Tax holidays and FDI inflows in ECOWAS countries: Application of PMG approach

Abstract

Developing countries use tax incentives in the hope of attracting foreign investors, but questions remain on the effects of these profit-based policies. This article reviews theoretical explanations of tax holidays, and empirically analysis of the impact of tax holidays on foreign direct investment in a selection of ECOWAS countries. The objective of this paper is to examine the short-term and long-term relationship between tax holidays and investment. In considering whether tax holidays facilitate or undermine development, we prepared a dataset for three members of the Economic Community of West African States: Nigeria, Ivory Coast and Ghana, for the period from 1990 until 2019. Using the autoregressive distributed lag model (ARDL), estimated by the PMG (Pooled Mean Group), it seems that tax holidays, regardless of their length, are not effective in triggering investment inflows. The econometric estimate enabled us to confirm that tax holidays are negatively correlated with gross fixed capital formation. For the first model, for which Foreign Direct Investment (FDI) represents the endogenous variable, tests conducted showed that tax holidays have a significant negative effect on Foreign Direct Investment (FDI) inflows to the three countries and a negative and statistically insignificant elasticity for the second model.  As a result of these achievements, supported by references in the literature, this type of incentive policy often concerns short-term investments whose profitability is cyclical in nature. It has even turned out that it could be harmful, which raises the question of why States continue to implement them. 

JEL Classification: F21, H25, E62, C32, H87

Paper type: Empirical research