GUATEMALA Investment Climate Assessment Evidence from the Manufacturing Sector December 2004 An Investment Climate Assessment Based on an Enterprise Survey Carried Out by the World Bank and FIAS with assistance from FUNDESA Acknowledgements This report was prepared by a team comprising Geeta Batra (Task Manager), Luke Haggarty, Bernice K. Van Bronkhorst and Francesca Recantini (Red Tape, Corruption and Crime); Eduardo Somensatto, Paulo Correa and Isabel Sanchez ( Infrastructure, Technology, Quality); Michael Goldberg (Finance); and José Barbero (Transport and Logistics). Jean Pascal Nganou, Juan Miguel Crivelli, Ana Margarita Fernandes, and Stefka Slavova provided excellent and invaluable research assistance. At various stages, the team received excellent guidance from Susan Goldmark, José Luis Guasch, Marianne Fay and Axel Peuker. The investment climate survey was designed by a DEC/PSD team composed of Pablo Fajnzylber, Ximena Clark and Geeta Batra, and was implemented by CID Gallup. The team wishes to thank the DEC colleagues and the members of CID Gallup for their support in survey design and implementation. The team would also like to thank all contributors to the recently completed Guatemala Country Economic Memorandum, which was an invaluable source of information. The report was prepared under the general supervision of Jane Armitage ­ Country Director for Central American countries, and Danny Leipziger ­ Director of the Finance and Infrastructure Department of the Latin America Region. The team also wish to thank FUNDESA for their overall strong support of the project as well as their assistance in survey implementation. Peer reviewers are Mary Hallward-Driemeier (DECRG), Theresa Bradley (CICIC) and Neeta G. Sirur (CMU). TABLE OF CONTENTS EXECUTIVE SUMMARY .......................................................................................................... vii CHAPTER ONE INVESTMENT CLIMATE MATTERS.............................................................1 A. Key Features of the Investment Climate..................................................................1 B. Overview of the Guatemalan Economy...................................................................5 C. The Survey--and What Its Findings Reveal .........................................................13 CHAPTER TWOLEGAL, REGULATORY AND INSTITUTIONAL FRAMEWORK ............16 A. Introduction................................................................................................................16 B. The Bermuda Triangle of a Dynamic Private Sector: Petty Corruption, Red Tape and Informality .........................................................................................................................17 C. Influencia : Grand Corruption, Influence and Policy Uncertainty.........................23 D. Costs of Crime and Violence.................................................................................25 CHAPTER THREE FINANCING FOR FIRMS: A WORLD OF FINANCIAL GROUPS, MAQUILAS, AND THIN COVERAGE ......................................................................................30 A. Introduction................................................................................................................30 CHAPTER FOUR INFRASTRUCTURE AND LOGISTICS ...................................................42 A. Introduction................................................................................................................42 B. Power ........................................................................................................................43 C. Transport, Ports, and Customs...................................................................................47 E. Telecommunications..............................................................................................55 CHAPTER FIVE INNOVATION, QUALITY AND SKILLS .....................................................60 A. Introduction................................................................................................................60 B. Technology ................................................................................................................60 C. Quality....................................................................................................................68 D. Skills ..........................................................................................................................70 E. Closing the Training Gap-Recommendations............................................................75 ANNEX A SAMPLING MYTHODOLOGY.............................................................................1 ANNEX C STANDARD INVESTMENT CLIMATE TABLES...................................................1 ii LIST OF BOXES Box 1.1 What is an Investment Climate Assessment? ..........................................................5 Box 1.2 The CAFTA Agreement ........................................................................................12 Box 5.1 A Low Skills Equilibrium......................................................................................74 Box 5.2 Chile: A radical change in the provision of vocational education and training.....77 LIST OF FIGURES Figure 1.1 Total Factor Productivity Growth and GDP Growth in Guatemala and Comparator Countries..................................................................................................................6 Figure 1.2 Average Annual Per Capita Growth in Guatemala and Comparator Countries, 1990-2002 ................................................................................................................7 Figure 1.3 Rates of Capital Growth...........................................................................................8 Figure 1.4 Exports and Imports as a Share of GDP in Guatemala and Comparator Countries, 2001..........................................................................................................................9 Figure 1.5 Rankings of Guatemala and Comparator Countries by the Extent of Irregular Payments for Import and Export Permits...............................................................11 Figure 1.6 Net Inflows of Foreign Investment as a Percent of GDP in Guatemala and Comparator Countries, 1990-2002.........................................................................11 Figure 1.7 Perceptions of the Investment Climate ..................................................................14 Figure 2.1 Bribery needed to get things done (percentage of sales), international Comparison............................................................................................................18 Figure 2.2 Informal payments as a percent of sales ................................................................18 Figure 2.3 International Comparison of Management Time Spent on Regulation .................19 Figure 2.4 Days of Inspection per year, International Comparisons.......................................19 Figure 2.5 Extent of Tax Evasion in Guatemala .....................................................................20 Figure 2.6 Informal Economy (%GNI)...................................................................................20 Figure 2.7 Policy & Regulatory uncertainty in relation to corruption ....................................21 Figure 2.8 Number of Procedures and Cost to Start a firm in Guatemala and Comparator Countries................................................................................................................22 Figure 2.9 Median Number of Days to Start a Business in Guatemala by Firm Size.............23 Figure 2.10 Grand Corruption Indicators..................................................................................24 Figure 2.11 Percent of firms who do NOT believe their property rights and contracts will be protected by courts.................................................................................................25 Figure 2.12 Crime in Guatemala and Comparator Countries....................................................26 Figure 2.13 Violent Deaths in Guatemala.............................................................27 Figure 3.1 Sources of Finance ­ Working Capital..................................................................31 Figure 3.2 Guatemala Banks could improve their efficiency..................................................36 Figure 3.3 Guatemala Banks have relatively low coverage....................................................37 Figure 3.4 International Comparison of 1% of Loans Requiring Collateral...........................38 Figure 4.1 Rankings of Guatemala and Comparator Countries by Overall Quality of Infrastructure..........................................................................................................42 iii Figure 4.2 Share of Firms in Guatemala and Comparator Countries Reporting That Infrastructure Is No Obstacle to Business Operations...........................................43 Figure 4.3 Electricity Coverage in Guatemala and Central America......................................44 Figure 4.4 Electricity Generating Capacity in Guatemala and Comparator Countries, 2001.45 Figure 4.5 Performance Measures for the Power Sector in Guatemala and Comparator Countries................................................................................................................45 Figure 4.6 Rankings of Guatemala and Comparator Countries by Quality of Ports and Roads......................................................................................................................48 Figure 4.7 Median Number of Days for Imports and Exports to Clear Ports and Customs in Guatemala and Comparator Countries...................................................................52 Figure 4.8 Delays in Ports and Customs Reported by Firms in Guatemala in Previous Year52 Figure 4.9 Obstacles to taking full advantage of CAFTA.......................................................52 Figure 4.10 Median Wait for Fixed Line Telephones Connection in Guatemala and Comparator Countries............................................................................................56 Figure 4.11 Mobile and Fixed Line Telephones Per 100 People in Guatemala and Central America..................................................................................................................57 Figure 5.1 R&D Expenditures per worker, 1995 ....................................................................61 Figure 5.2 Technology Indicators Guatemala and Comparators.............................................62 Figure 5.3 Evolution of the number of patent applications in Guatemala ..............................63 Figure 5.4 Product and Process Introduction ­ international comparisons.............................64 Figure 5.5 Technology Adoption, International Comparison .................................................65 Figure 5.6 Firms with computerized equipment .....................................................................65 Figure 5.7 The role of linkages in technology adoption, Central American Countries ..........66 Figure 5.8 ISO Certified Firms Guatemala and International Comparators ...........................68 Figure 5.9 Firms using quality standards other than ISO Guatemala and international comparisons ...........................................................................................................69 Figure 5.10 Percentage of firms providing formal training, Guatemala and international comparisons ...........................................................................................................71 Figure 5.11 Percentage of Guatemalan providing formal training, by firm size.......................71 Figure 5.12 Percent firms providing internal and external training in Guatemala by size........72 Figure 5.13 Sources of External Training in Guatemala...........................................................72 Figure 5.14 Reasons for providing little or no training by firm size.........................................73 LIST OF TABLES Table 1.1 Human Development Statistics, Guatemala ............................................................7 Table 1.2 Average Tariff Rates in Guatemala and Comparator Countries............................10 Table 3.1 Interest rates are the main constraint throughout Central America .......................32 Table 3.2 Foreign Ownership is more predominant among maquilas and large firms..........33 Table 3.3 Maquilas and Large firms export a larger share of sales .......................................33 Table 3.4 Costs are high, coverage is low compared to regional competitors.......................36 Table 3.5 Overdrafts cover some needs, but Firms need more reliable sources....................39 Table 3.6 Guatemalan firms have access to overdrafts, but 60% of the amount goes unused40 Table 4.1 Average Electricity price per kWh in Central America, June 2003 ......................47 Table 4.2 Road Performance in Guatemala and benchmarks................................................49 Table 4.3 Guatemala's port activity, 2002.............................................................................50 iv Table 4.4 Internet Users in Central America (Sep. 2003)......................................................58 Table 5.1 Public Expenditures registered as S&T in Guatemala's executed budget 61 Table 5.2 Firms' opinion about intellectual property protection, 2001 .................................66 Table 5.3 Indicators of Labor Force Qualifications...............................................................74 v GUATEMALA AT A GLANCE Topic Guatemala Nicaragua Honduras Brazil Ecuador 1995 2001 1995 2001 1995 2001 1995 2001 1995 2001 Macro Indicators GNI per capita, PPP (current international $)a 3,430 3,880 1,780 1,880 2,260 2,450 6,410 7,180 na na Population (Millions) a 10.0 11.7 4.4 5.2 5.6 6.6 159.5 172.4 11.5 12.9 Exports and Import of goods (% of GDP) 37.2 39.4 82.7 99.9 72.3 66.3 14.2 23.2 47.2 54.5 GDP growth (annual %) (1990-1995 vs 1996-2001)a 4.3 3.6 1.5 4.6 3.6 3.0 3.2 2.1 2.7 1.7 Gross capital formation (% of GDP) a 15.1 15.2 24.9 33.8 31.6 32.4 22.3 21.4 21.6 25.7 Foreign direct investment, (% of GDP) a 0.5 2.2 4.1 8.9 1.3 3.0 0.7 4.4 0.2 6.3 Average Years of Education b 3.1 4.4 4.1 4.6 6.5 Infrastructure Indicators Share of Firms that experienced a power cut c 74.1 88.7 92.1 64.1 71.1 Sales lost due to power outages (percent) c 2.3 3.9 3.0 1.3 2.5 Days to obtain an electricity connection c 62.3 31.4 32.5 25.6 41.2 Personal computers (per 1,000 people) a 3.0 12.8 8.9 10.8 17.3 50.1 13.1 23.3 Share of Firms that use email for business purposes c 66.4 38.5 50.2 92.0 83.2 Share of Firms that use a web site for business purposesc 29.2 16.6 21.8 73.1 55.4 Days to obtain a telephone connection c 47.7 118.4 175.0 18.2 129.7 Losses due to telephone interruption (% sales) c 0.2 0.7 0.3 0.3 1.1 Telephone mainlines (per 1,000 people) a 28.6 64.7 22.1 31.2 27.0 46.1 85.1 182.1 60.9 103.7 Roads, paved (% of total roads) a 26.0 34.5 10.0 11.0 20.4 20.4 8.9 5.5 12.7 18.9 Losses while in transport c 1.7 1.6 1.6 1.0 1.5 Losses due to transport interruptionsc 0.4 0.6 0.1 0.5 0.5 Days to Clear Customs - Importsc 9.4 5.2 5.1 13.8 17.1 Days to Clear Customs - Exports c 2.3 2.0 1.9 8.4 7.1 Governance Percentage of firms who don't trust the judicial systemc 47.7 41.0 38.6 22.5 56.4 Bribes on Government Contracts (% of Contract) c 3.7 4.3 4.6 12.2 9.0 Payments necessary "To get things done" (% Sales) c 3.7 1.7 2.5 na 2.6 Informal Economy (% GNI) a 51.5 45.2 49.6 39.8 34.4 Security Cost (as a percentage of total costs)c 5.5 2.9 3.6 1.9 5.2 Losses due to crime (% of Sales) 3.8 3.3 3.2 0.6 1.3 Share of firms experiencing a crime c 5.2 27.0 30.0 23.1 37.0 Days to register a business c 50.0 32.0 100.0 na na Number of Days spent dealing with Inspections c 9.9 21.3 12.1 13.7 15.5 Senior Management Time Spent dealing with Regulators(%) c 10.3 7.8 8.5 7.8 15.6 Innovation Share of Firms with a Foreign License c 19.6 9.1 15.2 7.5 23.4 Share of Firms with ISO Certification c 3.3 3.3 5.4 14.1 16.8 Share of Firms with Other Quality Certification c 11.9 20.3 17.0 9.1 21.0 Share of Firms with Computerized equipment c 23.5 11.1 21.4 na na Share of Firms Introducing Technological Innovations (Last two 80.9 67.9 67.3 na na years)c Share of Firms providing formal trainingc 55.0 37.4 49.3 67.1 68.9 Share of Firms using private training providersc 42.2 37.2 43.5 74.5 na Finance Interest Rate in USD for Large Firms c 10.2 13.3 11.0 na na Share of Firms with a Loan c 43.5 43.7 51.2 34.7 50.3 Share of Firms with Audited Financial Statements c 34.2 30.2 43.2 19.1 47.1 Percentage of Revenues Reported for tax purposes c 77.0 66.4 68.0 67.4 79.8 aWDI b"Closing the Gap in Education & Technology" World Bank 2002, c ICA dataset vi EXECUTIVE SUMMARY i Over the past decade Guatemala performed well on many macroeconomic indicators, implemented important reforms to increase trade integration, and achieved impressive social gains. This progress in the 1990s is heartening. Despite these improvements, Guatemala has fallen short of its growth potential. Economic growth on a per capita basis, was not sufficiently high to sharply reduce the country's high poverty rates, which is among the highest in the region. Which features of Guatemala's investment climate pose particular obstacles to economic growth and development? To answer that question, this investment climate assessment uses data from a 2003 survey of four hundred and fifty five manufacturing firms in Guatemala; a survey of two hundred and fifty enterprises in the rural and informal sector; and from a myriad publicly available sources. The hope is that the results will help identify the reforms most critical to private sector development and facilitate consensus on a more far-reaching agenda of reform. ii With the recently concluded Central American Free Trade Agreements (CAFTA) negotiations, Guatemala will have the opportunity to accelerate its pace of integration in the global economy in the next few years. Improving the investment climate in Guatemala will be critical for the country to take advantage of the opportunities provided by CAFTA, increase productivity and growth of the private sector, attract foreign investment, and to move to a path of sustainable growth. 1. This report is based on the results of a detailed evaluation of the investment climate in Guatemala using a unique database of manufacturing firms interviewed in 2003. The survey was conducted by the World Bank and a private firm, and covers a stratified sample of 455 firms in Guatemala. The survey was applied in the summer and fall of 2003 and therefore is reflective of the situation under the former administration. The firm level analysis presented in this report establishes four areas that we believe pose key constraints to investment and growth in Guatemala and proposes solutions. The four main areas are: i) the regulatory environment -- including policy and regulatory uncertainty, red tape, corruption and crime, ii) access to and costs of credit, (iii) Cost and quality of infrastructure services and logistics costs; and iv) low levels of investment and activity in innovation, technology absorption and human capital formation. These areas were determined by statistical analyses of the Investment Climate Survey database ­ both conducting simple comparisons of means, but also through more rigorous econometric techniques. A systematic econometric analysis was undertaken with the objective to estimate the impact of different investment-climate (IC) variables on firm productivity. For the purposes of the present report, productivity is considered to be that part of the production of goods (sales) which is not explained by the main production inputs (labor, intermediate materials and capital).1 The impact of key IC variables related to four areas ­ governance, infrastructure, innovation and technology, and finance ­ was tested in regressions, whose results are displayed in Table 1. Importantly, and as explained in Box 1, the regression results pertain to a pooled set of Investment Climate Survey data for firms in Nicaragua, Honduras and Guatemala. 1The productivity analysis employs several measures of productivity depending on the assumptions of the form and parameters of the production function and the estimation methodology utilized. Box 1 provides more detailed information on the six main productivity measures being used. vii 2. The results indicate that IC variables belonging to each of the four areas outlined in the previous paragraph are highly statistically significant and the direction of the effect is as expected. Higher levels of corruption and crime as well as higher business regulatory burdens have a negative impact upon productivity. Thus, the regulatory burden ­ as measured by the number of days spent on government inspections and regulation-related activities ­ has a sizeable negative impact on productivity. An extra day spent in such activities reduces productivity between 5.8 and 10.7 percent. Similarly, a lack of security ­ measured by the prevalence of crime ­ affects productivity negatively and significantly. For every new criminal attempt suffered, productivity is reduced between 1.8 and 3.2 percent. Infrastructure variables ­ such as power outages, losses during transportation, access to the Internet and number of days needed to clear customs ­ are also relevant for productivity across the three Central American countries. Among these variables, internet access has a particularly strong positive effect ­ having Internet access raises productivity between 11% and 15%. There is also evidence that labor training and innovation ­ as measured by external training provided for firm employees and the share of staff engaged in R&D ­ affect productivity in the expected manner and ­ in the case of labor training ­ with a strong positive impact. The effects of quality certification and other forms of innovation ­ such as the share of computer-controlled equipment ­ as well as of education of the labor force are positive but less pronounced. Among the quality, innovation and labor training variables, we find that external training of their workers raises firms' productivity between 8.9% and 11.7%. A one-percent increase in the fraction of firm staff engaged in research and development (R&D) activities increases productivity between 0.6% and 0.7%. Investing in ISO quality certification, and increasing computer-operated plant equipment also raise productivity but these effects are less potent and not robust to different definitions of productivity (see Box 1). Finally, financial and corporate governance variables also exhibit positive large and statistically significant effects on productivity. In fact, the highest positive effects on productivity are estimated to arise from having externally-audited financial statements and from listing on the stock exchange. Both raise productivity between 11.5% and 15-17%. 3. As part of the productivity analysis, individual country-by-country regressions were estimated to assess the impact of the investment climate variables mentioned in the previous paragraph on average productivity in each of the three Central American countries. These estimations rely on a relatively small sample of observations, covering the interviewed firms in each country. The results for Guatemala are presented in Table 2. These results make it possible to compare the impact of the IC variables on average productivity across the three countries, and to give an estimate of the impact of the IC variables on average productivity in each country. For example, as shown in Table 2, firms accrue gains and suffer losses due to IC variables related to Red Tape, Corruption and Crime. The net effect of the four variables is to decrease average productivity in Guatemala between 3.6 and 9.6 percent. In absolute terms, regardless of the sign of the effects, IC variables related to Red Tape, Corruption and Crime affect average Guatemalan productivity from 5.1 percent to 14.9 percent. Similarly, Guatemalan firms also incur losses and gain benefits from the infrastructure-related IC variables. Thus, power outages, time to clear customs for imports and the proportion of consignment cargo lost during transportation reduce average productivity; while access to the Internet raises it. The net effect of these four infrastructure variables on average Guatemalan productivity ranges from ­2.7 percent to ­5.7 percent. The aggregate effect of the infrastructure variables ­ regardless of the signs of the coefficients ­ is of the order of 6.5 percent to 10.6 percent. The IC variables related to Quality, viii Innovation and Labor Skills displayed in Table 2 exert only positive effects on average productivity. Their cumulative effect on average productivity in Guatemala ranges from 1.8 to 3.0 percent. The two finance and corporate-governance variables display effects of a similar magnitude ­ from 1.8 to 3.6 percent positive increase in average productivity. Finally, the additional control variables (firm age and share of imported firm inputs) raise average productivity between 2 and 4.3 percent. In absolute terms, the effects of all these investment climate variables on average productivity is of the order of 18.7 to 36.3 percent. Therefore, roughly between one-fifth and one-third of average firm productivity in Guatemala can be attributed to investment-climate conditions. 4. In order to gauge the economic impact of quantitative IC variables on productivity, the data collected through the Investment Climate Surveys of Honduras, Nicaragua and Guatemala were utilized in a systematic econometric analysis, which pooled together all firm observations from these three countries, generating a combined sample of 1,300 observations2. This is justified on grounds that if we were to conduct productivity analysis for each country separately, we would not be able to obtain meaningful statistical results and make inferences for individual industries due to the small sample size.3 Table 1 presents the results of this regression analysis conducted to estimate the impact of different investment-climate (IC) variables on six measures of productivity (see Box 1 for more on the six measures). Each row of the table shows the estimated regression coefficients of each of the explanatory IC variables, using productivity measures as the dependent variables and controlling for all the other explanatory variables listed in the table, as well as for industry, country and year dummies. In addition, the estimated regressions also control for age of the firm and the share of its imported inputs. The table shows estimates for both restricted and unrestricted OLS regressions, depending on whether the input coefficients of the production function are allowed to vary by industry (unrestricted), or assumed the same for all industries (restricted).4 For purposes of reading the table, the IC variables are divided into several categories: related to Red Tape, Corruption and Crime; Infrastructure; Quality, Innovation and Labor Skills; and Finance. We will refer to and use the econometric results of Table 1 throughout the report. As an additional check, country-by-country estimations of the same regression specifications given in Table 1 were performed. The results of these will only be reported to complement the main results of the pooled (regional) regressions and to give an indication of how the IC variables affect average productivity in Guatemala. They are shown in Table 2. 2The sample covers 461 firms in Guatemala, 370 ­ in Honduras, and 469 ­ in Nicaragua. 3For example, in such a country-by-country analysis we would end up with an industry having only 5 observations in Honduras. Pooling all the three countries together gives at least 33 observations in each industry, thus allowing for more reliable statistical results. 4For more on the restricted and unrestricted estimation and the functional forms of the production function see Box 1. ix Table 1: Elasticity and Semi-elasticity of Each Explanatory Variable, after Controlling for the Other Investment-Climate and Firm-Control Variables, Pooled Estimations: Nicaragua, Honduras and Guatemala Restricted OLS Estimation Unrestricted OLS Estimation Solow Res. 1 step Solow Res. 1 step Cobb-Douglas Translog Cobb-Douglas Translog Red Tape, Corruption and Crime Number of days spent in inspection-and -0.097** -0.099** -0.058 -0.101** -0.107** -0.068* regulation-related work [0.043] [0.043] [0.041] [0.043] [0.043] [0.041] Fraction of sales undeclared to the tax authority -0.601** -0.612** -0.416* -0.676** -0.767*** -0.593** for tax purposes [0.263] [0.260] [0.243] [0.267] [0.255] [0.250] Payments to deal with bureaucracy 0.031** 0.033*** 0.015 0.031** 0.030** 0.013 "faster", percent of sales [0.012] [0.012] [0.012] [0.012] [0.012] [0.012] Number of criminal attempts suffered -0.029** -0.031*** -0.018 -0.032*** -0.029** -0.018 [0.012] [0.012] [0.011] [0.012] [0.011] [0.012] Infrastructure Average duration of power outages (log) -0.095* -0.085* -0.072 -0.088* -0.075 -0.024 [0.052] [0.050] [0.047] [0.052] [0.050] [0.049] Days to clear customs for imports (log) -0.097** -0.106** -0.125*** -0.105*** -0.105** -0.119*** [0.041] [0.042] [0.039] [0.041] [0.043] [0.041] Shipment losses (fraction of sales lost) -1.860** -2.119** -1.229 -1.948** -2.530*** -2.063** [0.850] [0.867] [0.811] [0.852] [0.871] [0.825] Dummy for Internet access 0.147*** 0.144*** 0.119*** 0.139*** 0.128*** 0.111*** [0.038] [0.041] [0.039] [0.038] [0.039] [0.037] Quality, Innovation and Labor Skills Fraction of computer-controlled 0.119 0.13 0.132* 0.117 0.131 0.084 machinery [0.082] [0.082] [0.079] [0.083] [0.085] [0.086] Fraction of total staff engaged in R&D 0.594** 0.667** 0.581** 0.589** 0.607** 0.580** [0.287] [0.294] [0.270] [0.285] [0.280] [0.268] Dummy for ISO quality certification 0.154 0.167 0.024 0.142 0.176* 0.105 [0.102 [0.103] [0.093] [0.101] [0.105] [0.103] Fraction of total staff with 0.036 0.048 0.03 0.033 0.054 0.056 secondary education or higher [0.058] [0.059] [0.059] [0.057] [0.060] [0.062] Dummy for training provided beyond 0.117*** 0.105*** 0.089*** 0.116*** 0.110*** 0.098*** "on-the-job" training [0.036] [0.036] [0.033] [0.036] [0.036] [0.034] Finance and Corporate Governance Dummy for publicly listed firm 0.150*** 0.140*** 0.115*** 0.146*** 0.132*** 0.117*** [0.039] [0.042] [0.038] [0.039] [0.040] [0.038] Dummy for external audit of financial 0.168*** 0.159*** 0.121*** 0.170*** 0.150*** 0.116*** statements [0.042] [0.042] [0.038] [0.042] [0.042] [0.038] Other Control Variables Age of the firm (log) 0.050** 0.049** 0.046** 0.051*** 0.043** 0.032* [0.020] [0.020] [0.018] [0.20] [0.019] [0.018] Share of imported inputs (fraction) 0.113** 0.101** 0.096** 0.110** 0.074 0.101** [0.049] [0.051] [0.047] [0.049 [0.051] [0.048] R-Squared 0.20 0.20 0.36 0.26 0.51 0.94 Notes: (1) Robust standard errors shown in parentheses under coefficient estimates. (2) Significance is given by robust standard errors. * significant at 10%; ** significant at 5%; *** significant at 1%. (3) The regressions include a constant, industry dummies, country dummies and year dummies. x xi Table 2 %Average (log) Productivity Gains and Losses in Guatemala due to Investment Climate (IC) Restricted OLS Estimation Unrestricted OLS Estimation 1 Step 1 Step Solow Res. Cobb Douglas Translog Solow Res. Cobb Douglas Translog Red Tape, Corruption and Crime Number of days spent in Inspection and -5.89** -5.61** -1.97 -6.09** -6.23** -2.74* Regulation related work Fraction of sales undeclared to the tax -3.31** -3.16** -1.73* -3.71** -4.04*** -2.18** authority for tax purposes Payments to deal with bureaucracy"faster", 2.83** 2.79*** 0.78 2.8** 2.62** 0.78 percent of sales Number of criminal attempts suffered -2.13** -2.14*** -0.65 -2.32*** -2.0** -0.9 Cummulative Contribution -8.5 -8.12 -3.57 -9.32 -9.65 -5.04 Cummulative Absolute Contribution 14.16 13.7 5.15 14.92 14.89 6.6 Infrastructure Average duration of power outages (log) -1.65* -1.40* -0.67 -1.53* -1.25 -0.27 Days to clear customs for imports (log) -5.39** -5.5** -4.42*** -5.82*** -5.58** -4.4*** -0.74** -0.79** -0.4 -0.77** -0.96*** -0.55** Shipment Losses (fraction of Sales) 2.61*** 2.39*** 2.74*** 2.46*** 2.16*** 1.32*** Dummyfor Internet Access Cummulative Contribution -5.17 -5.3 -2.75 -5.66 -5.63 -3.9 Cummulative Absolute Contribution 10.39 10.08 8.23 10.58 9.95 6.54 Quality, Innovation and Labor Skills 0.23 0.23* 0.22 0.24 0.11 Fraction of computer-controlled machinery 0.22 Fraction of total staff engaged in R&D 0.7** 0.74** 0.08** 0.69** 0.69** 0.46** Dummyfor ISO qualitycertification 0.13 0.13 0.03 0.12 0.14* 0.06 Fraction of total staff with secondary education 0.33 0.42 0.14 0.31 0.49 0.35 or higher Dummyfor Training provided beyond "on the 1.57*** 1.33*** 1.35*** 1.56*** 1.42*** 0.88*** job" training Cummulative Contribution 2.95 2.85 1.83 2.9 2.98 1.86 Finance and Corporate Governance 2.1*** 1.84*** 2.27*** 2.04*** 1.76*** 1.1*** Dummyfor publicly listed firm Dummyfor external audit of Financial 1.52*** 1.35*** 1.31*** 1.54*** 1.3*** 0.7*** statements Cummulative Contribution 3.62 3.19 3.58 3.58 3.06 1.8 Others Control Variables Age of the firm (log) 3.35** 3.07** 2.66** 3.42*** 2.73** 1.42* Share of Imported inputs (fraction) 0.94** 0.8** 1.1** 0.92** 0.59 0.57** Cummulative Contribution 4.29 3.87 3.76 4.34 3.32 1.99 Grand Total Contribution -3.35 -3.51 2.85 -4.16 -5.83 -3.32 Grand Total Absolute Contribution 35.41 33.69 22.53 36.32 34.2 18.79 Box 1. Productivity Analysis: A Summary of the Methodology The methodology notes in this Box follow the analysis of Escribano and Guasch (2004), "Econometric Methodology for Investment Climate Assessments (ICA) and Productivity Using Firm-Level Data: The Case of Guatemala, Honduras and Nicaragua". The Annex to the Report includes a detailed explanation of the methodology. The present box provides a summary of the main methodological issues, and the key steps and procedures undertaken. xii There is no standard, universally accepted measure of productivity and total factor productivity (TFP). The analysis utilized in this report seeks to measure the impact of different investment climate (IC) variables on productivity, controlling for other firm characteristics. Inevitably, any empirical evaluation of the impact of the IC variables will be contingent upon the way productivity is measured. The only way to obtain interesting and valid for policy analysis results is to obtain general and robust conclusions, i.e. conclusions which do not depend on the particular measure of productivity used in the regressions. For this purpose, the methodology of the productivity analysis relies on six different measures of productivity, which we briefly summarize here. Escribano and Guasch (2004) argue that ­ for the purposes of the analysis in their paper ­ TFP includes any variables affecting the production process which are different from the main inputs of production ­ labor (L),capital (K) and intermediate inputs (M). In particular, TFP is assumed to capture IC variables, degree of capacity utilization (CU) and any other firm-specific characteristics (control variables C), such as the quality of labor, innovation, research and development (R&D), technological changes, competition, etc. Prior to measuring the impact of each of these on productivity however, we face a challenging identification problem due to common causes simultaneously affecting both the inputs of production (K, L and M) and the TFP, i.e. the IC , CU and C variables mentioned above. Generally, productivity and the inputs of production (K, L and M) will be correlated, thereby causing endogeneity problems in the estimation of the production function Y=F(L,M,K)TFP. To overcome these endogeneity problems, Escribano and Guasch (2004) propose a structural estimation approach which allows for several sources of simultaneity associated with the IC variables. They conduct estimations based on the rates of growth of the production function and on its levels, and conclude that due to the characteristics of our dataset ­ based on the Investment Climate Surveys (ICS) of Guatemala, Honduras and Nicaragua, which is essentially a cross-section of relevant data ­ it is more appropriate to use the level of TFP and the other variables which enter the production function rather than their rates of growth. To reduce the simultaneity bias associated with the fact that the IC variables may be correlated with the factor inputs, we use averages of the ICit variables taken at the level of region-industry cells. The coefficients on the investment climate variables and the firm-specific characteristics are usually estimated at the same level of aggregation, i.e. one coefficient for the whole sample. However, the production input coefficient are estimated at two different levels of aggregation. We allow for restricted estimation which assumes that the input coefficients on the factor inputs are the same for all industries; and for unrestricted estimation, which allows the input coefficients to vary across different industries. Furthermore, two functional forms of the production function are considered ­ Cobb-Douglas and Translog under the restricted and unrestricted estimations. This generates four different measures of productivity. Each of these is estimated under a single-step procedure ­ i.e. both input coefficients and coefficients on the investment climate, capacity utilization and firm-specific variables are estimated in a single equation. In addition, a two-step procedure is also used, whereby in the first stage the so-called Solow (1957) residuals are estimated as the residuals of the production function, and then ­ assuming that these residuals measure productivity ­ are used as the dependent variable in a second-stage regression, testing for the impact of the IC, CU and C variables. We call this method the Solow Residual method. It is performed both under the restricted and unrestricted estimations, using average cost shares of the production inputs as the input elasticities. Under the restricted estimations, the average cost shares are calculated as the average share of each input (K, L and M) across the whole sample of manufacturing firms over the last two years; under the unrestricted estimation the cost shares are calculated as the average industry cost share of each input across all firms from the three countries belonging to the same industry over the last two years (i.e. a separate cost share of each of the three factor inputs (K, L and M) is calculated for each of the nine industries covered by the ICS). This generates two more measures of productivity. We therefore work with six different measures of productivity. All these are obtained using the OLS estimator (see Annex I for Random Effects estimations as well). All the different regression specifications estimated include industry dummies, country dummies and a year dummy to control for differences in firm productivity due to industry-specific, country-specific and time-specific effects. For a more detailed technical discussion of the main estimation techniques carried out to estimate productivity and the impact of the IC variables and other control variables please see Annex I. Governance iii Guatemalan firms report high levels of petty corruption. In a region which struggles with the issues of corruption and unpredictable regulation, Guatemala ranks worst among its peers on both accounts. Guatemala ranks worse on measures of corruption than its neighbors-- with more than eighty percent of the firms reporting it as a major or very severe obstacle. xiii Symptoms of this problem include high levels of petty corruption, along with significant amounts of red tape that creates an ideal environment for informality to flourish. Guatemalan firms report spending 3.7 percent of their sales on "informal payments" to get things done which is higher than Honduras, Nicaragua, Pakistan, China or Bangladesh. The story is similar in public procurement with Guatemalan firms reporting that a payment of over 4 percent of the value of the contract is necessary in order to win public contracts. iv ...and high levels of Red Tape. Starting a business is relatively difficult in Guatemala compared with other countries. Executives surveyed for Global Competitiveness Report 2002/03, asked to rate the difficulty of starting a new business in their country, ranked Guatemala 62nd out of the 80 countries, worse than the rankings for all other Central American countries. Managers of Guatemalan firms spend a substantial percentage of time dealing with regulation and this is significantly correlated with higher levels of bribery in the sample. On average managers estimate that they spend about 11 percent of their time dealing with governmental regulation in Guatemala, significantly higher than the average we have found across a sample of countries in Latin America and East Asia. The data also show a significant correlation between the level of management time spent on regulation and levels of overall bribes paid by the firm. This suggests that, rather than greasing the wheels, informal payments are correlated with more management time spent dealing with regulation rather than less. One signal of the frustration with, and the cost of, this red tape to firms is the fact that, in order to lower their exposure to the bureaucracy, 83 percent of new registrants used intermediaries despite the fact that they pay a relatively high cost for these services. 