Policy and Operational Implications

The region as a springboard. On average, 65 percent of firms (by number) first invested within the region, and 28 percent of these firms that first invested in a South Asian country went on to invest outside the region. The finding provides suggestive evidence of the region being used by some firms as an experiential investment platform to launch into global markets. The finding is consistent with the aggregate data on FDI values that shows much higher shares for extraregional investments.

The findings of the report provide important new, actionable implications for policy interventions and investments. These recommendations are organized around enhancing knowledge connectivity, boosting physical connectivity and digital connectivity, establishing regulatory and promotional policies for OFDI, implementing IFDI promotion strategies, incorporating emerging global business practices into policy making, and identifying national policy reforms that may have regional implications. These policy recommendations apply globally but may be applied regionally to address frictions in regional engagement. They are also valid in the post-COVID-19 world, with greater emphasis in some areas.

ENHANCING KNOWLEDGE CONNECTIVITY

Lack of knowledge is often underrated as a source of friction and high costs. This report argues that focusing on knowledge connectivity, separate from other forms of traditional connectivity, is essential, because policies that reduce information frictions differ substantially from policies that reduce traditional trade costs. These information frictions reflect the high costs of search, matching, and contracting across borders and the high costs or market failures of the provision of channels or technologies to alleviate these frictions. The common determinants of the different modes of international engagement imply that addressing informational barriers would support intraregional investment as well as trade.

Policy interventions that address information and coordination failures can be extremely useful for potential regional investors. Some firms may suffer from being late entrants (and are hence unknown to the wider business community) and their more recent maturation to global competitiveness. Other competitive regional firms that are already linked to global value chains may resist incurring the sunk costs and switching costs associated with new partnerships (a “status quo” bias). Structural features of the private sector, such as prevalence of family firms and diversified business groups, may create an atmosphere in which information is generally shared more cautiously and is restricted to a select group.

The survey suggests that useful network development interventions could include support for regional and international business associations, industry meetings,

match-making events, and investment missions abroad. Industry associations could also tap an industry veteran for guidance and mentoring. Network development is important, given that entrepreneurial activities are relatively new to significant segments of South Asian society. Cross-border women’s networks would help businesses led by women to develop cross-border activity and partnerships and to identify unique challenges to women’s participation and advancement and collectively develop solutions. They may be useful given evidence that suggests women are less likely to proactively network because of, among other things, different beliefs about appropriate networking norms. Additionally, individuals may be more at ease networking with others of the same gender.

Information-enhancing policy initiatives, such as web portals, could provide the initial foundation for dynamic activities to support information exchange and updating and network formation, including deepening industry-specific portals and guidance. The most important type of information support requested by the survey respondents related to market opportunities abroad. The next three equally valuable types of information requested were legal and management support, information on conducting business abroad, and experiences of previous investors. Knowledge intermediaries, such as consulting firms that provide high-quality information on overseas markets and regulations, would be useful in this context. Investors and potential investors identified business travel and tourism as important sources of awareness about regional business opportunities, making air connectivity vital for information exchange and relationship-building. Following COVID-19, regional air travel may become more important relative to global travel, at least in the near term, which will help regional networking and relationship building.

Information dissemination, knowledge building, and network development increase inclusivity and democratize participation in regional engagements by reducing the fixed entry costs associated with new markets and new partnerships. Greater ethnic and social networks of regional pioneers enhanced inclusivity in investing beyond the few largest and most efficient firms; similarly, information support and network-building interventions may further diffuse the opportunities for international engagement to a broader set of firms and entrepreneurs. Human capital development that includes greater exposure to entrepreneurial activities and risk management is also important to expand the use of the opportunities provided by information support.

BOOSTING PHYSICAL AND DIGITAL CONNECTIVITY

Investments in transportation infrastructure and trade facilitation (including interoperability of different national digitization initiatives) would help increase both trade and investment. Some valuable initiatives include progress on electronic data interchange and risk-based management systems at seaports and land borders, development of ports and inland waterways as well as transnational highways, and improvements in air connectivity. Many of these initiatives, while valid for global trade, will have a

significant impact on intraregional trade. Countries can also build on the positive steps that some of them have implemented in the context of the pandemic, such as accepting electronic copies of trade documentation, to increase automation of border management processes. Electronic national single windows that do exist in the region need to be interoperable between trading partners to fully realize efficiency gains and boost global and regional trade. Extending digital acceptance of sanitary and phytosanitary documents (given the high share of vegetables and food stuffs in intraregional trade) will have positive region-specific effects.

REGULATORY AND PROMOTIONAL POLICIES FOR OFDI

Outward investment is the new frontier of foreign investment policy for emerging market economies. Gradually relaxing regulatory controls on OFDI or being more open to approving applications is important from both a competitiveness standpoint and the need to be agile in crisis situations, even for smaller economies. Relaxation of policy controls could be pursued within an integrated macroeconomic management framework and appropriate reporting by firms. Policy may be finessed based on private sector response.

