No end to tax-break beauty contest

Date: 20/11/1997

Bruce Barnard
THE European Commission's bid to stamp out incentives purely aimed at luring jobs and companies from one member state to another appears doomed to fail.

Internal Market Commissioner Mario Monti and his competition counterpart Karel van Miert this week fired the opening salvo in their latest attempt to combat a problem which threatens to undermine the single market, by announcing a full review of the special tax regimes used by governments to entice foreign investors.

But they shied away from biting the bullet by proposing concrete action, promising only to produce a report on the subject by the middle of next year.

Their caution is understandable: there is simply too much at stake for anything but a softly softly approach to be accepted by member states.

Foreign direct investment has overtaken exports as the driving force of global trade and Europe is a big player. For all the talk about dynamic Asian tigers and the lure of the Pacific Rim, it remains the top target for American investment abroad.

The scramble for investment has never been so intense for another very simple reason: foreign companies are creating the jobs that local firms cannot, a powerful attraction for EU governments confronted by 18 million unemployed.

The Commission itself is partly responsible for the spread of artificially low tax incentives.

It approved a 10% tax regime in the Dublin docks, a tax haven in Trieste and special tax breaks in the Canary Islands.

A code of conduct on predatory tax breaks would not ease the problem of 'unfair' bidding because inward investment agencies have years of expertise in massaging incentive packages. As a result, hand-outs are often twice the EU limit.

The competition for inward investment is no longer just between countries, but is increasingly within countries.

The UK - a role model for Europe's onward investment agencies, accounting for 40% of inflows into the Union - has been rocked by bitter accusations by English regions that their Celtic rivals, Scotland and Wales, are using underhand tactics to lure foreign companies and poaching existing investments.

The dispute has been simmering since the Welsh Development Agency (WDA) clinched Europe's largest single inward investment, a 2.3-billion- ecu electronics plant. Its offer of 42,921 ecu for each of the 6,100 jobs that will be created by LG, the giant South Korean chaebol, set a new subsidy record. The WDA is now in the limelight again because it is poised to win the first European plant to be built by Accer, Taiwan's top computer-maker, which will create more than 1,000 jobs.

The Northern Development Company claims it was about to sign up Accer, but the WDA retorts that it is merely making sure Accer sets up in the UK and not in the Netherlands.

Winning the Accer plant will put the WDA in pole position in the race to capture a large slice of investments by countries such as Taiwan and Malaysia. Wales is popular with Japanese firms because it was the site of Sony's first European television manufacturing plant.

This internecine bidding war has spread to EU member states with socially and culturally distinct regions.

The Basque administration upset Madrid by weighting special tax breaks for outside investors. Belgium is split in two, with the Flanders region luring foreign investors with a powerful mix of a flexible, productive and multilingual workforce and tax breaks - attractions that are perceived to be in short supply in its Francophone rival Wallonia.

Against this backdrop, there is little the Commission can do.

Moreover, not all EU countries are involved in the inward investment bidding war and those on the sidelines are giving only lukewarm support to the Commission's campaign.

Italy makes hardly any overtures to foreign investors, while high-cost, inflexible Germany is a turn-off for foreign companies unless they get massive subsidies - dwarfing WDA hand-outs - to set up plants in the East. Bonn is more interested in stopping the flood of German capital to Luxembourg and averting prying Commission eyes from its investment aid programmes.

The EU's drive to standardise investment incentives touches a raw nerve in Ireland, where foreign investment has created the bulk of industrial jobs.

The official yardstick of the Industrial Development Agency (IDA) is not the value of the investments, but the number of jobs created.

With a population of just 3.5 million, Ireland captures nearly 15% of all inward investment into the Union and 40% of all spending by US electronics and computer firms.

Dublin has deftly sidestepped Commission complaints that its 10% tax rate for manufacturing discriminates against other sectors which face a 36% corporate tax rate. When the manufacturing tax expires in 2010, it will be replaced by a 12.5% levy for all sectors.

There is growing resentment that the EU is attempting to penalise countries which began courting foreign investment two decades ago to allow latecomers to catch up.

Dublin notes that nearly 80% of its foreign investment comes from the US, insisting this shows it is not stealing jobs from the rest of the Union.

Meanwhile, France, traditionally the loudest campaigner against tax competition and job-poaching, is now among the most assiduous courters of foreign investment. It ranked third in the industrialised world in 1996 with an inflow of 18 billion ecu.

France is growing increasingly popular with US firms, leading Europe in key high-tech sectors and pharmaceuticals, and is tipped to win Toyota's second European plant, breaking the UK's near monopoly in the Japanese auto sector.

But Toyota will not come cheap. The company is expected to pick up some 218 million ecu in hand-outs to build its 873-million-ecu plant in northern France, way above the maximum 87.3 million ecu pay-out it would get in the UK.

The deal, yet to be finalised, is already stirring controversy in France, with Renault chairman Louis Schweitzer insisting Toyota should not get any government help.

Belgium, still smarting over Renault's closure of a plant near Brussels and its simultaneous call for state aid to boost production at its Spanish facility, is sure to join the war of words.

Toyota's choice of France will, however, be driven more by market factors than by the availability of state aid. Industry observers say that building a factory in a market hostile to Japanese cars will pay dividends when a controversial EU agreement limiting direct exports expires at the end of 1999. Providing thousands of jobs will help ease Toyota into the last frontier market for Japanese cars.

In the end, foreign investment decisions are swayed by an array of factors, with a pro-business, flexible hire-and-fire, low-tax environment topping the list.

Subsidies tip the balance when all these conditions are satisfied, and as aid for big-ticket projects like auto plants and semiconductor facilities can run into hundreds of millions of ecu, companies are keen to play off one region against another to increase the savings.

No matter what the EU agrees at an official level, subsidies are bound to increase as governments face up to a potent new threat on their doorstep.

Central and eastern Europe offers foreign investors a rare combination of a cheap and educated workforce, an abundance of sweeteners including start-up grants and tax holidays, and convenient sites.

South Korean firms like Daewoo and Hyundai have beaten their American and EU rivals in establishing a beachhead in the region, extracting generous concessions from the host nations.

They will soon start exporting competitively-priced products to the West - and that will probably start yet another subsidy war.

Major feature. See Section 6.5 for main set of references on this subject.