Report No. 29920-MX Mexico Mexico’s Challenge of Knowledge-based Competitiveness Challenges and Opportunities (In Two Volumes) Volume II: Main Report June 2006 Colombia and Mexico Country Management Unit Latin American and Caribbean Region Knowledge for Development Program, WBI Document of the World Bank KE Knowledge Economy KEI Knowledge Economy Index LLL Lifelong Learning MNC Multinational Corporations NAFTA North American Free Trade Agreement NAFIN Nacional Financiera NGO Non-governmental organization OECD Organization for Economic Co-operation and Development OEM Original Equipment Manufacturing PC Plaza Comunitarias PEMEX Petr6leos Mexicanos PISA Programme for International Student Assessment PROMEP Programa de Mejoramiento del Profesorado PRONABES Programa Nacional de Becas para l a E d u c a c i h Superior R&D Research and Development RCA Revealed comparative advantages SAT Servicio de Administracih Tributaria SCT Secretaria de Comunicaciones y Transportes SE Secretaria de Economia SEP Secretaria de Educaci6n Phblica SEPE Secretariados de Educaci6n Pliblica Estatales SME Small and Medium Enterprise SNI Sistema Nacional de Investigadores SNTE Sindicato Nacional de Trabajadores de l a E d u c a c i h S&T Science and Technology SOFES Sociedad de Foment0 a l a E d u c a c i h Superior STPS Secretaria del Trabajo y Previsi6n Social TFP Total Factor Productivity TIMSS Trends in Intemacional Mathematics and Science Study TSU TCcnico Superior Universitaria UNAM Universidad Nacional Autonoma de MCxico UNCTAD UnitedNations Conference on Trade and Development VAT Value-added Tax WTO World Trade Organization WBI World Bank Institute M K U V i c e President: Frannie Leautier,, WI Country ManagerDirector : Isabel M. Guerrero, LCC 1C Sector ManagerDirector: Daniel K a u h a n n , W I G P Task Managers: Y e v g e n y Kuznetsov/Carl Dahlman .. 11 Mexico’s Challenge o f Knowledge-basedCompetitiveness: Challenges and Opportunities Table o f Contents Acknowledgments iv Boxes, figures, tables V Part I. A Need for a Transition to Knowledge-based Economy 1 Chapter 1. N e w Challenges and Opportunities 2 Chapter 2. Benchmarking Mexico’s Position in the Knowledge Economy 20 Part 11. Major Policy Issues 29 Chapter 3. Transforming the Innovation and Enterprise Upgrading System 30 Chapter 4. Enhancing Education and Skills 66 Chapter 5. Updating the I C T Infrastructure in Mexico 96 Part 111. Implementation Options 122 Chapter 6. Toward National Vision and Leadership 123 Chapter 7. Regional Leadership in the Transition to a Knowledge 136 Economy Annexes 152 1. Theoretical Framework for Growth Projections 153 2. Knowledge Assessment Methodology (KAM) 160 3. Comparator Scorecards for Mexico, United States, the Republic o f Korea, China, and Ireland 161 4. Data for the Scorecards for Mexico, United States, Republic o f Korea, China, Ireland, and Spain (1995 and most recent) 162 5. Performance, Economic Incentive Regime, Governance, Education, Innovation, and Information and Communications Technologies: Scorecards for Mexico, United States, Republic o f Korea, China, Ireland, and Spain 163 6. Variables for state level 1knowledge assessment 169 References 170 ... 111 Acknowledgments The report was prepared by a team led by Carl Dahlman and Yevgeny Kuznetsov o f the World Bank Institute’s Knowledge for Development Program (WBIKD). Team members included Guillenno Abdel Musik (Instituto Tecnol6gico Aut6nomo de MCxico, Mexico City), Aimilios Chatzinikolaou (International Finance Corporation), Joost Draaisma (World Bank, Latin America and Caribbean Region, Economic Policy Sector), and Robert Stephens (IBRD-Global Information and Communications Technologies Department, Policy Division). Valuable contributions were made by Clemente Ruiz Duran (Universidad Nacional Aut6noma de MCxico, Mexico City), Carlos Mancera (Valora Consultores), Mark Hagerstrom and Harry Patrinos (World Bank, Latin America and Caribbean Region, Human Development), Daniel Crisafulli (IBRD-Global Information and Communications Technologies Department, Policy Division), and Derek Chen (WBIKD). Administrative and editorial assistance was provided by Faythe Calandra (WBIKD). We express special thanks to participants o f a discussion with the government organized by the Presidency o f Mexico on January 17, 2005, particularly Alejandro Werner (Secretm’a de Hacienda y CrCdito Piiblico de MCxico), Guillermo Aguirre (Consejo Nacional de Ciencia y Tecnologia), and Bemardo Gonzalez-Anechiga (Instituto Tecnol6gico de Estudios Superiores de Monterrey). Members o f the Mexico country team, particularly Krishna Challa and Anna Wellenstein (World Bank, Latin America and Caribbean Region, Finance, Private Sector and Infrastructure), provided guidance and advice. We would also !ike to thank Peter Scherer and our colleagues in Mexico, particularly Rene Villareal (Centro de Capital Intelectual y Competitividad), Roberto Villareal (Office of the President), Guillermo Fernandez de l a Garza (US-Mexico Foundation for Science), and Hector Moreira (ITESM) for their useful insights. Peer reviewers are Jose Luis Guasch (Latin America and Caribbean Region, Finance, Private Sector 2nd Infrastructure), Lauritz Holm-Nielsen (Latin American and Caribbean Region, Human Dekelopment, Education Sector), Alfred Jay Watkins (Europe and Central Asia Region, Poverty and Financial Sectors Development), and Fernando Clavijo (Analitica Consultores, Mexico). iv List of Boxes, Figures, Tables Boxes B o x 1.1. Health Care Services as a Global Opportunity: Lessons from India B o x 3.1. Discretionary Differences Among Firms: The Automotive Industry B o x 3.2. The Three Elements Illustrated: The Automotive Sector B o x 3.3. Linkages: Clusters and Value Chains B o x 3.4. Improving Decentralized Sectoral and Regional Funds B o x 3.5 Picking Winners by Multinational Companies: Lessons o f National Linkage Program in Ireland B o x 3.6. The Switching Period in Supplier Development in the Mexican Garment Industry B o x 4.1. Structure o f Mexico’s Education System B o x 4.2 Quality Control Mechanisms B o x 4.3. Mexico’s Proactive Approach to Small and Medium-Size Enterprise Support B o x 4.4. Achieving Change at the Margin: Charging Tuition Fees at Mexican Universities B o x 6.1. The Republic o f Korea’s Transition to a Knowledge Economy: From Vision to Implementation B o x 6.2. The Fundaci6n Chile Model and its Relevance for Mexico B o x 