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granting state aid instead of granting state aid as part of socio-economic policies for improved performance of the national economies. In this manner, when attracting


FDI, countries risk increasing public spending and decrease public reve- nues, often by lowering tax rates for better attractiveness of foreign capi- tal. By competing with neighboring countries in building the image of the most favorable destination for FDI, countries can easily fall into the ‘race to the bottom’ trap.


Data evidence The data showthat countries in the Western Balkan region that have higher value of state aid also have higher inflows of FDI. However, it is also noteworthy that countries in the region with higher economic growth also have higher foreign investment compared with the coun- tries with lower economic growth. Furthermore, the data suggest


that, contrary to the expectations, the three countries with higher profit tax rates (Serbia, Slovenia and Croatia) have higher inflows of FDI, while countries with lower profit tax rates (North Macedonia, Bosnia and Herzegovina and Montenegro) have lower inflows. It is clear that the countries in


the region which are already EU member states are using broad measures to attract FDI compared to the neighboring non-EU countries which are using narrowmeasures, such as lower tax rates to attract investment. In other words, North Macedonia, Montenegro, Bosnia and Herzegovina and Serbia, are ‘paying a higher premium’, as it were, to attract investment through lower tax to gross domestic product, due to their inability to compete with criteria such as rule of law, corrup- tion control, trust in institutions — areas in which Croatia and Slovenia are more competitive. This leads these countries to the


practice of ‘beggar thy neighbor’, where countries try to outdo each other with more generous stimuli and incentives to attract investment, causing the ‘race to the bottom’.


Whatare investors attracted to? The empirical analysis shows that there is a positive correlation between FDI and the gross domestic product (GDP) growth, but also between FDI and the granted state aid within the Western Balkans. The


STATE AID IN THE WESTERNBALKAN COUNTRIES (ABSOLUTE VALUE, $M)


100 200 300 400 500 600


0


Bosnia and Herzegovina


Croatia North Macedonia


FDI IN THE WESTERN BALKANCOUNTRIES (ABSOLUTE VALUE, $BN)


2.5 3


1.5 2


0.5 1


0


Bosnia and Herzegovina


Croatia North Macedonia Source: The World Bank


causality test indicated that with a time lag of six periods, the growth trend of the GDP predicted the trend in FDI, while with a time lag of two periods the trend in the granted state aid predicts the trend in FDI. Hence, the empirical analysis for


countries in the region (North Macedonia, Serbia, Albania, Kosovo, Montenegro, Croatia, Slovenia, Bosnia and Herzegovina) for the 2008–2018 period shows that state aid has a positive effect on attracting FDI in the short-run; however, in the long-run, foreign companies are directing their capital to the coun- tries with high GDP growth rates. This can indirectly mean that


sustainable FDI are looking for stable and developed markets where rule of lawprevails and where there is institutional trust. Final recommendations for the


Western Balkans countries to attract FDI:


■ Strengthening and clearer criteria and procedures for granting state aid while discarding the strategy for attracting FDIs which relies mostly or only on granting state aid in a


December 2020/January 2021 www.fDiIntelligence.com


non-transparent manner; ■ Availability of data and informa- tion not only of the allocated state aid but also availability of cost and benefit analyzes for the granted state aid; ■ Forsaking narrowmeasures, such as lowprofit tax rates, as an argu- ment for attracting FDI to countries in the region; ■Recognition of the importance of the rule of law, trust in institutions, control of corruption, in attracting FDI, which are the primary motives of the foreign investors in choosing the destination for their investments.■


Based on the Public policy study: Attracting foreign investments in the Western Balkans and state aid: race-to-the- bottom or necessity, developed by Center for Economic Analyses (CEA), Full Report Available at (https://cea.org.mk/wp-content/ uploads/2020/07/0.-STUDIJA-FINAL-State- Aid-and-FDI-designed-ENG.pdf)


Article prepared by Vesna Garvanlieva Andonova, Senior Economist at the Center for Economic Analyses-CEA, Skopje, North Macedonia, co-author of the full analysis, with Kovachev, G., Velkovksa, I., Nikolov, M.


117 MontenegroSerbia Slovenia MontenegroSerbia Slovenia


STATE AIDIN THE WESTERNBALKAN COUNTRIES (% OF GDP)


1.2 1.4 1.6


1


0.2 0.4 0.6 0.8


0


Bosnia and Herzegovina


Croatia North Macedonia


FDI IN THE WESTERN BALKANCOUNTRIES (%OF GDP)


0 1 2 3 4 5 6 7


MontenegroSerbia Slovenia


Bosnia and Herzegovina


Croatia


North Macedonia


MontenegroSerbia


Slovenia


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