5. The levels of red tape and corruption faced by formal firms, particularly small and medium firms, together with the obvious tax advantages, explain the powerful disincentive to formalization and firm growth that leads half of the economy to be informal. Reported market shares of informal firms across the sample are in the range of 20 percent. Independent estimates of the informal economy place Guatemala at 50 percent of GDP, about the same as Honduras and well above Nicaragua (45 percent), Dominican Republic (36 percent) and Costa Rica (26 percent)5 In addition, they estimate that firms in their sectors declare between 70 and 87 percent of their sales to tax authorities. The econometric results support the notion that firms which under-report a larger share of their income to the tax authorities are less productive. Informal firms do not pay taxes. And those firms which pay taxes, tend to under-report their taxable revenues. The regional regression results (Table 1) indicate that the proportion of annual firm sales that are not declared to the tax authorities exerts a significant negative effect on firm productivity. A one-percent increase in the fraction of undeclared sales (out of total annual sales) is estimated to reduce firms' productivity between 0.42 and 0.77 percent. As shown in Table 2, the average fraction of undeclared sales to the tax authorities in Guatemala decreases average productivity between 1.7 percent and 4 percent. v Regulatory impediments are especially felt by formal and foreign and export- oriented firms. Foreign firms in the manufacturing sector in Guatemala voice strong concerns about regulations as a barrier to their operations. These firms find regulation to be more constraining than their domestic counterparts. In particular, these firms face a heavy regulatory burden in terms of customs, labor and foreign exchange regulations. Similarly, exporting firms 5 Figures from Schneider (2002) xiv are more constrained by regulations and the bureaucracy as compared with non-exporting firms. Firms in the formal sector, in general, are more constrained by the investment climate along most dimensions, with the exception of financing, as compared with firms in the informal sector. vi Grand corruption creates greater regulatory uncertainty, which in turn stifles long term investment and innovation. The most recent Global Competitiveness Report ranks Guatemala the worst in the region along several indicators of "grand" corruption including diversion of public funds, irregular payments in government decision making and irregular payments in judicial decisions. "Grand" corruption is more insidious as it tends to affect the perception of stability in economic regulation and policy. More than seventy percent of Guatemalan firms (and over 65 percent of small and medium firms) rate this uncertainty as a serious constraint to the growth of their enterprise, much higher than those reported by firms in Honduras (45 percent). vii The uncertainty is not reduced by the judicial system which is also seen as corrupt and not impartial. The private sector regards the judicial system as open to corruption and hence it does not consider the courts as an effective tool to combat governmental policy changes. In fact 39 percent of firms do not believe that the courts will uphold their contracts and property rights in a dispute. This distrust of the courts is also evident in that only 2 percent of all firms with a payment dispute took it to court. Crime and violence appear to be rising in Guatemala and are a significant tax on firm operations. 84 percent of all Guatemalan firms consider crime and violence at least a major obstacle of business development. The material losses associated with the occurrence of violent acts and its prevention, both in families and businesses, are close to 6.8 percent of GNP and is the highest in the region. As a result, security costs, as a percent of total costs to a firm, is just under 5.5 percent for Guatemalan firms, higher than those reported by firms in Honduras (3.5 percent) and Nicaragua (3 percent). On average losses from crime are 2.7 percent of sales. Fewer than 6 percent of crimes reported are solved by the police, much less enforced by the courts, in sharp contrast to Nicaragua where roughly 30 percent of these crimes are solved by the police. The econometric analysis shows that criminal attempts affect firms' productivity negatively and significantly. With every new criminal attempt, firms' productivity is reduced between 1.8 percent and 3.2 percent. The regional analysis also points to crime mostly reducing productivity in old and large firms. The country-by-country analysis shows that the average number of criminal attempts suffered has a larger (in absolute terms) effect on average productivity in Guatemala than in Honduras and Nicaragua. The size of the productivity loses of the average number of criminal attempts on average Guatemalan (log) productivity is between ­0.6 percent and ­2.3 percent (Table 1-2). Figure 1: Percentages of sales lost due to crime and security expenses, all firms -- Central American countries xv Guatemala 1.94 4.58 6.5 Honduras 0.87 3.64 4.5 Nicaragua 0.88 2.63 3.5 Brazil 0.6 1.5 2.1 0 1 2 3 4 5 6 7 Losses due to crime (% of sales) Security Costs (as % of sales) Source: Investment Climate Surveys Finance viii Financial markets have low penetration. The financial sector is not responsive to the private sector's investment and operating needs. At 17.8 percent, Guatemala has one of the lowest ratios of private sector credit to GDP in the region. Guatemalan banks finance only 12 percent of private sector working capital needs, compared to 24 percent in Honduras and Ecuador, and 27 percent in Peru and Brazil. Compared to other countries in the region, Guatemalan firms must rely far more on retained earnings and less on bank loans to satisfy working capital requirements. ix Credit is costly for Small and Medium Enterprises (SMEs). Credit in Guatemala is expensive by Central American standards. The margin between the average lending interest rate and average deposit rate is 11.28 percent, making Guatemala a leader in Central America (the average margin is 9.8%). A large margin is considered to be a sign of uncompetitive and inefficient financial markets and act as a disincentive to firms to expand or invest research and development. In Guatemala, about 66 percent of the firms that could use external financing consider interest rates for working capital and investment credit so high that they do not apply for loans. Micro and small firms are likely to pay more than six percentage points higher than the rates offered to large firms. The higher costs of credit my be explained by a banking sector dominated by a few groups, and the lack of information on clients given the low coverage by the private credit bureau, the lack of annual percentage rates for loans, and the small percentage of firms with audited financial statements. x Access to finance is limited due to regulatory and judicial systems and bank infrastructure. Even for firms willing to pay a relatively high rate of interest, credit is often not available. Access to credit is limited by the lack of movable asset registries, contract enforcement problems, the high concentration of bank branches and other financial infrastructure in metropolitan Guatemala City. The lack of a well-functioning system for security interests in Guatemala results in higher interest rates and reduced access to credit--only 38 percent of loans are guaranteed by a security interest. Legal enforcement of collateral repossession is poor, and cadastres are deficient, which limits the creation of new titles establishing bankable property rights. There are also serious flaws in the legal and institutional framework for the pledging of xvi movable assets to secure credit. Another contributing factor is the difficulties of enforcing contracts in Guatemala. It takes four times as long to enforce a contract in Guatemala compared to the Latin American average (1460 days vs. 363 days). Procedural complexity has been cited as cause of enforcement difficulties (a rating of 90 for Guatemala, compared to a regional average of 70). Improved financial disclosure ­ through producing externally-audited financial statements and through listing requirements on stock markets ­ raises firm productivity. Two investment-climate-related variables gauge the impact of better information disclosure by firms on their productivity. The regional regression analysis indicates that being publicly-listed and having externally audited financial statements have a highly significant and positive impact on firm productivity. The size of the impact is large. By having their financial statements audited by an external auditor ­ which presumably improves financial disclosure and alleviates information asymmetries in the financial market ­ firms are estimated to increase their productivity between 11.6% and 17%. Similarly, by going public and listing shares on the stock exchange firms can raise their productivity between 11.5% and 15%. These findings are consistent with analyses and recommendations pointing to insufficient information disclosure in the financial market as causing inefficiencies. The individual country regressions for Guatemala in Table 2 indicate that the positive effect of the probability that a Guatemalan firm becomes publicly listed on average productivity ranges from 1.1 to 2.3 percent. The positive effect of the probability that a Guatemalan firm uses external auditors for its financial accounts raises average productivity between 0.7 and 1.5 percent. Infrastructure xi Reforms in infrastructure have resulted in improved access and quality, but important concerns remain in electricity, transport and telecommunications. Following the 1996 Peace Accords, Guatemala embarked on a major program of infrastructure reform involving the restructuring and privatization of the electricity and telecommunications sectors. Following these reforms, the quality of services appears to be relatively good in Guatemala. Business executives surveyed for Global Competitiveness Report 2002/03 were asked to rate the infrastructure quality in their country on a scale of 1 ("poorly developed and inefficient") to 7 ("among the best in the world"). Of the 80 developing and industrial countries in the sample, Guatemala ranked 63rd on the overall quality of infrastructure, higher than the other countries in the region, with the exception of El Salvador. In the last few years, budgetary restriction have led to decline in investment in infrastructure, and its quality has visibly deteriorated. xii Electricity continues to be a major or severe obstacle for about 27 percent of the formal enterprises and a third of the informal enterprises. Reforms in the electricity sector have clearly resulted in increased coverage and quality. Only 21 percent of firms in the sample stated they rely on generators, and firms reported a median number of power outages of 4. Median losses due to power outages are very low and just about 1 percent of sales. Yet, these reforms have come at prices that are still among the highest in the region in the range of 25-50 percent. In addition, social tariffs have created distortions which continue to exist. xvii The econometric analysis shows that power outages have a limited, but significant negative effect on firm productivity. The econometric analysis of firms' productivity reveals that a one-percent increase in the average duration of power outages (measured in hours per day) results in 0.02% to 0.1% decline in productivity, depending on the particular productivity measure used. The variable is significant in three of the six estimated regressions, albeit at the 10% level of significance only. The pooled regional estimates also indicate that the negative impact of outages on productivity generally affects old firms more than young ones. The country-by-country comparison establishes that among the three countries the negative impact of the average duration of power outages on average (log) productivity is more pronounced in Honduras and Nicaragua than in Guatemala. This finding is in line with the results of the previous paragraph, whereby Honduras and Nicaragua display the largest losses due to electric power outages. As shown in Table 1-2, the average duration of (log) power outages creates (log) average productivity losses between 0.3% and 1.6% in Guatemalan firms. Figure 2: Percentage of sales lost due to power outages, all firms -- international comparison Brazil 1.5 Peru 1.9 China 2.0 Guatemala 2.3 Ecuador 2.6 Bangladesh 3.0 Honduras 3.0 Nicaragua 3.9 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 Percentage of Sales Lost Source: Investment Climate Surveys Significant progress has been achieved through telecommunications liberalization, but Guatemala still has one of the lowest rates of internet access in Central and Latin America, and rural telecommunications are still under developed. Only 1.4 percent of the population has access to internet, a figure comparable to El Salvador but very low when compared to Mexico (4.7 %) and Costa Rica (9.3%). One of the reasons for the low internet access is the high cost of local calls. According to the results of the survey , while 67 percent of the firms use email on a regular basis with their clients, less than a third of the firms have a website. Clearly the rural population is under-served--only 5,000 rural communities have access to telephones while 45,000 have no access, and access is difficult. In addition it takes an average of 116 days (median of 30 days) for micro enterprises operating in rural areas to get a phone connection. The pooled regressions in Table 1-1 show that firms with Internet access have from 11% to 15% higher productivity than firms without Internet access. This effect is particularly strong for old firms and is highly significant statistically in all estimated specifications. The country-by-country analysis shown in Table 1-2 indicates that the probability that a Guatemalan firm has Internet access creates (log) productivity gains between 1.3 percent and 2.7 percent. xiii Poor port infrastructure and administration add costs and reduce trade. According to the Global Competitiveness report, of all the modes of transport, Guatemala ranked the worst on quality of ports--71st among the 80 countries, 68th in air transport and 50th for roads. However losses in transit in all modes of transport are not trivial and on average, are approximately 4 percent of the total consignment value, and a percentage point higher if accompanied by interruptions in transit. Although it has increased overtime, Guatemala's port activity is lower xviii than expected given the size of the Guatemalan economy. Absence of a strong regulatory body (maritime authority), limited private sector participation, corruption, unreliability, losses from theft and interruptions, weak human resource management have contributed to the under- utilization of capacity of ports. The poor performance of Guatemala's ports have contributed to Guatemala's poor share of trade in GDP (50 percent) which is the lowest in Central America, and well below the region's 2001 average of 80 percent. Almost 50 percent of the firms cited that land and maritime transport costs would be major obstacles to realizing the full benefits of CAFTA, suggesting the need for quick improvements. xiv Despite major customs reforms, enterprises are concerned about delays, particularly in the context of CAFTA. Five years ago, the performance of the Guatemalan customs was among the worst in Central-America, according to a 1997 INCAE study, and more recently, in the present survey, as a result of improvements, only 26 percent of the firms surveyed found customs regulations to be a major or severe constraint to operations. The median time required to clear ports and customs in Guatemala is five days for imports, and 1 day for exports, comparable to other countries in the region and China. However, the longest delays are about 20 days for imports and 5 days for exports. These long delays increase inventory carrying costs for firms. As a result, firms that import more than 10 percent of their inputs hold inventory stocks equivalent to 20 days of production, which is the longest import delay, while those that import less than 10 percent maintain an inventory equivalent to 11 days. With increased use of imported inputs with CAFTA, additional demands will be placed on the existing customs and transport infrastructure. More than 60 percent of the firms in the survey felt that customs (regulations and clearance time) would be a major obstacle to taking full advantage of CAFTA, necessitating the need for further improvements in the system. The econometric analysis of firm productivity in Central America indicates that the number of days firms wait for their imports to clear customs generally has a highly significant negative impact upon productivity. The estimated coefficients in Table 1 suggest that a one-percent increase in the number of days to clear customs will decrease productivity by approximately 0.1 percent. Days to clear customs are found to affect mainly young and small firms across the three Central American economies. The individual estimations for Guatemala in Table 2 establish that the average number of days to clear customs reduces average productivity between 4.4 and 5.8 percent. Quality, Innovation and Skills xv Guatemala has low levels of quality awareness and technology adoption which makes breaking into international markets harder. Only 3 percent of the firms in the sample were ISO certified and while quality standards other than ISO (including product- and industry- specific standards) are slightly more common than ISO certification in Guatemala, even here only 12 percent of Guatemalan firms hold a quality standard certificate, the lowest among comparator countries. The relatively small number of certified firms in Guatemala indicates that local entrepreneurs are either not aware of the potential returns of quality certification or consider it too expensive. In the area of technology, the overall amount spent on direct technology accounted for less than 2 percent of sales of firms. With the exception of technology xix transfer, Guatemala lags behind the region in R&D expenditures and patent applications. Acquisition of machinery is the main source of technology for enterprises. The main problems identified by firms as impediments to the purchase of the new technology were government regulation and taxation, lack of funding for acquisition of new technology, lack of qualified personnel to use new technology, weak protection of intellectual property rights, and lack of opportunity to interact with similar companies. The latter is particularly limiting to small firms (52%). Most of the financing for the purchase of new technology were internal, and small firms had little means to access bank financing. The econometric analysis of the impact of investment-climate variables on productivity indicates that in the regional regressions a dummy variable for having ISO certification is associated with higher levels of productivity, however the result is significant in only one out of six alternative definitions of productivity (see Table 1). The effect is as follows: obtaining an ISO certification is estimated to raise firm productivity from 2.4 to 17.6 percent. This result is particularly relevant for large firms. However, the result is merely suggestive due to the lack of significance in five out of six estimations. In the individual results for Guatemala (Table 2), we find that the probability of a Guatemalan firm having an ISO certification increases average productivity between 0.03 and 0.14 percent. Technology adoption ­ measured by the share of employees dedicated to R&D and the share of firm machinery which is computer-controlled ­ affects firm productivity positively and generally significantly. Two investment-climate variables measure technology adoption and investment in R&D by firms ­ the proportion of computer-controlled machinery (out of total machinery) which the firm uses, and the fraction of total firm employees engaged in R&D. In line with the discussion in the previous paragraph, the latter variable is statistically significant in all six regression specification, the former ­ only in one (see Table 1). Both display a positive impact upon firm productivity. The magnitudes of the impact are as follows: increasing the fraction of total staff engaged in R&D activities by 1% is estimated to raise firm productivity between 0.6% and 0.7%. Increasing the fraction of computer-controlled production equipment (out of total equipment) by 1% is expected to raise firm productivity by 0.1%, but this result is not robust to different definitions of productivity. Further results on the impact of the investment-climate variables on average productivity in Guatemala ­ shown in Table 2 ­ reveal that the average fraction of employees engaged in R&D raises average productivity between 0.1 percent and 0.7 percent. The average fraction of computer-controlled firm equipment increases average productivity by 0.2 percent. xvi The skills base and the ability of labor to absorb technology are still low. There have been improvements in education, but gaps remain. Guatemala has improved access to education, essential in creating a workforce with the skills and knowledge needed for a healthy investment climate. But other elements for a strong human capital base are missing. According to the Global Competitiveness Report Guatemala ranks 74th out of 80 countries in availability of scientists and engineers. Illiteracy rates are among the highest in the region, possibly reflecting poor education results in the 1970s and 1980s; gross primary, secondary and tertiary completion rates are among the lowest in the region and concerns about the quality of education remain. And xx despite the payoffs from training, Guatemalan firms under-invest in their employees, with the problem most acute among micro and small enterprises--78 percent of micro enterprises do not provide any formal training to their workers. Consistent with the use of mature technologies in production, Guatemalan firms seems to count excessively on learning by doing and informal training. xvii Training Supply is weak and fragmented. The existing supply of training by public institutions is fragmented and inadequate. The primary provider of vocational and private sector training in Guatemala is Instituto Técnico de Capacitación y Productividad (INTECAP). Although 80 percent of firms surveyed pay the 1% payroll levy that supports INTECAP, fewer than a third of them actually use INTECAP for training. There is a common view that the training provided, especially by INTECAP, and other public training providers, is not appropriate to the needs of the private sector, with a third of the enterprises finding the training irrelevant. In addition, institutional factors act to weaken the training market. The poor educational levels of workers and the 1% private sector levy that is managed by INTECAP act as a disincentive for further investments in training. In the context of the difficult economic conditions employers are reluctant to undertake further investments in training. While use of the levy for pre-employment training can be socially justified, as employers are the eventual users of the skills that are developed through these programs. However, the manner in which the levy is managed and allocated reduces the demand for training. In turn this has weakened the diversity and the responsiveness of the supply of training. The econometric analysis on firm productivity indicates that training provided by firms to their employees beyond training "on the job" affects firm productivity positively and the results are highly significant at the 1% level in all six estimations. The estimated impact is quite large ­ if a firm engages in a training program for its workers other than on-the-job training, its productivity is estimated to increase between 8.9 and 11.7 percent. The result is especially relevant for small firms. A second variable assesses the impact of education of firm employees on productivity ­ the variable utilized in the regressions is the percentage of firm staff (out of total staff) with secondary education or higher. This variable exhibits a positive effect on productivity, but its impact is not significant in any of the six estimated regression specifications for the three countries (see Table 1). The estimated size of the coefficients suggests that raising the fraction of staff (out of the total number of firm employees) with secondary or higher education by 1 percent will result in an increase in productivity between 0.03 and 0.06 percent. Therefore, the analysis suggests that training is more important than secondary education ­ a finding which is supported by other recent studies6. The analysis of the impact of the investment- climate variables on average productivity in Guatemala, shown in Table 2, indicates that the probability that a Guatemalan firm provides training to its employees, beyond "on-the-job training", raises average productivity between 0.9 and 1.6 percent. The average fraction of total firm staff with secondary or higher level of education raises average productivity between 0.1 and 0.5 percent. xviii Finally, a consistent theme running throughout this report is that micro and small and medium enterprises, are disproportionately affected by deficiencies in the investment 6See Coulombe, Serge, Jean-François Tremblay and Sylvie Marchand, (2004), "Literacy Scores, Human Capital and Growth Across Fourteen OECD Countries", Published by Statistics Canada. xxi climate. The smaller the firm, the more of its resources it devotes to bribes and to dealing with government visits and inspections--and the less likely it is to have access to formal finance. In addition, a high proportion of micro and small firms have less access to technology and training, as well as infrastructure such as telecommunications. These problems can pose great barriers to market entry and growth for small firms. All interventions in the context of service delivery should involve a diagnostic or an audit of these firms' capabilities and constraints, and how best these firms could benefit from linkages with larger foreign owned or domestic firms. Recommendations xix One of the reasons for the lackluster performance of the Guatemalan economy in the last few years has been a deteriorating business climate. Increasing levels of violence and crime, corruption and a confrontational attitude of the Government towards the private sector in the last four years discouraged many enterprise activities. The investment climate has also been affected by the failure to continue with the reform process begun in the nineties. While individually the costs of different dimensions of the investment climate may not seem too arduous, cumulatively they can be non-trivial. In fact, preliminary estimates for Guatemala indicate that the costs of corruption, crime, poor regulation and losses through disruptions in infrastructure provision, cumulatively add up to approximately 15 percent of sales, much higher than that in neighboring Honduras (12.9 percent) and Nicaragua (13.3 percent). In addition to the negative impact of these costs on the performance of existing enterprises, this could set a wrong tone with investors, especially with small-and-medium-sized investors with limited resources and export-oriented firms that could locate to competitor nations with more conducive investment climates. As the country moves forward, the findings of the investment climate survey should help identify the reforms most critical to private sector development and facilitate consensus on a more far- reaching agenda of reform. Issues for Action xx Dealing with these constraints is no simple matter. But their size and prevalence underscore the urgency of reform. While detailed recommendations have been provided in each chapter, the table below presents a summary of measures that could address the concerns of the firms. The new Government in Guatemala has already begun to address some of these issues. The key areas of policy challenges are: · Improved Governance and reducing corruption · Reducing the high cost of the regulatory burden · Combating Crime · Increased access to finance · Improving access to infrastructure particularly in the rural areas · Improving port and customs efficiency to take full advantage of CAFTA · Instituting and improving relevant skills and technology programs. xxii xxiii Table I.1 Recommendations to Improve the Investment Climate in Guatemala Deficiency by aspect of the investment Recommended measures Phasing2 climate Governance · The current approach to promote transparency in expenditures ST and government procurement, a civil service reform, the probity · Unnecessary regulations that cause delays and law, and greater enforcement of the laws should now be increase firms' costs complemented by the design of a comprehensive plan that will MT/LT · Harassment of the private sector through address many other areas of action informal payments · Continue efforts to modernize the judicial system ST · Inefficient functioning of courts · Review operating regulations and streamline by eliminating MT · Increased crime unnecessary ones · In the area of crime and violence, it will be essential to provide the police, the office of the prosecutor and the judicial system with adequate resources to increase the number of officers, and the ability to investigate and prosecute criminals. There is considerable room also for improving the coordination of criminal investigations between the Office of the Prosecutor and the PNC. Efforts should focus on the municipal level Finance: Access to and Cost of Borrowing · Increase access to finance in rural firms by speeding up the ST approval by Congress of the draft laws on the Cadastre and · Poor access to credit (especially long-term Property Registration, and on Secured Transactions, along with credit) and high cost of borrowing, an acceleration of the cadastre program and the modernization of particularly for small- and medium-size the Registry. enterprises and firms in rural areas · Greater transparency. The micro-finance market could benefit MT from a more transparent system and be transformed from unsupervised micro-credit to supervised micro-finance institution status. The efficient allocation of credit to small rural enterprises, particularly agricultural producers, will be crucial for an important sector of the population to enjoy the benefits of CAFTA and also to reduce the incidence of poverty. 