6.3 Monterrey Institute o f Technology and TecMilenio: Educational Spin-off as a Model o f Life-Long Learning B o x 6.4. Quasi-Rents as a Motivation for Concerted Action B o x 7.1 Transition to Knowledge Economy: Example o f Aguas Calientes B o x 7.2. Adoption o f Organisational Knowledge: Innovative Supplier Development Program B o x 7.3. Culture as a K e y Intangible: Potential o f High-Value-Added Tourism B o x 7.4. Scan Globally, Experiment Locally: Developing Managerial Capability Figures Figure 1.1 GDP per Capita Growth in the Republic o f Korea and Mexico, 1960-2002 Figure 1.2. Four Projections o f Mexico’s Real GDP per Capita, 2001-2020 Figure 1.3 Manufacturing Productivity in Mexico, 1993-1999 Figure 1.4. Manufacturing Industries in Mexico: Revealed Comparative Advantage by Technological Intensity, 1990-2000 Figure 1.5. Microeconomic Competitiveness Rankings o f Mexico and I t s M a i n Trading Partners, 1998-2004 Figure 1.6. Patents o f U.S. and Foreign Origin Granted by the US. Patent Office, 1981- 200 1 Figure 1.7. Worldwide Payments and Receipts o f Royalties and License Fees, 1970-2002 Figure 2.1. Global View o f Knowledge Economy Index V Figure 2.2. GDP per Capita and Knowledge Economy Index, 2002 Figure 2.3. Knowledge Scorecards for Mexico and the United States Figure 2.4 Mexico’s Performance on the Four Pillars o f the Knowledge Economy Figure 3.1. Innovation Variables: A Comparison o f Mexico and China Figure 3.2. Global View o f Innovation Performance Figure 3.3 Learning Capabilities by Type o f Firm Figure 3.4. Value Added per Worker in Mexico’s Motor Vehicle and Equipment Sector Figure 3.5. Finance and Execution o f R&D in Mexico by Sector, 2000 Figure 3.6. Efficiency o f Spending on R&D, Selected OECD Countries, 1985-2000 Figure 3.7. Public and Private Institutions Involved in Innovation in Mexico Figure 3.8. Convergence o f Enterprise Support and Innovation Programs Figure 3.9. Proyecto Innovar as a Possible Hub o f US-Mexico Innovation Networks Figure 4.1 Education Performance Scorecard: Mexico, Ireland, and the Republic o f Korea Figure 4.2. Mexico and the World: Education Figure 4.3. Ratio o f Yearly Remuneration, White-collar to Blue-collar Workers in Mexico’s Maquiladora Manufacturing Industry, 1988-2000 Figure 4.4. University Graduates in Engineering and Basic Sciences, Selected OECD Countries, 2000 Figure 4.5. School Enrollment in Mexico, by Age and Income Group Figure 4.6. Forces for Change in Reforming Education Figure 5.1. Network Readiness Index, 2003-2004 Figure 5.2. Benchmarking Mexico’s I C T Performance Figure 5.3. Mexico’s I C T Investments as a Share o f GDP, 2003 Figure 5.4. Internet Users per 100 Inhabitants in Mexico, Chile, and the Republic o f Korea, 1998-2003 Figure 5.5. Regional Distribution o f Main Lines per 100 Inhabitants in Mexico and GDP per Capita, 2004 Figure 5.6. Paid TV Subscribers per 1,000 Inhabitants in Mexico, 2004 Figure 5.7. Incumbent Market Share after Five Years o f Competitition Figure 5.8. International Long-Distance Traffic in Mexico, 1998-2004 Figure 6.1. Virtuous Circle o f Growth and Reforms Figure 6.2. National Supplier Development Program Figure 7.1. Regional Knowledge Index and GDP per Capita in Mexico Figure 7.2. Knowledge Index by Mexican States Figure 7.3. Timeline o f Transition to a Knowledge-based Economy in Aguas Calientes vi Tables Table 1.1. World Trade as a Percentage o f Global GDP, by Income Level o f Country, 1970 and 2001 Table. 1.2 Value Added o f Knowledge-Based Industries, OECD Countries Table 1.3. Gross Domestic Expenditures on R&D as Percentage o f GDP, 1981-2000 Table 1.4. R&D Spending in Selected Countries, by Income Level Table 1.5. Investment in Tangibles and Intangibles as a Percentage o f GDP, Selected OECD Countries, 1998 Table 1.6 Payments and Receipts o f Royalties and License Fees, by Income Level o f Country, 2001 Table 1.7. From First-Generation NAFTA to a Knowledge-Driven (Second- Table 3.1 Instruments to Support Innovation by Type o f Firm Table 3.2. The Share in Total Exports o f Commodity Groups in which Mexican Strength i s Concentrated, 1993 and 2000 Table 3.3. Exceptions and Promising Cases o f Innovation at Different Levels Table 3.4 Federal R&D Expenditures in Mexico by Sector and Subsector, 2001 Table 3.5. Number o f Federal Enterprise Support Programs in Mexico by Type and Organization, 200 1 Table 3.6 Program Evaluations Table 3.7. Venture Capital in Mexico: Supply and Demand Table 4.1. Average Years o f Schooling o f Adults in OECD Countries, 1980-2000 Table 4.2. Completion Rates in Mexcio and Dropouts per Year, by Age Group Table 4.3. Programme for International Student Assessment, 2000 Results for Selected OECD Countries Table 4.4 Higher Education in Mexico: Institutions, Students, and Teachers, 2000-2001 Table 5.1. I C T Indicators, Selected Countries, 2003 Table 5.2. Technology and Growth for Broadband Internet Access Services (Consumers), 2001-2006 Table 5.3. Telmex Market Shares = Table 5.4. Financial Performance o f Telecommunications Companies, December 2004 Table 5.5 Telephone Tariffs in Mexico, 1995-2003 Table 5.6. Local Prices for Telephone Services in Mexico and Other OECD Countries, 2003 Table 5.7 Local Loop Prices for Carriers 2002: E-1 CAPACITY Table 5.8. Telephone Prices for Rural Telephony Table 6.1. Mexico’s Three-Stage Policy Agenda in Innovation, Education, and I C T Table 7.1. Four Types o f States in Mexico and Four Policy Agendas vii Part I.Need for a transition to knowledge-based economy Where does Mexico aspire to be twenty years from now, and what will i t s industrial structure look like? This question is impossible to answer in any reasonable detail, just as it was impossible to predict, in the wake o f the debt crisis, h o w Mexico would be transformed over the past twenty years. Today Mexico needs to embark on a no less dramatic transformation. This transformation will be based on the North American Free Trade Agreement (NAFTA) economic model, but it will need to go further. Further reforms within the NAFTA agenda must focus o n dramatically improving national capabilities to generate knowledge and transform it into wealth. Such capabilities are largely about flexible and efficient networks o f public and private organizations interacting in a concerted way to generate and adopt knowledge. This “national learning capacity” i s what permits nations to adopt and innovate in their initial areas o f comparative advantage. It also helps create new areas o f advantage. To underline continuity with the existing model, and stress the need for a new generation o f reforms to tap into the knowledge revolution, we call a knowledge economy agenda for Mexico a “knowledge-driven (second-generation) NAFTA agenda.” Driven by the rapid application o f new information and communications technologies (ICT), and the application o f scientific discoveries to production in every sector o f the economy, the knowledge revolution has created massive opportunities for countries to dramatically increase their competitiveness and to achieve rapid growth. At the same time, it presents great challenges. Knowledge-driven supply chains and markets now dominate the global economy. If countries fail to position themselves properly in this global, knowledge-based marketplace, they will be increasingly unable to compete. 