The FDI location motive and effectiveness of tax incentives: evidence for Indonesia

Tax incentives are used to attract foreign direct investment (FDI), especially in less-developed countries, but the evidence for their effect is mixed. Recently, it has been argued that these incentives are effective for FDI that is motivated by lower production costs, but allocated indiscriminately across projects, suggesting that the motive is important. The paper explores this for Indonesia by conducting a survey of 224 foreign-owned plants, and associating the search for lower costs with labour resource-seeking under Dunning’s eclectic paradigm. Using regression analysis, it finds that the motive is important at plant establishment, but that the incentives neither favour this investment nor are more effective. This includes FDI in export processing zones where cost considerations are more important. The mixed evidence is discussed in the light of this.