There has been quite a bit of press about the US EU free trade negotiations.  The major news is that the French government has been posturing on “cultural” industries.

Matthew Yglesias has a much more sober take on the issue.

One interesting parallel is the proposed Multilateral Agreement on Investment (MAI) that failed in 1998.  One potential reason for the collapse of the this OECD investment agreement were issues related to cultural industries.  This ranged from French movies to Canadian radio quotas.

While cultural heritiage probably had some hand in torpeodoing this agreement, the failure was overdetermined.  In the book, Fighting the Wrong Enemy, Edward Graham argues that there was very tepid support for the MAI from the business community, limited interest from politicians, and outright hostility from civil society.  Protestors claimed victory when it failed while others blamed the hundreds of pages of cultural exceptions for killing the agreement.  But these seem like self-serving explanations.

Back to the US-EU agreement.  Why is there so much postering over cultural issues?  Most of these issues aren’t really even covered in the proposed US-EU pact.  One guess is that the the French government can claim victory by excluding cultural industries that probably weren’t going to be included in the agreement in the first place.  Other countires, like the US, probably would like to see French concessions in other policy areas, so allowing them a polical victory is a good way to hammer out an agreement.

To be honest, I’m making a lot of guessing on what is going on in this specific agreement, but MAI might provide some guidance on the role of cultural industries in trade and investment agreements.

Chris Blattman’s post on the value of cash transfers in economic development got me thinking about the other ways in which cash transfers could be used to solve a number of governance issues.  The Center for Global Development has a series of proposals on using cash transfers to mitigate the natural resource curse.  Here is a quick summary:

Todd Moss, senior fellow and vice president for programs at the Center for Global Development, demonstrates how leaders of poor countries can beat the resource curse — the paradox that countries that strike it rich often suffer from high poverty, dismal governance, and terrible corruption. His policy option, called Oil to Cash, helps foster a social contract in resource-rich countries by directly distributing natural resource revenues. Under this proposal, a government would transfer some or all of the revenue from natural resource extraction to citizens in a universal, transparent, and regular payment–and, importantly, then tax part of it back.

CGD also has a paper that addresses some potential criticisms, although these aren’t some of the obvious ones I would think of.

This is a really interesting idea, but I have a few concerns.

1.     The link between natural resources, political violence, and authoritarian is often attributed to the value of the state when the state controls natural resources.  See Thad Dunning’s excellent book.  It isn’t clear to me how cash transfers would change the incentives to rebel or for leaders hold onto power.  Unless there is a credible commitment to provide cash transfers in perpetuity, that value of controlling the state is very, very high.  That is one of the problems with natural resource wealth.

2.     Michael Ross has pointed out that many countries can use their natural resources as a means to borrow in international capital markets.  These “booty futures” lower the cost of borrowing for the state.  As long as natural resource producers can borrow against resource wealth, this can provide a steady stream of rents to the government.

3.     One classic problem with natural resources is that prices are volatile, affecting a government’s ability to budget.  I can imagine this being even more problematic for citizens.  One reason for governments (or MNCs) to control resources is that they mitigating the adverse effects of price volatility.

4.     A strong assumption in this work is that by allocating resources and then taxing them, citizens will demand more from the government.  This argument isn’t new, but I think the empirical evidence on this is shaky.  There is some good work on the “fiscal illusion” where citizens are especially bad at linking the costs of government spending to their own tax bills.

One final speculative concern, related to my own research, is how giving citizens direct access to revenue streams would affect a government’s incentives to uphold contracts with firms.  Many natural resource expropriations are popular with at least some segments of society.  Would giving citizens a direct financial stake in natural resource contracts increase their incentives to support expropriations or contract renegotiations with natural resource extraction firms?  Do citizens care more or less than the government about the reputational costs of reneging on contracts?

These are just a few random musings while my newborn son sleeps.  He sleeps a lot.  Shoot me off an email if you have seen any research related to this topic.

As part of a research project with Adam Rosensweig we examined a GAO report on U.S. companies using tax havens.  The report finds that 83 of the largest U.S. companies sampled had at least one subsidary in a country considered a tax haven.

Given how easy it is to use havens to avoid taxes, why don’t they all use tax havens?  Some companies, such as Walmart, have few foreign affiliates in general, and struggle to shift profits overseas given the structure of their business.

But there are a quick a few high tech companies that have patents that they could park offshore, yet they don’t seem to use tax havens.  Why?

Adam identified a statute (6 U.S.C.A. § 395) that specifically bars companies receiving government contracts from using tax havens (“inverted domestic corporations”).  There seems to be a least one straightforward way to control the use of tax havens.