1 Chapter 1 New Challenges and Opportunities M u c h o f the challenge Mexico faces in the global knowledge economy could be retold as a parable o f two small, family-owned garment firms, one in Chihuahua and the other in Michoacan. They share the same history and, until very recently, were almost identical in their endowments o f human and fixed capital. Yet one is prospering and exporting, while the other i s struggling to survive. The successful firm was able to plug into worldwide garment networks. Through this collaboration, it takes advantage o f design and marketing capabilities o f leading firms in Mexico and the United States. More generally, it learns about product differentiation and the importance o f just-in-time delivery. Given the rapidly changing tastes o f consumers and clothing designs, and the demanding production and logistics disciplines needed to keep pace with these changes, the successful firm i s becoming part o f the new, knowledge-processing economy. I t s small size and modest resources are not obstacles to success, precisely because manufacturing and marketing skills reside in networks, not individual firms. In contrast, the struggling firm is at risk precisely because, like so many other Mexican firms, it is trying to survive on its own, largely cut o f f from leading foreign corporations with direct investments in Mexico, and from other domestic companies. All the knowledge-induced changes that create opportunities for the first firm are threats to i t s neighbor, because the same disruptions o f routine and habit that allow the first firm to convert inexperience into open-mindedness and the ability to take a fresh approach create daunting risks for the second. Worse yet, the first firm is learning how to learn, while the second knows only h o w much it does not know. The first firm embarks o n a virtuous circle o f learning: success breeds success-inclusion in knowledge networks brings new expertise and makes subsequent learning more productive. The second firm falls into a vicious circle o f poverty; failure breeds failure-exclusion from knowledge networks diminishes further chances to catch up. This chapter discusses the knowledge revolution and the exciting opportunities for growth it presents for Mexico. Knowledge, as discussed in this book, is emphatically not just about high technology. By putting knowledge to work, the developing regions o f Mexico, small and medium-size enterprises (SMEs), and other less developed actors can improve everyday life and enjoy new possibilities. Mexico’s service sector (tourism and health services, for example) provides particularly fertile ground for the application o f knowledge. 2 Knowledge-based Growth One proxy for a nation's ability to absorb knowledge is total factor productivity (TFP), a residual in the production function that cannot be explained by inputs. This capability to adopt, adapt, and create knowledge i s critically dependent o n countries' institutions, particularly investment climate and regulatory framework. I t i s often measured by a so- called residual in the production function that cannot be explained by factor inputs.' This ability to put knowledge to work produces a dramatic difference in a country's wealth. Figure 1.1 illustrates the dramatic difference in wealth attributable to national learning capacities. The Republic o f Korea developed such a capability in the 1970s and 1980s, whereas Mexico did not. If, in the next fifteen years, Mexico embarks on the same trajectory o f total factor productivity growth as Korea, per capita GDP in the year 2020 is projected to be about $15,000 (see Figure 1.2). Clearly, the stakes are high in the process o f transformation to a knowledge-based economy. Figure 1.1. GDP per Capita Growth in the Republic o f Korea and Mexico, 1960- 2002 Knowledge Makes the Difference 12000 Korea 10000 G 2 v) - 0 8 - 8000 N .- 0 0 k n 6000 0 ! ? 2 4000 2000 1960 1965 1970 1975 1980 1985 1990 1995 2000 Source: World Bank (2005); see also Annex 1, Theoretical Framework for Growth Projections." While many countries have been able to embark on a path o f knowledge-based growth, there is no single path to such transformation. Different countries have found different ways to build on their strengths in order to improve their competitive positions. 1 Because TFP is a very imperfect proxy, Figures 3 and 4 are merely illustrative and serve t o outline qualitative scenarios o f development. 3 Three countries illustrate three distinct strategies for upgrading national capabilities: the Republic o f Korea, Ireland, and Finland. Korea represents a growth model based largely o n diversified conglomerates. These conglomerates took advantage o f the protected domestic market, which allowed them to generate surplus capital for investment. At the same time, these firms started investing in industries, such as shipbuilding or microchips, where the minimum efficient scale was the global market. This private sector strategy was complemented by an excellent education system. When the domestic market was opened, these firms were already world-class companies with significant technological capabilities. Ireland based its development strategy o n the attraction o f multinational corporations, particularly in the electronics and software industries. Once the firms had become established in Ireland, the country made a strong effort to create vertical linkages and develop suppliers, first as product suppliers, and later o