Investment incentives attract foreign direct investment: evidence from the great recession

• Published in: Public choice Vol. 200; no. 1-2; pp. 323 - 345
• Main Authors: Katitas, Aycan, Pandya, Sonal
• Format: Journal Article
• Language: English
• Published: New York Springer US 01.07.2024; Springer Nature B.V
• Subjects: American Recovery & Reinvestment Act 2009-US; Budget constraint; Companies; Counties; Economics; Economics and Finance; Efficacy; Elections; Foreign companies; Foreign investment; Government spending; Governors; Great Recession; Industrial policy; Infrastructure; Investors; Job training; Medicaid; Political economy; Political Science; Production capacity; Public Finance; Recessions; State elections; Stimulus; Tax incentives; Taxation; Fiscal stimulus; American recovery and reinvestment act (ARRA); Liability of foreigness; Tax incentives
• ISSN: 0048-5829; 1573-7101
• DOI: 10.1007/s11127-024-01158-0

Do investment incentives influence private firms’ location decisions? Whereas prior research emphasizes tax incentives, we focus on incentives that require real-time government spending including job training and infrastructure. Real incentives influence where firms invest by resolving costly information asymmetries, and are subject to budget constraints that give rise to political targeting. This paper evaluates how real incentives shape the location decisions of foreign firms, investors who suffer from acute information asymmetries. We leverage features of the Great Recession and the 2009 American Recovery and Reinvestment Act stimulus, which temporarily increased states’ fiscal capacity to fund real incentives. During the narrow stimulus spending window, states that received more federal Medicaid stimulus—instrumented with the exogenous component of the Act’s funding formula—attracted more foreign direct investment (FDI) and increased state spending on real incentives. The stimulus window approximately coincides with FDI’s temporary geographic expansion into US counties that lacked a history of these investments. On average, these counties had narrow vote margins in the prior gubernatorial election and garnered more state real incentive spending. These correlates are pronounced in counties with idle industrial capacity and in states whose governors sought re-election. Tax incentives had no effect on FDI. These findings have important implications for the efficacy of investment incentives and the political economy of industrial policy.