Government Policy:

Many governments see their role as critical in helping domestic industry to enable employment, export and economic growth. Different countries have differencing approaches. Although we cant understate the importance of these policies on Foreign Direct Investment, we will demonstrate that many governments are often impotent in the short term. The policies at the disposal of governments to influence FDI are numerous and include education to ensure a more skilled labour force, infrastructure investments such as ports, railways lines, airports & high roads to allow for easy access of raw materials and exports, ease of financial flows, tax policies to encourage higher returns for both corporations as well as making it attractive for employees, availability of land for industrial development, low cost energy, subsidies, currency risks, and other policies that encourage economic and political stability. Many of these policies, however, must be developed consistency over the long term. During the legislature of a single government, it is extremely difficult to have a major impact. Some governments have tried offering tax incentives, but unless foreign companies perceive those tax incentives to be long term, they are unlikely to work. The Irish government introduced a very attractive tax regime over 20 years ago, and has consistently kept to this policy, encouraging many foreign companies to establish an Irish subsidiary or head office, far more than the Irish economy would have justified. Similarly, the small Israeli economy has attracted a massive amount of FDI, thanks to a very educated labor force supported with attractive finance availability and low corporate tax rates. Over the past 30 years, the Western European countries have seen a massive decline in their industries. Many Western governments, have rightly been worried that major economies cannot survive by services alone. Hence the industrial policies of many governments have become very aggressive. I will illustrate the opportunities and limitations of government policies towards FDI through the Automotive industry in Europe, and more particularly in Belgium. Up till 10 years ago, Belgium had a unique position in Europe. Despite having no Belgian automotive brand, Belgium had the highest proportion of employment in the automotive industry in Europe. Both Renault and Volkswagen had major plants in Brussels, General Motors had a leading plant in Antwerp, Ford had a large plant in Genk, Volvo cars had the only large plant outside of Sweden in Gent, and so on. In 2003 over of a million people were employed by the industry and its subcontractors. This high proportion relative to the population was thanks to a great central location in Europe, good transport infrastructure (highways, a major port, and a good rail network) relative good productivity:

Figure 1: productivity Automotive industry 2006 - Group Alpha Employment, Skills & Occupational trends

Less than 10 years later that number has reduced by over 50% due to the closure in the past 5 years of the Renault plant, the Volkswagen plant, the GM plant, and the recently announced closure of the Ford plant. The Belgian government developed a very positive policy towards the automotive industry. Over the past 10 years, the Belgian government offered massive training subsidies, flexible economic unemployment, flexible shift premiums, low taxes thanks to the possibility of deducting a notional interest on the capital employed. So what went wrong? The European demand for cars started going into decline in 2009 creating a large overcapacity over the past 4 years. The opportunity to produce in Europe for the growing Far East markets is limited due to high relative labour costs combined with shipping costs. Only the German premium cars have succeeded in exporting cars to the Far East. As soon as the Automotive companies realized the necessary to reduce capacity, Belgium was one of the first countries to suffer due to very high labour costs not sufficiently matched with productivity benefits, and small local market. The Belgium labour costs are one of the highest in Europe due to high social security costs (over 50% of gross salaries) and additional employment tax (up to 50% of the balance after paying for social security). A typical blue collar employee in the Belgian automotive industry costs 37.5/hour, and is the highest in Europe bar Norway, but will only have a take home pay of 10/hour.

No government policy or lobbying was able to convince these companies to keep their Belgian plants. The economic need for plant closures was clear, so the manufacturers just decided which plants had the highest production costs and no short term government policy was able to change this facts. Belgium politicians have realized since many years that the high labour cost was not sustainable, but was necessary to sustain the social safety net and over 10% of the population who are employed by the government. Unfortunately, no Belgian politician have been courageous enough to reduce this cost to allow tax reduction. In conclusion, Government policy can have a major impact on FDI, but it needs to be coherent and long term. Short term measures can only have a very limited impact.