Rarely do two seemingly unrelated research projects come together.  One of my areas of research is tax competition for foreign investment.  The second is firm level corruption in developing countries.

I’m working on a paper that examines how the OECD Convention on Combating Bribery of Foreign Officials in International Business Transactions affects the propensity of firms to pay bribes.

While this convention came into force in 1999 and now includes 40 signatories (34 OECD and 6 non-OECD countries), the OECD has provided further guidance on rules on tax deductibility of bribes.  That’s right.  Bribery is tax deductible in a number of countries, including some countries that have signed the convention.

In a few countries bribes have been illegal and not tax deductible for decades.   The 1977 US Foreign Corrupt Practices Act makes bribery illegal and thus bribes are not tax deductible.  Apple and Starbucks reduced their taxes through other means.

But this OECD Observer article provides some interesting comparisons across countries on how bribes are treated:

In 1996 only 14 denied the deductibility of bribes to foreign public officials as a general rule. Canada, the United Kingdom and the United States denied it because of the illicit nature of the bribe in their own countries. In fact, if any part of the offence was committed in the United Kingdom, for example, whether the offer, the agreement to pay, the soliciting, the acceptance, or the payment itself, it would be covered by the corruption laws and would then not qualify for tax relief. Under Poland’s law, bribery is illegal and an offence for both the briber and the recipient of the bribe and both are punishable.

Other countries adopted approaches that were perhaps a little less explicit. The Czech Republic, for example, classified all bribes as gifts, which were mostly not deductible. In Japan, bribes were categorised as entertainment expenses, which by definition made them non-deductible anyway. In several countries – Finland, Greece, Hungary, Ireland, Italy, Korea, Mexico, Spain and Turkey – bribes of foreign officials simply did not qualify as a deductible expense, and were thus not allowed, even if there were no explicit provisions against them in some of these countries. In Denmark, Iceland, Norway and Sweden, bribes paid to foreign public officials were only deductible if they were documented business expenses and if they were a customary practice in the country of the recipient.

In the remaining countries – Australia, Austria, Belgium, France, Germany, Luxembourg, Netherlands, Portugal, New Zealand and Switzerland – bribes to foreign public officials were still as deductible as any other business expense, at least in principle. In practice, a deduction for a bribe was often disallowed because of insufficient documentation to support the fact that the expense was a necessary part of the transaction in question. Moreover, the deductibility of bribes to foreign officials was generally conditioned upon disclosing the identity of the recipient to the tax authorities, which taxpayers are naturally reluctant to do.

The article closes with some details on progress has been made across countries passing legislation that no longer allows the tax deductibility of bribes.

I’ve been working away on a book manuscript on investment incentives.  For the loyal reader(s) of this blog, I’m sure you’re tired of this topic.  But a friend of mine just emailed me some info about buying “unused” tax credits.

One interesting issue that we haven’t addressed in our research is the use of different types of incentive programs to attract firms.  Some countries, states and cities provide direct grants or loans to firms.  More common in the U.S. is providing tax exemptions or credits to firms.  The rhetoric behind these programs is that governments provide incentives to firms, but these firms only realize these incentives if they become profitable.

A lawyer friend of mine just emailed me that they have seen a bunch of tradable tax credits cross their desk.  Many U.S. incentive programs allow for the selling of tax credits.   My friend said that in Missouri they often trade for as much as $0.93 cents on the dollar.

To put this in broader perspective, here is an article about tradable film tax credits.

Unfortunately, numerous articles have noted that this isn’t a transparent market.  A few sites have tried to build tax credit exchanges but there seems to be very little trade volume on these sites.

I don’t have any punchy conclusion.  My gut is that these large incentives are almost as valuable to firms as cash (93 cents on the dollar) yet politicians aren’t criticized for handing out cash to firms.

If you have any data on this or general thoughts, drop me an email.

U.S. Film Tax Credits and other film and TV incentive program have been heavily criticized as wasteful government programs.

Pennsylvania provided a $5.1 million tax credit to Open 4 Business Productions to film a TV program in Philadelphia.  I thought I would take a quick look at the incentive.

The incentive was to film the medical drama series “Do No Harm” which proposed to generate 100 jobs.  The size of this incentive was identified as the main reason the show was filmed in Philadelphia.

This is what I can tell.  This series received one of the absolute worst ratings of any pilot and was canceled after two episodes.  Instead of seeing Pennsylvania taxpayer funded “Do No Harm” we will see even more episodes of Law and Order SVU in its place.

