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Foreign direct investment and the dark side of decentralization

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  • Sebastian G. Kessing
  • Kai A. Konrad
  • Christos Kotsogiannis

Abstract

"Both in the developed and developing world, decentralization of fiscal policy is frequently argued to foster investment, because allowing investors to choose between competing locations should make it difficult for each jurisdiction to tax the investment's returns. We point out that this 'horizontal' dimension of decentralization cannot eliminate ex post incentives to tax investments once they are irreversibly located in a jurisdiction, and that the negative ex ante investment effects of such 'hold up' problems are actually stronger when decentralization inevitably leads to multiple levels of taxation power in each location. Empirically, we detect significant negative effects on FDI of the 'vertical' dimension of decentralization, measured by the number of government layers, in a data set containing many countries and many suitable control variables. Indicators of overall fiscal decentralization do not appear to affect the investment climate negatively per se, but our theoretical arguments and empirical results suggest that policymakers should consider very carefully the form and degree of government decentralization if they aim at improving the investment climate." Copyright (c) CEPR, CES, MSH, 2007.

Suggested Citation

  • Sebastian G. Kessing & Kai A. Konrad & Christos Kotsogiannis, 2007. "Foreign direct investment and the dark side of decentralization," Economic Policy, CEPR;CES;MSH, vol. 22, pages 5-70, January.
  • Handle: RePEc:bla:ecpoli:v:22:y:2007:i::p:5-70
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Lessmann, Christian & Markwardt, Gunther, 2010. "One Size Fits All? Decentralization, Corruption, and the Monitoring of Bureaucrats," World Development, Elsevier, vol. 38(4), pages 631-646, April.
    2. Carsten Hefeker & Sebastian G. Kessing, 2017. "Competition for natural resources and the hold-up problem," Canadian Journal of Economics, Canadian Economics Association, vol. 50(3), pages 871-888, August.
    3. repec:spr:lsprsc:v:10:y:2017:i:3:d:10.1007_s12076-017-0192-z is not listed on IDEAS
    4. Luiz de Mello, 2012. "Fiscal decentralization and public investment," Chapters,in: Decentralization and Reform in Latin America, chapter 5, pages iii-iii Edward Elgar Publishing.
    5. Nils Herger, 2013. "On Discrete Location Choice Models," Working Papers 13.02, Swiss National Bank, Study Center Gerzensee.
    6. Adams, Laurel & Régibeau, Pierre & Rockett, Katharine, 2014. "Incentives to create jobs: Regional subsidies, national trade policy and foreign direct investment," Journal of Public Economics, Elsevier, pages 102-119.
    7. Sebastian Kessing & Kai Konrad & Christos Kotsogiannis, 2009. "Federalism, weak institutions and the competition for foreign direct investment," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 16(1), pages 105-123, February.
    8. Geys, Benny & Konrad, Kai A., . "Federalism and optimal allocation across levels of governance," Chapters in Economics, University of Munich, Department of Economics.
    9. Kaushal Kishore, 2016. "Tax Competition, Policy Competition and the Strategic Use of Policy Restrictions on Foreign Direct Investments," Working Papers 201684, University of Pretoria, Department of Economics.
    10. Luiz de Mello & Douglas Sutherland, 2014. "Financing Infrastructure," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1409, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    11. Nils Herger & Steve McCorriston, 2014. "Horizontal, Vertical, and Conglomerate FDI: Evidence from Cross Border Acquisitions," Working Papers 14.02, Swiss National Bank, Study Center Gerzensee.
    12. Nils Herger & Steve McCorriston, 2014. "Horizontal, Vertical, and Conglomerate Cross Border Acquisitions," Discussion Papers 1402, Exeter University, Department of Economics.

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