n higher value added activities such as software. Here again the government played a very active role in creating training programs to improve abilities specific to the industries. Finland is a resource-rich country, and not long ago its economy was based o n i t s rich forests. The country started doing research and development to further strengthen its strong industries-forestry, pulp, and paper. Based on the knowledge generated from the R&D activities, telecommunications, design, and consulting firms have sprung up. Given the small size o f the domestic market, these firms n o w are leaders on a global scale. Mexico shares certain elements with each o f these examples: large business groups, the presence o f multinationals, natural resources. However, the country should find its own strategy given its present conditions and strengths. At the level o f the firm, learning capability can be disaggregated into project execution capability, production capability, and innovation capability (Amsden and Hikino 1994). Project execution capability refers to the skills required to establish or expand corporate facilities. Included are the skills required for pre-investment feasibility studies (identification o f markets for project outputs, etc.), project management, project engineering (basic and detailed), procurement, construction, and start-up o f operations. Production capability refers to the skills required to operate the facilities once they are established. Innovation cupability refers to the skills for basic and applied research and related engineering, and to the ability to create new products and processes. In both Mexico and Korea during the period o f intense industrialization, major companies’ large-scale investment projects were established by means o f turnkey technology transfers in the continuous process industries such as soap, cement, and petrochemicals-industries characterized by high capital requirements and little opportunity for reverse engineering. Some o f the Korean companies, faced with export pressures, went on to become industrial leaders by quickly developing sophisticated 4 capabilities for project execution and innovation. In contrast, Mexican conglomerates (with some notable exceptions, such as CEMEX) still face relatively undemanding markets and do not innovate aggressively. Technology i s actively sought, but innovation capabilities, even in the best firms, are not considered a major competitive asset worth nourishing. Large Mexican conglomerates are some o f the best in the world in production and project execution capabilities, which i s no small achievement, but like every achievement, this could be a handicap to the extent that it reduces an urgency to develop sophisticated innovation capabilities. Korean firms, o n the other hand, faced the need to pursue more aggressive export strategies than their Mexican counterparts, and they were able to rely on more efficient public innovation organizations that were more responsive to private sector needs. Innovation (and the associated private investment in applied R&D and technology upgrading) thus became the strategic focus o f Korean firms, enabling them to compete internationally. Figure 1.2 presents four different assumptions regarding Mexico’s ability to utilize knowledge by the year 2020.2 A s in Figure 1.1, total factor productivity i s a proxy for national learning capability. Projection I plots the path o f Mexico’s real GDP per capita if the TFP growth rate were to take its 1991-2000 average value (- 0.13 percent per year)3. Projection 2 plots the path o f Mexico’s real GDP per capita if the TFP growth rate were 2 percent per year, which i s close to the 1991-2000 decade average for Korea. Projection 3 plots the path that Mexico’s real GDP per capita would take if the TFP growth rate were 3 percent per year, which is close to the 1961-1970 decade average for Finland. Lastly, Projection 4 plots the path o f Mexico’s real GDP per capita if the TFP growth rate were to be 4.25 percent per year-the approximate value o f the 1991-2000 decade average for Ireland. Projection 1 i s an inertial scenario, projections 2 and 3 are both realistic scenarios outlining a range o f possibilities for Mexico, and projection 4 i s a very optimistic yet not altogether impossible scenario. We see that knowledge, quite literally, makes the difference between poverty and wealth. All things being equal, the difference in per capita GDP between the realistically optimistic scenario 3 and inertial scenario by year 2020 is almost twofold. For all four projections, capital, labor, and human capital were assumed to grow at the 1991-2000 average growth rates for Mexico-3.32 percent, 2.75 percent, and 0.92 percent, respectively. 3 Alternative methodologies to calculate total factor productivity are available. T o make sure that our results are robust, Annex 1 develops and compares two methodologies which show consistent results - close to zero TFP growth. Our inertial growth projection uses the most optimistic TFP estimate (i.e. other estimates are even lower). Annex 1 also surveys the literature on TFP estimates for Mexico which are all consistent with the ones proposed here. 5 Figure I.2. Four Projections of Mexico’s Real GDP per Capita, 2001-2020 1995 US$ 23,500 -Actual 21,500 ..... - - Projection 1: 0.13 % TFP Growth 19,500 - Projection 2: 2% TFP Growth (South Korea) -Projection 3: 3% TFP Growth (Finland) 17,500 - Projection 4: 4.25% TFP Growth (Ireland) 15,500 / Projection 2 / 13,500 11,500 ”// I Projection 1 i 9,500 .................I i c 7 j 7,500 1995 2000 2005 2010 2015 2020 Year Source Based on historical data. For more details on the methodology and sources of data, see Annexl, ”Theoretical Framework for Growth Projections.” Note: For all four projections, capital, labor, and human capital were assumed to grow at the 1991-2000 average growth rates for Mexico-3.32 percent, 2.75 percent, and 0.92 percent, respectively. 