2ST-Short term (within a year), MT-Medium Term (3-5 years), Lt-Longer Term xxiv Deficiency by aspect of the investment Recommended measures Phasing2 climate · The Government should also support initiatives for private credit MT bureaus, as part of an overall campaign for consumer protection in the financial sector. Another element of this campaign would be a regulation to insure that annual percentage rates are provided by supervised financial institutions and strongly encouraged for unsupervised micro finance institutions. · The banks and finance companies need to improve internal systems that contribute to high processing costs and delays. MT Banks should improve selection techniques to move beyond reliance on physical guarantees, thereby opening up financial markets to more small and medium firms. Once the confidentiality of financial information is guaranteed, banks should participate in the credit bureau initiatives, to enhance their information base on actual and potential clients. · Licensing of a number of financial conglomerates and offshore banks. ST/MT Infrastructure I: Power · Reconsider the definition of the social tariff, focusing exclusively ST the most economically vulnerable people; · High costs · fine-tuning the regulatory framework, specially to provide MT · Distortions through social tariff incentives for long term investment and efficient energy use; · Push forward the PER implementation and formulate further decision and financing mechanisms to allow for on- and off-grid ST/MT solutions to provide electricity to the remaining households without electricity; · devise mechanisms to increase access to productive uses and MT/LT micro-finance services so as to allow customers to generate income through the use of infrastructure services such as electricity. Infrastructure II: Transport and Ports · Secure funding for COVIAL and making it an autonomous ST institution to avoid political interference. · Low road density and limited access · Increased planning capacity at both central and local levels LT particularly in rural areas xxv Deficiency by aspect of the investment Recommended measures Phasing2 climate · uncertain regulatory framework for transport · Reducing regulatory risk to encourage private sector participation LT Port inefficiencies that hinder export growth in construction, operation and maintenance of roads. This would · Port inefficiencies that hinder export growth require a suitable regulatory framework (concession law) and institutional capacity (independent concession unit). · Reduce political interference in publicly administrated ports LT through improving user's participation in the executive boards; introducing financial discipline; and modernizing management process in public ports · Implement regulatory and institutional reforms to facilitate ST private participation, perhaps starting with port extension Customs · Implement a custom reform strategy to improve trade facilitation, MT · Longer delays increasing costs possibly through the implementation of the Central America · Customs delays major constraint to realizing customs union; ST/MT full potential of CAFTA · Reinforce the credibility of customs by finalizing the modernization process, intensifying training, and implementing quality-based management. Infrastructure III: Telecom · Improve regulatory governance and power of regulatory agency, MT specially to oversee anti-competitive strategy by dominant firms · Rural telecommunications still underdeveloped · Improve mechanisms for private participation in rural telephone MT/LT · Lowest utilization of internet access by firms in infrastructure Central America · Weak regulatory governance · Poor co-ordination among technology institutions · Weak enforcement of Intellectual Property Rights · Absence Quality and Innovation · Overall, the government may need to strengthen the governance MT of technology policy, by defining an explicit technology and · Low levels of ISO and other quality innovation policy, and simplifying the concessions of public certifications funds for research and development. MT · Low levels of technology investments and · Strengthen the National Quality Information System to make patent inventions information on standards, technical regulations, and conformity MT xxvi Deficiency by aspect of the investment Recommended measures Phasing2 climate · Weak technology policyWeak or non-existent assessment programs in Guatemala more readily available to linkages between foreign and domestic firms. ST/MT enterprises, or large and MSMEs · Provide increased infrastructure for quality · Possible government assistance in quality and technology MT upgrading through matching grant programs for local firms, especially MSMEs, and laboratories · Improved enforcement of Intellectual Property Rights MT/LT · Targeted FDI attraction programs which encourage technology transfer to suppliers (and linkages), by reducing administrative barriers to investment Skills · Improving education MT/LT · Low educational base · Training reform--control of levy by private sector (revision of ST · Existing supply of training by public training law) MT institutions is fragmented and inadequate. · Separation of governance from provision of training xxvii CHAPTER ONE INVESTMENT CLIMATE MATTERS 1. In recent years policymakers and multilateral organizations have increasingly emphasized the importance of a sound investment climate for promoting economic growth in developing countries (Stern 2002b). Emphasizing investment used to mean advocating greater quantities of investment, under the assumption that a financing gap was a barrier to development. Today, few accept this simplistic view. Indeed, recent research shows surprisingly little correlation between investment levels and growth rates, at least in the short run (Easterly 1999). Thus while this report is concerned with investment, it does not focus on its quantity. Instead, it focuses on the institutional and policy environment that determines whether investments pay off in greater competitiveness for firms and in sustained growth for the economy--that is, the investment climate.7 A productive investment climate can be broadly thought of as an environment in which governance and institutions support entrepreneurship and well- functioning markets in order to help generate growth and development. A. Key Features of the Investment Climate 2. Defining investment climate precisely is difficult. But one useful definition is the "policy, institutional, and behavioral environment, both present and expected, that influences the returns, and risks, associated with investment" (Stern 2002b). This environment is generally seen as having three main features: macroeconomic conditions, governance, and infrastructure. Macroeconomic (or country-level) factors include such issues as fiscal, monetary, and exchange rate policies and political stability. Governance relates to government interactions with business, which typically mean regulation and corruption, both of which affect the costs of starting and running a business. Infrastructure refers to the quality and quantity of physical infrastructure (such as power, transport, and telecommunications). More broadly, it can also refer to financial infrastructure (such as banking)--or access to finance. Beyond these features of the investment climate, this report also looks at international integration and human resources. Governance 3. A country's general structure of governance and the institutions that govern interactions between business and government determine the burden that firms face in complying with government regulations, the quality of government services, and the extent to which corruption is associated with the procurement of these services. A large 7While social infrastructure is recognized as no less important than its physical and financial counterparts, a deliberate choice was made to exclude the provision of education and health services from the definition of investment climate used in this report. The issues involved in improving social services are quite different from those involved in improving infrastructure and regulation of industry, the focus of the report. 1 regulatory burden is often associated with corruption, involving payments to inspectors who visit firms or to officials who grant permits. Corruption can easily deter foreign and domestic investors. Recent empirical research confirms, for example, that measures of corruption are significantly and negatively related to inflows of foreign direct investment (Smarzynska and Wei 2000; Wei 2000). 4. Finding quantitative measures of the quality of government regulation and the cost imposed by corruption is generally difficult. But many researchers and practitioners have tried to produce aggregate statistics that can be used for comparisons across countries. One study looks at the regulatory and administrative issues affecting firms' day-to-day operations. Friedman and others (2000) compile indexes of taxation levels and "overregulation" (essentially, indexes of the business environment) in 69 countries. While they find no evidence that higher tax rates drive firms underground, they do find a significant correlation between measures of overregulation and the size of the unofficial economy: "more overregulation is correlated with a larger unofficial economy" (Friedman and others 2000). Thus while higher tax rates do not appear to drive away investors, the myriad obstacles to starting and running a business do. 5. This does not mean that all regulations in developing countries are only onerous and unnecessary. On the contrary, regulations and regulatory agencies can play an important role in mitigating market failures (such as environmental pollution), protecting consumers (for example, against firms that can exercise market power), and ensuring safe working conditions. But regulations in developing countries tend to be more complex and bureaucratic than necessary, are associated with corruption, and often are not intended to correct market failures or protect consumers. Indeed, Djankov and others (2002) find that more regulations are generally not associated with better societal outcomes in developing countries. This report focuses on the costs of regulatory inspections to firms, however; societal outcomes are beyond its scope. 6. A particularly important aspect of governance is the ease with which firms can enter and exit a market--an important determinant of productivity, investment, and entrepreneurship (Lansbury and Mayes, 1996). Where entry and exit are relatively easy, poorly performing firms can leave the market--permitting their assets to be reallocated to more productive uses--and new, more productive and innovative firms can emerge. The entrepreneurship that is unleashed accelerates economic growth and welfare improvements in developing and transition economies. New firms "have usually been the fastest-growing segment in transition countries" (McMillan and Woodruff 2002). 7. But the governments of many developing and transition economies, failing to recognize that births and deaths of firms are an inevitable corollary of entrepreneurial risk taking, have erected a maze of administrative obstacles to starting, operating, and closing firms. Compiling data on entry regulations in 85 countries, Djankov and others (2002) discover enormous variation in the number of procedures required to start firms, ranging from 2 in Canada to 21 in the Dominican Republic (with Bolivia and the Russian Federation a close second at 20). The time required to establish a firm ranges from 2 business days to 152 (in Madagascar). These procedures can be extremely costly to the 2 economy: in Bolivia the cost of official procedures (that is, excluding bribes) for setting up a new business amounts to 266 percent of per capita income. In Africa, Emery and others (2000) find, "this whole maze of often duplicative, complex, and non-transparent procedures can mean delays of up to two years to get investments approved and operational." Moreover, Djankov and others (2002) find that stricter regulation of entry is correlated with more corruption and a larger informal economy. Infrastructure 8. In countries with poor infrastructure, businesses must devote more resources to such tasks as acquiring information, procuring inputs, and getting their products to market. Especially for goods marketed internationally, poor infrastructure can undermine the competitiveness of firms--at best making it more costly for them to operate, and at worst deterring them from entering markets where they would otherwise have been able to operate efficiently. 9. Infrastructure and firm performance interact in several ways. Established firms already connected to utilities are affected by the quality of the service. New firms or firms hoping to expand are concerned with difficulties in connecting to utilities. Access to Finance 10. Economic theory holds that businesses will invest in projects where the expected benefits exceed the cost of investment. But this efficient outcome can be achieved only when entrepreneurs face no credit constraints unrelated to their own performance. Credit constraints are less likely in countries with well-developed and well-functioning financial systems. Indeed, a great deal of research has shown the importance of financial sector development for growth (Levine 1997; World Bank 2001b). A healthy financial system, by freeing firms from financial constraints, allows them to expand according to their expected potential rather than their current stock of cash. Thus countries with well- developed financial systems (banks, stock and bond markets) tend to grow faster than countries with less well-developed systems. International Integration 11. Research has shown that countries that aggressively pursued integration with the global economy (such as Brazil, China, India, Malaysia, Mexico, the Philippines, and Thailand) grew more quickly in the 1990s than those that did not. Indeed, many studies find that openness to trade and foreign direct investment accelerates growth (for example, Dollar and Kraay 2001; and Frankel and Romer 1999). 12. Studies using different measures of openness to trade--including the relative size of trade (as measured by imports and exports as a share of GDP) and the degree of trade distortion (as measured by average tariff rates and dispersion)--strongly suggest that greater openness is associated with faster growth in both industrial and developing 3 countries. Sachs and Warner (1995) find that openness is a highly significant determinant of growth and, when combined with property rights, might even represent a sufficient condition for growth in poor economies. Kang and Sawada (2000) find a similar effect of openness on growth, arguing that openness, combined with financial development, increases growth in developing countries by reducing the cost of investing in human capital. Technology and Human Resources 13. The availability of inputs is a crucial element of the investment climate. For human resources, this implies more than just an abundant supply of workers. It also implies workers with sufficient education and technological know-how. Linking the Investment Climate with Growth 14. Studies have found strong correlations between measures of investment climate and economic growth (see, for example, Kaufmann, Kraay, and Zoido-Lobatón 2000; and Knack and Keefer 1995). These studies typically use data generated from surveys of private businesses and reflect the extent to which investors or firms perceive problems with harassment, corruption, and inefficient regulation. But most macro-level indicators of investment climate used in these studies are of little help to countries in identifying exactly what needs to be done to create a better investment climate. That requires delving much more deeply, drawing on micro-level evidence from surveys of large numbers of firms, including small and medium-size enterprises. 15. To begin to get an objective, empirical look at the investment climate at the firm level in Guatemala, this report uses a new survey of 455 enterprises in the manufacturing sector. Following a standard approach for investment climate assessments, it compares the investment climate in Guatemala with that in other countries--including its main competitors, Honduras, Nicaragua in the region and China, India, Bangladesh and Pakistan--its main competitors in the garments sector--using similar surveys and publicly available country-level data sets (Box 1.1). And it explores the investment climate indicators from Guatemala in more depth at the firm level, through analyses that include investigations of how the investment climate differs between small and large, domestic and foreign firms. In parallel, a survey of 200 micro and small enterprises in the informal sector was also conducted to gain insights into the nature and the magnitude of constraints that affect the growth of these enterprises. The preliminary survey report is included in Appendix B of this report. 4 Box 1.1 What Is an Investment Climate Assessment? Investment climate assessments systematically analyze the conditions for private investment and enterprise growth in a country, drawing on the experience of local firms to pinpoint the areas where reform is most needed to improve the private sector's productivity and competitiveness. By providing a practical foundation for policy recommendations and involving local partners throughout the process, the assessments are designed to give greater impetus to policy reforms that can speed the private sector's growth, leading to faster economic growth and poverty reduction. Produced by the World Bank Group in close partnership with a public or private institution in each country, the investment climate assessments are based on a survey of private enterprises designed to find out what difficulties they encounter in starting and running a business--and, if the business fails, in exiting. The survey captures firms' experience in a range of areas--financing, governance, regulation, tax policy, labor relations, conflict resolution, infrastructure services, supplies and marketing, technology and training. All these are areas where difficulties can add substantially to the costs of doing business. The survey attempts to quantify these costs. Using a standard methodology, the assessment then compares the survey findings with those in similar countries to evaluate how the country's private sector is faring and how well it can compete. The findings of the survey, combined with relevant information from other sources, provide a practical basis for identifying the most important areas for reform aimed at improving the investment climate. The assessments look in detail at policy, regulatory, and institutional factors that hamper the provision of good-quality infrastructure services and the functioning of product, financial, and other markets, linking the constraints to firms' costs and productivity. In each country the investment climate assessments draw on the guidance and expertise of local partners in government and the business community. The findings and policy recommendations emerging from the assessments are discussed extensively with the private sector and other stakeholders in the country. This broad dissemination of the findings is aimed at engaging not only policymakers but also business leaders, investors, nongovernmental organizations, and the donor community in shaping the national private sector development strategy, forging consensus on the priorities for reform of the investment climate, and laying the groundwork for concrete responses to the problems identified. Updates of the assessment can help track progress in improving the investment climate. B. Overview of the Guatemalan Economy 16. Since 1986 Guatemala has implemented important measures to increase trade integration, liberalize its financial market and ­ more recently -- to reform its infrastructure sectors. Substantial progress has been made in reducing tariff rates, eliminating most non-tariff barriers (NTBs), removing export licenses and taxes8, and removing domestic price and foreign exchange controls. These policies have been complemented with a more open foreign investment regime and flexible foreign exchange arrangements. These structural reforms, combined with success in controlling inflation and maintaining relative macroeconomic stability, resulted in an increased economic growth during 1991-1999 and reversed the negative trend in total factor productivity of the previous decade (Figure 1.1). Between 1990 and 2002, GDP growth averaged 3.8 percent.9 8Guatemala maintains export taxes only for the coffee sector. Coffee growers must pay 1% of the f.o.b. 9 The pattern of growth in Guatemala is rather similar to those for the rest of Latin America. During the sixties and seventies economic growth was robust (averaging 5.5% per year). Nevertheless, Guatemala and the continent suffered a setback in the eighties, when growth rates of GDP per capita were actually negative. More recently, in the nineties, growth performance has improved, but has not returned to the levels achieved earlier. 5 Figure 1.1: Total Factor Productivity Growth and GDP Growth in Guatemala and Comparator Countries Total Factor Productivity Growth 1960-69 Real GDP Growth, 1995-99 1970-79 3 1980-89 Honduras 2 1990-99 1 El Salvador 0 Costa Rica -1 tigers -2 CostaRica ElSalvador Guatemala Honduras Nicaragua Guatemala -3 LatinAmerica EastAsian Nicaragua -4 -5 0 1 2 3 4 5 17. In parallel, the country undertook substantial investments in human development, Table 1.1 Human Development Statistics, Guatemala making improvements in areas as primary and Indicator 2000 secondary enrollment and reducing illiteracy. For Poverty headcount rate 56.2 example, net secondary enrollments doubled (percent)b between 1980 and 2000 from 13 percent to 26 Infant mortality rate (per 43 percent and net primary enrollments from 59 to 84 1,000 live births) percent over the same period. Infant mortality rates Life expectancy (years) 65.3 Net primary enrollment ratio 84 dropped from 97 to 43 between 1980 and 2001. (percent) Despite these improvements, Guatemala's human Net secondary enrollment 26.0 development indicators are among the worst in the ratio (percent) region, and economic growth on a per capita Illiteracy rate (percent) 31.0 basis, has not been sufficiently high to sharply b. Refers to the upper poverty line. reduce the country's high poverty rates, which is Source: World Bank. among the highest in the region. As noted in the Poverty Assessment, the poverty rate was reduced from 62 to 56 percent of the population from 1989 to 2000, a period during which the output per capita grew at an average rate of 1.3% a year. Such reduction in poverty yields a growth poverty elasticity of slightly less than one, which indicates that in order for the country to achieve the millennium development goal of cutting in half the poverty rate within the next fifteen years, the economy will have to grow much faster (over 5 percent per annum) and in a more sustained manner than in the last fifteen years10,11. 10Guatemala Poverty Assessment, 2003. The Millennium Development Goal of poverty reduction actually refers to extreme poverty, which stood at 16% in 2000. But since there was no reliable and comparable extreme poverty measure for 1990 (the reference point for the MDGs), if one takes the overall poverty rate as the proxy measure to reduce in half by the year 2015, GDP per capita would have to grow by 2.5% for the country to achieve the targets. With the more recent growth of 1.35 per annum extreme and overall poverty rates would decline only to 10.5% and 47% respectively by 2015. 11Poverty in Guatemala is clearly associated with historical patterns of exclusion, lower levels of education, the lack of access to physical assets (including basic utility services, land and housing), the low productivity of labor and the weak social capital. The Bank's Poverty Assessment provides a thorough analysis of the factors that have contributed to the high incidence of poverty that plagues the country. Besides the array of 6 18. Thus, while structural reforms have improved economic growth in Guatemala, they have had a limited impact on per capita income (Figure 1.2). Contributing to this lower per capita growth trajectory were low investment levels and relatively lower levels of integration with the world economy. Figure 1.2. Average Annual Per Capita Growth in Guatemala and Comparator Countries , 1990-2002 GDP per Capita Growth Rates 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 Guatemala- Guatemala- Guatemal- Costa Rica El Salvador Honduras Nicaragua -0.50 -1970s 1980s 1990-02 1990-02 1990-02 1990-02 1990-98 -1.00 Source: World Development Indicators, World Bank Investment Levels 19. The stock of capital in Guatemala (both private and public) has not grown sufficiently fast in the last few years to help generate the levels of economic growth necessary to reduce poverty. The average private investment ratio during the 90's in Guatemala -- roughly 15.6 percent of GDP, compares poorly with countries such as China with investment ratios higher than 30 percent. Estimates of the growth of the capital stock for Guatemala (Figure 1.3 ) show that capital accumulation was almost non- existent during the eighties and early nineties, and the recovery observed in the late nineties stalled once again in the last few years.12 Since 2000, the rate of growth of private and public capital combined has declined to less than 4 percent per year. factors mentioned, geographic location and household size are also found to be important correlates of poverty. Disparities in asset accumulation over time were found to be the main source of the existing income inequality (with education or human capital responsible for over half of the inequality in the country). 12Guatemala Country Economic Memorandum, 2004 7 Figure 1.3: Rates of capital growth 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 Private Public Source: Loening (2002) and Central Bank. 20. The annual rate of growth of private capital reached as high as 5 percent per annum during the periods of high economic growth in the seventies, when the ratio of Gross Private Capital Formation (excluding inventories) reached levels close to 16% of GDP. These ratios declined to 6% of GDP during the height of the armed conflict. More recently, in the last four years, private capital formation has also been reduced. The investment ratio had reached a high of 14.8% of GDP in 1999, only to fall to 12.8% of GDP in 2002.13 Integration with the Global Economy 21. While Guatemala has made some progress in terms of trade openness in the 1990s, evidence suggests that relative to its neighbors, Guatemala is less well integrated into the global economy. Trade flows (exports plus imports as percentage of GDP) increased by 11 percentage points between 1991 (39 percent) and 2001 (50 percent). However, most of this progress can only be attributed to import growth as total exports have remained practically stagnant for the last ten years at around 19 percent of GDP, despite positive developments in exports of maquila and other nontraditional products. Guatemala still exhibits the lowest share of trade in GDP in Central America and is well below the region's 2001 average of 80 percent. The lack of dynamism of Guatemala's exports is reflected in World Trade Organization (WTO) figures, according to which 13The decline occurred in equal proportion in construction and imported capital. Imported capital goods and construction material, which account for more than half of total fixed capital investment, have dropped from 7.2% of GDP in 1999 to approximately 6.0% in 2002. (Guatemala Country Economic Memorandum, 2004). 8 Guatemala's share of world merchandise exports decreased from 0.07 percent in 1980 to 0.04 percent in 2001, a drop of almost 50 percent in two decades.14 Figure 1.4. Exports and Imports as a Share of GDP in Guatemala and Comparator Countries, 2001 80% 70% Exports 60% Imports 50% 40% 30% 20% 10% 0% atemala lvador nduras staRica average Brazil Gu El Sa Ho NicaraguaCo CA Republic inican Dom 22. The stagnant export ratio of recent years is the result of significant differences in the trends of three different sectors. The first is the booming maquila sector, with net exports increasing steadily since 1990, as a result of US trade preferences and the success of the free trade zone regimes in attracting FDI.15 In current U.S. dollars, maquila exports grew at an average annual rate of 18 percent between 1992 and 2002. The second is the group of traditional export products (i.e., coffee, bananas, sugar and cardamom) which have seen trade volumes fall steadily during the 1990s, as a consequence of slow demand growth and low commodity prices. The third is nontraditional exports (e.g., flowers, seasonal vegetables, fruits, and organic crops), which grew dynamically until 2000 but have stagnated since then in part due to the recent recession in the US and Latin America. 23. What accounts for the trends in declining trade for Guatemala? Formal barriers to trade are clearly insignificant. With an average of 7.2 percent in 2002, Guatemala's tariff rates are close to El Salvador and Costa Rica, and among the lowest in the region (Table 1.2). In addition, the use of non-tariff barriers appears to be limited in Guatemala. No recourse of anti-dumping, countervailing or safeguard measures has been made in recent years.16 However, informal barriers to trade are also important. One such barrier is the 14Guatemala Country Economic Memorandum, 2004. 15The Guatemala maquila sector is distinguished in Central America for its emphasis on delivering the so- called "full package", in which textile producers are responsible for most phases of production. This ability fosters a competitive edge based on service delivery rather than solely on low labor costs. 16Guatemala Country Economic Memorandum, 2004. 9 weak performance of ports and customs in Guatemala (see the section on infrastructure). Another might be corruption, which imposes indirect costs that might discourage trade. Table 1.2 Average Tariff Rates in Guatemala and Comparator Countries Costa Rica El Salvador Honduras Guatemala Nicaragua Tariff Range 0-163 0-40 0-55 0-40 0-170 By ISIC sector Agriculture and fisheries 9.8 8.6 8.1 8.5 8.7 Mining 4.6 2.2 2.3 2.4 2.3 Manufacturing 6.8 7.5 6.0 6.9 5.8 Total 7.0 7.4 6.1 7.2 5.9 Source: various WTO Trade Policy Reviews. 24. Assessing the importance of corruption relating to imports and exports is difficult. But a survey of business executives carried out in 80 industrial and developing countries for the Global Competitiveness Report 2002/03 generated relevant data (World Economic Forum 2003). The survey asked business executives to rate on a seven-point scale how common irregular payments or bribes were for import and export permits in their country (with 1 meaning "common" and 7 "never"). Based on the average scores, the 80 countries were then ranked, with the countries with the lowest average scores--that is, those where bribes were most common--receiving the lowest rankings.17 Guatemala ranked 66 out of 80 countries (Figure 1.5). By contrast, Costa Rica ranked 58, Nicaragua 56, Honduras 65, and El Salvador 41. Although these qualitative rankings should be treated with caution, they do suggest large informal barriers to trade in Guatemala. 17As discussed in detail in Recanatini, Wallsten, and Xu (2000), averaging responses on qualitative surveys can be problematic for several reasons. Lall (2001) discusses other problems with the Global Competitiveness Report. 10 Figure 1.5. Rankings of Guatemala and Comparator Countries by the Extent of Irregular Payments for Import and Export Permits El Salvador Mexico Brazil Nicaragua Costa Rica Honduras Guatemala 0 10 20 30 40 50 60 70 Stronger Weaker Source: Global Competitiveness Report, 2003 25. Other evidence of weak integration with the global economy is the low level of incoming foreign direct investment in Guatemala. As a share of GDP, foreign direct investment in Guatemala (<2 percent) is lower than the other countries in the region (Figure 1.6). Figure 1.6. Net Inflows of Foreign Investment as a Percent of GDP in Guatemala and Comparator Countries, 1990-2002 FDI-GDP Ratios Costa Rica 16 El Salvador 14 Guatemala Honduras 12 Nicaragua 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 26. With the recently completed Central American Free Trade Agreements (CAFTAs) negotiations ( Box 1.2) -- Guatemala will have the opportunity to accelerate 11 the pace of its integration into the global economy over the next few years. It is expected that both ­trade and investment--will receive an impetus through CAFTA, thereby increasing productivity, growth and reducing poverty. Trade flows should increase by virtue of even lower trade barriers and improved customs procedures. CAFTA is also expected to encourage investment including FDI flows to Guatemala, although the magnitude of such flows is difficult to anticipate. Investors are likely to be attracted by the new profit opportunities brought about by CAFTA, and more significantly by the credibility effect (or reduced risk) that CAFTA is likely to introduce. However, improving the country's investment climate will be necessary to ensure that all these benefits from CAFTA are actually realized. Box 1.2: The CAFTA Agreement Free trade agreement negotiations between the United States and five Central American countries (Guatemala, El Salvador, Costa Rica, Honduras and Nicaragua) began formally in January 2003 and were completed eleven months later, on December 17, 2003. Nine rounds of negotiations were completed over the course of the year, culminating in the signing of the agreement by only four of the five nations -- Guatemala, El Salvador, Honduras and Nicaragua. Costa Rica signed onto the agreement a month later, on January 26, 2004. The Central American Free Trade Agreement (CAFTA) is a second-generation trade agreement, similar to NAFTA and the U.S.-Chile FTA. In other words, it does not cover free trade of goods only, but rather stipulates free trade for all sectors, including services. It opens market access by locking into low tariffs with clearly defined rules of origin. Relevant market sectors include agriculture, manufacturing and services. In addition to free trade of goods and services, the agreement contains provisions regarding non- market access issues, such as labor and environmental regulations, intellectual property rights, and dispute settlement. In view of this agenda, negotiations proceeded in five working groups: a) market access (including agriculture); b) investment and services; c) government procurement and intellectual property; d) labor and the environment; and e) dispute settlement and other institutional issues. The adoption of CAFTA generates significant benefits for Central American countries, such as making access to the U.S. market more permanent, thereby creating an irrevocable anchor to free trade. Under the current trade regime, the Caribbean Basin Initiative (CBI), these nations enjoy nearly equal access to U.S. markets, but due to the unilateral nature of the agreement, long term investors cannot be confident that preferential trade status will undoubtedly continue. CAFTA also grants exporters and investors a fuller set of protection and dispute resolution rules. Furthermore, the agreement acts as a catalyst to reform in the region by instilling an obligation on the CA countries to upgrade their existing rules and institutions regarding investment and trade (such as improving protection for intellectual property rights and labor and environmental regulations). These changes are expected to improve the business climate and thus lead to higher foreign and domestic investment. Yet, before CAFTA can be implemented, it faces a final daunting obstacle -- ratification by the U.S. congress. It seems highly unlikely in an election year swirling with protectionist rhetoric that the proposal of ratification will even be voted on by the legislature. Source: World Bank ­ CAFTA study (ongoing) 27. In fact, despite relative macro economic stability, trade liberalization and privatization, Guatemala's failure to increase investment and growth and reduce poverty, points to a critical need to improve its investment climate. This report seeks to provide a better understanding of the micro and institutional constraints impeding investment, which translates into higher productivity and export capacity. The report draws on the 12 findings of a survey of 455 private manufacturing enterprises in Guatemala in the fall of 2003. C. The Survey--and What Its Findings Reveal 28. What factors in the investment climate have prevented Guatemala from growing more quickly? To gather the firm-level data imperative for answering this question, the World Bank, with the support of FUNDESA, conducted a survey of 455 manufacturing enterprises in the fall of 2003. The lack of a reliable and recent census of manufacturers made sample selection especially difficult. The sample ultimately was drawn from lists of firms provided by chambers of commerce (see Appendix A for a discussion of the sampling methodology). 