TAX AND INVESTMENT INCENTIVES IN THE DEVELOPING COUNTRIES: A CASE STUDY OF THE MANUFACTURING SECTOR OF MALAYSIA

This study is an attempt to analyze the impact and effectiveness of tax and investment incentives on investment decisions in developing countries. The Malaysian experience is used as a case study. The importance of this study resides in the fact that nearly all developing countries have offered some form of tax and investment incentives to attract both domestic and foreign investments. Analysis of the effectiveness of these measures have been inadequate, and the results obtained have been ambiguous. This study can serve as an explanatory step toward a greater use of empirical tools for planning and executing more optimal and less wasteful investment incentive programs in developing countries. This study can also contribute to meeting the increasing demands for practical models in the literature on both public finance and development. The first step in this study is the formulation of an economic model of investment decisions. The model consists of a number of equations that are specified according to economic theory and, also, according to the way economic agents are believed to behave in the investment decision process. The second step entails the estimation and collection of data for each variable in the equations. The collection of data was done from both primary and secondary sources available in the various agencies of the Government of Malaysia. The final step was to apply the data obtained in "running" the model using simulation techniques. By identifying changes in the parameters and the important decision and policy variables of the model, we are able to make some important conclusions. Subsequently, we are also able to examine, first, the short-term impact and effectiveness of public policy in this area and, second, to understand structural changes in the manufacturing sector of the Malaysian economy over a longer period of time. The results of our study indicate that because of the multiplicity of incentives offered based on a discretionary and "case-by-case" method of approval, a number of biases and misallocations have resulted. Essentially, the incentives have created firm, sector, regional, and trade biases. Our results also indicate that shorter-duration projects with high capital intensities have been encouraged. This runs counter to the overall objectives of attaining stable, equitable, and continuous growth of employment through industrialization.