6 Mexico’s Growth Paradox Glimpses o f our high-case scenario - o f prosperous knowledge-based Mexico twenty years from now are already in the making. The engineering centers o f GE, GM, and Delphi, employing hundreds o f highly skilled knowledge workers, can become springboards for innovation clusters. The provision o f health services to retirement communities in San Miguel de Allende or Cuernavaca indicate the potential for high value added healthcare service and recreation clusters. (See B o x 1.1 on rising healthcare expenditures in developed countries and the potential o f healthcare tourism.) These two examples may seem worlds apart, but they both rely on efficient knowledge workers and knowledge organizations. The chapters that follow were written to inform the national debate o n how to develop a critical mass o f knowledge workers and knowledge organizations. Box 1.1. Health Care Services as a Global Opportunity: Lessonsfrom India India i s a well-known exporter o f software and IT-enabled services. Healthcare tourism i s poised to be the next significant business for India because o f its exceptional expertise, cost advantages, and world-class facilities. Worldwide, healthcare i s a $3 trillion industry, and India i s in a position to tap the top-end segment by highlighting i t s facilities and services, and exploiting the brand equity o f leading Indian healthcare professionals across the globe. Western Standard Hospitals are likely to generate about $20 billion in annual revenues by 2010, two-thirds o f which i s expected to come from patients who are not Indian in origin. From the Middle East, Bangladesh, S r i Lanka, Egypt, and Mauritius, patients are beginning to come to these hospitals for cardiac bypass surgery. The procedure costs $5,000 in India compared to $20,000 in the United Kingdom and $30,000 in the United States. Cataract patients from Europe also are choosing to have their cataract operations in India. Afterward they spend two weeks in Goa-an Indian island similar to Hawaii-to recuperate. These patients avoid the long waiting times for European hospitals, and the European insurance companies pay all costs (including the costs o f recuperating). Some Indian radiologists are beginning to read the X-ray charts o f U.S. patients and send their preliminary findings to U.S. radiologists, who verify their findings and do a thorough quality check. In this model, the initial 80 percent o f the work i s in India and the remaining 20 percent in the United States (with proper quality checks by professionals who have U.S. medical licenses). The provision o f health care services for the U.S. and Canadian population, in particular retirees, i s a major opportunity for Mexico. High-quality and low-cost healthcare can become one o f Mexico’s major attractions, along with i t s unsurpassed natural beauty and culture. Source: World Bank staff. Mexico has already developed many pockets o f excellence and high productivity associated with multinationals operating in high-tech and higher middle-tech industries, and with national conglomerates operating in mature industries. These are no longer maquila operations, since they employ many professionals, and in-house design and engineering. Yet these pockets o f excellence are often enclaves with few linkages to the 7 rest o f the economy. This i s Mexico’s growth paradox: a promise o f higher productivity, value added, and wages-a promise that remains largely unrealized. A key fact behind the paradox is the scant learning at the firm level, with a related l o w level o f productivity increase. Figure 1.3 captures this by decomposing Mexico’s gains in total factor productivity. I t shows the “within plant effect” (innovation) and reallocation effect. NAFTA gains are almost exclusively relegated to reallocation between and within sectors, rather than to an increase in technical efficiency (the “within plant effect”). Indeed, this is what economic theory would predict: reallocation effects based on change o f relative price followed by micro-level increases in efficiency based o n learning and innovation. Figure 1.3. Manufacturing Productivity in Mexico, 1993-1999 - -100% -80% -80% -40% -20% 0% 20% 40% 60% 80% 10096 IIWithin plant effect Reallocation within industry Reallocation acfoss industries 8 One indication o f Mexico’ new strength i s Mexico’s revealed comparative advantage by technological i n t e n ~ i t y . Figure ~ 1.4 shows that Mexico has modest but growing advantages in high-tech and medium-high-tech industries (dominated mainly by multinationals), and it i s starting to acquire comparative disadvantage in low and medium-low-tech industries, which are normally associated with low-cost labor. Figure 1.4. Manufacturing Industries in Mexico: Revealed Comparative Advantage by Technological Intensity Mexico Manufacturing Industries: Revealed Comparative Advantage by Technological Intensity % (Share of GDP) 1.0 , .................. ............... -\ .................................... -Med High Tech -2 5 .................................................................. -3 0 ............................................................................................................................... -3.5 1990 1992 1994 1996 1998 2000 Source: Data for imports and exports at the industry level were obtained from the United Nations COMTRADE database employing ISIC revision 3 industry codes. Mexico is now at a crossroads: it cannot yet compete on the basis o f knowledge assets (as can the OECD countries), yet its traditional comparative advantage i s being eroded by low-cost competitors. Both government and industry leaders are extremely concerned about Asian countries attracting many o f the firms now established in Mexico. This was clearly shown when Mexico tried to block China’s accession to the World 4 We use “contribution to the trade balance” as an indicator o f revealed comparative advantage. Mathematically, the contribution to the trade balance i s defined as X j +Mj (X, - M j ) - (x- M ) X+M Where 4 represents the exports o f industryj Mj represents the imports o f industryj X represents the total exports o f the economy M represents the total imports o f the economy. 