IBM Assignment

By

Each year, foreign companies generate billions in capital and

thousands of new jobs for the Kenyan economy. As can be expected,
Kenyan politicians, and local governments have aggressively
competed for foreign direct investment. Discuss the business of
attracting foreign corporation from the viewpoint of both the
companies and states. What are the matters of concern to companies
which they will take into consideration when making their location
decisions? What are the incentives which states can offer to lure
business to locate in a particular state? (20 Marks)

Introduction
Foreign direct investments may come in the form of multinational corporations
(MNCs) setting their base of operations in locations outside their home countries.
In so doing, there are a number of factors that such MNCs must take into account
as they scout for locations to establish their businesses. Further, host countries
need to attract FDIs and to do this, they should put in place specific incentives to
attract MNCs. This paper discusses the determinants of FDI from the viewpoint
of both the companies and states.
Location Determinants
A number of factors influence MNCs decision to locate in a specific nation other
than the home country. These are discussed as follows.
Market Orientation
Market orientation affects location decision of firms. A local market-oriented firm
will be more interested in state where commodity-based incentives such as tariffs
and quota protections are provided. In contrast, an export-oriented firm is not
interested in commodity-based incentives but on financial incentives such as tax
holidays. Such firms will also be interested to invest in countries where import
duty exemptions are extended to manufacturers.
Type of Investment
Whether an MNC expanding its operations or is a start-up affects where it locates
it business depending on what the host state provides as an incentive. If an MNC
has been operating in a specific country, its prior experiences increases its
propensity to make future investments in the same country. Such MNCs will be
interested in countries that offer incentives to generate more profits such as tax
holidays. Those making an entry into a country for the first time may be
interested in incentives that reduce their initial expenses such as feasibility
studies.
Country of Investment
A number of factors differ across countries and these influence location decisions.
These include distance from markets, size of markets, economic growth,

infrastructure quality, inflation rate, political risk, currency stability, and tax
rates. Thus, in a country where corporate tax rate is slow, tax holiday incentive is
undesirable to an MNC while it is very important in high tax rate regimes.
Product
The type of product manufactured by an MNC may also affect its location
decision. MNCs that manufacture apparel or electronics will be interested in
moving to locations where wage subsidies or depreciable asset incentives are
provided as opposed to locations where tax concessions or land grants are
provided as incentives. This is because the largest expenditures for such
manufacturers are for wages and acquisition of equipment. For service firms, this
is not the case.
Investment Size
The size of investment by an MNC also affects their location decisions. For large
investors, they will be interested in countries where the attractiveness of the
incentives increases with the size of investment. This includes incentives such as
cash grants or accelerated depreciation allowances. Small investors may not be
incentivised the same way.
Size of Labour Force
Companies also consider size of labour force to be absorbed by the organisation in
making the decision on where to locate their business premises. For companies
that are likely to employ a large number of people, they are more likely to locate
in countries where wage-related incentives are provided. These include wage or
training subsidies.
Market Size
An MNC may invest in overseas R&D to support their foreign production by
adaptations and the customization necessary for specific markets. Some of these
adaptations are best undertaken closer to the markets for which they are meant.
The location of this type of R&D investment, however, will be influenced by the
size of local markets. This is because it may not be efficient to make adaptations

for a very small market in view of economies of scale involved in innovative

activities.

Incentives by States
In order for states to attract businesses to locate in their states, there are a
number of incentives that states must offer. Some of these have already been
discussed above. The most important incentives include:
(1) no restrictions on non-dividend payments,
(2) no controls on dividend remittances,
(3) import duty concessions,
(4) exemption from dividend withholding tax,
(5) guarantees against expropriation,
(6) tax holidays,
(7) cash grants for fixed assets,
(8) accelerated depreciation, and
(9) subsidized loans.
As observed, most of these incentives revolve around income taxes and foreign
exchange restrictions. With the exception of export processing zones and
industrial estates, where infrastructure and land are subsidized, developing
countries are more likely to base their incentive schemes on tax holidays and
other fiscal measures that do not require direct payments of scarce public funds

References
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