Incentives play an important role in the investment promotion strategy of more or less any country. This is especially true for the attraction of export-oriented FDI projects. In particular, incentives constitute an integral part of the services offered by various export processing zones (EPZs). But, as of January 1, 2003, the WTO’s SCM Agreement generally prohibits the use of subsidies linked to export performance. (An illustrative list of prohibited export subsidies is attached to the agreement; see www.wto.org/English/docs e/24-scm oi e.htm).

There are, however, important exceptions. First, the 49 least developed countries and certain other less-developed WTO members listed in Annex VII(b) of the agreement are exempted (until their GNP per capita reaches $1000 in constant 1990 dollars for three consecutive years). China does not benefit from this rule because it agreed to phase out any remaining export subsidies when joining the WTO. Second, 21 developing countries were recently granted an extended transition period for specific export subsidy schemes. Third, the SCM Agreement is only related to trade in goods. Services are not covered.

Beyond that, a number of subsidies that are often used to attract export-oriented FDI could be challenged by WTO members if they can demonstrate that the subsidies involved adversely affects their interest. In WTO legal jargon, they are “actionable”. There is an element of uncertainty for investors because which of these additional subsidies are actionable has not yet been tested.

What options can be considered by countries that are covered by the ban on export subsidies? They may maintain incentives but eliminate the link to export performance, as long as these are not specific to certain firms and do not cause negative effects on another WTO member. Countries can also continue to exempt exports by companies in EPZs from indirect taxes and border taxes; they use duty drawbacks and duty exemption schemes; and they can still use subsidies linked to the export of services.

Obviously, the use of incentives has a cost attached to it. Incentives should not be used as isolated measures to attract export-oriented FDI, but rather as a part of a broader policy package. In countries in which incentives have played a role in efforts to promote inward FDI, they have typically complemented a range of other measures, such as those aimed at enhancing the level of skills, technology and infrastructure. With regards to EPZs, even in the absence of export subsidies, countries may still see an advantage in using such zones as islands of efficiency and as steps towards expanding such facilities more widely in the country as the economy develops.

The bottom line is: attracting export-oriented FDI has become more difficult and more risky.

Karl P. Sauvant Director, Division on Investment, Technology and Enterprise Development, UNCTAD

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