8 minute read
Information Frictions and Enhancing Knowledge Connectivity
learning reduce fixed entry costs and lead to investment entry. Firms may learn from their own experience in different modes of engagement with lower start-up costs, from the pioneering activities of related firms in their business group or conglomerate, and from unrelated competitor firms. The results also indicate that knowledge connectivity is relatively more important than productivity improvements, especially for services firms. The finding on the importance of knowledge connectivity applies to trade as much as it does to investment, and thus offers an additional element with which to explain the shortfall of potential trade in South Asia.
Given the limited trust in the region, which is critical for value chains that rely a great deal on relational contracting, FDI (with its security of ownership) appears to be the best option for developing regional value chains in South Asia. Once investment occurs, the firm’s presence in neighboring countries should lead to deeper trust through greater knowledge, networks, and people-to-people interactions. These regional value chains offer an increasingly important alternative mechanism for upgrading. Upgrading is important in an environment in which the growth of global value chains has slowed; global and regional lead firms are seeking or facing pressures to diversify and locate at home or nearer home, a trend accelerated by the pandemic; trade protection measures are on the rise; and COVID-19 (coronavirus) has led to an increase in trade costs arising from the need to accommodate global health security concerns, disruptions in shipping, and reductions in passenger travel (which affects air freight).
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 and digital connectivity, addressing regulatory and promotional policies for outward FDI (OFDI), finessing inward FDI (IFDI) promotion strategies, incorporating emerging global business practices into both inward and outward investment policy making, identifying national policy reforms that may have regional implications, and spelling out the implications of the pandemic for policy prioritization and regional engagement. These policy recommendations have global relevance and are applied regionally to address frictions in regional engagement.
Establishing a prominent role for knowledge connectivity, separate from other forms of traditional connectivity, is important 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 in the provision of channels or technologies to alleviate these frictions. The common determinants in the different modes of international engagement imply that addressing information barriers would support intraregional investment and trade alike.
Policy interventions for potential regional investors are warranted to tackle information and coordination failures. For example, some firms may suffer from being late entrants (and hence are unknown to the wider business community), arising from more recent maturity 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 the prevalence of family firms and diversified business groups, may create an atmosphere in which information sharing is generally more circumscribed and restricted to a selected group.
Information dissemination and network development can democratize regional investment by reducing the fixed costs of entering new markets and new partnerships for a broader set of firms and entrepreneurs. Just as the inherent ethnic and social networks of some pioneers have enhanced the inclusivity of investing beyond the largest firms, knowledge connectivity–related interventions may further diffuse the opportunities of international engagement to a broader set of firms and entrepreneurs. The solutions for addressing information and networking frictions are not well established, but recent experience provides some guidance.
NETWORK DEVELOPMENT
Networks are important for a variety of reasons that include information provision, referrals, training, intermediate goods sourcing, finance, and other services. Business networks were deemed the single largest source of awareness about business opportunities abroad in the South Asia Regional Engagement and Value Chains Survey.
At first glance, network development may not seem to be a good target for policy interventions, with networks benefiting the more inherently connected and those most comfortable forming cross-border connections. Nonetheless, policy interventions have addressed the networking frictions that lead to suboptimal relationships. Studies have documented that business association formation at the national level has been found to have positive effects on firm performance through learning and partnering (Cai and Szeidl 2018; McKenzie and Woodruff 2014). However, managers may not initiate such associations to avoid “free rider” problems, such as high setup costs that fall unevenly onto the organizer, and because they underestimate the gains of network formation. Such issues may call for policy guidance that encourages such networking, albeit in a structured way designed to maximize participation and information exchange.
The survey results suggest that useful interventions could include support for regional and international business associations, industry meetings, matchmaking events, and travel missions abroad. Industry veterans could be a prime resource for guidance, oneon-one mentoring, and networking.
Cross-border women’s networks may address the very low share of women entrepreneurs and the even lower share of women-led outward investments. Network formation targeted at women can help reduce their specific fixed entry costs of engagement.
