EU battles to lure big spenders

Date: 01/05/1997

By Bruce Barnard

EUROPE faces a lethal subsidy and tax war as countries wage a tense battle to lure high-spending corporate investors from the United States, Japan and South Korea.

The fight is no longer limited to traditional employment black spots such as Wales, Scotland, Spain and Ireland chasing high-tech firms to replace the old 'smokestack' industries and find jobs for farmers leaving the land.

Switzerland is the latest country to parade its attractions to foreign corporations as it confronts a new phenomenon - unemployment which is scaling 5.6&percent; and rising.

New players have also emerged such as Berlin, which runs its campaign from offices on the site of the former Checkpoint Charlie, and the countries of central and eastern Europe, particularly the front runners for EU membership: Poland, Hungary and the Czech Republic.

The increasing ferocity of this race for investors is underlined by the fact that the number of inward investment agencies in Europe has more than doubled in five years to over 650.

Meanwhile, the investment pool has got bigger as the giant chaebols of South Korea race to catch up the Americans and Japanese, spending enormous sums on everything from shipyards in Ukraine to auto factories in Poland and semiconductor plants in Wales.

But as the competition increases, so does the level of subsidies, tax breaks, construction grants and other sweeteners which threaten to distort investment flows, particularly in the EU's border-free single market.

The danger of an investment subsidy war shot to the top of the agenda in Brussels in March in the wake of Renault's decision to shut a car plant in Vilvoorde, a few kilometres from the European Commission's down-town headquarters, with the loss of 3,100 jobs.

But the pressure has been building up for a long time.

The Commission itself had a run-in with the German Land of Saxony over planned hand-outs of 400 million ecu to car manufacturer Volkswagen. Just a few miles away, however, a Californian group was pocketing hundreds of millions of ecu to build a massive semiconductor plant.

The use of subsidies is deeply rooted in the Union and, apart from policing the guidelines, there is little the Commission can do. What is more, these same guidelines allowed it to approve the biggest ever hand-out - 217,000 ecu for every job created by a Volkswagen-Ford joint venture auto plant in Portugal in 1991.

The Commission is working on proposals to stop companies from moving from one country to another simply to maximise subsidies, but few observers think that it will succeed. Investment has become too mobile to be constrained by rules which any canny accountant can twist.

Moreover, the subsidy war is not just being waged between countries but also within them.

In the UK, Welsh, Scottish and English regions engaged in a bidding battle to play host to South Korean LG Group's 2.4-billion-ecu electronics complex after seeing off their continental European rivals.

South Wales emerged the victor, securing the plant and the promise of over 6,000 jobs, but in return it had to pledge to pay an estimated 282 million ecu in grants.

With the globalisation of industry, inward investment has become a buyer's market.

Bundesbank president Hans Tietmeyer has observed that the competition between countries is not over exports of goods and services, but investment, as German firms build factories abroad.

Siemens, the electronics and engineering giant, was able to choose from a list of 26 competing countries, ranging from the Czech Republic and Ireland to China and Malaysia, for the site of a 326-million-ecu memory chip plant in 1996.

Portugal, the eventual winner, admitted that financial incentives worth up to 40&percent; of the investment were the clinching factor.

While the Commission can keep the lid on conventional subsidies, it has little control over the spread of tax competition as countries seek new inducements to attract increasingly mobile investment flows. Some EU member states have developed elaborate tax schemes to attract foreign firms, the most successful being Ireland's 10&percent; corporate tax rate.

But tax breaks are not the preserve of the Union's poorer, peripheral countries: Belgium's 'coordination centres' tax regime has convinced scores of multinational corporations to locate their headquarters in the country.

Multinationals are also skilfully exploiting the varying tax regimes in the EU through transfer pricing, which moves their profits to the country where they attract the lowest tax rate.

As with subsidies, 'fiscal dumping' is not just a problem between EU countries but also within them.

In a recent celebrated case, the Spanish government mounted a legal challenge to a decision by three Basque regions to cut the standard corporate tax rate to attract foreign and domestic firms.

There is little the EU can do to stamp out 'tax poaching'.

A recent Franco-German plea for a code of conduct failed to get support from other member states. Now a task force set up by the Organisation for Economic Cooperation and Development is studying ways of curbing tax competition, but few people expect that its report, due to be completed by May 1998, will prompt speedy, meaningful initiatives.

Most companies claim fears that investment is being distorted by subsidies and tax breaks are highly exaggerated.

They insist that access to skilled workers, flexible working practices, proximity to markets, distribution and logistics, and research and development facilities are the key factors which determine the location of an investment.

The sweeteners are the icing on the cake.