.1%. A second policy that is not well understood is why governments provide subsidies to invest to foreign investors while taxing them at the same time. Hansson and Stuart (1989) explained this ‘taking with one hand and giving with the other’ as an equilibrium in a perfect foresight representative agent model where governments sequentially set tax policy in the period they are in power. This paper argues that, even without any changes in government, it is optimal for the host government to provide a subsidy to investment in combination with a positive corporate tax rate under two fairly simple and reasonable assumptions: investment is irreversible1 and subject to an uncertain payoff. The reason is that a subsidy to an investment that cannot be undone facilitates entry and enables obtaining post-entry tax revenues that exceed the cost of the subsidy. Whereas corporate taxation enlarges the barrier to entry faced by a foreign firm subject to uncertain demand and sunk entry cost, the subsidy reduces it and encourages investment. Profit taxation and subsidies have a different impact on the investment decision by the foreign firm and do not simply cancel out if their present values are equal because of the uncertainty effect. Corporate taxation leads to sharing of uncertainty surrounding future benefits with the host government, while an investment subsidy shifts part of the sunk cost completely from the foreign firm to the host government.2 In the extreme case of full subsidization of the cost of investment and taxing away all the benefits from foreign investment over exporting, the investment decision is entirely reversed. In that case, the firm would be indifferent between investing abroad and exporting. However, this combination of investment subsidy and corporate taxation is not optimal for the host government as it yields an investment rule for the firm that is not optimal from a welfare point of view. Investment would take place too rapidly since the value in waiting to invest is disregarded. The option effect of waiting, or from the downside perspective labeled by Bernanke (1982) as ‘the bad news principle’, should not only be considered by the firm, but also by the host government since tax income and corporate profit are positively correlated. The main theoretical idea behind the literature on investment under uncertainty, as surveyed by Dixit and Pindyck (1994), is that uncertainty creates a value in waiting with investment. Firms only invest when the profits from investing exceed the cost of investment by the option value of waiting.3 The effect on investment of uncertainty in tax policy has been analyzed in MacKie-Mason (1990), Alvarez et al. (1998), and Hassett and Metcalf (1999). The first paper gives the insight that non-linear taxes may have surprising effects on investment decisions when output price is uncertain. Main insights of the latter two papers are that higher uncertainty in tax parameters may lead to more rapid investment, contrary to conventional wisdom. The difference between these papers and our approach is that they consider taxes and tax changes as exogenous, whereas we consider endogenous taxation. In our model, the uncertainty surrounding future profits comes from randomness in the market size. Hence, the foreign firm invests when the market size reaches a critical threshold. This assumption fits neatly with the agglomeration and concentration effects on FDI that are found in empirical papers (Head et al., 1995; Brainard, 1997; Devereux and Griffith, 1998). The resulting model also generalizes Buckley and Casson (1981) who, neglecting uncertainty and taxes, derive a critical size of the market at which a firm switches from exporting to FDI. The argument they put forward relies on the observation that exporting requires a low fixed cost but a high marginal cost, while the opposite is true for FDI. Adding the uncertainty argument to the agglomeration effect, we would predict that uncertainty in market growth might deter firms from investing despite high tariffs or transportation cost and agglomeration effects.4 Part of the uncertainty in market growth will arise from political risk in the host country. By finding a significant negative effect of political risk on the share of sales through affiliates in a host country as percentage of total sales, Brainard (1997) gives some empirical underpinning for the uncertainty hypothesis. We derive a partial equilibrium model where in a first stage the host government (credibly) announces corporate tax, lump-sum tax (or subsidy) and import tariff as to maximize domestic benefits. In a second stage, the firm chooses the market size at which it will undertake FDI so as to maximize total profit. As long as this market size is not reached, it sticks to exporting, whenever profitable.5 After setting up the background model and assumptions in Section 2, we consider four specific models. In the first model, considered in Section 3, we derive the critical market size for FDI, the optimal corporate tax and the optimal subsidy to the cost of investment when the foreign firm and the host government jointly maximize their surplus under Nash bargaining. This outcome is the efficient solution or the socially desired one. In Section 4, we examine three non-cooperate models. In the first, the government only sets the corporate tax rate. In the second, the firm fixes the corporate tax rate and the lump-sum subsidy (tax) to investment. Finally, in the third model, the host government maximizes domestic welfare by setting the two tax policy instruments and a tariff that applies to the export of the good from abroad. The first non-cooperative model derives the optimal tax rate as an interior solution. The optimal trigger of investment at this tax rate reflects a double markup over the investment cost; the first being the markup over investment cost that is required by the foreign firm and the second representing the host government’s markup over the firm’s profit. This outcome just reflects the double marginalization outcome in a sequential monopoly and shows that there is significant underinvestment in this case. In the second non-cooperative model, we show that the government can fully capture all benefit by nearly fully subsidizing the investment cost in combination with nearly taxing away benefits that exceed the gains from exporting. The result gives a pecuniary rationale for subsidizing foreign investors rather than traditional arguments like spillovers from foreign investment, such as job creation ( Brander and Spencer, 1987). Lastly, examining the optimal tariff, we find that a higher tariff increases the firm’s propensity to invest (because of the tariff-jumping argument 6) and thus increases the present value of tax benefits. As a consequence, it is shown that maximizing net domestic benefits yields an optimal tariff that is higher than the classic outcome by Brander and Spencer (1984) that disregards the dynamics of FDI and the interaction between optimal tax and tariff policy.

This paper challenges the widespread idea that state aid across the world should be reduced unconditionally. Given some level of corporate taxation, the efficient level of investment can only be obtained by an investment subsidy. Policy proposals to reduce state aid that include a reduction in the maximum allowed capital grant would only have limited effect on the socially optimal flow of FDI if corporate tax rates decrease or tax holidays are left out of the policy reform. Considering the implementation of the optimal tax and tariff policy, it seems that less developed countries often lack capital to implement a tax rule in which an investment grant is paid prior to the receipt of tax income. Still, paying a part of the sunk cost drastically reduces the investment deterring effect of profit taxation and uncertainty alike, and leads to higher gains for the host country. So, if the host country is credit constrained, there is a profitable role for international organizations to finance and recoup the cost of the investment, while the host country can benefit from potential spillovers. With respect to the modeling, an obvious extension is including an active role for the home government of the foreign firm and examining imperfect competition. A model of multiple firms operating in oligopoly and trading off exports and FDI would be severely more complicated, but probably would not change the basic results derived in this paper. The main results in this paper stem from the tariff-jumping argument and the differential effect of profit taxes and lump-sum taxes on irreversible investments. From Brander and Spencer (1984), we know that only the magnitude of the optimal tariff changes when allowing for more than one firm. Also, from Dixit and Pindyck (1994), in a Stackelberg duopoly the significance of uncertainty on the value of waiting to invest is reduced, but the sunk cost effect remains. We leave an exact formulation of this topic for further research.