This post is an excerpt from “Cost-Benefit Analysis of Investment Incentives” in Rethinking Investment Incentives. Trends and Policy Options

Cost-benefit analysis of investment incentives can help economic development and government leaders make better decisions when using incentives to attract investments. Assessing project benefits and strategic value, estimating fiscal impact, and modeling the economic impact of a proposed investment will direct resources to the most promising opportunities while limiting exposure to weak projects unlikely to generate net benefits.

Employing cost-benefit analysis and other data and analytical tools can also shift the focus of incentives use from a transaction orientation, in which completing a deal is the prime objective, to an economic development orientation, in which helping a community prosper is the primary goal. It can also help to rebalance the interaction with the potential investor and eliminate some of the risks posed by information asymmetry by emphasizing the need for the investment to meet some baseline criteria in order to be worthwhile for a government or community to participate in via incentives. These criteria can then become the foundation for post-award compliance assessment and program evaluation.

Cost-benefit analysis is not necessarily easy, but it does not have to be overly complicated either. It is worth some time and resources to develop internal analytical tools or procure existing models to allow a government to answer basic questions about the expected costs and benefits of a proposed incentives package relative to an investment. Government agencies, economic development agencies with similar fiscal structures, and regional or national organizations serving EDOs or investment promotion agencies (IPAs) can band together to share costs and expertise in order to maximize internal investment in these models.

Incentives are one tool in the business attraction toolbox, and business attraction is one element of a good economic development strategy. Thoughtful cost-benefit analysis and quality evaluations can help ensure that incentives programs play an appropriate role within economic development efforts and do not obscure their broader objectives. 

For more information, please see our previous articles:

Rethinking Investment Incentives

Beyond the deal: meeting goals with economic development incentives

How to collect data to determine if incentives are working

How to ensure incentive deals align with economic strategy

3 steps to effective cost-benefit analysis