Blog

Foreign Direct Investment and innovation related to the fiscal burden

The average foreign direct investments in WB6 in 2019 are in the level of. 6.2% of GDP. What matters for FDI relates to their treatment as one of the factors that need to be integrated with internal elements and under specific conditions, where their synergy can improve the economic development of the Balkan countries.

However, in order to be competitive in the Balkan and European markets with the aim of attracting a considerable amount of investment, it is inevitable that the necessary reforms will be implemented, with the most important being: reducing corruption, improving the efficiency of the administration to reduce indirect costs. On the other hand, effective strategies should be devised for direct and personalized attraction of investments that are likely to occur, ie. create an attractive and family business environment for investment.

It is important to maintain a sound economic and financial model, as well as a competitive tax system, but with content and taking into account the fulfillment of budgetary objectives, before considering competitiveness.

But FDI depends not only on domestic policies but also on regional policies as a whole. Issues such as transport and energy interconnections, disputes between countries, arbitrary decisions on customs duties directly affect each other and where relevant, may not create incentives for foreign investors.

The FDI in the WB6 region remains limited, where the average stock of FDI per capita in the WB6 is less than half the value of FDI per capita in Eastern Europe (members of the EU), and only as much as 1/7 of the average FDI per capita in other EU countries. However, the region still has the potential to invest in WB6, attracting investment from EU countries as well as East Asian countries.

From the FDI structure it is clear that there is still a dominance of the services sector and the inflow from large European and Asian countries, which are part of the market programs and territories of large foreign companies.

The total FDI shows that only the Republic of Serbia has more than half of the total FDI stock in the region, while the rest is divided between five other countries, which roughly corresponds to the size of the market and their economies.

The service sector is dominated by the financial services sector, as well as the trade and manufacturing sectors, which account for about 1/5 of the FDI stock of the chemical, food and beverage industries, as well as products for the automotive industry. The region's efforts seem to need to focus on investments that require efficiency. Export-oriented FDI needs to foster competitiveness and efficiency, which in fact depend on foreign-domestic interaction with the acquisition of innovative knowledge and technology to become part of the future economy for the domestic market.

In support of the economic purpose to esase the inflow of FDI, tax incentives in respect of R&D in WB6 countries should become a day-to-day policy of widespread adoption. Although tax incentives are no different from incentives for economic development policies, they are far from the strategy for a research and development system.

Tax incentives must necessarily be specific to market developments and innovation appropriate to its development.

Taxable income deductible expenses are the most popular current R&D policy, followed by recognition for most of them, as recognized expenses. Other stimulus policies push the depreciation rate for R&D higher than usual.

The vast majority of tax incentives are based on corporate income tax, while some countries have (additional) incentives that apply to social security contributions and / or payroll tax. The individual tax would be broader, if individuals would prefer to finance their own research with their own resources, or with funding from private organizations and investors. The tax benefits that apply to innovation income (mainly patents) are increasing both in number and in the types of patents being registered.

In the last two years, eleven EU member states have offered a reduction in corporate income tax, for income derived from intellectual property, as well as a reduction in personal income tax in the case of the self-employed.

Currently, only a few WB6 countries still have tax incentives closely linked to specific R&D. Usually today the incentives are based on a combined model between the specific research expenditure scheme and the scheme based on their volume. Promoting FDI from competitive tax policies with low rates is more effective if FDIs are withdrawn, aimed at efficiency based on low production costs, which means low fiscal burden on labor. In this context, if Kosovo, Albania and North Macedonia keep their labor costs low compared to other WB6 countries, what needs to be taken into account is transparency and strong fiscal policy management.

In Tab.13 when we look at foreign net investment as percentage of GDP in 2019, it turns out that labor costs should be seen as closely related to per capita income or the well-being of employees in countries where investment is invested and the cost as a single element does not has a reflective relationship with FDI. From this comparison, although it should be seen as related to the fiscal burden as a whole, it can be concluded that beyond the low cost of labor and the fiscal burden it is necessary to have a balanced economy, low cost administration and transparent policy in a financial market. developed and linked to world markets. Expansion of foreign trade disparities of the Western Balkan countries during 2019, as well as in 2018, were financed by the increase in foreign capital inflows, mainly through FDI.