These film credits are notoriously complex, often with incentives ranging from construction in state, to hiring workers, to buying the rights of musicians who live in state.  I’m not sure how much the states lost or gained from this show.  But it seems clear that the show was terrible.

I am co-authoring a paper with three of my graduate students (Noel Johnston, Chai-yi Lee, and Abudulhadi Sahin) on government decisions to break contracts with foreign investors.  Our main finding in the paper is that governments are actually less likely to break contracts during periods of economic crisis, and that governments that are dependent on other countries for foreign aid for support from the multilaterals (specifically IMF programs) are less likely to expropriate investors assets or income streams.  Our data analysis include a model that predicts expropriation events in a country-year, and a survival analysis of political risk contracts issued by the U.S. government political risk insurance agency (OPIC).  We’re revising our paper for submission over the next week or two.  Drop me an email if you want a copy.

A final part of the project is a series of case studies of “pre-claims” from the World Bank’s political risk insurance arm, the Multilateral Investment Guarantee Agency (MIGA).  The MIGA folks have bee really helpful in providing feedback on our project and providing information on the “pre-claims” of expropriation, where they document government actions taken that threatened investors and how this dispute was eventually settled.

These cases provide a window into both why governments “try” to break contracts and why they eventually back down.  The table at the end of this post provides basic info on the disputes.  I had the opportunity to talk to MIGA about a bunch of these cases.

Table 1 does provide some examples of government incentives to renege on contracts during periods of crisis, although there are two important points.  First, these are cases of pre-claims, where the government either ultimately backed down from the initial policy to a resolution with the investors or in a few cases the negotiation is still under way.  Second, these crisis-triggered expropriations are quite uncommon.  Only seven of the 34 cases are related to economic crisis, and three of these are related to the financial crisis in Argentina.

Other types of disputes are much more common. In some cases political change leads to an investment dispute, for example a new minister of mines in Guatemala denying tariff adjustments or a regime change in Guinea leading to the canceling of a telecommunications contract.  Also common are reviews of privatization programs or the revising of contracts written by previous regimes previous contracts.  Examples include privatized natural resources investment in the Democratic Republic of the Congo and Moldova. Political change in Ecuador let to a review of all water concession contracts.

Other patterns of investment disputes are related to what seem to be legitimate environment regulations.  In Costa Rica the government expropriation an investment with compensation to preserve a rain forest, was a dispute was over the level of compensation, not the legitimacy of the government action.  The government of Guyana’s canceling of a contract due to a mercury contamination from a mining operation is another clear example. A dispute in Benin over potential environmental and safety issues in a hotel investment that was being build over buried oil pipelines is an example of environmental issue leading to a dispute over who pays for unexpected costs to a project.

The most common pattern of these pre-claims is governments attempting to renegotiate terms of contracts, often on the tariffs that power and water providers can charge consumers or payments owed to firms from the government.  Why do governments want to rewrite these contracts?

Interviews with MIGA staff point to unbalanced contracts as one potential trigger for expropriation threats.  In a number of power contracts, investors pushed much of the risk onto the host government that eventually led to major financial losses by the government.  The contract on hydroelectric generation by AES in Uganda is a clear example of this pattern.  AES negotiated favorable terms for a power generation contract, which became obvious during a period of low rainfall.  The government attempted to renegotiate the contract, claiming that they were incurring major financial losses by making minimum payments to AES. Similar examples include the 2003 geothermal dispute in Nicaragua, 2003 and 2004 power disputes in Kenya and Guatemala, and 2007 dispute over the investment in a cotton gin in Afghanistan.

This wide variety of types of pre-claims provides evidence of exogenous shocks (crisis, environmental disasters), political change, and simply disputes between firms and governments.  There are also a number of cases that could be classified as “corruption”, often where government officials either attempted to extract from firm, or that the government was attempting to force our the firm in order to help a competitor. Given this wide range of triggers for the disputes, is there a common pattern to how these were successfully renegotiated?  To answer this question we drawn on a number of interviews with MIGA officials.

One of the major tools that can be used is to articulate how these claims, made public through MIGA, would have negative consequences for the country’s reputation.  Some of the clearest cases were the disputes in China, where in a couple of pre-claims local or provincial government officials took actions against a firm and MIGA contacted the central government to intervene.  The conclusion of the 1998 dispute in China was literally a public ceremony signifying a conclusion of the dispute that included the company and government officials.

While different in nature, the role of reputation in the 1998 dispute in Guatemala was important in resolving the issues at stake.  In essence, the energy minister was pushing for changes in a power contract.  MIGA consulted with the Ministry of Finance, articulating the potential financial consequences of expropriation behavior.  The political fight between these ministries is complicated, but the Minister of Finance eventually prevailed.

