Analyzing Digital Foreign Investments in CAREC Countries

Capacity building activities for workers can include training on data science and cyber security. Photo credit: Asian Development Bank.

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Enhancing internet connectivity, data security, and workers’ digital skills can reduce the digital gap in the CAREC region.

Introduction

In the digital era, corporate digital competitiveness is on the utmost agenda of firms and policymakers globally. Luring foreign direct investment (FDI) into the digital economy is a crucial tool. Literature suggests that FDI brings knowledge and technology in addition to capital, supporting firms and countries to improve their digital capabilities.

However, attracting FDI in the digital economy may require specific policies, regulations, and measures because digital firms have business models that vary from traditional brick-and-mortar businesses. Digital FDI is more vulnerable to policies, regulations, investment climate, and coordination failures.

A recent research on the Central Asia Regional Economic Cooperation (CAREC)[1] region reported a higher digital divide in digital FDI, digital security, regulations, and Internet quality, while it observed moderate digital divide in terms of access and infrastructure, digital payments, and Internet cost.[2] Thus, exploring underlying reasons for lower digital FDI would help firms and countries devise their investment strategy accordingly. The second phase of the CAREC Institute study aims to analyze the main components of digital FDI, primarily its enablers and inhibitors, and lists suggestions on how to improve the digital economy.

Context

Developing countries seek to attract digital FDI based on two grounds: i) lack of hefty capital investment in developing and updating of digital infrastructure and related sectors; and ii) lack of human capital, knowledge, and expertise to develop and adapt new technologies. Therefore, developing countries are more eager to attract investment in digital sectors amid its rising impact on employment, remittances, and growth.

Figure 1: Digital FDI Framework

Source: Elaborated from UNCTAD 2017, Stephenson 2020, Satyanand 2021 as cited in Report on CAREC Digital FDI Ecosystem in the CAREC Region by the CAREC Institute.

This study intends to evaluate FDI Ecosystem and explore factors that derive digital FDI in host countries. This study considers five core pillars as determinants of digital FDI, each having several sub-dimensions as follows:

  1. New Digital Activities – data privacy and security; consumer laws; investors’ rights; and firm-specific regulations, which influence digital FDI inflows
  2. Digital Adoption – support for digital adoption; tariffs and taxes; and independence of ICT regulations
  3. Digital Infrastructure – connectivity; availability of networks; access to infrastructure, finance and manpower; ease of receiving visas and licenses; and privatization and taxation
  4. Digital Restrictions – sectoral restrictions; restrictions on key foreign personnel/directors; other restrictions, foreign equity limits; and screening and approval of FDI
  5. Digital Promotion Tools – incentives and promotions for FDI, including information technology agreements

Conducive policies in these dimensions would encourage digital FDI in host countries.

Policy Design

Since the digital FDI ecosystem is multifaceted and requires an in-depth analysis of regulatory and non-regulatory factors that affect FDI location choices, the report integrates possible dimensions and highlights the gray areas requiring policy intervention. It considers all stakeholders, including firms, businesses, consumers, and government/legislators. This policy design is innovative based on cross-country comparison using a comparable indicator’s scale. It provides a baseline for future studies to evaluate annual marginal improvement in each indicator and their cross-country comparison. The framework can be expanded to the integrated regional FDI ecosystem or consider new indicators of digital FDI attractiveness/restiveness.

Policy Implementation

The proposed policies are primarily based on three aspects of the digital economy:

  • digital infrastructure (network operators, internet service providers);
  • digital firms (local and foreign); and
  • digital adoption (local businesses, public institutions, and governments).

The implications cover demand-side factors (for digital investment opportunities), supply-side factors (regulatory requirements and measures that governments can adopt to create digital-friendly investment climates), and integration of both to facilitate win-win investment strategies for all stakeholders.

Moreover, it identifies essential policies, measures, and regulations, such as tax administration (tax incentives/exemptions and deferral) or FDI restrictiveness (foreign equity restrictions, discriminatory screening or approval mechanisms, and operational restrictions), that governments of CAREC countries can adapt to attract investment in the digital economy and improve institutional and organizational aspects for financing to reduce the digital gap in the region.

Policy Outcomes

The proposed policy framework identifies the bottlenecks for inward digital FDI flows for CAREC countries. Policy outcomes can be found in a variety of different forms—tangible outputs and less-tangible outputs—for which the impacts are more difficult to measure.

An interim evaluation of the FDI ecosystem (five pillars) is recommended. Policies implemented for New Digital Activities, Digital Adoption, Digital Infrastructure, Digital FDI Restrictions, and Digital Promotion Tools may separately evaluate and compare their incremental improvement to evaluate the policy relevance. Apart from that, the suggested policy outcomes may be subject to other exogenous factors such as a conducive regulatory environment, stable political system, and continuation of policies. Since CAREC countries have different levels of economic development, social structure and geo-political situation, it is necessary to consider each country's specific situations and take adequate measures to align regional policies through integration.

Recommendation

The effectiveness of regional integration/investment agreements is based on i) conventional factors (firm location, local competitiveness, and investment motives) and ii) new drivers of digital FDI (digital regulation, data privacy and security, digital freedom, and digital adoption).

Aligning digital regulation and policies across countries is essential to provide a conducive environment for foreign technology firms. Many of these firms originate from developed countries and face higher barriers while making investment decisions in developing economies.