9 Trade Organization (WTO). However, these leaders seem to understand the problem o f lack o f competitiveness as a problem arising mainly from differences in labor costs; they ignore the close relationship between the country’s performance and its technological capabilities (including adoption, adaptation, and creation o f knowledge). Failure to recognize this critical link will result in h r t h e r loss o f productivity. Underlying the sense o f urgency i s the fact that Mexico i s losing ground in terms o f the quality o f the competitive environment for firms compared with Mexico’s main training partners and competitors. Figure 1.5 illustrates that Mexico’s competitive position i s quite l o w for an economy so highly integrated with the United States and Canada without signs o f consistent improvement. Figure 1.5. Microeconomic Competitiveness Microeconomic Competitiveness Rankings 1998-2004 m a 1WD 2000 2001 2002 2003 2004 0 I States 10 20 Y) P 30 % 2 40 50 60 Source: The Global Competitiveness Report (2005), World Economic Forum. T h e Knowledge Revolution The incredible speed with which knowledge is created, shared, and applied in all parts o f the economy and society has led many commentators to talk about the knowledge “revolution.” Indeed, this revolution in many ways mirrors past periods o f rapid economic and social change. Examples include the changes brought about by the printing press in the 1 5 0 0 ~ ~ harnessing o f steam in the 1800s, and the development and the expansion o f electricity and the automobile industry in the 1900s. However, what is different today from these earlier periods i s that rapid and pervasive change is widely diffused. Indeed, i t i s experienced across almost all technologies and sectors-not only 10 the information and communications technologies (ICT) sector or the high-tech sector. Today new scientific discoveries are everyday occurrences, and, in the marketplace, product l i f e cycles have shortened, reflecting the degree and pace o f invention and innovation. Complementing this, the extent to which scientific discoveries are now being codified and shared-another key enabler o f the knowledge revolution-has led to the development and application o f new technologies at an unprecedented rate. Closer links between science and business have encouraged faster uptake o f the new technologies; indeed, proximity to relevant university research facilities i s fast becoming a key locational driver for leading companies. Spurred by increasing levels o f demand from more sophisticated consumers than ever before, business has invested heavily in research, design, and development to produce higher quality functionality in products. Massive amounts o f knowledge-in the form o f design, software, and services-are embedded in even the most basic products. In this new economy, education and skills enhancement have become increasingly important to business. With the constant changes taking place in production technology and the regular introduction o f new products, life-long learning has become an important policy consideration for governments and a critical investment for businesses. At the same time, greater policy liberalization, improvements in transport and communications technologies, and pressure on business to find the most cost-effective locations have increased the scale and widened the nature o f global activity and competition. International business has growing numbers o f supply chains spanning many countries, as businesses balance what each location can contribute to their overall competitiveness. This new global economy provides enormous potential for countries to strengthen their economic and social development by providing more efficient ways o f producing and delivering goods and services. Dynamic networks and new styles o f organization and management are also creating new forms o f competition. Wealth i s created not just by natural resources or production, but also by the ways in which products and services are designed and delivered to the market. The power o f ideas and brand names-and the harnessing o f knowledge and information to leverage them-are driving the world economy. Keeping up with these new developments requires investments in such intangibles as R&D, software, education, training, marketing, distribution, organization, and networks. In short, more knowledge is being created and applied around the world than at any previous time in history. One indicator o f the accelerating creation o f knowledge is the number o f new patents registered each year. In the United States, the annual number o f patents grew from about 50,000 at the end o f the 1980s to nearly 100,000 in 2000- 2001 (Figure 1.6). Part o f this surge i s due to the greater importance o f protecting intellectual property-a sign o f the awareness o f what knowledge means for wealth creation. 11 Figure 1.6. Patents of U.S. and Foreign Origin Granted by the U.S. Patent Office, 1981-2001 Patents granted by the USPTO 1981-2001 2oo,om l80,Wa 160,000 140,wO 100,Wa 40 ,Wa 20 ,wO 0 1981 1982 1983 1584 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 19% 1996 1997 1998 1999 20(#1 2001 -US Origin -Foreign Origin Total Source: US. Patent and Trademark Office, http: //www.uspto.gov/ The rapid development and spread o f knowledge are creating a more competitive and interdependent world. The share o f world trade (exports and imports) in world GDP, an indicator o f globalization and competition in the global economy, rose from 28 percent in 1970 to 57 percent in 2001 (see Table l.l).5 Other indicators o f greater global interaction include increased foreign direct investment, international sourcing o f production inputs, and interfirm alliances for R&D and technology licensing. Accelerating this process are three factors: the wider availability o f information and communications technologies, the deregulation o f financial and product markets, and the liberalization o f trade, investment, and capital movements. Greater international competition, in turn, spurs f i r m s to create new products and more efficient production processes. T h e direct role o f technology in this process i s reflected in the changing patterns o f international trade. Between 1976 and 1996, the share o f high-technology and medium-technology products increased from 33 percent to 54 percent o f total goods traded. A t the same time, the share o f other primary commodities f e l l from 34 percent to just 13 percent, while that o f resource-based products remained constant. These trends have major implications for developing countries, which are primarily exporters o f primary commodities. N o t only the share but also the prices o f their exports have been falling over the past five decades. 12 Table 1.1. World Trade as a Percentage o f Global GDP, by Income Level o f Country, 1970 and 2001 Note: World trade i s imports plus exports o f goods and services. a. For 2000. Source: World Bank, Statistical Information Management and Analysis (SIMA) database.