But according to WB studies and research reports from EBRD, and the IMF country reports, all of them suggests that the size of capital inflows is not related to an interdependent relationship with the lack of capital. Furthermore, FDI inflows were directed to investments in sectors such as financial services, real estate and construction, which do not generate strong performance for export and increase the competitiveness of the economy.

The first place for FDI stock according to GDP is held by Montenegro, followed by Albania. But Serbia remains the most important country for FDI volume in the Western Balkans, although it holds the third place for net FDI stock to GDP, with an approximate inflow as in 2018. Albania benefited from large volume of foreign investment directly in the region, mainly in energy projects and financial services, as a continuation of large projects started several years ago. In contrast, Bosnia and Herzegovina was weak, perhaps due to its increasingly segmented economic environment and lack of political stability in the country.

North Macedonia and Kosovo received more FDI than a year ago, despite growing political debate in those countries. Suppliers of the automotive and electronics industries make North Macedonia the only country in the region with the highest share of FDI in production. The analysis of FDI of WB6 countries identifies different relations of foreign direct investment, exports and imports in the GDPs of these countries, as well as the different composition of their GDPs. According to the analysis, the impact of FDI on the economic development of Bosnia and Herzegovina, North Macedonia and Montenegro in recent years has not been the main influencing factor.

On the contrary, in Albania and Serbia, FDI has had an impact on the GDP of respective countries, being reflected in their levels of economic growth. This attitude does not exclude the specific importance of foreign direct investment, but of course they are not the decisive factor in the development of these countries. If the period of about twenty years is analyzed, almost all the economies of the Western Balkans can be observed to be quite weak.

FDI inflows, while showing a positive trend, are still below their level to reach the ambitious target of doubling FDI by the end of the current decade. In addition to the traditional channel of privatization through mergers and acquisitions of local businesses for FDI inflows, investors are also increasingly turning to renewable energy investments. This interest is partly generated by investment incentives currently offered and the spread of specific economic zones in the region.

If we start from the logic of economically developed countries, as well as those that are moving at an accelerated pace of development, it can be noted that if the economy relies on a developed infrastructure, services and effective public administration, increasing productivity to target a relatively relative market. greater, then the competitiveness of the tax rates and fiscal burden wins only advantages granted or when these conditions exist.

These conditions are mostly achieved in the largest number of OECD member countries, which although have a high fiscal burden, they are much more effective in attracting foreign investment. A low tax burden on the other hand cannot compensate an unattractive economic environment for investors. Tax incentives can be used in a more oriented way and to be cost effective for the expenses that investors will incur, but also to meet the needs of the budget.

Taxes are only one of the elements that even in the conditions of a low rate offer can not compensate for the poor infrastructure, poor market access and other conditions on which an investor is based, such as p. sh. space to move freely in the financial market. If businesses (especially SMEs) do not have sufficient lending and low cost, then their growth will continue to be weak and of course investment and labor market will be affected.

Balkan governments have responded to these pressures of competition in various ways. Many countries have lowered profit tax rates, as the shortest and most easily monitored way to achieve investment objectives.

In fact, what they need to do is tax cooperation between them. Interaction and coordination of fiscal and economic policies should be conceived to be implemented within the borders of the Western Balkans, without returning to the policy of non-cooperation. Fiscal policy competition does not work within the Western Balkans.

But, if the states were part of the big market, they would have a real opportunity to compete with the policy of lowering tax rates. The competition between each other helps powerful states and companies to easily enter through the policy of disintegration of the Balkan states.

However, lowering tax rates tends to be costly for the budget, as the revenues that are deducted from the budget from the policy of lowering tax rates actually undermine fair competition in the country, but also turn into an added burden for certain segments and groups of taxpayers.

On the other hand, the reduction of tax rates turns into a culture for citizens to put pressure on governments to maintain such a policy permanently, without having an effect on the need to expand the base and distribute the burden equally.