This paper analyzes how investment incentives may or may not be used to foster private investment, particularly in developing countries. As practitioners and policymakers can attest, political economy exerts a powerful influence on incentives. Many incentives especially generous ones have persisted because of lobbying by special interests and politicians' need to curry favor. Yet little research has been done on how political economy affects incentive policy. Second, the paper sheds light on the role that political economy plays in the popularity of incentives and the related shortcomings. Incentives are sometimes used to dole out favors to investors, so investors who benefit from incentives resist attempts to eliminate them. This paper suggests a way to tackle such problems. Third, the paper compiles good practices on managing and administering incentives in developing countries, drawing on government and private sector experiences. Finally, the paper provides policymakers with a framework for analyzing the efficacy of investment incentives based on the sector and level of development involved, and suggests reforms for moving toward best practice.