28. Two criteria were used to choose industries for the survey: the industries had to be important to the Guatemalan economy, and there had to be some overlap with industries covered by surveys in other countries to facilitate comparisons. The two criteria are complementary in Guatemala. For example, the ready-made garment industry is especially important to Guatemala, and firms in this industry compete with similar manufacturers in such countries as Honduras, Nicaragua, China, India, and Pakistan 29. .Industries included in the survey are: Apparel, Textiles, Beverages, food and tobacco, furniture and wood products, leather products, Non-metal minerals, metal products and paper and commerce. The survey collected data from a total of 455 firms in Guatemala city and surrounding areas. (see Appendix C for a breakdown of the firms by industry, city, and other factors).18 30. To get an initial sense of how firms view the investment climate, the survey asked firms to rate the extent to which a large number of factors in the investment climate constrain their operation and growth. By far the most frequent complaint was corruption, followed closely by crime and economic policy uncertainty (Figure 1.7).19 What is interesting is that a sizeable percentage of firms find all the constraints to be major obstacles; for example, even for the constraint ranked as 16th, more than 40 percent of the firms find the education and skill levels of the workforce to be a major constraint to business. Micro and small and medium enterprises are more constrained by access to finance, and cost of finance as well as corruption and security costs, whereas large firms appear to be more constrained by customs and trade regulations and power. Export oriented firms are more constrained by customs and trade regulations, business licensing, transportation, and property rights and the legal system as compared with non-exporting firms (Appendix C). With the exception of financing (cost and access), corruption and legal systems, firms with foreign ownership appear to be significantly more constrained than domestic firms along most dimensions particularly in key regulatory areas including 18The survey and its analysis focus on the investment climate of the urban manufacturing sector. A survey of 200 enterprises outside of the urban areas was also conducted in parallel and results are available on request. 19Not shown in the figure are constraints such as electricity, customs, access to land and labor regulations which less than 30 percent of firms find to be a major or severe constraint (Annex C). 13 trade and customs regulations, tax administration and business licensing. This could explain the lower FDI flows into the country. 31. The ranking results raise two issues. First, firms ranked economic policy uncertainty third, highlighting the importance of stable macroeconomic policies. Since the importance of these issues is well understood, this report focuses on microeconomic issues. Second, the rankings are subjective and may not indicate actual economic problems. For example, most entrepreneurs want cheaper financing, but that does not necessarily mean that the cost of financing is an economic problem. 32. Nonetheless, these rankings provide a starting point for the analysis, and the survey contains a wealth of additional information to investigate these and other issues more objectively and in greater depth. Most important, the analysis reveals that the general constraints identified by the firms impose serious costs on them. Figure 1.7 : Perceptions of the Investment Climate % firms ranking obstacle as major or severe Availability of financing Efficiency of legal system Skills and education of available Workers Access to financing Tax Administration Cost of financing Anti-competitive practices Tax rates Macroeconomic Instability Economic and Reg. Policy Uncertainty Crime & Violence Corruption 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 Source: Investment Climate Survey 33. The survey findings underscore many unfavorable features of its investment climate. And they measure the serious effort that the country must undertake if it is to stimulate growth and catch up with faster-growing economies. This Investment Climate Assessment complements other important ESW recently carried out for Guatemala, such as the Poverty Assessment (2003), The Country Economic Memorandum (2004), and a series of Policy Dialogue Papers that will be discussed with the new Government that recently took office in January 2004. Among the aims of this study is to aid the Government's Poverty Reduction Strategy, one of whose objectives is to accelerate growth to more than 5 percent a year. But is this growth target realistic for Guatemala? How will it be attained? The Poverty Assessment, recognizing the private sector as the 14 main engine of economic growth, has highlighted improvements in a host of factors relating to the investment climate as a priority area for action. The hope is that this report, by shedding further light on the cost of a poor investment climate, will help inform the national debate on issues relating to private sector development and aid the consensus building necessary to enact productive reforms, to increase investment and growth. 15 CHAPTER TWO LEGAL, REGULATORY AND INSTITUTIONAL FRAMEWORK A. Introduction 34. Increasingly, it is being recognized that a critical role for government is to reduce transactions costs through the transparent establishment and enforcement of the rules of the game.20 This implies an agreed and widely understood system for discussing and implementing changes to the rules as well as predictable enforcement mechanisms that are not easily subject to corruption, political influence or social pressure on a day-to-day basis. If these basic elements for economic activity are not provided, investment will be deterred, transactions will not occur and there will by less dynamism, less innovation, lower growth and fewer jobs than could be achieved with the same resources. In addition, significant incentives will be created to operate informally or illegally, thus further weakening the public sector through rent-seeking and lower tax receipts. 35. In a region which struggles with the issues of corruption and unpredictable regulation, Guatemala ranks worst among its peers on both accounts. While firms in Central American countries often complain of high levels of corruption and discretionary enforcement of poor regulation, Guatemalans have more room to complain. Symptoms of this problem include high levels of petty corruption, along with significant amounts of red tape creating an ideal environment for informality to flourish. Informality can be thought of as a spectrum extending from firms operating without any government permits and paying no taxes at one extreme to more subtle instances such as under-reporting sales and not registering new workers at the other. A considerable body of literature has developed recently showing that petty corruption and policy uncertainty, a symptom of grand corruption, contribute to higher levels of informality, lower investment and slower growth. For an introduction, see Mauro (1995), Loayza (1996), Johnson, Kaufmann and Zoido-Lobaton (1998) and Gaviria (2001). Recent evidence presented by Beck et al (2002) also concludes that corruption has a significant impact on all firms, but particularly SMEs. 36. A new pro-business government has promised to work hard to fight corruption. The survey was applied in the summer and fall of 2003 and therefore is reflective of the situation under the former administration. Recently, the conservative Grand National Alliance Party, headed by Oscar Berger Perdomo has set alleviating corruption as a national priority. If the administration succeeds in fighting corrupt officials within a corrupt environment, informality should decline and long term investment should increase, setting Guatemala on the path towards convergence with the rest of the world. The administration has proved itself to be successful in bringing together politicians from a large chunk of the spectrum of Guatemalan politics, 20See Kaufmann, Kraay and Zoido-Lobaton (1999), Johnson et al. (1998), Schneider and Enste (2000), Ihrig and Moe (2000), Bouev 2002), World Bank (2004), Coase (1988), Williamson (1985), Rodrik (2002) among others 16 demonstrated through the fact that this administration is the first coalition government in recent times. Hopefully this is indicative of the future and corruption can be effectively combated on all sides. 37. Not all corruption is petty, and nor do all types of corruption have the same consequences. "Grand" corruption or influence, appears to be Guatemala's most serious problem compared to its neighbors. "Grand" corruption, such as influencing the content or application of laws and regulations for personal gain, political financing, affecting the judicial process and influencing outcomes of public procurement This sort of corruption could foster an environment of high uncertainty among firm owners reducing their ability to plan in the long term to remain ready to adapt to new or arbitrary regulations. 38. Crime and violence raise firms costs in visible and less visible ways and disproportionately affect small firms. High levels of crime and violence add direct costs to operation of firms as well as affect firm operations in other ways (inability to attract workers for night shifts for example) that lower productivity and job creation. These costs are disproportionately borne by small and medium firms making it much more difficult for them to be competitive. Failure to deal with these issues in a straightforward way will lower the impact of other reforms including the ability of Guatemala to maximize the positive impact of CAFTA. 39. Most of these deficiencies are within the control of the public sector but they need increased levels of attention by policy makers and more effective collaboration with the private sector to ensure higher impact in implementation. This chapter will first examine petty corruption and its connections with red tape and informality, then the consequences of grand corruption and finally the costs of crime and violence on firms. B. The Bermuda Triangle of a Dynamic Private Sector: Petty Corruption, Red Tape and Informality 40. Petty bribery to facilitate processes and gain contracts is a common practice in Guatemala. Guatemalan firms report spending 3.7 percent of their sales on "informal payments" to get things done which is higher than Honduras, Nicaragua, Pakistan, China or Bangladesh (Figure 2.1). In terms of total payments, while the percentage of sales paid as bribes declines with an increase in firm size in Honduras and Nicaragua, firms of all sizes in Guatemala report making payments between 3.2 and 4.1%. Another finding unique to Guatemala is that , exporting and non-exporting firms pay roughly the same percentages of income in bribes (Figure 2.2) . 17 Figure 2.1: Bribery needed to get things done (percentage of sales), international comparison. Ecuador 6.6 Guatemala 3.7 Honduras 2.5 Bangladesh 2.5 Pakistan 2.0 China 1.9 Nicaragua 1.7 Tanzania 1.5 0 1 2 3 4 5 6 7 Unofficial payments to get things done (% ann. sales) 41. The story is similar in public procurement where Guatemalan firms report that an "extra" payment of over 4 percent of the value of the contract is necessary in order to win public contracts (Figure 2.2). This is roughly equivalent to reports from Nicaragua and Honduras suggesting that kickbacks for public contracts is still a common practice in the region. Figure 2.2 Informal payments as a percent of sales Guatemala Honduras Nicaragua 4.5 Per 4 cen 3.5 t of 3 sal 2.5 es 2 1.5 1 0.5 0 Large Med Small Micro Non- Exporter exporter 42. Firms' perceptions of corruption are connected with their experience of corruption which differs significantly across institutions. Corruption appears to be most common in construction permits, electrical connection and import permits. The private sector's perceptions of corruption in the subjective rating is significantly correlated with the number of times they report being asked for a bribe and the number of inspections they had last year. In other words their experience plays and important part in forming their opinion about the level and effects of corruption. Looking at specific transactions we observe that the rates of reported corruption (that is where firms report being asked for a bribe) vary dramatically by agency. Bribery rates are highest for the tax inspectorate (22 percent), construction permits (20 percent, infrastructure services such as 18 electricity distribution companies (16.4 percent) when asking for a connection, environmental permits (10 percent), health permits (17 percent), followed by key operational permits such as import licenses (17 percent), and operating license (9 percent). 43. Managers of Guatemalan firms spend a substantial percentage of their time dealing with regulation, and higher levels of regulation are significantly correlated with higher levels of bribery. On average managers estimate that they spend about 11 percent of their time dealing with governmental regulation in Guatemala significantly higher than the average we have found across a Figure 2.3 International Comparison of sample of countries in Latin Management Time Spent on Regulation America and East Asia (Figure 2.3) Large Medium Small Micro The data also show a significant 18 16 correlation between the level of 14 management time spent on 12 regulation and levels of overall 10 8 bribes paid by the firm. This 6 suggests that rather than speeding 4 things up informal payments are 2 0 actually correlated with more Ecuador Nicaragua Guatemala Honduras Brazil Bangladesh management time spent dealing with regulation rather than less. This finding is consistent with those of Wei and Kaufmann (1999). 44. In an effort to reduce regulatory costs, over half of the sampled firms hired intermediaries to get needed permits for registration and operation, but this does not actually appear to reduce the time to get the permits. 51 percent of the firms in the sample needed to renew permits in the last year. On average firms needed two permits in the last year to continue operating and which took 45 days on average to acquire (median of 15) compared to just 14 days in Nicaragua (median 8). One signal of the cost of this red tape to firms is that fact that, in order to lower their exposure to bureaucracy, 37 percent of existing Guatemalan firms and 83 percent of new registrants used intermediaries when renewing permits, despite the fact that they pay a relatively high cost for these services (e.g. median of US$1,800 for large firms). Why do firms pay relatively large sums of money to intermediaries despite taking much longer to gain their permits? It may well be that firms only contract the intermediaries after having tried to attain the permits themselves and becoming frustrated with the process or it may be that some firms do not even attempt to do it themselves given what they have heard and Figure 2.4 Days of Inspection per year, simply accept that the permit gathering International Comparisons Large Medium Small Micro exercise will be long and costly. 45 40 35 45. Inspections of firms in year 30 25 Guatemala do not appear overly onerous per 20 15 by international standards except for the ysaD 10 5 0 emala Brazil 19 icaraguaN ondurasH Ecuador Guat Bangladesh level and composition of inspections for small firms. 27 percent of the firms found inspections to be a major or severe regulatory obstacle. Guatemalan firms report average levels of inspections for firms overall (10 per year) (Figure 2.4). Tax and labor inspections are high across all firm sizes with large firms (as expected), subjected to more inspections on average than the other firm sizes. There appear to be marked jumps in regulatory costs associated with increased size of the firm, particularly when transitioning from micro to small and from medium to large. These jumps in days of inspections closely match the differences in management time spent on regulation by firm size. On average firms are inspected by tax authorities for 4.6 times on average, and report a total of 10 inspections per year. Large firms, however, are inspected on average 20 days each year, followed by medium size firms at 7 days. When considering medians though, only large firms have a median over 0 (2.5 days) in terms of tax audits, and medians for total inspections are 15 days and 3 days for large and medium firms respectively. As can be seen in Figure 2.4, Guatemalan firms are inspected more infrequently than their neighbors as well as international comparators. Figure 2.5 Extent of Tax Evasion in Guatemala % of revneue undeclared to tax authorities 35 % of Sales Accounted for by Informal Enterprises 30 25 selaS 20 of % 15 10 5 0 Large Med Small Micro 46. The levels of red tape and corruption faced by formal firms, particularly small and medium firms, together with the obvious tax advantages, help to explain the powerful disincentive to formalization and firm growth that Figure 2.6 Informal Economy (% GNI) leads half of the economy to be informal. Informality can be seen as a Bolivia logical response to either overly costly or Guatemala haphazardly enforced regulation. Honduras The issues of regulation, corruption, Nicaragua informality and growth has been the AVERAGE subject of considerable study over the Ecuador last several years.21 In general all of Costa Rica these studies show that high levels of Chile 0 20 40 60 80 21For example see Johnson,et al. (1998), Schneider and Enste (2000), Ihrig and Moe (2000) Bouev (2002), World Bank (2004). 20 regulation, particularly if accompanied with substantial discretion and corruption, leads to higher levels of informality. Informality, in turn, has large negative consequences on both public finance and economic growth (Johnson, Kaufmann and Zoido-Lobaton (1998)). Many countries get caught in a negative spiral of low tax collection, consequent low provision of public goods (including education and infrastructure) and yet higher levels of informality. 47. In Guatemala the combination of higher percentages of management time spent on regulation, additional costs of intermediaries to get initial and recurrent permits for operation, and substantial annual outlays in bribe payments do not make formalization an attractive proposition for new firms. When the costs of tax and labor requirements are added it is a simple decision for many micro and small firms to eschew formality. Firms in the sample report that informal firms account for 20 percent of the market; they estimate that firms in their sectors declare between 70 (in the case of micro enterprises) and 87 percent (large enterprises) of their sales to tax authorities (Figure 2.5). Independent estimates of the informal economy place Guatemala at 50 percent of GDP, about the same as Honduras and well above Nicaragua (45 percent), Dominican Republic (36 percent) and Costa Rica (26 percent) (Figure 2.6)22. Figure 2.7 Policy & Regulatory Uncertainty in relation to Corruption 100 80 rmsfi 60 rmsfifo 40 %20 0 Guatemala Brazil Peru Ecuador Nicaragua Honduras Bangladesh Policy Uncertainty Corruption Regulatory Unpredictability 48. Moreover, according to a 2004 survey of informal Guatemalan firms by CIEN advantages to being formal are few(Appendix B). However, 60 percent of these "informal" firms paid some sort of taxes, suggesting that many "informal" firms are in fact semi-formal complying with some, but not all, regulations. Survey findings suggest that firms with a high degree of informality had the same concerns in regards to regulation, corruption and bureaucracy and were actually hassled less by the authorities than their formal counterparts. 49. How costly--and how difficult is entry? More than 30 percent of the firms in the sample found business registration to be the most cumbersome relative to all regulatory obstacles. Data from the ICS and the World Bank's Doing Business project suggest confirm these findings. An entrepreneur in Guatemala must complete thirteen 22Figures from Schneider (2002) 21 procedures to start a firm--slightly higher than the regional average of 12 and it takes 45 days (median) to complete the process (Figure 2.9). The cost of these procedures amounts to 67 percent of per capita income--by far the lowest among the countries in the region (Figure 2.8). Figure 2.8 Number of Procedures and Cost to Start a Firm in Guatemala and Comparator Countries Figure 2.9 Median Number of Days to Start a business in Guatemala by Firm Size Median Number of Days it takes to register a business small Micro total medium large 0 20 40 60 80 100 120 Source: Investment Climate Survey 50. Another measure suggests that starting a business is relatively difficult in Guatemala compared with other countries. Executives surveyed for Global Competitiveness Report 2002/03, asked to rate the difficulty of starting a new business in their country, ranked Guatemala 62nd out of the 80 countries, worse than the rankings for all other Central American countries (Figure 2.10). 22 51. Recommendations for reduction of petty corruption, red tape and informality Guatemala has, with the change in government, begun to take steps to address the issues discussed here. Some useful steps that can be taken are: · A strategic focus, at least in the short term, for administrative simplification efforts on areas which affect opportunities created by CAFTA, foreign enterprises and in particular affect SMEs. This suggests that an initial approach should include business registration, import and export processes, health and phyto- sanitary standards and certification, environmental permits and licenses and municipal regulations. · Combine the simplification program with strengthened internal performance monitoring in public agencies through the use of performance indicators (based on transaction data) as well as structured, annual feedback from users. C. Influencia : Grand Corruption, Influence and Policy Uncertainty 52. Unlike petty corruption, which promotes greater informality, grand corruption creates greater regulatory uncertainty, which in turn stifles long term investment and innovation. Grand corruption or influence is the practice of influencing the content or application of laws and regulations for personal gain, illegal political financing, affecting the judicial process and outcomes of public procurement. High levels of "grand" corruption have been a serious problem in Guatemala for some time.. The most recent Global Competitiveness Report has several indicators of "grand" corruption which show Guatemala as the worst in the region.(Figure 2.10). 53. Grand corruption leads to increased levels of uncertainty of economic and regulatory policy and lower levels of investment and growth. As opposed to the petty corruption we discussed above "grand" corruption or influence is more insidious as it tends to affect the perception of stability in economic regulation and policy. Firms perceive policy as more unstable because they believe that parts of the regulatory framework, such as laws and regulations governing market access, can be changed through influence or bribery of high level officials. More than seventy percent of Guatemalan firms (and over 65 percent of small and medium firms) rate this uncertainty as a serious constraint to the growth of their enterprise. These concerns appear to be justified by recent work such as Kaufmann (2003) which shows that high levels of influence (or crony bias) are Figure 2.10 Grand Corruption Indicators associated with a number of poor outcomes such as higher levels of informality and lower levels of per 6 5 capita income. 4 3 2 54. The uncertainty introduced through grand 1 oor----------------------------------GoodP corruption is not reduced by the 0 Guatemala Honduras Nicaragua Ecuador Brazil Bangladesh Costa Rica judicial system which is also seen as Diversion of Public Funds Irregular payments in gov't policymaking Irregular payments in ju 23 corrupt and not impartial. As can be seen in Figure 2.10 the private sector regards the judicial system as open to corruption and hence it would not consider the courts as an effective tool to combat governmental policy changes. In fact 39 percent of firms do not believe that the courts will uphold their contracts and property rights in a dispute. This distrust of the courts is evident in that firms took only 2 percent of all their payment disputes to court (Figure 2.11). Figure 2.11 Percent of firms who do NOT believe their property rights and contracts will be protected by courts 55. Recent measures. After the Micro firms Small firms Medium firms Large firms peace accords, 70 various plans were 60 designed to improve the management of 50 public funds but no 40 measurable impacts 30 have been realized.23 20 One important set of 10 initiatives is related to improvement 0 Ecuador Guatemala Nicaragua Honduras Peru Brazil public fund administration by means of an integrated system of financial management (Sistema Integrado de Administración Financiera-SIAF). Through SIAF, financial transactions are incorporated in a single system of public accounting, improving transparency and helping to reduce corruption. There is still need for legal and institutional strengthening of SIAF as well as for the overall anti-corruption system.24 The Contraloría General de Cuentas (CGC) has been strengthened, provided with modern control mechanisms, assigned operative auditing functions and has started to use results-oriented tools. Two new institutions were created, the Subcontrolador de Calidad de Gasto Público and the Subcontrolador de Probidad, the latter tasked with oversight of income declarations of the public servants, which has been made compulsory. To complete the anti-corruption legal framework, a new law that regulates the integrity and responsibility of public workers has been passed ­ the Ley de Probidad y Responsabilidad de Funcionarios y Empleados Públicos.25 Finally, in December 2002, the National Commission for Transparency and against Corruption was formally set up ­ within the National Program for Global Transparency in Guatemala. 23Guatemala Country Economic Memorandum, 2004. 24 Several measures were adopted among which: (i) the creation of a unique database for all financial transactions with open internet access to the public; (ii) the creation of new auditing processes and reduction of practices allowing corruption to take place, (for instance, multiple accounts, discretional payments, ghost suppliers, and prices with penalties for late payment); and (iii) a new and transparent acquisitions system that brings about a significant reduction in the prices paid to providers. In February 2000, a WB report (Guatemala, Expenditure Reform in a Post-Conflict Country, 19617-GU) concluded that with this system, administrative discretion with respect to payments had been reduced. 25The law has received some criticisms, as for instance, to the fact that the wealth statements of the public servants reviewed by the Subcontrolador de Probidad will be treated as confidential and data will be verifiable only by means of a judicial process. 24 56. Recommendations. While petty corruption is generally facilitated by increased interaction between public sector regulators and private firms, grand corruption is typically much easier where power is highly concentrated and accountability is low. Clearly there are no quick and easy ways to reduce levels of influence, particularly in small economies. The new administration is taking strong steps to strengthen the anti corruption framework. Other promising measures include: · Reducing the concentration of influence can be achieved through improvements in mechanisms of voice and accountability throughout society. In the private sector in particular more representative and active private sector organizations, such as chambers of commerce, that have higher levels of membership is an effective way of dissipating the influence of a small number of powerful firms or groups. · Reducing the levels of corruption and improving the economic literacy in the judiciary is crucial to restoring confidence in the court system. An impartial and predictable court system is critical inspiring private sector confidence in adjudicating both private disputes and challenges to government regulation. In an environment of suspicion of influence in government policy making an independent, non-political court is indispensable as a check on cronyism. D. Costs of Crime and Violence 57. Firms rate crime as a very serious problem in Guatemala. 2684 percent of all Guatemalan firms consider crime and violence a major obstacle to business development. The material losses associated with the occurrence of violent acts and its prevention, both in families and businesses, are close to 6.8% of GNP (1.85% corresponding to costs of public security).27 The figure is highest in the region, higher than that in Colombia (6.4%), Venezuela (6.6%), El Salvador (4.9%), Mexico (3.6%), Brazil (1.4%) and Peru (1.4%). According to CIEN, this is an under-estimate since indirect costs such as medical attention of parties injured, loss of human capital and the overall negative impact on the investment climate of the country have not been included. 58. ICS evidence shows that there are several costs associated with crime, particularly the direct cost of added security to protect a firms private property. Cost of security, as a percent of total costs to a firm is just under 5.5 percent for Guatemalan firms. To put this figure in perspective, security costs account for 3.5 percent and 3 percent of Honduran and Nicaraguan firms costs, respectively. This substantial added cost makes Guatemalan goods less competitive in relation to its neighbors. Street crime, according to the WBES in 2000 is reported by almost 50 percent of firms to be a major obstacle to the business environment as well. This statistic is similar to Guatemala's neighbors and above the Latin American average of 43 percent. 26This section draws heavily on World Bank's 2004 Guatemalan Country Economic Memorandum 27CIEN 2002 25 In Guatemala, as opposed to its neighbors, much of the street crime reported is perpetrated by Guatemalan gangs known as Maras. These gangs, which consist of 30 to 40 children with an average age of 14 have existed in Guatemala since the 1980s and have only recently become violent. Historically, they were seen as less violent and destructive than their Salvadorian counterparts, but recent anecdotal reports and press information suggest that this is changing, partially as a result of guerilla demobilization. 59. Criminal activities have increased over the past three years, reversing the initial success of the peace accords. For example, the average number of monthly human rights violations verified by Mision de Verificacion de las Naciones Unidas en Guatemala (MINUGUA) has increased from 231 in 1998 to 489 in 2002. 28 In addition, according to the Policia Nacional Civil (PNC) the number of violent deaths have been increasing in recent years, particularly in 2002. Thus, the initial improvement in combating violence after the 1996 peace accords have been reversed, a downward trend has taken hold and violence has returned to 1996 levels (Figure 2.12). Figure 2.12 Crime In Guatemala and comparator countries Frequency of and losses due to crime Average Cost of Security (as %of total costs) 4.0 6.0 # of Criminal Cases in 2002 Losses to Crime as % of sales (for victims only) 3.5 5.0 3.0 s 2.5 stoC 4.0 2.0 3.0 1.5 altoTfo 2.0 1.0 % 0.5 1.0 0.0 0.0 Nicaragua Honduras Guatemala Nicaragua Honduras Guatemala Source: Investment Climate Surveys Figure 2.13 Violent Deaths in Guatemala Annual violent deaths, 1995-2002 Monthly violent deaths, 2000-2002 Source: Policía Nacional Civil, Guatemala 28 PNUD, Guatemala: Una Agenda para el Desarrollo Humano, Sexto Informe Nacional sobre Desarrollo Humano, 2003. 26 60. Like El Salvador, gang problems are much more prevalent in Guatemala than Honduras and Nicaragua, as demonstrated through ICS evidence. Roughly 65% of all victimization of firms is the result of gang related activities in Guatemala, while in Honduras and Nicaragua, less than 30 percent of crime is the result of gangs. Without viable alternatives to life on the streets, such as higher education and stronger prospects of a future of consistent employment, gangs will remain a serious problem in Guatemala. 61. As expected, in terms of number of criminal cases and losses to crime as a percent of sales, Guatemala dwarfs its two neighbors. On average losses from crime are 2.7% of sales (Figure 2.13). The survey results suggest that Guatemalan firms are fully fed up with the high crime environment they must conduct business in. Even though nearly fifty percent of Guatemalan owners do not believe their property rights will be protected by the courts, 70 percent of firms report a crime. However, less than 6 percent of the cases are solved by the police, must less enforced by the courts. In Nicaragua on the other hand, under 55 percent of crimes are reported, but roughly 30 percent of these crimes are solved by the police. 62. The occurrence of homicides is not distributed evenly across the territory of Guatemala. Important regional disparities are present, with ten departments showing homicide rates higher than the national average.29 The crime rates are very high in the northern department of Petén and those at the border with Honduras and El Salvador. In particular, for the period 86-98, Petén and Jutiapa had average homicide rates of 57.6 and 53.3 per 100,000 inhabitants respectively, which is high according to international standards.30 By contrast, the very populated department of Guatemala, where the capital is located, had an average rate of 27.3, lower than the LAC average. These results seem to indicate that violence is not an urban phenomenon in Guatemala, which contradicts evidence gathered for Brazil, Colombia, Peru and El Salvador. It might be related to the fact that Guatemala has one of the lowest levels of urban concentration in the region. As in most countries, criminal behavior in Guatemala has been related to organized crime, mostly connected to international drug dealing structures and mafias, and to gangs involved in common violence or street crime. 63. Guatemala's inequality, poor institutions and inadequate police force cultivates a culture of crime. Guatemala has the third most unequal distribution of income in the world; 20% of citizens live in extreme poverty and over half the population lives in poverty. In addition, a low aggregate income level, widespread corruption and an inability to develop successful policies to provide employment and basic services, such as an effective police force, exacerbate the situation. Furthermore, a weak judicial system lowers the incentive to solve cases since legal rulings can be very inconsistent. 