[web address?] All sectors and industries are being affected by these changes. Even such traditional industries as textiles, cement, and steel are using new technical knowledge and information systems to improve the design and quality o f products and production processes, and the efficiency o f marketing and distribution. In agriculture, greater understanding o f plant reproduction and growth, advances in genetic engineering, and better techniques for harvesting, storage, transportation, and distribution are changing the value and competitiveness o f different types o f plant and animal products. And such services as transportation, distribution, finance, insurance, health, and education are becoming more sophisticated and more intensive in knowledge and information. Global Trends in Knowledge The Organization for Economic Cooperation and Development (OECD) uses the term “knowledge economy” to draw attention to the importance o f knowledge in all economic activities. Once applied only to manufacturing industries that made intensive use o f technology, the concept has expanded to include services that are heavily knowledge- based. The knowledge economy n o w accounts, o n average, for roughly h a l f o f n o n g o v e m e n t economic activity in the OECD (see Table 1.2). 13 Table 1.2. Value Added o f Knowledge-basedIndustries, OECD Countries Note: T h i s i s based on an OECD classification. I Estimate. Regroups Austria, Denmark, Finland, France, Italy, Spain, Sweden, and the UK. For tercentage shares o f value added, also includes Germany and Ireland up to 199 1, and Belgium up to 1995. Estimate. Includes the EU countries, Canada, Japan, Korea, Mexico, Norway, and the US. For percentage shares o f value added, also includes also the Czech Republic up to 1990 and Hungary up to 1992. Estimate. From data in China’s Statistic Yearbook (1999). HT industries do not include medical, precision, and optical instruments. Source: OECD (2002b, Annex Table 4, p. 286). Increased Spending on R&D In most OECD countries, spending o n R&D has risen faster than GDP, although there have been year-to-year fluctuations (see Table 1.3). Perhaps even more importantly, there has been a shift in the composition o f R&D. After 1990 and the end o f the Cold War, the share o f defense-related R&D declined for some o f the largest R&D spending countries-notably the United States, the United Kingdom, and France. Conversely, the share accounted for by nondefense research rose to more than 90 percent o f the total. I n the OECD, the number o f researchers in the economy grew faster than the labor force as a whole. Table 1.3. Gross Domestic Expenditures on R&D as Percentage o f GDP, 1981- 2000 a Data for year 1999. Source: OECD (2002b, Annex Table 7, p. 289). 14 Table 1.4. R&D Spending in Selected Countries, b y Income Level R&D spending as a R&D spending as percentage of GDP a percentage o f (1989-00) world total World 2.38 100 Low income 0.5a 0.67 India 1.23 0.67 Lower-middle income 0.72 3.39 I China I 1.oo I 1.02 I Upper-middle income 0.9gb 2.02 Brazil 0.77 0.69 High income 2.61 88.47 United States 2.69 30.83 Europe EMU 2.12 20.43 Japan 2.98 19.39 Mexico 0.43 0.25 O f global R&D, 88 percent is undertaken by high-income countries (see Table 1.4), with 31 percent o f global R&D centered in one country: the United States. Multinational companies, now carrying out R&D in countries other than their home countries, are establishing strategic alliances-even mergers and acquisitions- to collaborate o n technology and acquire technological assets. Also on the rise is the number o f international collaborations in patenting and technical publications. The share o f scientific publications with foreign co-authors more than doubled for many OECD countries, reaching an average o f 26 percent for 1995-97 (OECD 2000). Even large countries rely o n knowledge from abroad. This is evident from royalty and licensing payments to other countries and from the technology they import in capital goods and components. One study (OECD 1998) found that the R&D implicit in imports was as high or higher than domestic R&D. An important implication is that knowledge produced outside the country can be as important in the development process as domestically produced knowledge. Therefore, all countries need to focus on these twin challenges: how to create and use domestic knowledge, and how to obtain knowledge produced outside their borders. Indeed, there has been a shift over the past two decades from an almost exclusive focus o n generating knowledge to a broader focus on acquiring and disseminating knowledge, especially knowledge acquired from abroad. 15 Increased Inflows of Foreign Direct Investment Foreign direct investment i s the k e y agent o f globalization. High-productivity and high- value added FDI (the one which generate linkages in local economies and stay in the country, unlike footloose investments, for a long time) are determined mainly by the desire to exploit knowledge assets o n a global scale-technology, management, access to markets, and access to such special resources as finance, labor, and natural resources. Knowledge does not depreciate with use, so once it i s developed, there i s a strong incentive to exploit it over the largest scale possible. Foreign direct investment inflows increased fifteenfold between 1982 and 1999, during which period its share o f world gross fixed-capital formation rose from 2.6 percent to 14.3 percent. I n 1997 the estimated value added o f home and overseas production by transnational corporations was $8 trillion-more than 27 percent o f world GDP (UNCTAD 2000, 3). Transnational corporations are estimated to account for two-thirds o f international trade, with roughly h a l f that between parents and affiliates or among aff1iatese6 Transnational corporations are also estimated to undertake some 75 to 80 percent o f global R&LD.