In many cases, powerful external actors also intervened.  The clearest example was the heavy involvement of President of the World Bank and the Prime Minister in Spain in the 2003 power dispute in Moldova.  According to MIGA sources, the government was harassing a Spanish power provider to entice the company to sell to a Russian company.  The President of the World Bank and Prime Minister of Spain directly sent letters, including a direct threat of cutting off World Bank, International Finance Corporation, and European Bank for Reconstruction and Development financial support.

The World Bank was also active in adjudicating the 2009 power dispute in Uganda.  But, as noted above, this was a relatively unbalanced contract in favor of the investor.  While the World Bank pushed for the Uganda government to moderate their claims, the World Bank wasn’t completely unsympathetic to the government concerns about the contract.  The contract was eventually rewritten with the firm taking more the risk in the electricity generation part of the contract, although the government took on a number of major risks at the distribution end of the contract.

Similar pressure was put on Benin by the Bank for their discriminatory treatment of a foreign cell phone provider.  This foreign firm was threatened with a major up front fee for future taxes to continue their operations, despite domestic providers not being included in this new fee plan.  The World Bank threatened to cut off future grants to Benin and the pressure on the foreign firm subsided.

The Democratic Republic of the Congo is one of the more complicated cases of foreign involvement, where the International Finance Corporation (IFC) and MIGA had involvement in a mining operation.  DR Congo was in the process of transforming their notoriously secretive mining contracts into a paradigm of transparency, signing onto the high profile Extractive Industries Transparency Initiative (EITI).  But the problem was on how to deal with the previous contracts.  Rather than providing a formal rule on how old mines would be treated, each mining operation engaged in one-on-one negotiations with the government.  This was a process rife with potential corruption, but the World Bank (IFC and MIGA) backed mine opted for the highest EITI standard.  This hardline stance by the World Bank lead to a major disagreement with the government.  The Bank negotiated hard, although the number of important post-conflict World Bank programs in DR Congo actually made threats of cutting them off from funding less credible than in the case of Benin and Uganda.

In some cases, international financial institutions not only provided the sticks, they provided carrots to help negotiate a settlement.  The ill-faded cotton gin dispute in Afghanistan was solved with money from multilaterals, while the Inter-American Development Bank provided funds to help cover power contracts that were costing the Guatemala and Nicaraguan governments scarce foreign currency.

The role of multilaterals isn’t a guarantee of stable relations between investors and governments.  Ecuador’s expelling of the World Bank from the country and Argentina’s tense relations with the IMF and Bank documented above provide evidence that multilateral involvement isn’t a panacea.  But the evidence does suggest that these institutions wield carrots and sticks that can be used to avoid expropriation events, even in cases of contracts that were very unfavorable to host governments.

Our cases study of the 34 “pre-claims” from MIGA compliments our statistical analysis in the paper.  We show that there is no absolute guarantee against the expropriation of investment.  Pressure to expropriate or breach contracts can come from a number of different factors.  Governments that are concerned about their reputation and/or governments dependent on multilaterals for financial support are much less likely to engage in expropriations.  At the other extreme, when a government such as Argentina as already alienated investors and multilaterals, there are few remaining constraints from reneging on contracts.

We’re still writing up these details and interviewing more people at MIGA on these disputes.  But it seems like these “pre-claims” are a window into government incentives to initially break contracts, and how diplomatic or economic pressure leads the governments to eventually back down.

Table 1: MIGA Pre-Claims (1998-2010)

Blogging has been light due to vacation, end of semester, and preparing for our second child to arrive (late May…we hope).

I’m trying to wrap up a book project with Eddy Maleksy on governments providing financial incentives to firms.  I took a quick look at the Canadian incentive data.

While some Canadian provinces ban certain types of incentives, our data reveals over 400 incentives given by provinces and cities from January 2010 to April 2013.  The vast majority of these incentives are provided by the two largest provinces, Ontario (170 incentives) and Quebec (147 incentives).  Three of deals top $100 million (Canadian), including $304 million (Canadian) for Shipbuilding in Nova Scotia, $142 million (Canadian) to Toyota’s expansion in Ontario, and $132 million (Canadian) for the upgrading of a paper mill in Quebec.  Unlike many of these U.S. incentives, the majority of Canadian incentives are in the form of subsidized loans.