29Centro de Investigaciones Económicas Nacionales (CIEN), Estudio sobre la magnitud y el coste de la violencia en Guatemala, May 2002. 30It is difficult to find data that allow international comparisons. Londoño, J.L. and R. Guerrero, in Violencia en América Latina. Epidemiología y Costos, IDB, documento de trabajo R-375, 1999, calculate that for 1996 the rate of homicides per 100,000 inhabitants in Latin America and Caribe was close to 30 and that this rate was approximately five times higher than the world average. 27 Recommendations 64. Comprehensive Strategy to Reduce Crime. Most actions undertaken by the Guatemalan government in recent years have failed to be effective due to the absence of an appropriate strategy and a lack of coordination, and resources. Main measures to combat crime were defined in the broader policy context of implementation of the peace accords. Particular emphasis was placed on initiatives to ensure the protection of human rights and to provide an active role to civil society through the strengthening the National Civil Police, the Office of the Prosecutor and the Judicial System.31 Although these institutions have experienced some restructuring in the past years, MINUGUA32 estimates that they still demonstrate "poor coordination, and suffer from a lack of resources, inadequate training of personnel, and endemic corruption" 65. Such a comprehensive strategy for combating crime and violence in Guatemala should include (1) increasing resources of the National Civil Police to combat crime, and the Office of the Prosecutor to investigate crime (2) develop a strategy to combat corruption (3) improve co-ordination among the different agencies responsible for crime control and prevention (4) regulate the use of firearms and private provision of security services and (5) improve data collection on crime statistics so as to identify the groups that are most at risk and to define preventive measures. 66. Firms can, and should, take measures to reduce the probability of crime and violence and the impact it may have their firm and employees. At the level of the firm there is much that can be done to prevent and reduce crime and violence. Measures to improve safety of the premises and the employees can be taken through actions such as: improved lighting on and nearby the premises; provision of safe transportation for employees ­ particularly after regular hours; provision of conflict resolution/mediation services and skills training for employees; provision of crime victim support services; and provision of domestic violence reduction programs - raising awareness and helping employees that are victims of domestic violence as well those that commit it. Larger firms might also consider Early Childhood Education programs and vacation programs for children of employees ­ both proven to reduce crime and violence in the community. Supporting local Crime and Violence Prevention initiatives is also very important. Some of the ways this can be done is through: providing resources for local diagnostic studies; support for community-level recreational activities; staff-community mentoring programs; and very importantly, the firm's participation in youth training, internships, and job placement programs for local at-risk youth, young fist-time offenders etc. 67. What is most urgently needed is municipal level efforts, combining public and private sectors, to understand and attack the factors which facilitate crime. 31In particular, the two accords more closely related to public security are the Acuerdo Global sobre Derechos Humanos and the Acuerdo sobre Fortalecimiento del Poder Civil y función del Ejército en una sociedad democrática. 32MINUGUA, Hacia una Guatemala segura: un plan integral para el fortalecimiento de la seguridad pública, 2003. 28 Also, emerging international consensus on policy approaches to combating crime and violence emphasizes specific crime and violence prevention interventions, focusing at the municipal level and targeting risk factors such as easy access to firearms, school drop- outs, family and media violence and unemployment.33 For example, the city of Bogota, Colombia, adopted such a comprehensive local crime and violence reduction approach and succeeded in reducing homicides by 50 percent over a period of 7 years changing its status as the most violent capital in the world to becoming one of the least violent of the larger cities in the region today. The Bogota Chamber of Commerce was an active and important partner in this city- level initiative . 68. Experience from Latin America and elsewhere suggests that one of the most effective entry-points for crime and violence prevention is the local or municipal level. It also shows that the primary responsibility is not just that of the police, but that governments, communities and partnerships at all levels also need to be actively engaged. This can be achieved through effective and multi-sectoral local partnerships with active private sector participation. An effective strategy must be based on comprehensive 'Safety Audits' or crime and violence diagnostics, and combine a three-tiered approach: (1) Judicial/ Policing Reform - ensuring that order, fairness, and access to due process is maintained in the day-to-day activities of the community and reducing the fear of crime; (2) Social Prevention - targeted multi-agency programs that address the causes and associated risk factors of crime and violence, with: (3) Situational Prevention - measures that reduce the opportunities for particular crime and violence problems through urban spatial interventions such as the Crime Prevention Through Environmental Design (CPTED) methodology. This involves integrating crime prevention principles in the design of public spaces, housing, lighting, public transport, recreational spaces, parks, etc. 33Methodology of municipal intervention includes a rigorous process, a partnership with a leader, a local diagnosis of insecurity, a local strategy for urban security and implementation. Possible forms of crime prevention at the municipal level include measures to reinforce family socialization, measures targeting neighborhoods, measures in favor of the security of women, measures in favor of socialization of youth, alternative justice, measures bringing the police closer to the population. (Prevention of Urban Crime, Safer Cities Program, HABITAT). 29 CHAPTER THREE FINANCING FOR FIRMS: A WORLD OF FINANCIAL GROUPS, MAQUILAS, AND THIN COVERAGE A. Introduction 69. Since the late 1990s, Guatemala has gone through a period of high crime, increased corruption and economic uncertainty that has affected private sector competitiveness and productivity. After taking such country risk and macro economic issues into account, the cost of financing, and access to financial services were found to be major constraints for over a third of the firms in the survey. Figure 3.1. Sources of Finance - Working Capital 70. The Guatemalan financial 70 system is sound in general terms and Ecuador 60 is poised for a process of Brazil 50 modernization. A recent set of Peru 40 reforms, particularly through the Honduras approval of important new 30 Guatemala legislation has set up the conditions 20 Nicaragua for a more solid expansion and 10 consolidation. The new laws 0 improved bank licensing provisions; Banks Trade Equity consolidated supervision and Retained credit regulation of financial groups, earnings including off-shore banking; strengthened the regulatory framework and prudential rules; enhanced governance and transparency of banking institutions; and limited the deposit insurance system. It also guaranteed the Central Bank independence, defined its roles, and ensured the measures of capital markets liberalization that had taken place earlier through executive decrees. 71. However, despite recent improvements, there are clear indications that the financial sector is not responsive to the private sector's investment and operating needs­ at 17.8%, Guatemala has one of the lowest ratios of private sector credit to GDP in the region.34 Guatemalan banks finance only 12% of private sector working capital needs, compared to 24% in Honduras and Ecuador, and 27% in Peru and Brazil. As Figure 3.1 reveals, compared to other countries in the region, Guatemalan firms must rely far more on retained earnings and less on bank loans to satisfy working capital requirements. In addition, access to finance is a leading constraint for firms in rural areas (Appendix B). 34 Doing Business, 2003. 30 72. This chapter will summarize the results of the finance section of the Investment Climate survey by focusing on two key issues ­ the costs of credit and the difficulties faced by firms of different sizes and sectors in gaining access to a range of financial services. 73. For financial services cost and access, firm size matters. One overarching conclusion is that there are different financial services offers and constraints depending on the size of the firm. However, the results mirror those from other Central American countries, in terms of the hierarchy of constraints ­ led by interest rate concerns, then collateral, and finally cumbersome application processes (Table 3.1). Table 3.1: Interest rates are the main constraint throughout Central America* Application procedures Collateral requirements Interest rates are too for bank loans are too of bank loans are too high cumbersome stringent Honduras 28% 47% 82% Nicaragua 27% 57% 79% Guatemala 33% 45% 68% *Other constraints (under 10 percent) include the necessity of having contacts or giving informal payments to get loans, and the belief that the loan would not be approved. Source: ICA survey results for Guatemala, Nicaragua, and Honduras (2003) 74. Large firms are linked to export markets and have easy access to local financing. Large firms (with more than 75 employees) did not cite the costs, availability or access to financing as one of the most important constraints.35 Half of the large firms export at least 25 percent of their production, and almost 30 percent have foreign owners. Two thirds of the large firms with loans have long-term loans from local sources in local currency with an average maturity of 43 months.36 Only 11 percent report that they were discouraged from taking out loans due to some constraint. Of all large firms in the ICA sample, only 5 percent complained about interest rates. Since 22 percent of large firms have some degree of foreign ownership, it could be that there are financing agreements (such as export financing) that provide a share of the required financing of operations. Large firms are the least likely to use supplier credit for working capital (14.2 percent of total working capital comes from this source), but the more likely than other firms to turn to this source for investment capital (12.8 percent of total requirements). About 35 percent of large firms export more than 25 percent of their production. Large firms also tend to be members of financial groups, which include banks, finance companies, insurance agencies, and other service providers. Therefore, most large firms tend to have an appropriate level of access to financing at a reasonable cost. Table 3.2: Foreign ownership is more predominant among maquilas and large firms 35 The analysis of large firms does not include 28 large maquilas in the sample. These are analyzed separately, due to special relationships with investors, trade partners. 36 It should be noted that it is not possible to ascertain if these are single long term loans or a series of rollover loans which add up to a long term maturity. 31 Size Domestic Foreign Total Maquilas 43.85 56.2 100 Micro 97.1 2.9 100 Small 98.6 1.4 100 Medium 96.7 3.3 100 Large 77.8 22.2 100 Total 89.9 10.1 100 Table 3.3: Maquilas and large firms export a larger share of sales Size of Share of Sales Exported Firm 0% 1% to 25% 26% to 50% 51% to 75% > 75% Total 0 0 0 12.5 87.5 100 Maquilas Micro 91.3 6.7 1.0 0 1.0 100 Small 78.3 13.0 5.1 0 3.6 100 Medium 58.2 32.9 6.6 2.2 0 100 Large 37.8 27.8 20.0 5.6 8.9 100 Total 63.7 17.6 7.0 2.4 9.2 100 75. Maquilas are built on a special relationship with investors and export markets. The maquila (assembly) industry subsample of 32 large and medium sized firms reveals that 72 percent these firms do not rely on banks for financing.37 The maquilas with loans pay less and have the longest loan maturities compared to other large and medium firms, whether for loans in quetzales or dollars.38 The cost of financing is critical to these firms, since they face increased competition based on cost and efficiency from firms in Honduras and El Salvador. The industry has a few important advantages ­ a strong cluster infrastructure, low labor costs, and a good location. However, the key barriers for these maquilas include low fiscal incentives, port and customs inefficiency, lack of specialized infrastructure, low access to markets, low technology investment, and high dependence on the U.S. market. These firms lag behind their neighbors in terms of technology levels and have just begun to make the transition from simple assembly to exporting a complete package of services. More attractive financial services (especially dollar-denominated loans) could enable them to overcome the technology gap and smooth the transition to the complete package of services increasingly demanded by clients. 76. Many medium sized firms have access to loans, but are charged as if they were micros. Fifty six percent report that they have loans from banks, while 15 percent don't require such financing. The remaining firms report that applications were rejected (5 percent) or that serious constraints blocked them from gaining access (24 percent). They are less likely to have a loan application approved by a bank than large firms (approval rates are 65 percent for medium firms compared to 88 percent for large firms). 37 This subset included 27 clothing assembly factories, two chemicals producers, two metal producers, and one textile firm. 38 Maquilas pay an average of 7.8 percent for quetzal loans (sample average is 17.4 percent) and 10.3 percent for dollar loans (sample average is 13.33 percent). Maquila loan maturities are 60 months for quetzal loans (sample average is 40.4 months) and 66 months for dollar loans (sample average is 44 months). 32 Medium sized firms are price sensitive, with 75 percent citing interest rates as an important constraint. These firms were the least likely to mention collateral requirements or cumbersome application processes. For collateral, they were able to use machinery and equipment, intangible accounts (accounts receivable and inventory) and personal assets more than other firms. More than all other firms, medium sized businesses turn to internally generated funds for investment capital, but are the least likely to use this source for working capital. Thirty two percent of medium firms export some part of their production. As CAFTA takes effect, a greater number could become competitive in overseas markets, if financial and other constraints are resolved. They are too small to be members of financial groups, and are too large to qualify for consumer loans from commercial banks or production loans from specialized micro-finance institutions. 77. Small firms pay more for credit, when they can get it. Of 136 small firms in the ICA survey, only 41 percent report that they have access to bank financing. More than 29 percent don't report a need for credit, twice the rates of small firms in Honduras (15 percent) and Nicaragua (15 percent). The remainder of small firms in Guatemala report that their application was rejected (7 percent) or the constraints discouraged them from applying (24 percent). These firms are the most likely to point to cumbersome applications as an important problem, and are less likely than other firms to point to interest rates (even though they pay the most for quetzal-denominated loans).39 In terms of collateral, small firms are more frequently required to back loans with land and buildings, and are less able to use personal assets. Less than 15 percent have access to dollar loans, and 22 percent export at least some part of their production. As CAFTA takes effect, they are likely to face increased competition in the national market. Greater access to financing could enable them to modernize, train workers, expand product lines, and become more competitive in other ways. 78. Formal micro businesses face limited access and cite costs and collateral as the reasons. Formally registered micro businesses are more concerned with financing, and cite the cost, availability and access to financial services as important constraints. Only 29 percent have access to credit (quetzal-denominated loans only), and pay about 18 percent for loans with an average maturity of 30 months. However, this compares favorably to micro firms that do not need a loan in Honduras (15 percent) and Nicaragua (17 percent). Another 30 percent state that they do not require loans, while the remaining firms were either rejected (3 percent) or did not apply due to constraints (39 percent). Almost 75 percent of those that identified constraints pointed to interest rates, while about half mentioned collateral requirements. With such low access, micro businesses are much more reliant on internally generated funds to cover working capital and investment capital needs. While they are not likely to gain directly from CAFTA or generate a significant number of new jobs, micros could become significant suppliers of other firms. 79. Informal micro businesses rely heavily on internally generated funds and some remittances. A recent study conducted by the Centro de Investigaciones Económicas Nacionales (CIEN) found that informal sector micro firms rely more heavily 39 Small firms pay an average of 19.9 percent, compared to 18.2 percent for micro and medium firms, 13.6 percent for large, and only 7.8 percent for maquilas. 33 than formal sector micro firms on internally generated funds, local markets, and direct links to consumers.40 These firms contributed an estimated 28 percent of the national domestic product in 2000, and play an especially important role in ceramics, jewelry, construction materials, and wood and paper products. Of the urban firms, 73 percent reported that access to loans was a problem, and it was ranked as the fourth most important limitation. The cost of financing was cited by 80 percent of the urban informal firms as a constraint (ranked as the second most important problem). More than 97 percent rely on retained earnings to finance operations, which cover 84 percent of expenses on average. Remittances and funds from family members accounted for 10 percent of capital, and were used by 27 percent of the firms. Only 3 percent reported having an overdraft or bank loan at the time of the survey, and only 2.9 percent had a credit card. 38 percent of the firms have deposit accounts with a commercial bank, but only 15 percent have ever obtained a bank loan. 80. The next two sections reveal the causes behind these findings, in terms of both the costs of credit and access to financial services. The last section provides recommendations on how firms can obtain better access to financial services at a reasonable cost. The Costs of Credit. 81. Credit is Expensive by Central American Standards. The margin between average lending interest rate and average deposit rate is 11 percent (Table 3.4), making Guatemala a leader in Central America (the average margin is 9.8 percent, and the margin in El Salvador is only 4.6 percent).41 A large margin is considered to be a sign of uncompetitive and inefficient financial markets (Doing Business, 2003). These high lending interest rates are a disincentive to firms to expand or invest research and development. In Guatemala, about 66 percent of the firms that could use external financing consider interest rates for working capital and investment credit so high that they do not apply for loans. While high by international standards, the interest rate spread is comparable to those found in many Latin American countries (Table 3.2). 40 The CIEN study is not a direct comparator with the ICA survey, since it includes both rural and urban samples and focuses only on Guatemala City and surrounding communities. (CIEN, 2004). 41Doing Business database, 2003. 34 Table 3.4: Costs are high, coverage is low compared to regional competitors Country Private Credit ( % Five bank Interest rate spread GDP) concentration ratio (%) (%) Bolivia 52 57 24 Chile 61 79 5 Ecuador 30 69 10 Guatemala 18 44 11 Honduras 35 63 11 Nicaragua 48 87 11 Peru 26 80 14 82. The structure of the finance sector provides some answers to the high costs. The ratio in Table 5.4 shows a relatively low five bank concentration ratio for Guatemala, implying a competitive financial sector. However, this interpretation is deceptive. The banking system in Guatemala consists of 29 private national banks, two branches of private foreign banks, a state "financiera" and 20 private "sociedades financieras". There are also 18 insurance companies, 13 finance companies and 7 "casas de cambio" However, the financial sector is dominated by 12 financial groups. A more revealing statistic is private credit as a percentage of Gross Domestic Capital, which illustrates the productive financing role played by the commercial finance sector. At only 18 percent, it is among the lowest in Latin America, compared to 26 percent for Peru, 35 percent for Honduras, and 48 percent for Nicaragua. The high costs are partially explained by administrative costs, which average 5 percent of assets (compared to only 4.3 percent in Nicaragua, and 3.0 percent in Honduras, as Figure 3.2 shows). Figure 3.2: Guatemalan banks could improve their efficiency (Defined as administrative expenses over assets, international comparison) 8 7 6.4 5.9 6 5.0 5 4.3 4 3.0 3 2 0.9 1 0 ca aal a Costa Ri Hondura raguaac El anamP Guatem Ni adorvalS Source:BancoCentral (BCH) and CNBS 2002 83. A lack of information on client repayment behavior also raises the cost of credit. Additional factors raising the cost of credit include low coverage by the private credit bureau, the lack of annual percentage rates for loans, and the low level of firms with audited financial statements. The private credit bureau covers only 35 borrowers per thousand, far below the regional average of 197 and the OECD coverage of 443 (Doing 35 Business, 2003). The lack of coverage makes it impossible for financial institutions to quickly gauge the repayment performance and indebtedness of a potential borrower. There is also no requirement for banks to provide a loan's annual percentage rate (APR) that would enable potential borrowers to compare lending service costs provided by the financial institutions, increasing competition. The lack of external audits for the majority of firms also contributes to higher lending interest rates. The financial institution must assume the additional cost and burden of constructing financial statements in some cases, and confirming values and management practices in others. This can become a major source of processing delays and costs. Figure 3.3 Guatemalan banks have relatively low coverage 100 90 80 72.8 70 60 51.2 50 44.6 43.7 43.5 40 34.7 30 20 10 0 Ecuador Honduras Peru Nicaragua Guatemala Brazil 84. Size and Sector characteristics can contribute to higher interest rates. A regression of 187 firms with bank loans in the survey shows that micro and small firms are likely to pay more than six percentage points higher than the rates offered to large firms. Medium sized firms pay a 4.5 percent premium. Chemical and rubber firms are able to obtain interest rates 2.5 percent lower than the average for firms in the apparel sector. Access Issues 85. Access is limited due to regulatory and judicial systems and bank infrastructure. In a regional comparison, Guatemalan firms are less likely than most to gain access to bank loans (See Figure 3.3). Even for firms willing to pay a relatively high rate of interest, credit is often not available. Access to credit is limited by the lack of movable asset registries, contract enforcement problems, the high concentration of bank branches and other financial infrastructure in metropolitan Guatemala City. 86. Failures in Regulatory and Judicial areas present formidable barriers to access. The lack of a well-functioning system for security interests in Guatemala results in higher interest rates and reduced access to credit. A recent study determined that judicial efficiency (both for creating security titles and enforcing contracts) appears to be the main driver of the interest rate spread42. Stronger rule of law is associated with more effective private credit registries, which are in turn associated with lower financing 42Laeven, Luc and Giovanni Majnoni, "Does Judicial Efficiency Lower the Cost of Credit?", October 10, 2003. (data collected across 106 countries at aggregate level). 36 constraints and a high share of bank borrowing in firms' financing structures43. The Guatemalan situation is particularly severe -- only 38 percent of loans are guaranteed by a security interest. The ICA survey findings confirm that collateral is not as critical a constraint as in other countries ­ 27 percent of bank credits did not require collateral or a compensatory savings deposit, compared to 10 percent in Honduras and Nicaragua. 87. Guatemalan banks are not comfortable with guarantees, which are difficult to establish and execute. Legal enforcement of collateral repossession is poor, and cadastres are deficient, which limits the creation of new titles establishing bankable property rights. When collateral is taken to back a loan, stringent requirements are involved (45 percent of the ICA sample pointed to this issue, compared to 57% in Nicaragua and 47% in Honduras). The average level of collateral required was cited as 115 percent of loan value, very low compared to other countries in the region (218 percent in Nicaragua, 177 percent in Ecuador, and 154 percent in Honduras). Figure 3.4 International Comparison of % of Loans Requiring Collateral 100 92.4 89.2 85.3 83.0 80 73.1 72.5 70.6 69.9 69.3 67.0 60 40 20 0 China emala Peru Brazil Nicaragua Honduras Malaysia uatG Ecuador Pakistan Bangladesh 88. There are serious flaws in the legal and institutional framework for the pledging of movable assets to secure credit. To compensate for this increased risk, banks often charge higher interest rates and ration credit by lending only to large creditworthy or well-connected companies. Furthermore, larger, wealthier companies in Guatemala tend to form economic groups and buy or start a bank to provide credit to the group members, leaving out the poor and middle classes and small and medium companies. 89. Another contributing factor is the difficulties of enforcing contracts, including financial services contracts, in Guatemala. It takes four times as long to enforce a contract in Guatemala compared to the Latin American average (1460 days vs. 363 days). Contract enforcement requires only 19 steps, fairly streamlined compared to the 33 step regional average and close to the OECD average of 17 procedures. However, 43Love, Inessa and Nataliya Mylenko, "Credit Reporting and Financing Constraints" October, 2003 37 procedural complexity has been cited as cause of enforcement difficulties (a rating of 90 for Guatemala, compared to a regional average of 70 and an OECD average of 49). 90. Given such constraints, it is not surprising that rapid growth in bank assets has not translated into loans for the private sector. The rapid growth of the commercial bank system without a proportional increase in lending activity has contributed to already conservative lending practices that limit access. Total banking system assets were US$8.4 billion in December of 2003, representing rapid growth over a four-year period (134 percent in real terms) with relatively slow economic growth (10.7 percent in real terms). These figures understate the true size of the system, since much of the banking activity that occurs within Guatemala is booked in unregulated domestic subsidiaries of the banks or in an offshore bank member of a financial group. However, the increase in assets has not turned into increased lending to the private sector, with commercial bank lending as a share of total assets stagnant at around 45 percent since 2000. 91. Loan portfolio quality problems are another brake on bank lending. According to Superintendency of Banks statistics, portfolio quality as of December 2003 has also been an important issue, with 10.7% of the banking system loan portfolio classified as having at least one late payment (3.1 percent) or overdue after maturity (7.6 percent), with 5 percent in judicial recovery. However, this represents an improvement over December, 2002 ­ when 3.5 percent of the portfolio had at least one late payment and 10.5 percent was overdue after maturity (including 7.5 percent in judicial recovery). 92. The financial sector is going through a rationalization process. Given the size of the local market and the economies of scale of the banking business, the number of banks and finance companies is slowly being reduced through mergers, interventions and liquidations. The aftershocks of the 1999 banking crisis continue to affect the sector. Three banks were unable to repay their loans under restructuring programs and were intervened by the Monetary Board during the first quarter of 2001 alone. As of February 2004, only about 16 percent of the more than US$2 billion in Government support provided to the three banks has been recovered. 93. On the other hand, many banks provide overdrafts and lines of credit to almost half of the firms in the ICA survey. These appear to be renewable, providing longer maturity than a standard loan for firms. They also provide a risk management tool in terms of liquidity management and client selection for banks, as well as greater flexibility for interest rate hikes in the future. Such renewable short term arrangements may be useful for working capital needs, but do not offer the long term stability for machinery and other investments. Even for working capital, supplier credit is a more viable alternative for firms (except for the large firms). Also, on average, 60 percent of the amount of the overdraft is unused. Table 3.5: Overdrafts cover some needs, but Firms need more reliable sources Firm % Firms % Firms % using % of Size with Overdrafts with Loans Loans for Loans for investment capital working capital Micro 44.1 28.7 13.4 5.6 38 Small 47.3 41.1 17.2 11.1 Medium 53.5 56.1 13.8 12.4 Large 52.5 63.1 21.7 14.7 Maquilas 53.1 28.1 5.6 10.0 Total 49.0 44.4 15.8 10.7 Table 3.6: Guatemalan firms have access to overdrafts, but 60 percent of the amount goes unused Firm Size Nicaragua Honduras Guatemala Micro 19.8 22.5 44.1 Small 25.3 34.9 47.3 Medium 40.5 58.3 53.5 Large 63.8 66.7 52.5 Total 30.7 42.7 49.0 94. Access to credit is linked tightly to the geographic location of the firm. In January, 2003, 91 percent of bank loans were made in the Guatemala City metropolitan area. The second largest city, Escuintla, garnered only 2 percent of bank loans. Quetzaltenango, the third largest city, received a scant 0.5 percent of bank loans, despite serving as headquarters for two of the larger banks. Recommendations 95. Improved Regulation. The private sector could benefit directly and significantly from an improved legal and regulatory framework, greater transparency and more responsive financial institutions. In particular, the draft laws on the Cadastre and Property Registration, and on Secured Transactions, along with an acceleration of the cadastre program and the modernization of the Registry, should be passed and implemented. 96. The Public and Private Sectors should take steps to improve the transparency of the Financial Sector. The Government, supervised financial institutions and the private sector can take specific actions to promote more affordable access to a range of financial services. The most important contribution of the Government would be to continue to minimize the fiscal gap between spending and income, thereby avoiding additional "crowding out" of private investment. The Government should also support initiatives for the development of a private credit bureau system, as part of an overall campaign for consumer protection in the financial sector. Another element of this campaign would be a regulation to insure that annual percentage rates are provided by supervised financial institutions and strongly encouraged for unsupervised micro credit institutions. 97. Judicial reform would help to lower the risks of financial transactions and lessen the uncertainty of financial contracts. An improved movable assets legal and regulatory framework would improve the ability of borrowers to use movable assets as guarantees for loans. Creditors would benefit in terms of streamlined contract 39 enforcement. Banks would benefit from more streamlined review of loans under judicial review. 98. The Superintendency of Banks should establish additional safeguards as the banking sector rationalization process continues over the next few years. In particular, the financial groups should be carefully tracked, to protect depositors, borrowers, and investors in the event that a financial institution faces a crisis. As Government bonds become a less important source of risk-free investment, the banks should be encouraged to upgrade their infrastructure to take full advantage of existing technologies (such as parametric models). 99. The banks and finance companies need to improve internal systems that contribute to higher processing costs and delays. Even though Guatemalan banks are better than some in the region, these banks could invest in technological improvements to improve their efficiency significantly. For instance, parametric models that can classify good and bad clients efficiently are not commonly used in Guatemala. Given the poor quality of the existing loans portfolios, banks should improve selection techniques to move beyond reliance on physical guarantees, thereby opening up financial markets to more small and medium firms. Once the confidentiality of financial information is guaranteed, banks should participate in the private credit bureau initiatives, to enhance their information base on actual and potential clients. They could also improve the menu of payment and transfer products, lowering profit margins to broaden coverage. By partnering with micro finance institutions that have reached scale, such as Génesis Empresarial, commercial banks and finance companies could broaden their coverage while spreading the sunk costs required to develop new products and new client bases. 100. A clear legal and regulatory framework for microfinance could support the sector's orderly growth. There should be a clear line drawn between microfinance activities (which intermediate savings to finance a share of the loan portfolio) and microcredit activities (in which donor and other investor funds are retailed to microbusinesses). Developed in coordination with the microfinance industry association, REDIMIF, and building on international examples and best practices, a clear legal and regulatory framework could contribute significantly to improved outreach and financial performance. 101. Business associations could help to establish standards for member firms that enable a rapid and transparent assessment of a firm's growth potential and risks (including sector specific risks). They could also organize periodic meetings of financial institutions and small and medium firms, to improve the exchange of information and contribute to more client-friendly products and bank business processes. This would be a low cost solution to one element of the high cost of commercial banks in doing business with small and microbusinesses. A study of the financing arrangements of maquilas could lead to new opportunities and local synergies. Since the maquila sector is now a leading source of employment, it becomes increasingly important to understand their dynamics, the sources of their 40 competitive advantage, and the factors that could endanger this market position. Maquila business associations, such as Vestex, could play an important role in maximizing the national impacts of the maquila industry. 