To get the most from foreign direct investment (FDI), developing countries should "abandon their incentives and regulations, and concentrate instead on strengthening their economic foundations", new research by global consulting firm McKinsey has shown.

Discussing what it called "the folly of incentives", McKinsey said governments made a mistake trying to entice FDI with costly tax breaks, import duty exemptions and land and power subsidies.

"Our evidence suggests that they are largely ineffective," it said. "In many cases, governments give away substantial sums for investments that would have been made anyway."

It said research showed developing countries should focus on building a strong infrastructure, including roads, power supplies and ports, if they wanted to attract export-oriented FDI.

A survey of 30 executives using outsourced labour in India ranked financial incentives after accessibility by air, the regulatory environment, the availability of trained workers and high-quality infrastructure, which was the most important factor.

However, there were often unintended consequences following incentivised foreign investment.

Costs could escalate and generous incentives could encourage overinvestment, as well as subsidise inefficient production.

Reg Rumney, a director of investment and empowerment consultancy Business Map, said the McKinsey findings were backed by local experience.

Infrastructure and a sound regulatory environment were considered more important than incentives.

"Investors need assurance that, if they invest, they will be safe from expropriation and will not face unfair competition."

Rumney said the "real incentives [for investment] are high economic growth, which we do not have enough of, market size and specific opportunities". 

In South Africa only limited financial incentives are offered to foreign investors.

The focus is rather on crowding infrastructure into industrial development zones, using the critical infrastructure fund to improve transport through investments of over R80 billion in the next decade.

Big investments do receive limited incentives in the form of tax breaks and small businesses can access grants.

However, these grants are increasingly targeted at research and development and technology oriented start-up companies.

But critics of the incentives policy said that if the country wanted to compete with other developing countries, it needed to match the more generous packages on offer elsewhere.

McKinsey argued that once FDI had been secured, it was a mistake for governments to restrict foreign operations to protect local companies.

The most popular restrictions were local content and joint venture requirements, but executives said they would have sourced locally produced goods in any case and that joint ventures often made economic sense because of local market knowledge.

Forcing local firms to compete with foreigners was essential to "diffuse the impact of foreign investment", because without this the entry of foreign firms had little effect on inefficient domestic firms or productivity, McKinsey said.

Citing studies from Mexico, Brazil, China and India, McKinsey said that in 13 cases FDI had unambiguously helped the economy by raising productivity and output, "thereby raising national income while lowering prices and improving quality".

It "nearly always generated positive spillovers for the rest of the economy", the report said.