Also, as the CAREC region is distinct due to its unique socio-political structure, it requires a broad framework of North-South and South-South cooperation in socio-economic, political, and technical domains. Political and technical cooperation among governments and firms (particularly big technology companies) helps to align ICT regulations related to data localization/privacy policies, digital security, and intellectual property rights. Political and technological integration is imperious to offer platforms for settlement of investment disputes. This could reduce FDI sectoral restrictions, enforce ICT trade agreements, reduce tariffs and taxes, and facilitate implementation of a dual taxation system.

Social and cultural integration would help to reduce restrictions on top tech firms that reinforce further opportunities for the digital platform economy. Most CAREC countries have higher restrictions on social media and web-based social and e-commerce services, which can be reduced by offering regional digital broadcasting and commerce policies.

Moreover, a regional investment promotion agency could be established to identify business opportunities across CAREC countries and offer a one-window platform for mutual investment and business expansion in neighboring countries. Regional integration efforts of multi-development partners, such as the Asian Development Bank and CAREC Program, support member countries in capacity building and complement existing national-level policies.

Regional cooperation and integration are juridically established via international agreements and conventions. Under the CAREC Integrated Trade Agenda 2030, the development of e-commerce and digital transformation has long been the top priority. ADB and the CAREC Institute completed two studies that examined the infrastructure and regulatory frameworks related to the growth of e-commerce ecosystems. They also created knowledge-sharing modules on the Regional Improvement of Border Services and Digital SPS Certification (ADB 2022). Further, CAREC countries have digital startup support programs, initiatives, and established technonology and IT parks. Each member country has digital startups that lead the market in their respective sectors (finance, tourism, health, transport, and other services). Therefore, regional integration support with additional access to funds to scale up and enter the CAREC regional markets is another big opportunity to foster trade and economic growth.

Specific recommendations based on key findings of this study include

Improve international and national network connectivity. Launch 5G networks in major cities and industrial hubs, as well as in rural areas, particularly in Kazakhstan, Mongolia, and Uzbekistan.

Enhance data security. Develop Internet exchange points and domestic data centers to support reliable data transmissions and security. Update data security regulations to improve people and firms’ trust in digital transactions, fintech, and other business operations.

Improve digital skills. Conduct training on digital skills and capacity building of workers to provide an equipped labor force to local and foreign firms in Pakistan. In particular, these programs can focus on application development, back-end development, data science, and cyber security.

Minimize tariff and taxes. Reduce taxes on ICT equipment and devices to facilitate local infrastructure development and promote digital FDI. In the CAREC region, Pakistan has the highest tariff rate, followed by Azerbaijan.

Ease restrictions on lease/acquisition of land for business. Simplify the process for property leasing and registration to encourage multinational companies to establish and expand their digital business operations in the People’s Republic of China and Tajikistan.

Promote regional coordination and cooperation. Improve regional integration to ensure infrastructure bilateral and multilateral investment agreements on the mutual protection of investments in Turkmenistan. Initiatives could include infrastructure investment and technology transfer from digitally advanced countries in Azerbaijan.


[1] CAREC is composed of Afghanistan, Azerbaijan, People’s Republic of China, Georgia, Kazakhstan, Kyrgyz Republic, Mongolia, Pakistan, Tajikistan, Turkmenistan, and Uzbekistan.

[2] Digital CAREC Virtual Policy Dialogue: Analysis of the Regional Digital Gap. February 2022.

Resources

A. Razzaq et al. 2022. Digital CAREC: Analysis of the Regional Digital Gap (Phase 1). Xinjiang: CAREC Institute.

A. Razzaq et al. 2023. Report on CAREC Digital FDI Ecosystem in the CAREC Region. Xinjiang: CAREC Institute.

Asif Razzaq
Senior Research Specialist, CAREC Institute

Asif Razzaq holds a PhD in Economic System Analysis and Management Science from Dalian University of Technology. His core areas of interest include: digitalization, foreign direct investment, climate technology, and environmental/resources sustainability. His papers have been published in various journals.

Tofig Babayev
Director, Regional Innovative Technologies Academy

Tofig Babayev is also the Head of International Relations and Innovation Department at the Institute of Control Systems, Azerbaijan National Academy of Sciences and chief of eCommerce Working Group of EU4Digital project in Eastern Partnership countries. He was previously national coordinator of 12 ICT-related European Union-funded projects, including the Study on Harmonisation of Digital Markets (HDM) in the EaP (eTrade, eLogistics, Digital Transport Corridors.

Qaisar Abbas
Chief of Research Division, CAREC Institute

Dr. Qaisar Abbas holds a PhD in Human Resource Development from Nankai University, PRC and M.Sc. and M.Phil in Economics from Quaid-e-Azam University, Pakistan. His research works have been published in various national and international journals and conference presentations. He has also worked as Dean of the Faculty of Business Administration and Director at Comsats University.

Central Asia Regional Economic Cooperation Institute (CAREC)

The Central Asia Regional Economic Cooperation Institute (CAREC) is an intergovernmental organization promoting economic cooperation in Central Asia and along the ancient Silk Road through knowledge generation and sharing. CAREC is jointly shared, owned, and governed by 11 member countries: Afghanistan, Azerbaijan, People’s Republic of China, Georgia, Kazakhstan, Kyrgyz Republic, Mongolia, Pakistan, Tajikistan, Turkmenistan, and Uzbekistan.

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