Central America´s Business Blog

Poor countries should stop giving privileges to foreign investors.

For years, many poor countries have persuaded themselves that foreigners will set up various kinds of manufacturing and service operations in them only if they get special advantages, including the right not to pay taxes.

But this is unfair to local companies, which don’t receive the same benefits.

In addition, giving special privileges to foreign investors in developing economies is like robbing from the poor and giving to the rich – instead of foreign companies paying taxes in places which desperately need the money, they pay them in their own countries, which have a lot.

Even more ironic, offering special breaks in order to attract to foreign investors only works when one country does it.

But as soon a poor economy attracts investors using these privileges, all other developing countries must do likewise, in order to stay competitive.

As soon as two or more countries do this, none is more attractive than another to investors, in which case all of them are giving up tax revenue for nothing.

Privileges for investors – mainly foreign companies - located in so-called free zones of developing economies, usually involve labor-intensive operations, whose products or services are exported to other countries.

The main arguments in favor of exempting these operations from local taxes are that they create jobs and generate foreign exchange, teach local managers how to improve quality control, and - if they are high-profile - attract other productive investments to the country. But in most developing economies, local companies create more jobs – many of which involve world-class skill levels - than free-zone operations.

Like free-zone businesses, local exporters and tourism operations generate foreign exchange.

The presence of high-profile investors may make other companies think of coming to a particular country.

But these high-profile operations would attract other companies just as effectively, while paying local taxes.

When companies think about where to make investments, the main factors involved in the decision generally include labor cost and quality, shipping distances, political stability, currency risk, and the price and reliability of telecommunications services and energy.

Tax issues tend to be less important, especially since poor countries usually charge low rates.

Also, investors can generally reduce tax bills in their own countries by amounts which their operations pay to the governments of foreign countries.

It may be senseless for a poor country to give up tax revenues, without gaining any competitive advantage.

But it is a bad idea that won’t die.

For its part, the World Trade Organization several times in recent years tried to eliminate free zones on a worldwide basis.

Each time, it failed.

In this case, individual countries need to realize – as Mexico did at the end of the 1990s – that it’s possible to attract foreign investors without giving them special privileges.

Eliminating tax breaks for foreigners won’t make poor countries rich.

But a few million dollars a year in a poor country would pay for several medical clinics and give many kids a better education – while putting an end to discrimination against local companies.