Investment Incentives Can Attract Foreign Direct Investment: Evidence from the Great Recession

Abstract

Do investment incentives influence private firms' location decisions? We distinguish between tax incentives and incentives that require real-time government spending including job training and infrastructure. The latter can influence where firms invest by resolving information asymmetries. We evaluate how these incentives shape the location decisions of foreign firms, investors who suffer from high information asymmetries. We leverage features of the Great Recession and 2009 Recovery Act stimulus, which temporarily increased state's fiscal capacity to fund real-time incentives. During the narrow stimulus spending window, states that received more federal Medicaid stimulus  - instrumented with the exogenous component of the federal Medicaid funding formula - attracted more foreign direct investment (FDI) and increased spending on real-time incentives. During the spending window, foreign-owned manufacturing plants located in US counties that lacked a history of FDI. On average, these counties saw more real-time state incentive spending. Counties with idle industrial capacity were more likely to be new FDI recipients only if they had narrow vote margins in the prior gubernatorial election. These findings suggest that governors offered real-time incentives in counties with lower start-up costs and more swing voters. Tax incentives had no effect on FDI. These findings have important policy implications for the efficient use of investment incentives. 

Last updated on 05/23/2024