A business and policy platform that is open to the diaspora would help businesses led by women develop cross-border activity and partnerships, and would help identify unique challenges to women’s participation and advancement and collectively develop solutions. Diaspora women could enable access to capital and information, provide mentoring, and act as a bridge between their countries of origin and their current home markets. Such an intervention may be justified, given that some evidence 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 (Howell and Nanda 2019).
Multilateral institutions could play a convening role to build networks nationally and across borders, support business development (capital access and capabilities development), and support policy initiatives and solutions with technical assistance (for example, to overcome regulatory barriers to women’s participation).
INFORMATION SUPPORT
Low knowledge connectivity implies that firms have suboptimal knowledge about opportunities and potential partners abroad. This report endorses and deepens the arguments in favor of information-enhancing operations and technology-enabled platforms to promote trade and investment in developing countries. For example, established web portals could provide the foundation for dynamic activities to support information updating and exchange and network formation. Such portals could enable industry-specific curation with guidance from industry veterans and include all the relevant players in the pertinent value chain (such as logistics firms and consultancy firms). Portals and similar instruments need to be publicized to promote their wide use, and registration should be actively encouraged at home. At the same time, their existence should be publicized abroad (Ecorys 2014).
The most important type of OFDI-related information support requested by the survey respondents was about market opportunities abroad, followed by information on legal and management issues, conducting business abroad in South Asia, and experiences of previous investors (figure 5A.1 in the annex to this chapter). Information on regulations, procedures, and opening a representative office in South Asia and key commercial hubs was also deemed useful. This report attempts to fulfill the demand for knowledge of firm strategies that have worked. In this context, detailed expositions of pioneer firm experiences through case studies and interactive forums with entrepreneurs, focusing on solutions and outcomes of investments, would be valuable.
ENHANCING VISIBILITY AND COMPENSATING FOR RESTRICTED AVAILABILITY OF INFORMATION
Firms that are not listed on the stock exchange and do not make their annual reports public (for example, family firms and medium firms) have a harder time signaling their
value as potential partners. In addition to setting up corporate websites, they may need to use external mechanisms to signal their value, such as globally recognized certifications for management quality standards and sustainability practices (for example, from the International Organization for Standardization). The costs of these certifications have been prohibitive for some firms. The visibility issue for medium firms may be one reason that primarily large firms get involved in regional or global partnerships. These concerns are equally relevant for both IFDI and OFDI.
HARNESSING THE POSSIBILITIES OF INVESTMENT PROMOTION AGENCIES AND EMBASSIES
The survey responses relating to channels of information on business opportunities abroad indicated only a minor role for destination countries’ foreign investment promotion agencies and their embassies in the home country. This result could be interpreted to mean that such agencies will need appropriate focus and reorientation to possibly play a larger role. Further, embassies of home countries in investment destinations could provide information on markets, firms in relevant sectors, and steps toward opening a representative office.
AIR CONNECTIVITY FOR INFORMATION EXCHANGE AND RELATIONSHIP BUILDING
Investors and potential investors identified business travel and tourism as important sources of awareness about regional business opportunities. Thus, direct air connections would be a valuable source of connectivity. Direct air connections between India and Sri Lanka have played an important role in bilateral trade and investment. Nepal’s regional pioneer confirmed that tourist travel in Sri Lanka and interaction with Sri Lankans induced him to invest in Sri Lankan hotels, which has led to his undertaking much bigger investments in the hospitality industry in Nepal and elsewhere. Recent research using data on travel from Germany to the United States (Hovhannisyan 2019) has also shown that business travel by air is associated with increased innovation. Air connectivity is especially important for trade by landlocked economies because it offers possibilities for market and product diversification and for building new relationships, within South Asia and beyond the region. After COVID-19, regional air travel is likely to become more important relative to global travel, at least in the near term, which will help regional networking and relationship building.
Policy interventions may build on the lessons from India–Sri Lanka air travel liberalization, including adopting an incremental approach to the freeing up of air services (see Kathuria [2018], chapter 4, for details). The bilateral relationship continues to deepen with the upgrading of Jaffna airport in northern Sri Lanka and its links to southern Indian cities, which could help revive this postconflict area of Sri Lanka. An air corridor program that subsidizes air freight may not be financially viable in the long term, but a