41 CHAPTER FOUR INFRASTRUCTURE AND LOGISTICS A. Introduction 102. Following the 1996 Peace Accords, Guatemala embarked on a major program of infrastructure reform involving the restructuring and privatization of the electricity and telecommunications sectors. Following these reforms, the quality of services appears to be relatively good in Guatemala.44 Business executives surveyed for the Global Competitiveness Report 2002/03 ranked Guatemala higher than other countries in the region in infrastructure quality (World Economic Forum 2003). The executives were asked to rate the infrastructure quality in their country on a scale of 1 ("poorly developed and inefficient") to 7 ("among the best in the world"). Of the 80 developing and industrial countries in the sample, Guatemala ranked 63rd on the overall quality of infrastructure, higher than the other countries in the region, with the exception of El Salvador (Figure 4.1). Figure 4.1 Rankings of Guatemala and Comparator Countries by Overall Quality of Infrastructure Overall quality of Infrastructure Nicaragua Costa Rica Honduras El Salvador Guatemala Stronger 0 20 40 Weaker 60 80 Source: Global Competitiveness Report, 2003 103. Evidence from the firm-level investment climate surveys confirms that the quality of infrastructure services is not a significant problem for the formal or informal sector in Guatemala, with the exception of electricity being a major obstacle for about 27 percent of the formal enterprises (32 percent for informal enterprises). Asked to rate the extent to which telecommunications, electricity, and transport hampered enterprise operations and growth in their country, 38 percent of enterprises in Guatemala reported 44This section draws substantially on the Guatemala Country Economic Memorandum 2004 and the Infrastructure Reform, World Bank Policy Research Working Paper. 42 that electricity posed no obstacle (Figure 4.2).45 Electricity was a smaller concern in Honduras and Nicaragua. Enterprises in Guatemala rated services in other infrastructure sectors higher, with transport posing no obstacle for 48 percent, and telecommunications posing no obstacle for more than 60 percent of the enterprises (Figure 4.2). Figure 4.2. Share of Firms in Guatemala and Comparator Countries Reporting That Infrastructure Is No Obstacle to Business Operations 70 62.64 63.47 61.2865.04 60 48.35 49.9 50 37.36 40 29.42 30 18.57 20 10 0 Guatemala Honduras Nicaragua Telecommunications Transportation Power Source: Investment climate surveys. B. Power 104. Guatemala started restructuring the electricity sector in the early 1990s46 but performance improved substantially after the new Electricity Law was enacted in 1996.47 Only 26.6 percent of the firms in the sample found electricity to be a major or severe constraint to operations, with the problem posing a more severe constraint to large firms as compared with micro and SMEs. 105. Institutional Arrangements complete. The legal, regulatory and institutional framework is almost complete. There are three institutions responsible for regulation-- National Electrical Energy Commission (CNEE), Administrator of the Wholesale Market 45The ranking was on a five-point scale, with 0 implying that infrastructure services posed no obstacle and 5 implying that it posed a very severe obstacle. To avoid problems associated with averaging subjective answers, the number of enterprises reporting that infrastructure was no obstacle is presented. 46In 1992, Empresa Eléctrica de Guatemala SA (EEGSA), one of the state electricity companies, was sold in an effort to stimulate private investment and capacity additions that would reduce the chances of supply outages. Private investment was attained through long term power purchase agreements (PPAs) that created stranded cost in the implementation of the subsequent market oriented strategy. 47The key features of the 1996 sector Law are: (a) unbundling the activities of the sector in generation, transmission, distribution and commercialization of energy; (b) competition in the generation and commercialization activities; (c) unrestricted and open-access to the transmission system; (d) freedom of large energy consumers to choose their supplier; and (e) unregulated generation prices, and transmission and distribution prices regulated according to established and transparent norms. 43 (AMM), and the Ministry of Energy and Mining (MEM). The CNEE has a semi- autonomous status; it is technically is part of the MEM, but its budget is financed with the proceeds of a 0.3% tax on the electricity sales of distribution companies. Notwithstanding the reforms, the state-owned INDE retains a dominant position in the system. It still controls about half (mainly hydroelectric) generating plants, but competes with independent power producers that control the rest of the (primarily thermal) capacity. Furthermore, INDE continues to own and operate the national transmission grid. 106. In recent years, key regulations of the Law and technical norms have been drafted, a law organizing the operation of the wholesale market has been approved and new policies, specially regarding rural electrification, have been developed. After more than seven years of application, the General Electricity Law has generally proved to be adequate for the country's power sector. There is need, however, to consolidate the institutional structure created as a result of the reforms.48 29. Increased Capacity and Coverage. An important benefit of the electricity reform has been the rapid increase in capacity and coverage. Installed capacity increased by 27 percent from 1,314 MW in 1996 to 1,670 MW in 2002. Improvements in efficiency and the implementation of a rural electrification program have resulted in a significant increase in electricity coverage from 53% in 1996 to 85% households connected in 2002, the second highest level in Central America after Costa Rica. Coverage is expected to reach levels close to 90% in 2004. 49 Yet, generating capacity remains low relative to that in other countries in Central America. While Guatemala had about 0.14 kilowatts of capacity per capita in 2001, Costa Rica had 0.4 and El Salvador had 0.16. Figure 4.3 : Electricity Coverage in Guatemala and Central America 1..1 Electrification coverage 1995-2002 comparisons Central America coverage (1990-2002) (% of households) Source: Comisión Nacional de Energía Eléctrica Source: CEPAL, Evaluación de diez años de reforma en la 48CNEE is highly vulnerable to legislative changes which could reduce its independence. Also, attention should be given to the future of the entities that still remain in the public sector. 49Comisión Nacional de Energía Eléctrica (CNEE), Informe de Labores 2002-2003, Guatemala. 44 Figure 4.4 Electricity Generating Capacity in Guatemala and Comparator Countries, 2001 (kilowatts per capita) Electric Generating Capacity per capita(million kw) 0.6 0.5 0.4 0.3 0.2 0.1 0 Panama Costa El Guatemala Honduras Nicaragua Rica Salvador Source: U.S. Energy Information Agency. Figure 4.5 Performance Measures for the Power Sector in Guatemala and Comparator Countries 35% 33% 3.5% 3% 30% 27% 3.0% outages) 25% 2.5% 21% 2% power 20% 18% 2.0% to generators) 15% 1.5% due with 1% (%10% 1.0% losses 5% 0.5% 0% 0% 0.0% (median Guatemala Honduras Nicaragua China Source: Investment Climate Surveys 107. With improvements in coverage and quality, only 21 percent of firms in the sample stated they rely on generators, and firms reported a median number of power outages of 4. In addition, median losses due to power outages are very low and just about 1 percent of sales (Figure 4.5). 108. Higher Costs. Compared with other countries in the region, Guatemalan firms incur higher costs for electricity in the range of 25-50 percent.50 Prices have risen 50Guatemala Country Economic Memorandum 2004. 45 substantially after the reforms. Under the new regulatory framework, privatized distribution companies are allowed to pass on to the customers the variations in the purchase cost of energy. Due to the fact that the current Power Purchase Agreements (PPAs) signed between generators and distributors are indexed to the US dollar and the price of oil, prices have risen substantially since 1998, between 60 and 80 percent depending on the company. 109. Distortions still exist. Electricity law authorizes large consumers to contract directly from generators or marketers, or buy from the spot market, while medium and small consumers must pay regulated tariffs. The law establishes cost-recovery principles for the tariff setting.51 However, significant stranded costs were created by the PPAs signed prior to 1996. The characteristics of "existing contracts" -- involving approximately 33% of all energy produced in Guatemala --account for the high electricity prices.52 These high prices are only passed on to consumers subject to regulated tariffs. In addition, a generalized social tariff introduced by the 2001 Social Rate Act creates further distortions. The Law establishes a "social rate" at a low price for users consuming less than 300 kWh per month. The limit set is so high that it applies to close to 90 percent of all residential users, and 43 percent of energy distributed, thus representing a general subsidy53. Thus, although real electricity tariffs increased by between 60 and 80 percent following the reform, residential consumers have been shielded by the social tariff that has kept charges at pre-reform levels of US0.08 per kilowatt hour. This policy costs US$50 million per year. Table 4.1 : Average electricity price per kWh in Central America. June 2003 Firm / Country 51All distribution companies must supply their regulated customers through long-term contracts, trading net balance in the spot market. 52They lasted approximately 15 years, have a separate price for energy and capacity and originally set very high levels to the minimum amount of energy and capacity that should be paid by distributors, independently of whether they were provided or not. They were subscribed in US$ and were tied to the evolution of the international oil price. After several frustrated attempts, the contracts were renegotiated in 2000 lowering the capacity charge and reducing the obligations to buy the capacity and energy not delivered. In exchange, the duration of these contracts was extended. 53Low voltage customers not subject to the social tariff pay between 1.8 and 2.1 times more for electricity. 46 Sector Consumption EGAS CAESS ENE EDN y S ICE ElectraNE Guatemala(1) El Honduras Costa Salvador Panamá Nicaragua Rica Residential 100 kWh 7.86 7.49 5.07 8.65 5.26 12.56 250 kWh 7.75 11.10 6.95 8.85 5.98 12.39 1,000 kWh 14.19 10.57 9.54 12.90 9.17 12.31 Commercial 1,000 kWh 13.79 10.45 11.45 13.11 10.07 9.55 15,000 kWh, 41kW 14.37 8.05 11.45 11.69 8.70 11.53 50000 kWh, 137 kW 14.36 8.04 11.45 12.47 7.91 11.52 Industrial(2) 15,000 kWh, 41kW 14.37 8.04 11.45 11.64 8.70 11.53 50,000 kWh, 137 14.36 8.04 11.45 11.70 7.91 11.52 kW 100,000kWh,274kW 13.34 8.04 9.25 11.73 7.91 9.80 (1) Guatemala applies a subsidized tariff to residential customers with consumption below 300kWh/month (2) Load factor 50% Source: Proceso Demanda Eléctrica, CENPE, Instituto Costarricense de Electricidad 110. The current situation is unlikely to be sustainable in the future as demand increases at a relatively high rate. The needs of social tariff consumers may not be met in the future with low cost generating sources. Furthermore, the social rate has caused significant opportunity costs for INDE, the public company, and could potentially threaten its financial viability. The political resistance to rate increases and elimination of subsidies, may jeopardize the reform of the power sector in Guatemala. Recommendations 111. Moving forward, the Government should (i) reconsider the definition of the social tariff, and a more pro-poor policy would be to channel these resources towards expanding coverage of electricity to the un served population; (ii) improve the regulatory framework to provide incentives for long term investment and efficient energy use; (iii) push the PER implementation forward and institute decision and financing mechanisms to allow for on- and off-grid solutions to provide electricity to the remaining households without electricity. C. Transport, Ports, and Customs 47 112. As noted, results from the firm-level surveys suggest that transport is a bigger problem in Guatemala than in some comparator countries, with enterprise managers in Guatemala less likely than those in Honduras and Nicaragua to say that transport posed no obstacle to enterprise operations and growth (Figure 4.2). Figure 4.6 Rankings of Guatemala and Comparator Countries by Quality of Ports and Roads Costa Rica Honduras Air Roads Guatemala Ports El Salvador Panama 0 20 40 60 80 100 Strongest Weakest 113. This is consistent with evidence from Global Competitiveness Report 2002/03 (World Economic Forum 2003). Based on executives' ratings of the quality of infrastructure sectors in their country, Guatemala ranked 71st among the 80 countries for ports, 68th in air transport and 50th for roads (Figure 4.6). Although Guatemala outperformed most Central American countries in the ranking for roads, it ranked lower than Honduras and El Salvador for ports, and only slightly better than Honduras and Nicaragua in air transport. 54 percent of the firms in the informal sector found transport to be a major or severe impediment to business operations. 114. Low density of roads. In 2002, Guatemala had a 26,000 km road network, of which 14,000 km were classified.54 However, the classified road density is in the lower range in Central America, and significantly lower than what would be expected from the country's level of development (Table 4.2). As a result, relative physical isolation is not uncommon in Guatemala: some 13% of households lack access to a motorable road (surfaced or un surfaced) with the proportion being higher in rural areas and rising with poverty.55 However, a significant part of the road network is paved (the highest proportion in Central-America, although it remains lower than countries with a similar level of development). This quality is widely acknowledged by users. According to a 2000 survey56, almost the entire business community in Guatemala was satisfied by the 55Poverty in Guatemala , Report 24221-GU, The World Bank, February 2003. 56Investment Climate Around the World, 2002 (Batra, Kaufmann and Stone) 48 quality of roads, compared to satisfaction rate of 59 percent for Central America as a whole. Budget constraints, limited private sector participation, and an uncertain regulatory framework has adversely impacted the development of road transport. Table 4.2 : Road performance in Guatemala and benchmarks Guatemala Centro América Latin Countries with incl. w/o America similar GDP per Guate Guate capita * Classified road density (km/km2) 0.13 0.29 0.32 0.16 0.45 ­ 1999 Class. Road density (km/1,000 1.3 3.8 4.3 5.2 4.1 people) ­ 1999 % paved roads ­ 1999 35 24 21 24 59 % businesses satisfied by road 98 59 51 51 53 quality ­ 2000 · With per capita GDP PPP between 3,000 and 4,000 USD in 1999. Source: World Development Indicators 115. Although it has increased overtime, Guatemala's port activity is lower than expected given the size of the Guatemalan economy. Ports are the main entry points for 80 percent of the country's foreign trade (with imports being 50 percent higher than exports). The Caribbean ports move 60percent of the freight; the Caribbean terminals (Santo Tomás de Castilla and Pto. Barrios) deal with more than 77 percent of the container cargo, and the Pacific terminals (Puerto Quetzal) handle the remaining 23 percent57. Guatemala has five ports but only three are in operation, Santo Tomás de Castilla and Puerto Barrios (on the Atlantic Coast) and Puerto Quetzal (on the Pacific Coast). Between 1995 and 2002, the tonnage of freight handled in Guatemalan ports has experienced a significant increase (larger than most other ports in the region). In 2002, Guatemalan ports managed 21 percent of the freight handled in Central-America ports (ranking second after Panama with 38 percent). However, when compared to the country's population or size of the economy, port activity in Guatemala is low compared to the average observed in Central-America, as for instance Honduras (Table 4.3). Limited trade (which itself could be constrained by a low efficiency of Guatemala's ports) provide a credible explanation to the low port activity: when compared to the intensity of trade flows, port activity is at the regional average. 116. Absence of a strong regulatory body (maritime authority), limited private sector participation, corruption, unreliability, losses from theft and interruptions, weak human resource management have contributed to the under-utilization of capacity of ports.58 572002 data 58Efficiency rankings of ports are--Puerto Barrios, despite its limited infrastructures (3 berths), then Puerto Quetzal whose efficiency has improved since 1998, and, finally, Santo Tomás where corruption and unreliability problems have been reported. 49 Table 4.3: Guatemala's port activity, 2002 Guatemala Central-America Including Excluding Guatemala Guatemala Port activity (tons per capita) 1.02 2.15 2.37 Port activity (tons per million USD GDP) 525 863 930 Port activity (tons per million USD trade flows) 1,276 1,249 1,243 Source: COCATRAM. 117. Air freight transportation is concentrated in La Aurora international airports (Guatemala city), where freight facilities have been concessioned to a private-public provider; regional aircrafts of regular lines are the main users. Guatemala has adopted an open sky policy with respect to air freight transportation. Intra-regional trade (40%), is mostly carried out by road. 118. Interruptions in transport are not uncommon among firms, and affect exporters and non-exporting firms to a similar extent. 30 percent of firms in the sample experienced interruptions in transport in 2002. The average number of interruptions was 2, with the average number for exporters and non-exporters slightly higher for non-exporters. The average duration of these interruptions as measured by the median of the sample is 4 hours, with the duration higher for non-exporters at 5 hours. On an international basis, Guatemala performs better than other countries in LAC--for example, in Brazil the median duration of these interruptions is 10 hours, 8 hours in Honduras and 24 hours in Nicaragua. Losses (as a percentage of sales) from transport interruptions are on average 1.6 percent.59 Survey results show that slightly higher losses are experienced by non exporting, domestic market oriented firms. This is consistent with both the average number of occurrences of transport interruptions and the duration of the interruptions, which also decrease with an increase in export activity. 119. To the extent that non-exporting firms tend to rely more on road transport, the duration of the interruption is more likely to be related to the inefficiency of the transport service rather than the infrastructure itself. The trucking industry in Guatemala, consistent with the rest of the region, is characterized by an aged fleet, lack of adequate regulations for vehicle and drivers operating conditions, discrimination of foreign trucks (even where regional agreements are in place), and anti-competitive practices (cartels). 120. Losses during transit are not trivial. On average in the sample, 40 percent of the firms declared that they had incurred losses during transit. The losses may have arisen on account of breakage, spoilage, or theft. On average, for those enterprises experiencing losses, the loss is of 4.2 percent of the total consignment value. For those 59A high correlation was observed between the duration of transport interruption and losses incurred as a result of these interruptions. Preliminary analysis suggests that 24 hours of additional total time of transport interruption reduces the probability of a firm reporting profits by 15 percent. 50 firms facing transport interruptions, the total loss during transport increases to 5.2 percent of consignment value, while for those firms that do not face transport interruptions (but still face losses during transport) the loss is 3.3 percent60. When the firms are classified by being located in a free-zone v/s outside, we find that firms operating in free-zones experience slightly higher losses on average. These firms are more likely to use air transport and hence this finding may be an indication of relative inefficiencies in the Guatemalan air transport sector, or - more likely - in the trucking services connecting the airports with the manufacturing plants. The concession of La Aurora freight facilities and the open sky policy for freight transport make air transport relatively efficient, although capacity constraints may show up in the near future if the demand keeps growing.61 6263 121. Customs has improved significantly, but delays continue. How ports and customs work together is critical: firms that import or export rely on well-functioning ports and efficient customs procedures to bring in needed inputs and send out finished products. Here Guatemala has shown substantial improvement in recent years. Five years ago, the performance of the Guatemalan customs was among the lowest in Central- America, according to a 1997 INCAE study.64 In 2000, the business community still had a negative perception of the performance of Guatemalan customs, accordingly to the World Bank's WBES. A modernization process has started recently, as customs has been integrated in the modern and autonomous Superintendencia de Administracion Tributaria (SAT). Custom units have been equipped with computers since 2001 (with an on-line system allowing a close monitoring of custom operations and a "workflow-type" management of procedures65); collection of customs fees and taxes are made directly by local banks; and a training program has also being implemented 60Losses are higher when firms use Puerto Quetzal. Assuming that firms are likely to use the same port when exporting, an interesting result is that firms using Puerto Quetzal (located in the Pacific) experience higher losses during transport than firms using Puerto Santo Tomás de Castilla (in the Caribbean). This loss could be related to losses incurred inside the ports, but also to losses incurred enroute from the firm to the port. Santo Tomás de Castilla ­ which moves almost half of the containers - is the most critical port for textile exports, because of its location relative to the U.S. Gulf and East Coast markets. The port is under public management, with some crane and handling services leased to private firms. Efficiency is low, resulting in a cost that is estimated to be 30 percent higher than other comparable regional ports. The current surcharge is in the range of $180 per container. 61Source: Estudio Centroamericano de transporte 62The impact of transport interruptions on the losses faced by firms while transporting their goods is even more pronounced when we look at firms whose principal export market is Central America, and where most of the transport is by road: firms that experience transport interruptions face a loss equivalent to 5.3 percent of their consignment value, while firms that do not experience transport interruptions face a loss of 2.7 percent. 63The World Bank: A Tale of Two Ports - The cost of Inefficiency. Research Report, December, 2003. 64According to Romero, E. and J. Barahona, Reporte de Seguimiento a la Reforma del Sistema Aduanero de Guatemala, INCAE, June 1997, only about a quarter of the custom units had a computerized system (compared to two thirds in El Salvador and 100% in Costa Rica) and the proportion of professionals in total custom staff was 5% in Guatemala (compared to 12% in El Salvador and 21% in Costa Rica). The average time to obtain custom clearance (for imports) was 22 hours in Guatemala, 20 hours in Honduras, 19 hours in El Salvador and only 1 hour in Costa Rica. The collection rate per custom employee was also lower: 600,000 USD in Guatemala, compared to 613,000 USD in El Salvador and 968,000 USD in Costa Rica. 65The Declaración Electrónica de Control Aduanero ­ Póliza Electrónica, has been implemented in July 2000 in Puerto Queztal customs and in 2001 for 14 other customs. 51 through SAT's training center (CENSAT). As a result of these improvements, only 26 percent of the firms surveyed found customs regulations to be a major or severe constraint to operations, and as expected, with a larger percentage of large, exporting and Figure 4.7 Median Number of Days for Imports and Exports to Clear Ports and Customs in Guatemala and Comparator Countries 8 imate surveys. 5 5 5 4 4 3 1 1 1 0 Guatemala Honduras Nicaragua China foreign enterprises finding these regulations to be a major constraint as compared with micro and SMEs, or domestic firms respectively. The median time required for imports to clear ports and customs in Guatemala is five days and for exports, 1 day (Figure 4.7). Figure 4..8 Delays in Ports and Customs Reported by Firms in Guatemala Wait at customs 25 typical w ait 20 longest w ait 15 aysD10 5 0 Imports Exports Source: Investment Climate Survey, 2003 Source: Investment Climate Survey 52 122. The average wait for imports to clear customs in Guatemala was nearly 9 days, while the average longest wait was 20 days (Figure 4.8). For exports the average wait was nearly 2 days, and the average longest wait 5 days, the latter being higher than those reported by firms in Honduras and Nicaragua.66 These waits can be costly to firms. On average, delays are longer at Puerto Quetzal (losses are also higher here) as compared with Puerto Santo Tomas de Castilla. 123. Longer delays increase inventory carrying costs for firms. The importance of analyzing not only the average but also the longest clearance period for imports lies in the uncertainty that the latter represents, and the fact that it may induce firms to hold larger inventories of imported products to cover this uncertainty. This comes at an extra cost for firms(see Guasch and Kogan, 2001), in particular for small enterprises that face higher liquidity constraints. Survey results confirm this --firms that import more than 10 percent of their inputs hold inventory stocks equivalent to 20 days of production, which is the longest import delay, while those that import less than 10 percent maintain an inventory equivalent to 11 days. 124. More than 55 percent of the firms in the sample declare that they would increase their use of imported inputs with CAFTA, placing additional demands on the existing transport and logistics infrastructure. More than 60 percent of the firms in the survey felt that customs and air transport costs would be major obstacles to taking full advantage of CAFTA. Almost 50 percent of the firms cited land and maritime transport costs as major obstacles (Figure 4.9). Figure 4.9. Obstacles to taking full advantage of CAFTA Obstacles to taking full advantage of CAFTA(% firms reporting major or severe) Maritime transport costs US customs Land transport costs Existence of a list of excluded prod. Fromagreement Increased requirements health and sanitary reg Access to distrib. Channels in the US Increased requirements labor reg Customs in other Central American countries Insuff. Time to adjust to the new regulations Air transport costs Increased requirements of quality certification Customs in your country 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 66The survey asked firms about ports and customs simultaneously, so it is impossible to determine whether the delays are caused primarily by the port or by customs. But this approach is necessary because entrepreneurs typically know only the total delay, not who is responsible for the delay. Future surveys should experiment with ways of eliciting information on ports and customs separately. 53 Recommendations The benefits of CAFTA would be better realized with: 125. Increased port efficiency. Greater efficiency will allow for better capacity utilization, especially as demands increase with CAFTA. Policy should involve, among others, two priorities: (i) reduced political interference in publicly administrated ports through improving user (private sector) participation in the executive boards; introducing financial discipline; and modernizing the management process in public ports with due attention paid to human resource management, productivity and transparency (if privatization is not feasible);67 and (ii) implementation of regulatory and institutional reforms to facilitate private participation, perhaps starting with port extension (e.g. in Puerto Quetzal due to a saturation problem). 126. Improved roads infrastructure and trucking industry regulation. In Guatemala, access is a key issue, as the country is predominantly rural and the urbanization process is exceptionally low.68 In this sense, it will be necessary to extend coverage selectively with focus on strengthening rural-urban linkages and developing trade corridors. Another issue is the impact of the fiscal adjustment on resources for road maintenance: minimum maintenance levels should be kept to avoid excessive deterioration and associated higher recovery expenditures. One alternative would be to secure funding for COVIAL and making it an autonomous institution to avoid political interference. Increased planning capacities at both central and local levels is desirable. Also, reducing regulatory risk would allow private sector participation in construction, operation and maintenance. A suitable regulatory framework (concession law) should be implemented and building institutional capacity (independent concession unit) might be necessary. Several efforts are in progress, and should be strongly supported. The trucking industry regulation should be reviewed, with a view to long term efficiency and sustainability. Finally, security in highways should be effectively improved. 127. Improved Regulation (for all infrastructure). Since there is no concession law in Guatemala (although a project of law has been drafted), the Constitution and a 1985 Ley 67 Only Puerto Barrios is a private port, the two others are being managed by state-owned institutions ("empresas portuarias"). The only private port (Puerto Barrios) is also perceived by private users as the most efficient; Puerto Quetzal, where some services (stevedore in particular) are under concession and where the use of some infrastructure has been contracted (to ENRON in 1993 and the enterprise San José Limitada, in 1997), has become more efficient, while Santo Tomás where private sector involvement is minimal is still considered by users as the least efficient of Guatemalan ports. 68Over the past decade, the share of urban population has evolved from 38% to 40%, compared to 45% and 55% for Honduras or 52% to 62% for El Salvador. In addition, the primacy rate is also very high: in 2000, 72% of the urban population was living in the capital city (compared to 35% for El Salvador or 28% for Honduras). This means that secondary cities are underdeveloped in Guatemala. Urban concentration is mostly happening in the capital city, where inefficient urban transportation is a bottleneck to the development of the urban economy. The urban economics literature stresses the importance of secondary cities to foster economic growth. See Henderson, V., The effect of Urban Concentration on Economic Growth, WP 7503, National Bureau of Economic Research, 2000. 54 de contratación del Estado have been used to provide a legal basis for existing concession schemes in Guatemala. This has resulted in ad hoc legal arrangements in which each concession scheme contract is unique, increasing legal uncertainty. In addition, the fact that each concession model has to be approved by the Congress has brought significant political interference into the process. The institution in charge of managing concessions in Guatemala is a unit of the MCIV. With a staff of six, the institutional capacity of this unit would be clearly insufficient should the number of concessions increase significantly. In addition, past political interference suggests that this unit is should be given its autonomy to act as an efficient regulatory body. 128. Customs reform. Customs was transferred to SAT in 1998, an agency specialized in tax collection.69 This has had a negative impact on the entity's ability to improve trade facilitation. Moving forward, the government should focus on : (i) implementing a custom reform strategy to improve trade facilitation, possibly through the implementation of the Central America customs union; and (ii) reinforcing the credibility of customs by finalizing the modernization process, intensifying training, and implementing quality-based management (perhaps considering an ISO 9,000- certification). 129. Improved cross border movement. Automatic, paperless, non-discretional processes should be introduced at border crossings, while adopting systems that can be harmonized with neighboring countries. 130. Facilitating air transportation. The impact of CAFTA will be significant for Guatemala's air freight. Longer term, the relocation of the Guatemala airport should be reconsidered. The air transport policy for passengers - with which a large proportion of the freight is linked ­ should also be reviewed. 131. Better logistics organization and multimodal transportation. The development of ports and airports should be done from the viewpoint of modern logistics operations, and establishing additional ZALs70. The development of regional short sea shipping and changes in the rules considering containers as transportation equipment ­ and not temporary imports ­ will also foster multimodalism and facilitate the flows between entry points (ports, border crossings) and enterprises. D. Telecommunications 132. The Telecommunications Law of 1996 paved the way for one of the most radical market liberalizations witnessed in the region. All barriers to competition were removed with immediate effect, as were all regulatory restrictions on prices and quality of service. The reform has had a major impact on the performance of the 69SAT was created in 1998, as a decentralized state entity, a status, which gives SAT functional, economic, financial, technical and administrative autonomy. Its executive board includes the Minister of Finance (chairman), four executive directors and a secretary, SAT's general manager. In 2001, SAT collected 97% of Guatemala's fiscal revenues. 70ZAL: Zona de Actividad Logistica 55 Figure 4.10Median Wait for Fixed Line Telephone Connection in Guatemala and Comparator Countries 35 30 30 30 25 20 20 15 10 5 0 Guatemala Honduras Nicaragua Note: Data refer only to firms receiving a fixed line connection within the two years before the survey. Source: Investment climate surveys. telecommunications sector in Guatemala and resulted in increased efficiency. Consistent with these developments, only 7 percent of the enterprises surveyed in Guatemala rated telecommunications as a major or severe constraint to operations. 133. Significant progress achieved through telecommunications liberalization. Since 1999, access to telephone services has substantially increased, specifically in the mobile phone segment. The number of total lines more than doubled between 1999- 2002, with mobile lines increasing more than threefold. Supply of fixed phone services is concentrated in metropolitan areas, especially in Guatemala City, where 69 percent of the investment in new fixed lines took place. In addition, getting a telephone connection also appears to be relatively easy in Guatemala. In the investment climate surveys, enterprises obtaining a telephone connection within the previous two years reported a median wait of 20 days in Guatemala, shorter than the 30 day wait in Nicaragua and Honduras (Figure 4.10). Tariffs are also low. Despite this large investment and improvement, Guatemala has a low telephone density compared with its neighbors. In 2001, Guatemala's fixed phone density was lower than levels in El Salvador, Panama and Costa Rica (Figure 4.11). Nevertheless, the mobile phone density is only lower than that of Mexico and Panama. 