Interestingly, the pattern of incentives seems related to the electoral calendar.  Quebec’s most recent general election was held on September 2012 after the dissolving of parliament in August 2012.  While there is not direct evidence that the government was providing more generous incentives in the run up to the election, the descriptive data fits this pattern.  While 2012 had a similar number of incentives offered (38 incentives) to 2011 (42 incentives), the size of these incentives increased dramatically, from an average of under $3 million in 2010, under $5 million in 2011, to over $9 million in 2012.  The incentives thus far in 2013 (as of this week) were back to the pre-election levels of just over $5 million.

Perhaps this is just a spurious correlation.  What does the pattern look like in Ontario?  Fortunately for us, Ontario’s general election was held in October 2011, roughly a year earlier than Quebec’s general election.  For Ontario, we find an even clearer pattern, with the government offering many more incentives during their election year (72 incentives) than the year before elections (47 incentives) or the year after the elections (34 incentives).  The size of these incentives is equally striking.  In the year before the general election the average incentive was $1.62 million and $3.16 million after the election.  During the year of the elections the average was over $6 million.  Put another way, Ontario’s total dollars in incentives increased by over 400% during the election year.

Our point general argument is that politicans offer incentives to “claim credit” for investment that was coming to their province anyway.  This is some simple descriptive evidence that is consistent with our theory, although it could be consistent with a couple of alternative theories.  But something fishy is going on during election years.

The New York Times ran a series on investment incentives, including the Kansas City Border war.  I’ve also bloggedon the topic.  Kansas City is an extreme example of a competition for investment between two cities that share the same name:  Kanas City, MO and Kansas City KS.

As part of a book project with Eddy Maleksy, I had two of my undergrad RAs collect some data on this border war.

The states of Missouri and Kansas, along with cities in the Kansas City metro area, have fiercely competed for 67 firm investments just from 2010-2012. These 67 incentives have cost $312 million to the two states, with an average cost of over $4 million per investment.  These incentives were exceptionally generous, averaging over 50% of the capital expenditures of the firms and $37,000 per job created.  What is driving this border war?

Perhaps to the surprise of at least some readers, rarely did these firms provide direct contributions to the either the Missouri or Kansas governor’s election campaign.  Only 4 of the 67 firms provided direct contributions to the Governor’s campaigns in 2010 or 2012. The biggest player by far was engineering firm Burns & McDonnell.  Our data work for a book project (with Eddy Maleksy) identified direct contributions by employees to the Jay Nixon (Missouri-D) campaign of $137,000.  Documentation by OpenSecrets, an online campaign contribution tracking website provides a more complete picture of their contributions, including PAC contributions.  This company has a PAC that largely funds incumbent Representatives and Senators across the country.  The key point is that while this company is politically active in the state and Missouri and beyond, it is by far the exception.  The other three contributors provided $3,500, $2000, and $1000.

We also examined the contributions of employees of these 67 companies beyond the governor elections and coded any campaign contribution by employees of the firm to state politicians.  Only 6 more companies (a total of 10) provided contributions.  Burns & McDonnell and insurance broker Lockton Companies both gave roughly $22,000.  The remaining companies gave an average of just over $1000 each.  In summary, the 67 incentive recipients gave an average of $3,000 across all state and local elections in Missouri and Kansas from 2010-2012.

The use of campaign contributions, at least the direct ones we can track, doesn’t seem to be the deciding factor in shaping these incentive decisions.  Similar to an analysis of Texas investment incentives that we blogged about in the past, there is a strong correlation between the number of jobs created and the size of the incentives (correlation of 0.30).

Ok, if campaign contributions aren’t responsible for this incentive war, perhaps the tough competition for capital is driving this.  In most cases of these incentives, we couldn’t find evidence of competing incentive bids, or even concrete evidence that the firm was considering an alternative location. For 31/67 of these incentives, the firms were simply expanding existing operations in their previous locations.  For others, they were jumping to the other side of the border since “new” investment can receive incentives, while existing plants (without expanding) often can not.  We could only find evidence of claims of competition from other locations in 20 of the cases, with many of the companies citing “other Midwestern locations” or other vague claims of competitors.  In 6/20 cases, the competition was from across the state line in either Kansas or Missouri.  Only in two of the cases could we find direct evidence of competing offers, where two firms locating in the Kansas City, Kansas suburb of Overland received competing incentive bids from Missouri.

Thus in the majority of cases, there is little evidence that direct competitive forces, such as bids from alternative locations, were driving these incentives.

While we can not conclusively say what is driving this border war, our data collection efforts document that most of these firms do not provide any campaign contributions, nor where these incentives and obviously outcome of a bidding war.  In many cases, firms received only one offer, often to jump across the border to Kanas or Missouri.

Our book project extends the logic of this paper on the use of incentives for credit claiming by politicians.  Credit claiming, not campaign contributions are driving this incentive competition.