Active support for OFDI could be restricted to information support and network formation abroad, but without creating new institutions. The institutional structure governing OFDI varies across countries and is fragmented compared with IFDI. Currently, most approvals are processed by a department of the central bank, whereas promotional support is divided across various institutions. Information and network support for OFDI could be incorporated within trade promotion agencies and inward investment promotion agencies without the need to create new institutions. This approach conserves fiscal resources made even more scarce by the need to cope with the pandemic, but also allows an integrated approach to trade and inward and outward foreign investment promotion.

IMPLICATIONS FOR INWARD FOREIGN INVESTMENT POLICY AND PROMOTION

Given the role of sunk costs in investing, smaller countries may find it practical to target affiliates of global firms in larger South Asian countries (that have already incurred the high entry costs). The inference is that investors are more likely to invest in a second South Asian economy because the entry costs would be lower, reflecting learning through prior investments in a regional neighbor. Given the highlighted lack of awareness in the region of globally competitive South Asian firms, governments may also consider seeking out and courting these firms for IFDI. The gradual approach of some investors and the potential importance of small investments requires a sophisticated incentive structure that accommodates these new entrants.

Government initiatives for inward investment facilitation may be viewed as reducing entry costs, both directly and in accessing information about procedures. Thus, initiatives such as faster and one-stop clearances, simplification of administrative procedures, and greater use of information and communication technology would reduce entry costs and encourage FDI inflows. Countries could also build on digitization initiatives, such as those relating to investment approvals and facilitation, initiated during the pandemic.

Targeting high-quality and high-visibility foreign capital is important because firms that are industry leaders and engage for the long term can attract other investors; governments will also seek FDI that has the potential for technology diffusion and engagement with local firms. Global site selection firms, which act as knowledge brokers to large multinationals, could also be targeted to enhance country visibility. Also, countries that have not made systematic efforts to bring in FDI may need to signal their intention to attract and retain value chain leaders with sustained efforts, including courtship of investors by the highest levels of government.

INCORPORATING EMERGING BUSINESS PRACTICES INTO GOVERNMENT POLICY

Government policy will benefit from an understanding that the distribution of firms within an economy is skewed, with a cluster of large, high-performing firms driving national and cross-border activity. While promoting competition, firm entry, job creation, and support to small and medium enterprises, governments, at the same time, should not constrain the growth of high-performing firms. Such an approach would also benefit from corporate firms being mindful of their role in national development. Governments are also urged to be aware of evolving business strategies, such as “asset-light” approaches, which may provide benefits similar to those from FDI without involving the traditional flows of capital across borders. Such interactions, such as the recent growth in intellectual property licensing, should be encouraged and facilitated and may require, for example, additional access to finance for local partners.

THE IMPACT OF UNILATERAL NATIONAL REFORMS ON REGIONAL ENGAGEMENT

Policies that support greater internal integration, an improved investment climate, financial sector reform, entrepreneurship education, trade policy reform, and competition within a country are likely to support regional engagement. For example, the adoption of the unifying Goods and Services Tax by the Indian government in 2017 is likely to encourage South Asian exporters and investors, given that the various taxes in different states and additional charges to cross state lines previously in effect were viewed as multiple fixed entry costs.

COVID-19 AND IMPLICATIONS FOR POLICY PRIORITIZATION

The global pandemic and induced recession heighten the importance of reforms in general but also have implications for policy prioritization that will vary by country. It is possible that in the post-COVID-19 scenario, regional engagement will gain increasing importance. Regional investment may rise relative to global investment because of increasing trade costs and reduced knowledge connectivity arising from a relative reduction in air travel from distant partners. This effect may be reinforced by structural changes in value chains that encourage regionalization and reshoring or nearshoring by lead firms from advanced economies, thereby making South Asian regional value chains more important. Also, global lead firms seeking to diversify their production locations and not rely only on China can also create more opportunities for attracting global investment in South Asia. Another factor is the importance of services in the global recovery and the large services sector in the region. Moreover, regional trade can also help provide trade buoyancy and substitute for lackluster growth in world trade, especially when the region is dynamic and can look forward to many decades of catchup growth.

Three policy reforms are linked to issues that seem to be growing in importance in the post-COVID-19 world. First, regulatory reform of OFDI policies and knowledgeconnectivity interventions may be viewed as increasing the ability of national firms to gain global competitiveness and resilience. Second, timely and targeted inward investment promotion is critical to attracting global firms seeking new locations to diversify their supply chains. Third, because health security and other trade costs have increased during the pandemic, it has become important to accelerate trade facilitation reforms to keep overall trade costs in check, which is important for maintaining trade flows as well as investment.

Finally, to ameliorate the disruptions of COVID-19 and the inevitable future pandemics and disruptions, three factors could receive greater prioritization. First, investments in digital capabilities for both governments and firms need to be prioritized as digital platforms, and digitalization more broadly, gain a larger role in communications and the conduct of business. Second, several business sectors—including health care, pharmaceuticals, medical equipment, e-commerce, education (including information technology–enabled education), and information technology–enabled services, to name a few—are likely to increase their weight in national and global economies, and governments should ensure that they do not stifle their growth through undue regulatory barriers, including those related to trade and investment. Third, government resilience and crisis-response capabilities could receive greater weight in investment destination decisions. The latter will involve both immediate logistical responses to support business continuity and longer-term fiscal responsibility that facilitates government action under crisis situations.