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Promoting private investment to create jobs: A review of the evidence

Jann Lay and Tevin Tafese

No 02/2020, PEGNet Policy Studies from PEGNet - Poverty Reduction, Equity and Growth Network, Kiel Institute for the World Economy (IfW)

Abstract: The promotion of private investment, in particular in the form of Foreign Direct Investment (FDI), has been a key component of economic development strategies since the early 1990s. Recent development policy initiatives, for example the G20 Compact with Africa (CwA) but also Germany's "Marshall Plan with Africa", put re-renewed emphasis on mobilizing foreign private capital for accelerated economic growth and, most importantly, the creation of productive employment at scale. This emphasis rests on two important assumptions: First, it assumes that FDI is conducive to economic development through technology transfer, increased productivity and additional jobs - at least when it comes as greenfield investment. Second, it assumes that government policies can be successful in attracting FDI to achieve those benefits. Both developed and developing countries have "redcarpet policies" in place, which - in developing countries - are often supported by bilateral donors and multilateral institutions: governments provide special tax treatment and subsidies to foreign investors, have established special economic zones and investment promotion agencies, seek to mobilize private finance through blending, and improve the investment climate, for example by negotiating investment treaties. The present study reviews the empirical evidence that puts to test these two assumptions. After presenting a conceptual framework we systematically review the vast empirical literature on the ramifications of FDI in developing host countries with a focus on employment effects. This part of the study is followed by an assessment of the empirical evidence on the impact of different investment promotion instruments on FDI inflows and subsequent development outcomes, again emphasizing employment outcomes. As the review will show, direct estimates of the cost-effectiveness of FDI promotion policies are scarce. Yet, taken together, the two parts of this study allow for insights as to whether the effects on FDI flows and the subsequent development, in particular employment, effects are quantitatively large enough to justify the costly efforts of governments to attract FDI. In a last part, we therefore discuss the policy implications of the reviewed evidence.

Date: 2020
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