Tax incentives foreign direct investment and economic growth :: The case of Indonesia

ARIANTO, Stephanus Tatok, Prof. Mayasuki Okawa

2009 | Tesis | S2 Magister Ekonomika Pembangunan

The role of Foreign Direct Investment (FDI) in many countries’ economy has been increasing over the last two decades. FDI has been a point of major concern, especially for developing economies hoping to utilize FDI in order to finance and develop their economies. Many countries are competing against each other to attract FDI. In reaction to the FDI phenomena, many attempts have been made to analyze FDI more deeply and in particular its determinants and its relationship with economic growth. Some studies have examined how FDI can be attracted by providing inducements to invest. Others have analyzed the impact of FDI on economic growth. However, some previous studies have not described or clarified the linkages between FDI, its determinants, and economic growth, simultaneously. They are mainly restricted to partial views of the impact and relationship of these variables. This research tries to fill the gap by focusing on both the role of tax incentives as one of FDI determinants in Indonesia and the impact of FDI on economic growth in the case of Indonesia. Furthermore, it also reveals the impact of FDI both on national level and on each of Indonesia’s industrial sectors. At the national level, the linkages between FDI and economic growth are examined using least squares method on time series data. This is the prelude to the next analysis, which examines the effect of FDI on economic growth in industrial sectors. A fairly intensive annual data of FDI and domestic investment are collected from the Indonesia Investment Coordinating Board and the BPS-Statistic Indonesia. The period coverage of the analysis is from 1980 to 2005. In national level analysis, my main finding is relatively similar with other studies. The OLS regression on the effect of FDI on economic growth reveals that FDI has positive impact upon economic growth. This relationship is also statistically significant; it can be shown by the t-statistic value of FDI. Using panel data from 21 industrial sectors in Indonesia, I find that FDI influences economic growth positively and has statistically significant impact in most industrial sectors. The majority of significant results come from manufacturing sectors. Many foreign firms established their enterprises in Indonesia’s manufacturing sectors because Indonesia has both abundant resources and potential market size. For Indonesia the potential benefits of FDI include domestic market growth, technology and managerial skills transfer, and human capital development, as well as increases in its total Gross Domestic Product (GDP). Regarding to the role of tax incentives in attracting FDI, many countries provide several policies on this issue. Even though they know that tax incentives can be costly, seemingly that tax incentives can be benefit to countries as well, in case of encouraging foreign investors for bringing in capital. On the other hand, one question arises in this issue is related to the implementation of tax incentives either it is an appropriate policy or not. To examine the linkages of tax policy and FDI, I investigated the cases of Special Economic Zones (SEZs) in Indonesia. In the SEZ that has the maximum possible tax-based incentives on offer; FDI does show a dramatically increase over time, but not in another area with fewer incentives. The number of foreign companies in this area is also escalating, year by year, but not as much as in the fully-tax incentives SEZs. However, in fact, there is no direct evidence for the relationship between tax incentives and FDI because the number of foreign firms located in outside of that zone is also expanding. This means that tax incentives become a minor determinant of FDI. This is definitely an encouraging sign for the government to retract some regulation initially used for providing tax incentives to attract investment, because even without tax incentives, the investment climate in Indonesia has grown better and shows a statistically significant impact on economic growth. Accordingly, withdrawing some tax incentives will benefit government finance in Indonesia because these tax incentives are costly. By reducing the cost of attracting FDI, government can enact policies to expand domestic investment for future growth.

Kata Kunci : Foreign direct investment,Tax incentives,Economic growth,Panel data