56 Figure 4.11 Mobile and Fixed Line Telephones Per 100 People in Guatemala and Central America Mobile and Mainlines Phone, 2001 250 s)t 200 anti abhni 150 100 1.000 erp( 50 0 1995Mainlines 2001Mainlines 1995Mobile 2001mobile 134. 136. Despite liberalization, the fixed telephone sector remains concentrated, while the mobile market is more competitive. The liberalization has allowed 15 companies to provide fixed local telephone services, but they account for only 7 % of the local service market. As pointed out by Superintendencia de Telecomunicaciones (SIT)71, new operators are concentrated primarily on the more lucrative market segments, such as Guatemala City and other urban areas. Several companies compete in the long-distance market. According to available data on international calls, an index of market concentration, the Herfindahl-Hirschman Index72 (HHI) is 1,800 points, close to levels characterizing competitive markets. Regarding the mobile sector, liberalization has brought three new strong competitors into the market to compete with SERCOM PCS 30. Digital, TELGUA´s subsidiary: Comunicaciones Celulares (subsidiary of Millicom International, USA); Telefónica Centroamericana Guatemala (subsidiary of Telefónica de España) and Bell South Guatemala, with an HHI of 3,300 points. 135. Guatemala however has one of the lowest rates of internet access in Central and Latin America. Very different figures are provided about internet users. The most recent estimation is that only 1.4 % of the population has access to internet, a figure comparable to El Salvador but very low when compared to Mexico (4.7 %) and Costa Rica (9.3%) (Table 4.4). One of the reasons for the low internet access is the high cost of local calls. One hour of internet use costs Q 21.0. A flat rate for internet access would help resolve the cost issue, but Guatemalan law does not permit SIT to regulate internet 71Guatemala has 67% of the total number of fixed lines; Quetzaltenango, 5.34%; Escuintla, 3.85%, and Sacatepéquez 2.4%. 72The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between them increases. It can be used to estimate the equivalent symmetric number of firms in an industry. Markets in which the HHI is between 1000 and 1800 are considered to be moderately concentrated, and those in which the HHI is in excess of 1800 points are considered to be concentrated. 57 tariffs. According to the results of the survey, while 67 percent of the firms use email on a regular basis with their clients, less than a third of the firms have a website . Table 4.4: Internet users in Central America (September, 2003) CENTRAL Current Users, Users, Users Increase Population AMERICA Population , 2003 year (2000- 2000 most recent data (%) 2003) Penetration Belice 257,400 15,000 22,000 1.7 % 46.7 % 8.5 % Costa Rica 4,148,500 250,000 384,000 29.2 % 53.6 % 9.3 % El Salvador 6,178,700 40,000 300,000 22.8 % 650.0 % 4.9 % Guatemala 14,223,400 65,000 200,000 15.2 % 207.7 % 1.4 % Honduras 6,606,100 40,000 200,000 15.2 % 400.0 % 3.0 % Nicaragua 5,777,700 50,000 90,000 6.8 % 80.0 % 1.6 % Panamá 2,991,000 45,000 120,000 9.1 % 166.7 % 4.0 % Total Central América 40,182,800 505,000 1,316,000 100.0 % 160.6 % 3.3 % Source: ExitoExportador.com 136. And Rural telecommunications still remain underdeveloped.73 A major unresolved issue in the telecommunications sector relates to the inadequate strategy and institutional arrangements for rural telecommunications. It is estimated that only 5,000 rural communities have access to telephones while 45,000 have no access. GUATEL and FONDETEL are the main institutions in rural telephony. In addition it takes an average of 116 days (median of 30 days) for micro enterprises to get a phone connection. The lack of coordination among them has resulted in inefficient investments and duplication of efforts74. On one hand, the Government has left the responsibility for operating the original GUATEL´s rural phone networks with the new GUATEL, the residual entity. However, the unclear objectives and roles for GUATEL have led this institution into expanding its own rural telephone network, resulting in inefficient investments, duplications of networks, and the corresponding need for excessive subsidies. On the other hand, FONDETEL was created with proceeds of the spectrum auctions, as a fund to channel subsidies to the private sector to install and operate new rural telephones. FONDETEL's approach is consistent with international best practices as applied in many other LAC countries, such as Peru, Chile or Colombia. By now most of FONDETEL´s original funds have already been invested, and no new funding arrangement has been set in place. Its main problem is financing, since no new revenues from the spectrum auctions are expected. Furthermore, its fund (Q 49,100,000.0) has been moved to general public accounts by Decree 26-2003. In other countries, the financing is often provided by a small levy (about 1%) on all sector revenues. In Guatemala, however, this would require a change of the law.75 73Guatemala: Private Participation in Infrastructure, Implementation Completion Report, SCL-41490, Technical Assistance Loan, The World Bank, June 2003. 74The World Bank has financed a rural telecommunications strategy study, which identifies the strengths and weaknesses in both GUATEL and FONDETEL and provides specific recommendations for improving the provision of the rural telecommunications services in Guatemala. 75Guatemala Country Economic Memorandum, 2004. 58 137. Regulatory Governance. The Regulatory agency is empowered, in theory, with regulation, arbitration and control functions, but is constrained with respect to implementation. SIT, created in 1997, with functional autonomy from the Ministerio de Comunicaciones, Infraestructura y Vivienda. In order to ensure its independence, SIT was provided with a capital fund and with revenues derived from its enforcement assignments. However, more recently SIT´s consolidation has been adversely impacted. First, its capital fund was removed by Decree 47-2002 and now it depends on the public budget. Meanwhile, the radioelectric spectrum usufruct is almost exhausted and no income can be obtained from its auctions. Second, SIT has never exercised its arbitration function to resolve an essential facility dispute, in spite of three well-known recent disputes between operators. Third, although the telecommunication law empowered SIT to use sanctions in the event of non-compliance, no such proceedings have been implemented. Finally, although the law enhances the promotion of competition, SIT has not been assigned the function of promoting competition, and no instruments have been designed to obtain any information about how the market is functioning. In brief, the role of SIT is not very clear either as a regulatory agency, or as a control and supervisory entity. Recommendations 138. The tremendous progress achieved so far could be sustained and improved by (i) improved regulatory governance and increased power of the regulatory agency, especially to oversee anti-competitive strategies by dominant firms; and (ii) improve mechanisms for private participation in rural telephone infrastructure. 59 CHAPTER FIVE INNOVATION, QUALITY AND SKILLS A. Introduction 139. The issue of technological capabilities is central to policy initiatives to improve productivity growth in the manufacturing sector. How and where firms acquire their technology is important. Policymakers have tended to focus on promoting formal R&D, though other less formal forms of technology transfer--from technology and know-how licensing, modern equipment purchases, joint ventures, subcontracting relationships or linkages--may be just as important. Adoption of international quality standards, technological innovation and improvement of the labor force skills are key interrelated elements that are needed to increase firms' productivity and growth. More recently, worldwide there is also growing policy interest in "The Knowledge Economy", and the potential economic development made possible by the revolution in information and communications technologies (IT). Governments in many developed and developing countries have begun to promote IT as a strategic tool for enhancing their international competitiveness. 140. Education and training should be an integral part of any strategy of technology-driven productivity growth in manufacturing. Highly skilled workers, especially professional, technical and managerial employees, play a critical role in the adoption, adaptation and effective use of new technologies developed elsewhere; scientific, engineering and technical (SET) personnel play a similar role in in-house R&D activities. Many of the skills needed for technical change are acquired through pre- employment education and training; many other skills, especially those specific to technologies used by employers, must be developed through in-service training and on- the-job learning while working with existing or new technologies. Without complementary investments in training and skills upgrading, productivity gains made possible by the introduction of new technologies are unlikely to be realized. B. Technology 141. Guatemala spends less on research and development (R&D) as a share of GDP than do most other developing countries in Latin America for which data are available (Figure 5.1).76 In 1995, public R&D expenditures per worker were estimated at 9.6 USD and private expenditures at 6.2 USD.77,78 According to the Ministry of Finance, public 76This chapter draws on some of the findings in the Country Economic Memorandum, 2004. Estimating Guatemala's R&D expenditures is also difficult as there is no institution monitoring neither public nor private expenditures in this sector. 77See World Bank (2003). World Bank (2003): "Closing the Gap in Education and Technology". The World Bank Latin American and Caribbean Studies, Washington, D.C. 78Latin American average in 1995 was 34 USD per worker for public R&D and 14 USD for private R&D in 1995, which in turn was lower than other East Asian developing countries such as Korea, Philippines, Singapore and Thailand. The four country average for R&D reached 41 USD for public and 78 USD for private R&D expenditures per worker. 60 expenditures related to Science and Technology amounted to less than 20 million Q per year during 1997-2002, i.e. less than 1 USD per worker (Table 5.1). Although this figure obviously does not account for all public expenditures in Science and Technology, such a low level of officially registered funding as well as the volatility of expenditures, provides an indication of the extent to which Science and Technology policy has been treated as a priority. , 79 80 Table 5.1: Public expenditures registered as S&T in Guatemala's executed budget. Million Q 1997 1998 1999 2000 2001 2002 Total public expenditures 11,518 15,517 18,728 19,110 21,327 22,541 Science & Technology - as % of public expend. 0.1 < 0.05 < 0.05 < 0.05 0 .3 < 0.05 - amount 11.5 < 7.8 < 9.4 < 9.6 64.0 11.3 Source : Ministry of Finance Figure 5.1. R&D expenditures per worker - 1995. Source : World Bank 142. The low level of R&D spending in Guatemala is reflected in relatively low levels for other measures of innovation. As shown in Figure 5.2, according to the Global Competitiveness Report, Guatemala ranks unfavorably against other countries in the region in licensing as well as the number of scientists and engineers. In fact, with the exception of technology transfer, Guatemala's technology indicators are relatively worse than its own competitiveness.81 79Regarding private R&D expenditures, the WEF (2003) survey estimate it to be in average for Central and Latin America, and close to what would be expected given the country's level of development. 80In 2003, cumulated public R&D expenditures were estimated at 30 million USD or about 8 USD per worker. A large portion of these expenditures is also supported by external source, such as IDB loans or grants from international research programs to assist universities' research efforts. 81 Key elements used by WEF to assess the level of technology transfer include relevance of FDI as a source of technology transfer and licensing of foreign technology as a common way to acquire technologies, but these rankings are based on qualitative questions only (World Economic Forum, 2003). 61 Figure 5.2 Technology Indicators Guatemala and Comparators 90.00 80.00 767876 (weak) 70747175 71 75737570 70.00 6965 59 high 60.00 57 to 49 51 504953 50.00 43 45 46 42 41 40.00 37 36 (strong) 30.00 21 20.00 10.00 7 Ranks--low 0.00 Costa Rica or a ad uras am Salv Pan El Guatemala Hond Nicaragua overall Competitiveness Technology index ICT Sub Index Innovation subindex Technology Transfersubindex 143. Guatemala lags behind in patent activity, a key indicator of national innovation. Patenting activity is usually interpreted as a sign of success in the creation of industrial inventions. Inventors in all technological fields ­agriculture, health, biotech, and electronics­ can choose to apply for patents in countries they wish to protect their inventions. While there are several strategic factors that influence the patenting decision, the advantage of using patents, rather than the frequently used measure of R&D, is that while the latter is a measure of an input into innovation, the former is an outcome indicator, measuring successful innovative attainment.82 144. Patent activity in Guatemala is still extremely limited (there were 13 applications and 2 patents granted in 2000, 5 application and 3 patents granted in 2001) (Figure 5.3). Although other countries in Central-America (with the exception of Costa Rica) experience similar low levels for the number of residents' patents, Guatemala has the lowest performance when compared to the size of its population or economy. Over the last decade, there has been no significant change in the residents' patents activity in Guatemala, while the number of residents' patent applications has increased by about 50 percent in the Latin America and Caribbean region over the period 1992-2000.83 82In fact, a common deficiency of most aggregate quantifications of technological capability is their tendency to club together input and output data. 83Out of a group of 10 Latin American countries, Guatemala ranks 9 or 10 depending on the criteria used (only Venezuela and Honduras were lower in 2000 for patent applications compared respectively to GDP and to population) 62 Figure 5.3 : Evolution of the number of patent applications in Guatemala. Source : Red Iberoamericana de Ciencia y Tecnologia 145. While Guatemala is evidently far from the technological frontier, the ICA survey results demonstrate a certain level of innovation among Guatemalan firms, which upgrade and renovate their product offerings in order to remain competitive ­ at least in their local markets. Survey results show that in the last two years at least 53 percent of Guatemalan firms developed a new product line and 43 percent introduced a new technology that substantially changed the production process. Moreover, 81.5 percent of Guatemalan firms upgraded and existing product line and 70 percent of the enterprises introduced new products. Such a dynamic response is similar to that of firms located in other Latin and Central American countries (Figure 5.4). Although these figures suggest a certain amount of innovation among Guatemalan firms, the scope of the product or process innovations introduced does not seem to be broad enough to improve significantly the firms' competitiveness, nor to foster their successful participation in international markets.84 84Exports in Guatemala lag behind: in the manufacturing sector, they only amount to 4.5% of GDP, the third lowest level in the Central American region. It is estimated that 4.2% of GDP corresponds to exports from non-high tech industries characterized by a low level of industrial transformation. This is substantially lower than the corresponding figures for Costa Rica (12.3) or El Salvador (10.6). (WDI, 2001). According to the ICA survey, 33% of the Nicaraguan firms export more than 10% of their sales, a proportion similar to Honduras (34%) and relatively larger than Nicaragua (24%). In Guatemala as in Honduras, large firms are more export oriented. Only 25% of them export less than 25% of their sales or not at all, while in Nicaragua about 50% of large firms show this behavior. The overall differences among the three countries are mainly due to the lower level of development of the apparel sector in Nicaragua. 63 Figure 5.4 Product and process introduction ­ international comparisons Brazil Ecuador Nicaragua Guatemala Honduras Bolivia 0 20 40 60 80 100 Process change New product line Upgrade an existing product line Source: Investment Climate Surveys 146. Acquisition of new machinery or equipment is the most important channel of technology. Eighty one percent of manufacturing firms surveyed claim to have adopted some form of technological innovation in the past three years. As is common in many lower income countries such as Guatemala, technology transfer and innovation mainly takes place by incorporating new capital equipment into the production process (Figure 5.5). Still, imports of capital goods ­a major source of technological transfer and productivity gains--relative to gross capital formation and to GDP-- are in the lower range for Central America. Other important channels of technology include employment of key personnel and adaptation of existing technology within the firm ­ the last one being less relevant in Guatemala (and in other Latin American countries) as compared with East Asian economies such as China. 147. However, the technological content of equipment appears low. While approximately 60 percent85 of Guatemalan firms innovate by introducing new equipment, a substantial number of firms (76 percent) do not own computerized equipment (Figure 5.6). Although this proportion is high, Guatemala performs better than Honduras and Nicaragua where the corresponding percentage is 79 percent and 89 percent respectively. Firms that export in Guatemala are relatively better equipped than non-exporters, with 38 percent of them using such equipment, more than double the proportion in the non- exporting sector. The quality of equipment, together with the low penetration of ICT services86, may contribute to low productivity levels and be an obstacle to innovation. 85This is obtained by multiplying 80.9% (Guatemalan firms that introduce innovation) and 73.9% (firms that innovate by introducing new equipment. Note that Figure 5.5 shows simple percentages only (i.e. 73.9% for Guatemala) as the question "did you introduce an innovation or not in the last three years" was not asked in all countries. 86The estimated stock of personal computers of 1.4% per 100 inhabitants compares poorly with Central American average of 5.3 (International Telecommunication Union, 2002). 64 Figure 5.5: Technology adoption87, international Figure 5.6 Firms with computerized equipment88 comparison 90 80 70 Nicaragua 60 50 40 30 Guatemala 20 10 Source: Investment Climate Surveys 0 r Ecuado Peru Brazil sh ala Honduras Banglade China nduras Ho NicaraguaGu atem New equipment Hiring Developed or adapted within the firm Licensing/turnkey ops 0% 5% 10% 15% 20% 25% 30% 148. Technology licenses are infrequently used in Guatemala. Consistent with the findings in the Global Competitiveness Report, where Guatemala ranks 77th out of 80 countries, technology licensing, which is a common mean of innovation in East Asian economies, is not a preferred channel of innovation for Guatemalan firms. Only 4 percent of the firms surveyed firms licensed foreign technology since 2000, compared with 3.8% of Honduran and 2.4% of Nicaraguan enterprises. Licensing or turnkey operations from domestic sources are also uncommon. These licensing levels are low when compared to other Latin American countries such as Ecuador (8.2%) or Brazil (7.3%) and very far from those observed in China (23%) (Figure 5.5). 149. Weak or Non-Existent linkages. Guatemalan firms rarely use any form of cooperation ­ with clients or suppliers, industry associations or R&D institutions-- to introduce innovation. Firms' weak integration in the productive chain, which is a common pattern in Central and Latin American countries (Figure 5.7), prevent firms (especially MSMEs), from benefiting from economies of scale, knowledge spillovers and joint learning and innovation. Not surprisingly, technological linkages among firms, universities and other research institutions are also limited and few Guatemalan universities and labs offer technological services to the private sector. Only 0.4 percent of firms perceive universities and public institutions as an important source of technological innovations. 87For each type of technology adoption, the figure indicates the % of firms that have chosen it as one of its three main ways of introducing innovation in the past three years. 88Data for international comparators are not available. 65 Figure 5.7: The role of linkages in technology adoption7, Central American countries 90 80 70 60 50 40 30 20 10 0 Honduras Nicaragua Guatemala New equipment Equipment suppliers Trade Fairs/StudyTours In cooperation with clients Transferred from parent company Consultants Business/industry assoc Universities, public institutions Source: Investment Climate Surveys 150. Weak Protection of Intellectual property Rights. Clearly low spending on R& D and related activities in Guatemala might reflect its low per capita income relative to that in other comparator countries. But it might also reflect problems in the institutional environment: recent work has shown that R&D spending tends to be lower in countries where intellectual property rights are less well protected and the rule of law is weak (Clarke 2001). This is supported by findings of Global Competitiveness Report wherein, Guatemala's Intellectual Property Rights (IPR) legislation does not provide as much protection as in comparator countries mainly due to weak institutional capacity (Table 5.2). Table 5.2 Firms' opinion about intellectual property protection, 2001. Guatemala Central-América Latin Countries with including w/o America similar GDP per Guatemala Guate capita * Intellectual property protection is 2.3 2.9 3.0 3.1 3.2 1: weak/non-existent, 7: equal to the world's most stringent *Countries with per capita GDP PPP between 3,000 and 4,000 USD in 1999. Source: World economic Forum ­ World Competitiveness Report 2002 Recommendations 151. Technology adoption would benefit from trade integration and increased FDI. The government should review trade policy in order to improve trade integration and thereby technology absorption through the acquisition of better intermediate goods. Imports of capital goods could be facilitated by reviewing import tariffs, existing tax benefits and improving access to financing acquisition of machinery and equipments, especially for micro, small and medium firms, as well as the scope of measures (possibly extending the measures to the acquisition of computers and related goods). FDI policy should be revisited to gradually attract more technology-intensive investments, through reducing regulatory and administrative barriers. The focus should be sectors that have been aggressively adopting ICT technology, one of the main sources of productivity 66 gains over the 90's. Among others, these sectors would include the banking and retail sectors, the last one also subject to important scale economies.89 152. Increased public support to increase technological activity in firms. On the part of firms it will indeed demand an increase in investment in plant and equipment for state-of-the-art laboratories and testing facilities as well as in-house R&D activity. Given the externalities in knowledge creation arising from the imperfect appropriability of the returns to such investments, this R&D push is likely to be compromised unless mechanisms that correct for this market failure exist. In addition to defining a technology policy, the government should improve economic incentives for technology transfer from public research institutes and universities to the private sector by promoting output- based/market-oriented R&D in public research institutes and universities. One possible way to achieve this is by gradually reducing their access to earmarked funds (if necessary) and ­ at the same time-- expanding their autonomy to look for new sources of funding, particularly through different partnerships with the private sector. Another measure in this direction will involve the application of flexible regulation ruling the assignment of property rights over inventions generated in these institutions, possibly by allowing main researchers and their institutions to benefit from their discoveries. 153. Better co-ordination among technology institutions. In Guatemala there are roughly 108 Science and Technology institutions, but their capacity to engage in output- oriented research and partnerships with private enterprises varies significantly. Several isolated initiatives have been launched by these universities to develop cooperation with industry (see Guatemala Country Economic Memorandum for details). Most initiatives are isolated initiatives, building on some opportunities of building partnerships with the industry, and are not driven by the incentives managed by the national science and technology institutional frameworks (CONCYT and FONACYT). Improved co- ordination among these institutions would improve the quality and efficiency of the R&D effort. 154. Business development and technology extension services ­ similar to those employed in agriculture sector ­ might be a useful tool for technology acquisition, diffusion and, in certain cases, even for the development of innovation activities. Such privately run (and mostly privately owned) centers would have the specific purpose of providing firms --especially MSMEs-- with specific training and advisory services (e.g., on equipment use and improvement of production processes) and with access to (and information on) new technologies (e.g., for raw material quality control, design, manufacturing, production and testing techniques, and packaging and labeling). These 89Van Ark, Inklaar, McGuckin (2002) demonstrate that most of the productivity growth of the US economy during 1995-2000 may be attributed to the service industries mainly ­ although not only -- derived from the use of ICT technologies. The authors also argue that the entire productivity growth differential between the US and Europe in this period was generated in three sectors ­ retail, wholesale and security trading. Yet, technology gains in these sectors were generated not only by ICT use but also by economies of scale associated to newly built "big box" stores. See Van Ark, B., R. Inklaar, and R. H. Mc Guckin (2002), "Changing Gear: Productivity, ICT and Service Industries: Europe and the United States", paper presented to Brookings Workshop on Services Industry Productivity, Washington, D.C., May 17. 67 centers could also dedicate resources to develop targeted R&D ­ specifically aimed at improving productivity in selected clusters.90 Currently, some of these services, especially training and consulting, are being offered by Guatemalan public institutions, but private firms perceive them as inadequate to meet their needs. C. Quality 155. According to the ICS, 3 percent of Guatemalan firms surveyed are ISO- certified, less than any other comparator countries'and sixteen times lower than China's (Figure 5.8). In Guatemala, maquilas and firms operating in the apparel, food and tobacco, and metal industries do somewhat better (about 12.5% maquilas and about 5% of the enterprises operating in the apparel, metal and food and tobacco industries are ISO certified). ISO certification is practically unknown to Guatemalan MSMEs and to firms operating in many sectors of the economy (e.g., chemical and rubber, ceramics, cement, furniture and wood).91 In addition, there are no ISO certifiers in Guatemala. Thus, to be certified, firms need to rely on foreign institutions, which increases their costs and may prevent them from getting certified. Figure 5.8 ISO Certified firms Guatemala and International Comparators China Malaysia Brazil Pakistan Ecuador Poland Honduras Nicaragua Guatemala 0% 10% 20% 30% 40% 50% 60% Source: Investment Climate Surveyss 156. Adoption of other quality standards is also lower in Guatemala as compared with other Central American and comparator countries. Quality standards other than ISO (including product- and industry-specific standards) are slightly more common than ISO certification in Guatemala.92 About 12 percent of Guatemalan firms 90Similar centers, often labeled as CITEs (Centros de Innovacion Tecnologica) developed recently in a number of countries. See a detailed description of the objectives and structure of these Centers in Annex 2 of the Honduras Trade and Productivity Loan (2003), and in Fuster J. (2004), background paper for the Honduras Trade Project. 91Complementary studies (ISO Survey of ISO 9000 and ISO 14000 Certificates) show that 22 ISO 9000 and 1 ISO 14000 certificates were issued in Guatemala by the end of December 2002. 92The quality certificates most often reported include: Those issued by customers such as JC Penney, Kmart, and Wal-Mart; Hazard Analysis Critical Control Point Systems (HACCP); Good Manufacturing Practice (GMP); 68 hold a quality standard certificate, the lowest among comparator countries (Figure 5.9). Other quality certifications are mostly used by large firms, maquilas and firms operating in the apparel and chemical and rubber sectors (similarly to ISO) as well as by companies in the non metallic mineral sectors (where no firms are ISO certified in the sample). Medium and large firms in Guatemala are especially lagging behind their counterparts in other countries (respectively, 30 percent and 6 percent have some certification, versus 48 percent and 26 percent in Nicaragua, or 42 percent and 18 percent in Honduras). Guatemalan companies operating in the apparel industry are also less aware of the importance of quality certification than apparel firms in Honduras (19 percent versus 36 percent have some type of certification other than ISO). Figure 5.9: Firms using quality standards other than ISO Guatemala and international comparison China Ecuador Nicaragua Honduras Guatemala 0% 5% 10% 15% 20% 25% 30% 35% Source: Investment Climate Surveys 157. While econometric evidence indicates that quality certification is associated with higher exports, most Guatemalan firms seem to perceive quality as a cost rather than an investment that would increase their export potential. The relatively small number of certified firms in Guatemala indicates that local entrepreneurs are either not aware of the potential returns of quality certification or consider it too expensive. This points to the need to provide specific incentives to facilitate adoption of quality systems, especially among MSMEs. Recommendations 158. Increase demand for quality certification and accreditation through government assistance. The Government could finance technical assistance and matching grant programs for local firms, especially MSMEs, and laboratories. Preliminary assessments show that Guatemalan firms need training in the requirements for compliance with quality and environmental management system standards and related certification. Laboratories need capacity building to meet the requirements of ISO/IEC 17025, the international standard for measuring the competence of testing and calibration laboratories that has been adopted as a national standard of Guatemala and is used as the basis for laboratory accreditation. Technical assistance and matching grant programs should be complemented by quality promotional campaigns especially for MSMEs and labs, as well as trade associations and key local industry leaders. La Ceiba de Oro, an award administered in Central America by Opinión Pública La Ceiba, S.A. (OPSA), which is based on public opinion studies where consumers choose their preferred brands. 69 159. Increased infrastructure for quality. Several components of a national quality system already exist in Guatemala, or are in the process of being established. To improve the supply of quality systems, Guatemala should further develop its quality infrastructure by establishing institutes that can certify firms according to ISO and other technical standards. Currently, there are no facilities that are able to certify products, firms' management systems, or services, such as those in the tourism sector in Guatemala. Local capabilities should be developed to provide certification services. Otherwise, firms in Guatemala must rely on foreign certification services, adding to the cost. 160. Strengthen the National Quality Information System. Information on standards, technical regulations, and conformity assessment programs in Guatemala are not readily available. This threatens the country's ability to comply with the requirements of its trading partners and makes it more difficult and costly for local firms to collect information on export requirements, and for foreign firms to understand the requirements for selling their goods and services in Guatemala. This will be particularly important with CAFTA. To improve the quality of local information services, the government should consider carrying out a thorough assessment of existing sources of information on quality. In addition, it should ensure that the staffs of local information service centers are properly trained and that the centers subscribe to international databases including information on quality. D. Skills 161. Skills development strategies will clearly need to underpin Guatemala's vision of attracting more FDI and competing in the face of increasing globalization and economic integration. A well educated and trained workforce will be key to provide domestic firms with a competitive edge and workers require higher levels of skills to adapt to technological changes and, has will be . For policymakers in Guatemala, the immediate challenge is how best to increase the supply of skilled workers to meet current private sector needs as well as projected growth in skills demand; and upgrade skills and technical competencies of the workforce to facilitate technological and organizational change to enable enterprises to compete internationally. 162. There have been improvements in education, but gaps remain. Guatemala has improved access to education, essential in creating a workforce with the skills and knowledge needed for a healthy investment climate. But other elements for a strong human capital base are missing. Fewer scientists and engineers are available than in many other developing countries, including many of the comparator countries in Central America. According to the Global Competitiveness Report Guatemala ranks 74th out of 80 countries in availability of scientists and engineers. Illiteracy rates are among the highest in the region, possibly reflecting poor education results in the 1970s and 1980s; gross primary, secondary and tertiary completion rates are among the lowest in the region and concerns about the quality of education remain. 