Fiscal institutions boost FDI in LICs
Weak growth and uncertainty in low-income economies often lure policymakers to aggressive incentives; new IMF-CEPR analysis argues credibility and strong fiscal institutions matter far more for attracting both volume and quality of foreign direct investment.
Low-income countries attract less than 1% of global FDI, a share that remains aligned with their output but is far from transformative for convergence. The IMF-backed research finds that fiscal discipline and robust fiscal institutions correlate with higher inward investment and with a shift toward more R&D-intensive projects, rather than the extractive and energy sectors that have dominated FDI in poor economies. The policy implication is stark: credibility and institutional quality matter more than the generosity of tax holidays or SEZ regimes.
Across multiple empirical angles, the study shows that stronger revenue administration, better public financial management, and credible macro-fiscal frameworks are linked to both greater quantities and higher-quality inflows. The results hold especially for LICs, where policy credibility cushions investors against geopolitical and financing uncertainties. Yet the benefits of incentives are conditional; in weaker institutional environments, tax holidays and SEZs have little or even negative effects on investment, eroding revenue without boosting deployment.
The authors argue for a shift in strategy: prioritise building fiscal institutions and macro-fiscal credibility before offering large incentives. Incremental improvements to tax administration, budget transparency, and public investment management can reduce risk and costs of compliance, making a country a more attractive long-term destination for development-enhancing FDI. In a world of heightened uncertainty, credibility becomes a binding constraint on the investment impulse and the growth dividend that flows from it.
The upshot for policymakers is actionable and practical: strengthen institutions first, use incentives sparingly and strategically, and measure how policy credibility interacts with uncertainty. Tracking changes in FDI inflows and the share of high-R&D inflows in LICs will be critical to validate whether credibility translates into observable shifts in investment mix and technology transfer.