70 163. Despite the payoffs from training, Guatemalan firms under-invest in their employees. Figure 5.10 places Guatemala in international perspective. The percent of firms providing training in Guatemala (55 percent) is higher compared with South Asian countries like Pakistan, Bangladesh and India, and neighboring Nicaragua and Honduras, but substantially lower than Brazil or East Asian countries such as China. The incidence of training increases with firm size. There are very marked differences in the incidence of training by firm size. The proportion of firms that do not provide any formal training is highest among the micro firms (78 percent) and lowest, but still considerable among the largest size firms ( 33 percent). On average, 45 percent of the workers receive training. Figure 5.10--Percentage of firms providing formal Figure 5.11--Percentage of Guatemalan providing training, Guatemala and international comparisons formal training, by firm size Pakistan 11.1 Large Bangladesh 26.6 India 27.2 Medium Nicaragua 37.4 Small Honduras 49.3 Guatemala 55.0 Micro Brazil 67.1 Total China 69.6 0 20 40 60 80 0% 20% 40% 60% 80% 100% Source: Investment Climate Survey, World Bank, 2003 164. Yet, the private sector is the most important source of training and plays, and will continue to play, a key role in skills development. It is evident that in Guatemala changes in skills demand over the last few years have outstripped the capability of public training institutions, and that the private sector will have to play an increasingly greater role in training and meeting its own skill needs. The survey revealed that many employers can, and do, meet their skill needs through formal, structured programs of in-service training. In fact, not withstanding the conclusion that firms under- invest in training, employers provide in-service training to more workers than traditional vocational and technical training institutions. Across all firm size categories, the proportion of firms providing internal training was higher than those using external providers (Figure 5.12). In addition, a higher proportion of workers were trained internally as compared with external providers. Even among external providers, private providers were the most frequently used source by medium and large firms, whereas micro and small firms use public training institutes to meet training needs (Figure 5.13). 36 percent of the enterprises felt that the external training provided was not very relevant to their training needs. 71 Figure 5.12 Percent firms providing internal and external training in Guatemala by size internal training external training Large Large Total Medium Medium Small Figure 5.13 Sources of External Training in Guatemala Small Micro Micro Total 0 10 20 30 40 50 60 70 0 10 20 30 40 50 Figure 5.13: Sources of External Training in Guatemala 60 50 Public Institutes Private Training Schools 40 Partners or other firms 30 University Technical/vocational public 20 schools 10 0 Overall micro small medium large Source: Investment Climate Survey, World Bank, 2003 165. Guatemalan firms seems to count excessively on learning by doing and informal training. Learning by doing was the most commonly cited reason (36 percent) for why firms in Guatemala provide no training (Figure 5.14). This is supported by the responses of firms suggesting that informal training is adequate in many cases. Typically, when firms use mature technologies there is little scope for improving existing production techniques. As such, no additional training becomes important and workers quickly become proficient at their jobs through learning-by-doing and informal training. Furthermore, employers may not need to train when mature technologies are widely diffused since there is plentiful supply of skilled labor using the older technologies in the external labor market, and they are readily hired from other firms. In general, the Guatemalan economy's traditional dependence on low-wage-based commodity exports has not created a high demand for human capital. These problems are especially acute for micro and small enterprises, which tend to use older, more manual equipment and lack the financing not only to purchase newer equipment but to train workers on its use. These factors "interact to create a vicious cycle of low levels of investment in human capital, low levels of productivity, and with limited resources, few incentives to train or adopt new technologies." These patterns hold true by firm size as well. Financing constraints appear to be an issue for almost 15 percent of the firms in Guatemala, indicative of imperfect capital markets. 72 Figure 5.14 Reasons for providing little or no training by firm size Skepticism about benefits of training All Lack know ledge about training techniques and programs Large Medium Costly due to high labor turnover Small Micro Skills learned in school are adequate Skilled w orkers readily available Training is not affordable Informal training is enough learning by doing is sufficient 0 5 10 15 20 25 30 35 40 45 50 166. The existing supply of training by public institutions is fragmented and inadequate. The primary provider of vocational and private sector training in Guatemala is Instituto Técnico de Capacitación y Productividad (INTECAP). Although 80 percent of firms surveyed pay the 1% payroll levy that supports INTECAP, fewer than a third of them actually use INTECAP for training. There is a common view that the training provided, especially by INTECAP, is not appropriate to the needs of the private sector. The courses are not reviewed on a systematic basis and the course areas frequently are not in the main areas of private sector need. Courses that have become obsolescent often are not replaced. Overall the training provided is basic training, and the more advanced needs of industry are not met. Less than a third of the firms in the sample found the training provided by INTECAP to be effective and only 28 percent of the firms in the sample use INTECAP to meet their training needs, with the proportion being significantly lower among micro (14 percent) and small enterprises (23 percent). More than half the firms suggested that there was a clear need for INTECAP to upgrade their courses and make them more relevant. Some technical and occupational training for the private sector is also provided by technological institutes, universities, government ministries, and municipalities. However, the training provided by these diverse sources is fragmented--there is little coordination among them--and, even combined, meets only a tiny fraction of demand. 167. A Low Skills Equilibrium? The training market in Guatemala could perhaps be described as a cycle of weak demand and supply. This might be described as a `low- skills equilibrium', whereby demand and supply interact to reinforce their respective weaknesses. The weak demand has prevented the emergence of a more robust private training market, and the weak supply has not stimulated demand from the private sector and from individual workers. This weak training market is on a foundation of a weak education system, and poor levels of education of the Guatemalan labor force. The illiteracy rate reached 30% of the population over age 15 in 2002 in Guatemala, compared to 10.5% on average in Latin America. In 2000, the average years of schooling 73 in Guatemala was 3.5, lower than Nicaragua., Honduras, El Salvador and Costa Rica. Performance in terms of secondary and tertiary education is also below all comparable countries (Table 5.3). Table 5.3: Indicators of labor force qualifications. Fraction of the adult population Illiteracy Rate Years of No school Some Some Some (% of the pop schooling Primary Secondary Tertiary over 15 years old) Costa Rica 4.2 6.0 10.4 56.0 15.7 17.8 El Salvador 20.3 5.2 27.9 48.8 13.4 9.8 Guatemala 30.1 3.5 39.5 42.1 13.4 5.0 Honduras 23.8 4.8 16.6 58.9 18.8 5.7 Nicaragua 32.9 4.6 28.9 43.1 19.8 8.3 Panama 7.7 8.6 9.1 36.2 35.8 18.8 LAC- 10.5 n.a n.a n.a n.a n.a Average Thailand 4.2 6.8 12.6 61.5 15.1 10.9 Source: Barro and Lee (2002) and WDI (illiteracy rates). 168. Institutional factors act to weaken the training market. At the base level employers are reluctant to invest in training because of the poor educational level of workers. In addition, the 1% private sector levy that is managed by INTECAP acts as a disincentive for further investments in training. In the context of the difficult economic conditions employers are reluctant to undertake further investments in training. It is also the case that a large percentage of the revenue from the levy is used for pre-employment training. This may be justified socially, as employers are the eventual users of the skills that are developed through these programs. However, the manner in which the levy is managed and allocated reduces the demand for training. In turn this has weakened the diversity and the responsiveness of the supply of training. Box 5.1 A Low Skills Equilibrium The British economist David Finegold (Finegold and Soskice,1990) described The United Kingdom in the early 1990s as being locked into a low skills equilibrium. This was, he argued, a self sustaining balance between low levels of industrial skills ­ low value added and low priced products ­ low wages - low levels of demand for training ­ and low general levels of education amongst the workforce. Amongst other factors the behavior of the UK financial markets, which required short term rather than long term returns on investment ­ thus discouraging investment in skills-contributed to this equilibrium. The UK economy was compared with other high skills economies that concentrated upon high-quality ­ high valued and higher priced products that required high levels of industrial skills and corresponding high levels of education and training, and wages. Although it is difficult to compare Honduras with the UK, its `low skills' model can be applied to Guatemala within Latin America. 74 E. Closing the Training Gap-Recommendations 169. Firms are more likely to train when they are large, employ a more educated workforce, invest in technology and are foreign-owned. Thus policymakers in Guatemala should view training policy not just as subsidizing or providing "training" but also increasing the demand for training through appropriate technology-related policies and increasing the trainability of workers through appropriate educational policy. Education is the most important enabler of training and technology change its important instigator. 170. Promoting Education. Existing low rates of continuation into further education or post-secondary education cannot sustain desired rates of post-employment training and re-training. Continuous learning and skills upgrading are required for moving into higher technology production. As such, firm incentives to train will increase as education policies to promote higher school retention rates and more technical education are implemented. 171. Implement a technology policy. In addition, investments in new technology and licensing agreements are associated with increased training, a fact that reinforces the need for continuous skills upgrading if firms are to adopt more technology intensive production. Guatemala should implement a sound technology policy to improve access to new technologies and stronger incentives to adopt them. 172. Increased support for MSMEs. Micro and small enterprises have weak training capabilities relative to large firms. A high proportion of micro and small firms do not train and are more financially constrained than their larger counterparts. However, the data suggest that micro and small firms also use older vintage, more manual equipment and rarely have quality control systems. Reliance on outdated technologies and production methods creates little demand for high-level skills or training. These weak training and technological capabilities interact to create a vicious cycle of low levels of investments in human capital, low levels of productivity, and with limited resources, few incentives to train or adopt new technologies. To the extent that the problems in micro and small firms are systemic, what is required is a proactive approach to assisting these enterprises. All interventions in the context of service delivery should involve a diagnostic or an audit of these firms' capabilities and constraints, and how best these firms could benefit from linkages with larger foreign owned or domestic firms. 173. Training Reform. The National vocational training system in Guatemala will need to balance the conflicting demands of diversity, responsiveness and flexibility with those of quality and coherence. This balance also should encourage individual and industry investment in training. Many countries in the region have implemented reforms to their training systems and moved away from the `traditional' Latin American model of training, and met with success as in the case of Chile (Box 5.2). Many private sector representatives are of the opinion that the 1% levy should be more directly controlled by the private sector93. Typically they have commented that `it is our money'. More radical 93World Bank Competitiveness project, 1999 75 proposals than changing the membership of the INTECAP board are that INTECAP should be radically restructured, and that the allocation and management of the levy should vested in the hands of the private sector through an industry council. Administration of Training Levies Examples in Latin America of the private sector being vested with the executive function of administering the levy include ­ Brazil (SENAI), Peru (SENATI), Argentina (CONET), Chile (SENCE). In these cases industry associations have assumed the responsibility. It has been important for the industry bodies to have responsibility for the bulk of the funds and to be able to work with both training providers and enterprises. The executive function has been invested in a private agency also in Mauritius. 174. Separation of governance from provision. In order to stimulate demand for and reform the supply of vocational training in Guatemala, the government must first separate the governance and planning of training from the provision of training. Currently, INTECAP is responsible for all aspects of training in Guatemala, which creates conflicts of interest, inefficiencies, and insensitivity to market needs. Training reform in Guatemala requires reducing INTECAP's monopoly. The government should establish a national training agency to plan and direct vocational training in Guatemala. In order to ensure the alignment of the national training system with social and economic objectives, the training agency must have some government oversight. At the same time, in order to ensure a high level of private sector participation and support, the training agency must have some degree of autonomy from the government. To ensure the proper balance, the details of the agency charter and the public-private composition of its governing council should be determined through a planning and investigation process that engages the major public and private stakeholders. Through the same process, the government and the private sector also need to reach a consensus on the use of the payroll levy that balances the needs of the productive sector with the national priorities set by the government. 76 Box 5.2 Chile: a radical change in the provision of vocational education and training Context: In the mid 1970s the Chilean government implemented a series of reforms aimed at creating a market-oriented and open economy. The components of the liberalization process included the downsizing of the public sector through the privatizations of most public enterprises and a reduction in the number of public servants, the creation of private health insurance and pension systems, the deregulation of the labor market, the renegotiation of the external debt and the reform of the vocational education and training system. The purpose of the vocational education and training reform was to decentralize the provision of training services, diversify the supply of the vocational education and training, increase the market relevance of work-related education and training activities and foster integration of the vocational education and vocational training systems. The main mechanisms adopted to promote the reform were a system of tax incentives for in-firm training programs, the transference of management responsibilities for public vocational schools to municipal authorities and private corporations, the participation of industry associations in policy formulation and institutional coordination relating to vocational education and training. Additionally, strategic alliances between firms and local authorities at the regional level have been initiated by the private sector for the purpose of promoting efficiency, quality and relevance of vocational education and training by a greater participation of firms in policy formulation, curricula design, teacher training and funding, coordinating the activities of agencies involved in vocational education and training and pooling private and public resources allocated for vocational education and training. The Ministry of Education resigned its role as a training provider and transferred the management of its 159 vocational schools to local authorities or private corporations. The vocational training system for adults was also reformed with the adoption in 1976 of the Vocational Training and Employment Statute which created the National Training and Employment System, SENCE. Instead of providing free through the National Vocational Training Institute (INACAP), the system subsidizes the training demand of enterprises and monitors the performance of the system. Over 2,000 private training agencies including universities, vocational and technical schools, training centers, consulting firms, non-profit organizations compete to sell the services to more than 13,000 firms and government sponsored training programs. Firms decide the amount and kind of training they will purchase and the government subsidizes in-firm training through tax rebates, as well as financing training programs for workers excluded from enterprise programs. SENCE, which is part of the Ministry of Labor and Social Security, monitors the overall performance of the fiscal incentive system, plans and supervises public training programs and provides technical support to a network of over 150 decentralized public employment services. Firms organize training programs as well as apprenticeships for new recruits. The government grants fiscal incentives to cover training and apprenticeships up to the equivalent of 1% of the firm's payroll. Training expenditure in excess of the amount that is tax deductible is considered to be current expenditure for tax purposes. The content of training programs designed by training agencies have to be approved by SENCE, which also has to be notified where and when the training activity will take place. At the end of the year firms must submit total training expenditure to SENCE for final approval before submitting income tax declaration. Intermediate Technical Organizations (OTIRs) plan and organize training for affiliated firms. OTIRs were created in 1989 in view of the poor use that the entrepreneurial sector was making of public subsidies, and to facilitate access to training in particular small and medium enterprises. Sources: Martinez Espinoza Eduardo (1997), Chile: Experiences in a market-oriented training system. ILO. Rodríguez Juan Manuel (2002), Labour training policies in the OAS countries. ILO. 77 ANNEX A SAMPLING MYTHODOLOGY Main Components of a Typical National Quality System National Quality Standards include standards for specific sectors (e.g., IEC standards for electronics, ASTM standards for steel and metal) and general standards related to management processes (e.g., ISO quality management system standards for manufacturing and service industries). The aim of National Quality Standards is to protect human health, safety, and the environment; they also facilitate interoperability, increase efficiencies, and reduce the production of defective parts and materials. National standards should be defined on the basis of the World Trade Organization's (WTO) Code of Good Practice for the Preparation, Adoption and Application of Standards, included in the WTO's Agreement on Technical Barriers to Trade (TBT). Metrology Systems include scientific and legal metrology systems. Scientific systems include centers responsible for maintaining national measurement standards (e.g., for length, mass and volume), as well as calibration services that ensure precision of equipment for public and private sector laboratories. Legal systems include centers that have responsibility for checking that measurement standards used by firms are consistent with national measurement standards (e.g., checking that supermarkets' scales are correct). Certification Institutions certify conformance of firms' products and services with National Quality Standards. Certification institutions can be public or private and can be accredited by a National Accreditation Authority. Accreditation Institutions certify conformance of laboratories' functions with National Quality Standards. Like certification institutions, accreditation organizations can be public or private and can be accredited by a National Accreditation Authority. Quality Information Centers help firms and consumers identify requirements for both domestic and export markets. Many National Information Centers also serve as the Enquiry Points required under the WTO TBT Agreement. Among its duties, the Enquiry Point responds to requests for information from other WTO members concerning technical regulations, standards and certification systems in effect in its country. In return, information from the other 144 WTO members is available at the Enquiry Point. Source: Motta M., Stein J. et al (2004), Honduras Trade and Productivity Project, and Thompson D. (2004), background paper prepared for the project. Industrial statistics in Guatemala are inadequate. There is no consolidated institutional effort to generate comprehensive, periodic data on industry. The quality of the statistical data that are available erodes during the long time lag between their collection and their publication. Lacking a reliable and updated universe, the team and the survey firm had to develop its own sample frame. It adopted the methodology of assembling in one unique frame the establishment lists from different sources. The main sample frame used was drawn from the "Directorio Nacional de Empresas y Locales, DINEL", from the Central Bank of Guatemala. It was complemented with the following other sources. 1 1. Directorio Nacional de Empresas y Locales, DINEL Banco de Guatemala, Instituto Nacional de Estadística 2,001 - 2,002 2. Directorio Telefónico de Guatemala Páginas Amarillas PUBLICAR Directorio 2,003 3. American Chamber of Commerce in Guatemala Directorio 2,003 4. Asociación Gremial de Exportadores de Productos No Tradicionales (AGEXPRONT). Directorio de Exportadores. 5. Vestuario y Textiles (VESTEX) Directorio 6. Instituto Guatemalteco de Turismo (INGUAT) Directorio Hotelero The sample was drawn by CID Gallup, using as parameters sectoral samples sizes provided by the World Bank. A size-stratified random sample covering firms of all sizes was drawn, except in the retail sector, where it was decided to focus on large firms only. Given the similarity in industrial structures between Guatemala and Honduras, sectoral sample sizes were chosen to be consistent with those used for the Honduras sample, with minor adjustments made in order to allow for the inclusion, with the same total sample size of 500 firms, of a sub-sample of retail firms. The manufacturing sectors covered in the sample were responsible in 2002 for 80% of total manufacturing value added. The survey instrument was developed by the World Bank and CID Gallup, who administered the survey under World Bank supervision. The survey covers a stratified sample of 500 firms in 10 manufacturing sectors, as well as the sectors of hotels and retail, across 15 provinces of Guatemala. Finally, based on experience with similar surveys, a 100 percent replacement rate was agreed on. 2 1 ANNEX B STANDARD INVESTMENT CLIMATE TABLES Table A1 Sample Structure for Guatemala Investment Climate Survey Sample population Sample population Firm size Firm activity Micro 104 Apparel 111 Small 139 Beverages 12 Medium-size 94 Chemical 55 Large 118 Food & Tobacco 82 Furniture, etc. 57 Leather & shoes 12 Nonmetal minerals 39 Market orientation Textile 24 Exporter 146 Metal Products 39 Nonexporter 309 Paper 4 Commerce 20 Firm ownership Firm location Private, domestic 409 Metro Guatemala 329 Private, foreign 46 Metro close 42 State 0 Metro far 14 Altiplano 33 Coast 24 Eastnorth 13 1 Table A2 Globalization of Markets and Inputs in Guatemala, by Type of Firm (percent) ez r ityc ict orte ityc all mes exp- Guatemala Honduras Nicaragua Micro Sm Medium-si Large Foreign Do Exporter Non Low-capa High-capa 1..1 Composition of sales Sold domestically 84.2 75.7 84.8 97.8 91.7 89.6 59 42.5 88.9 51.3 99.7 88 79.9 Exported directly 13.3 21.3 9.4 1 6.4 8.5 36.1 51.4 9 41.1 0.2 9.5 17.6 Exported indirectly 2.5 3 5.8 1.2 1.9 1.9 4.9 6.1 2.1 7.6 0.1 2.5 2.5 1..2 Source of inputs and supplies Domestic sources 67.6 67.6 64.3 82.1 81.8 59.6 43.9 34.9 71.2 47.2 77.1 68.9 65.9 Imported directly 22.2 25 15.3 6.4 10.9 28.2 45.2 54.5 18.7 42.4 12.8 20.9 23.8 Imported indirectly 10.2 7.3 20.4 11.4 7.3 12.1 10.9 10.6 10.1 10.4 10.1 10.2 10.3 2 Table A3: Share of Firms Assessing Constraints to Operation as Major or Very Severe in Guatemala, by Type of Firm (percent) i - - rge por Constraint Guatemala Honduras Nicaragua Micro Small m- size La Fore gn Dome stic Ex ter porxe ac ac ter Low cap ity High cap ity Telecommunications 6.6 18.8 12.8 10.7 3.6 5.3 7.6 10.9 6.1 6.8 6.5 8.5 4.6 Electricity 26.6 36.7 34.1 25.0 26.6 23.4 30.5 26.1 26.7 26.7 26.5 29.1 23.9 Transportation 13.6 7.6 12.4 12.5 10.8 17.0 15.3 17.4 13.2 15.8 12.6 14.1 13.3 Access to Land 15.2 12.9 17.5 19.2 15.8 13.8 11.9 13.0 15.4 12.3 16.5 17.1 12.4 Tax rates 56.5 34.9 32.5 49.0 59.0 60.6 56.8 63.0 55.7 61.0 54.4 62.4 49.5 Tax Administration 34.8 22.5 16.6 28.2 30.9 40.4 40.7 41.3 34.1 37.7 33.4 37.6 31.8 Customs regulations 26.0 10.6 10.0 6.2 20.5 37.2 39.7 31.1 25.4 37.9 20.1 26.5 25.0 Trade regulations 12.6 8.5 6.8 1.0 6.9 19.4 23.5 22.2 11.5 22.8 7.6 10.3 15.2 Labor regulations 16.7 14.3 5.8 14.4 16.5 18.1 17.8 21.7 16.1 17.1 16.5 17.9 15.6 Skills and education of available Workers 31.4 27.8 15.3 22.1 28.8 42.6 33.9 21.7 32.5 28.8 32.7 38.9 22.9 Business Licensing, etc. 15.6 21.0 9.5 7.7 10.1 22.3 23.7 21.7 14.9 19.9 13.6 16.2 14.7 Availability of financing 30.8 48.6 49.6 27.9 38.8 37.2 18.6 17.4 32.3 29.5 31.4 37.6 22.5 Cost of financing 43.3 60.0 58.3 43.3 50.4 48.9 30.5 26.1 45.2 39.0 45.3 49.6 35.8 Access to financing 34.1 50.1 53.1 31.7 39.6 44.7 21.2 23.9 35.2 30.1 35.9 40.6 26.1 Economic and Reg. Policy Uncertainty 66.4 47.2 56.4 56.7 69.8 75.5 63.6 22.2 11.5 67.1 66.0 73.9 57.8 Macroeconomic Instability 60.9 53.1 47.8 57.7 62.6 72.3 52.5 21.7 16.1 60.3 61.2 65.8 55.0 Corruption 80.9 63.0 63.1 81.7 81.3 83.0 78.0 21.7 32.5 80.1 81.2 85.5 75.7 Crime & Violence 80.4 60.6 39.2 79.8 78.4 86.2 78.8 21.7 14.9 80.8 80.3 84.2 76.6 Anti-competitive practices 56.3 37.7 47.1 54.8 56.8 59.6 54.2 17.4 32.3 54.1 57.3 62.4 49.1 3 Table A4 Infrastructure Performance Indicators in Guatemala, By Type of Firm r ityc ict orte ityc all mes exp- Indicator Guatemala Honduras Nicaragua croi Sm Medium Large Do Foreign Exporter Non Low-capa High-capa Share of Firms that experienced a power cut 74.1 92.1 88.7 72.1 74.8 72.3 76.3 74.0 73.9 75.3 73.5 78.1 69.7 Frequency of power outages (times last year) 13.7 29.4 29.8 9.2 14.7 13.1 17.0 13.9 11.7 12.6 14.2 14.5 12.9 Total Hours lost due to power outages 60.0 127.0 129.5 35.8 41.2 115.9 59.8 63.6 26.5 33.6 72.3 43.3 77.9 Sales lost due to power outages (percent) 2.3 3.0 3.9 3.0 2.7 1.8 1.5 2.4 1.3 1.7 2.5 2.9 1.6 Share of firms that own a generator 21.7 33.3 19.9 9.3 12.5 19.1 44.4 20.3 28.3 31.5 16.2 20.3 22.0 Days to obtain an electricity connection 62.3 32.5 31.4 71.1 47.1 84.2 52.0 68.2 24.9 72.9 55.8 66.2 57.6 Share of firms that experienced a phone cut 19.6 24.8 26.2 12.5 18.0 25.8 22.9 18.6 26.1 21.9 18.4 19.8 19.3 Frequency of phone cuts (times last year) 2.6 6.5 7.0 0.7 1.2 3.6 4.9 2.7 1.6 1.3 3.2 1.5 3.7 Total hours lost due to phone outages 17.5 56.0 79.5 12.0 12.0 32.9 16.6 17.0 21.5 15.1 18.6 16.3 18.7 Sales lost due to phone outages (percent) 0.2 0.3 0.7 0.0 0.2 0.5 0.1 0.1 0.7 0.0 0.3 0.2 0.2 Days to obtain a telephone connection 47.7 175.0 118.4 116.4 23.7 38.3 35.0 49.2 38.2 45.5 49.1 58.8 36.4 Share of Firms who communicate with clients through email 66.4 50.2 38.5 32.7 56.8 83.0 94.1 63.1 95.7 91.1 54.7 62.9 70.2 Share of firms who communicate with clients through a website 29.2 21.8 16.6 6.7 20.1 28.7 60.2 25.4 63.0 50.7 19.1 24.5 34.4 Days to obtain a water connection 68.1 54.5 54.6 130.5 32.4 76.0 8.8 70.7 3.0 79.3 63.2 93.6 10.9 4 Table A5 Sources of Finance for Firms in Guatemala, By Type of Firm Hond all Guatemala uras Nicaragua Micro Sm Medium Large Share of firms with audited financial statements 34.2 43.2 30.2 22.6 19.4 44.2 56.4 Share of firms with overdraft or line of credit 49.0 42.7 30.7 44.1 47.3 53.5 52.5 Share of credit currently unused-Mean 60.0 61 55.5 58.1 57.6 57.3 66.6 Share of firms with a loan from a bank or other financial institution 43.5 51.2 43.7 28.4 40.3 52.3 55.5 For the most recent loan or overdraft Share of loans requiring collateral 73.1 89.1 92.4 79.3 69.2 73.3 73.2 Average value of collateral required, as a share of loan 115.1 154 217.8 125 120.2 97.1 119.2 Average interest rate on US$ denominated loan 13.9 11.3 16.4 na 12.1 11.8 10.2 Average duration of US$ denominated loan (months) 41.7 38.5 32.5 na 40.5 35.4 46.3 5 Table A6 Sources of Finance for Firms in Guatemala, by Type of Firm all Guatemala Honduras Nicaragua Micro Sm Medium Large Sources for working capital Retained earnings 59.2 49.2 57.6 69.0 58.4 53.6 54.9 Banks 13.0 25.9 14.0 5.6 11.4 17.5 18.6 Supplier Credit 18.3 13.0 16.3 16.0 20.2 19.4 17.2 Equity 1.4 0.6 0.4 1.3 0.8 1.0 2.5 Informal sources 0.8 1.5 0.8 0.7 0.4 1.1 1.2 All others 7.4 9.8 10.9 7.4 8.8 7.4 5.6 Sources for new investments Retained earnings 59.4 52.7 68.6 66.7 57.8 64.7 50.6 Banks 19.5 27.9 17.0 13.4 18.7 16.3 28.2 Supplier Credit 8.4 5.7 3.7 6.4 9.6 6.2 10.4 Equity 1.4 2.2 0.8 1.3 1.2 1.2 1.8 Informal sources 0.7 1.4 0.1 1.0 0.5 0.1 1.2 All others 10.7 10.1 9.8 11.2 12.2 11.5 7.8 6 Table A7 Regulatory Burden and Administrative Delays in Guatemala, by Type of Firm r ityc ict orte ityc 1..2.1.2 Nicaragua all mes exp- Guatemala Honduras Micro Sm Medium Large Foreign Do Exporter Non Low-capa High-capa Confidence in the judiciary (% disagree) 47.7 38.5 41.0 44.2 47.8 55.9 44.1 41.3 48.4 50.3 46.2 52.2 43.0 Share of senior management's time spent dealing with regulations 11.16 8.6 7.7 6.42 9.98 12.95 15.34 19.14 10.26 13.24 10.18 11.8 10.4 Informal payments to officials to "get things done" as a share of revenue 3.7 2.5 1.7 3.6 4.1 3.6 3.2 3.4 3.7 3.5 3.8 3.9 3.4 Share of revenue typically reported for tax purposes 77.3 68.4 66.4 70.3 75.3 76.6 86.5 87 76.2 81.9 75.2 77.2 78 Days spent in inspections or required meetings with officials 9.9 12.2 21.3 5.4 6.3 7.2 20.3 14.9 9.3 15.8 7.1 7.9 12.1 Interpretations of regulations (% of disagree) 71 45.9 42.2 69.2 72.7 71.7 70 69.6 71.1 75.3 68.9 74.4 67.4 Share of disputes taken to the courts 1.4 2.1 2.1 2.1 0.9 1.6 1.2 1.3 2.1 1.0 1.6 0.9 1.8 Security Costs (% of total costs) 5.5 3.6 2.9 4.7 4.2 7.0 6.4 5.2 7.8 7.1 4.6 5.8 5.2 7 Table A8 Technology Indicators in Guatemala by Type of Firm Mi ict ter all mes - Indicator Guatemala Honduras Nicaragua cro Sm Medium Large Foreign Do Exporter Non expor High- cpacity Share of firms introducing a technological innovation 80.9 67.3 67.9 69.2 79.1 81.9 92.4 91.3 79.7 87.7 77.7 81.4 Method of introducing innovations New machinery or equipment 73.9 79.2 71.6 61.1 78.2 66.2 83.5 81.0 73.0 79.7 70.8 78.9 Hiring key personnel 49.5 49.5 45.3 63.9 40.9 44.2 52.3 50.0 49.4 46.1 51.3 48.9 Licensing or turnkey operations from int'l sources 4.1 3.3 1.7 0.0 4.5 2.6 7.3 4.8 4.0 6.3 2.9 4.4 Licensing or turnkey operations from domestic sources 1.4 1.7 0.7 2.8 0.0 2.6 0.9 0.0 1.5 2.3 0.8 1.1 Developed or adapted within the establishment locally 46.2 39.9 44.9 43.1 49.1 48.1 44.0 38.1 47.2 50.0 44.2 46.7 Transferred from parent company 5.2 7.6 4.4 1.4 1.8 5.2 11.0 28.6 2.1 8.6 3.3 7.2 Developed in cooperation with client firms 12.0 11.2 9.8 11.1 9.1 16.9 11.9 4.8 12.9 9.4 13.3 8.9 Developed with equipment or machinery suppliers 18.2 20.1 16.2 18.1 15.5 19.5 20.2 23.8 17.5 20.3 17.1 17.2 From a business or industry association 7.9 3.3 5.7 8.3 7.3 10.4 6.4 4.8 8.3 9.4 7.1 7.8 Trade fairs and/or study tours 16.8 18.2 16.9 15.3 15.5 19.5 17.4 11.9 17.5 17.2 16.7 16.1 Consultants 6.8 7.3 5.7 6.9 4.5 5.2 10.1 4.8 7.1 4.7 7.9 5.0 Universities, public institutions 3.0 3.0 4.4 2.8 4.5 5.2 0.0 0.0 3.4 2.3 3.3 3.3 Share of firms with a foreign license 19.6 15.2 9.1 10.6 12.2 16.0 39.0 34.8 17.9 30.1 14.6 19.9 Share of firms with ISO Certification 3.3 5.4 3.3 1.0 1.4 3.2 7.6 10.9 2.4 4.8 2.6 3.2 Share of firms with other quality certification 11.9 17.0 20.3 1.9 7.9 6.4 29.7 26.1 10.3 24.7 5.8 14.9 Share of firms with computerized equipment 23.5 21.4 11.1 4.8 16.5 23.4 48.3 41.3 21.5 38.4 16.5 24.0 Share of Firms with a major new product line since 2002 53.0 46.5 47.0 49.0 50.4 54.3 58.5 47.8 53.5 58.2 50.5 51.1 Share of firms that upgraded an existing product line since 2002 81.5 72.3 85.1 78.8 83.5 83.0 80.5 80.4 81.7 83.6 80.6 84.2 Share of firms that Introduced new technology since 2002 43.3 45.2 52.5 33.7 46.8 41.5 49.2 52.2 42.3 57.5 36.6 48.0 8 Table A9 Transport comparisons in Guatemala, by Type of Firm S rs ict ne orte zo e zone Micro mall Medium Large mes Do Foreign exp- fre Exporters Free Guatemala Honduras Nicaragua 1..1.1.1.1.1 Non No Transport Interruptions % of firms experiencing interruptions 29.9 9.3 15.5 15.4 28.8 36.2 39.0 37.0 29.1 37.0 26.5 28.9 52.6 Number of interruptions (a) 7 4.1 7.4 6.4 5.7 8.0 7.7 7.2 7.0 6.9 7.1 7.2 5.0 Average duration of interruptions, hours (a) 8.4 10.6 18.2 7.9 9.6 8.5 7.3 5.0 8.8 7.5 8.9 8.5 6.9 Losses due to interruptions (a) (% sales) 2.8 2.9 6.8 7.0 2.5 2.0 1.4 1.0 3.2 1.9 3.5 3.0 1.3 Losses while transporting goods % of firms that experienced losses 40 36.9 26.3 23.1 30.2 53.2 55.1 45.7 39.1 41.8 38.8 38.8 63.2 Losses (% of consignment value) (b) 4.2 4.5 6.2 8.5 3.6 4.0 3.0 3.8 4.2 4.2 4.1 4.1 5.1 Customs clearance times (days, mean values) imports, average period 9.4 5.1 5.2 9.3 8.5 11.1 8.9 6.9 10.0 8.2 10.9 9.5 7.9 imports, longest period 19.3 9.6 10.3 15.1 13.8 18.9 21.8 15.2 20.3 18.3 20.5 19.3 19.5 exports, average period 2.3 1.9 2.0 2.0 2.9 2.1 2.2 1.9 2.4 2.3 2.2 2.2 2.5 exports, longest period 5.5 2.9 3.0 3.6 4.7 4.9 6.1 3.9 6.0 5.6 4.4 5.4 5.8 Notes: (a) numbers apply to those firms having transport interruptions. Losses are as % of sales. (b) Apply to those with positive losses. 9 Table A10: Labor and Training in Guatemala, by Type of Firm Guatemala Honduras Nicaragua2.1.1.1.1..1 ict r all - yit yit icro Sm Medium Large mes Non ortep Low acp High acp Do Foreign Exporter Ex Ca Ca Labor Composition Share of workers that are permanent 97.0 86.8 88.2 94.3 97.3 98.5 97.9 96.8 98.7 97.2 96.9 97.2 96.8 Share of permanent workers that are female 28.8 26.4 24.8 21.9 27.6 28.6 36.4 27.0 44.4 36.7 25.0 27.6 30.1 Share of temporary workers that are female 26.4 24.0 17.9 22.3 18.9 36.3 34.2 25.9 33.3 37.1 21.5 28.9 24.3 Share of perm. skilled wkrs. that are foreign nationals 0.8 0.9 0.8 1.3 0.2 0.3 1.3 0.4 4.4 1.1 0.6 0.4 1.1 Labor Turnover New employees as a share of total 10.4 14.9 10.2 10.9 9.7 11.8 9.8 10.3 11.4 11.2 10.0 10.2 10.6 Employees that left as share of total 12.1 16.7 13.7 10.6 11.7 13.1 12.9 12.2 11.2 11.4 12.4 13.3 10.7 Avg. time to fill a skilled techn. vacancy (weeks) 5.8 4.3 4.2 5.8 5.8 7.5 4.9 5.9 5.3 4.7 6.5 7.3 4.0 1.07 Avg. time to fill a prod/service wkr. vacancy (weeks) 2.1 1.6 1.7 1.8 1.6 4.0 1.4 2.189 1 1.6 2.3 2.4 1.7 Share of firms offering formal training 55.0 49.3 37.4 37.5 50.4 53.2 77.1 53.3 69.6 67.1 49.2 57.3 51.8 Desired Change in Workforce if there were not regulatory restrictions 8.1 8.6 5.8 13.2 8.1 8.7 3.0 8.0 9.0 6.8 8.7 8.6 7.5 Labor Unrest Total days lost to labor disputes or civil unrest 1.3 0.3 1.0 1.4 1.2 1.6 1.3 1.3 1.4 1.2 1.4 1.2 1.5 10 References Bruno, Michael, and William Easterly. 1998. 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