~ Greater Investment in Intangibles Investment in intangibles (education, R&D, and software) has also been increasing dramatically. In OECD countries, public investment in intangibles (8.6 percent o f GDP) has nearly reached the same level as investment in machinery and equipment (9.0 percent). Table 1.5 almost certainly understates the level o f investment in intangibles, since it does not include private investment in education, public and private investment in skills training, or investment in design, marketing, advertising, brand development, engineering, publishing, and the arts. Table 1.5. Investment in Tangibles and Intangibles, Selected OECD Countries, 1998 Investment in tangibles and intangibles as a percent o f GDP 1998 I Gross fixed I Ofwhich: I Investment I Ofwhich: I R&D I Software capital investment in Public formation in intangibles spending on as percent machinery as percent educationa of GDP and of GDP equipment OECD 21.0 9.0 8.6 5.2 2.2 1.2 USA 19.2 9.1 9.1 5.0 2.6 1.5 EU 19.9 8.0 8.0 5.2 I 1.8 I 1.o Japan 26.8 10.5 7.6 3.5 3.0 1.1 UK 17.4 8.6 7.8 4.7 1.8 1.3 Mexico 20.9 11.1 5.0 4.2 0.4 0.4 UNCTAD (2000, citing World Investment Report 1996). ’UNCTAD (2000, citing World Investment Report 1995). 16 aFromthe W o r l d Bank, Statistical Information Management and Analysis (SIMA) database. Public spending o n education includes public spending o n public education plus subsidies t o private education at the primary, secondary, and tertiary levels. The total investment in intangibles i s calculated based o n the indicated data o n education spending. Source: OECD (2002b, Annex Table 3, p. 285). With intangibles increasingly important for economic activity and international competitiveness, there has been more trade in intellectual property. Globally, trade in intellectual property, as measured by royalties and license fees (receipts and payments), increased from about $4 billion in 1970 to about $1 15 billion in 2002 (see Figure 1.7). Figure 1.7. Worldwide Payments and Receipts of Royalty and License Fees, 1970-2002 Worldwide payements and receipts of royalty and license fess 1970-2002 1970 1974 1978 1982 1986 1990 1994 1998 2002 I -Royalty and license fees, receipts -Royalty and license fees, payments Source: W o r l d Bank S I M A database. Country data o n trade in royalties and licensing show the large gap between high- income and developing countries. The high-income countries receive almost 99 percent o f all royalty and licensing payments, with low- and medium-income countries paying out an amount disproportionate to what they r~eceive from these sources (see Table 1.6). Three countries-Germany, Japan, and the United States-accounted for as much as 75 to 80 percent o f all receipts from royalty and licensing fees in 2001. A big part o f the payments for royalties and fees involves intrafirm payments between transnational corporations and their affiliates. 17 Table 1.6. Payments and Receipts of Royalties and License Fees, Selected Regions and Countries, 2001 ($ million) Source: World Development Indicators 2003, World Bank. Towards a knowledge-based NAFTA Agenda To take advantage o f the knowledge revolution and assure the necessary productivity gains, Mexico needs move up value chains by developing efficient education, innovation, and I C T systems. This would require creating a stock o f efficient knowledge workers and knowledge organizations. This part o f the knowledge economy agenda i s largely about improving productive (plant-level) efficiency. While the first generation o f NAFTA-related reforms was based o n low-cost labor, the second knowledge-based generation will be based on lower cost skilled labor. A skilled workforce with high school diplomas and engineers will need to become a major comparative advantage. For instance, average earning for engineers and researchers in the United States i s about 300 dollars per day, while in Mexico it is about 120 dollars per day.' Improving R&D links with the United States and Canada-in venture capital and innovation, exchange o f researchers and engineers-is at the center o f a knowledge-based (NAFTA-plus) agenda. Table 1.7 summarizes the main accomplishments o f NAFTA reforms and outlines this emerging knowledge-based agenda. 8 Data provided by Director General o f CONACYT 18 Table 1.7 F r o m First-Generation NAFTA to a Knowledge-Driven, Second- Generation) NAFTA Results o f NAFTA agenda Knowledge-driven (second-generation) NAFTA Trade and FDI, particularly maquilas, as a major FDI and strategic alliances with knowledge capital flows: source o f employment organizations abroad as a source o f knowledge-based move up higher-value added jobs value chains Large stock o f accumulated FDI with 0 Attract knowledge-intensive FDI few links to the domestic economy 0 Promote spillovers from the existing FDI stock: supplier and cluster development 0 Promote strategic alliances with foreign universities, firms, technology and research organizations Labor flows: Migration and remittances as an Migration as a source o f entrepreneurship, knowledge, maximize escape valve and shock-absorber and capital for Mexico: benefits o f 0 Reach agreement to regularize low-skilled migration Remittances as a second source o f undocumented flows foreign revenues after tourism Reduce transactions costs o f remittances transfer and create conditions for productive use o f Large and rapidly growing stock of remittances both low-skilled (largely 0 Utilize Mexican professionals abroad: create “brain undocumented) and higher slulled circulation” and venture capital networks labor from Mexico in the United States Services: Mexico as a major tourist destination Knowledge-intensive services as a major source o f reposition employment: Mexico’s Move to higher-brand tourism nature and 0 Develop engineering and other high value culture professional services 0 Develop high-quality health services to attract retirees and health tourists from OECD countries 0 Capitalize on Mexico’s history and culture: Dromote investment into media. movie industrv. etc. Source: Wc Bank staff. World-wide experience shows that such a strategy can be developed in three steps. First, a benchmarking framework i s introduced to measure country’s initial conditions and progress towards knowledge economy (Chapter 2). Second, core issues o f knowledge economy: necessary reforms o f innovation, education and I C T systems are analyzed. This i s a question o f what should be done (Part I1 o f the report). Third, implementation issues o f the knowledge strategy are considered. This implementation issues include political economy considerations, investment climate and other issues. Although not analyzed in detail, these issues are touched upon in the analysis o f what could be done in terms o f transition to knowledge-based competitiveness given constraints Mexico faces. (Part I11o f the report). 19 Chapter 2 Benchmarking Mexico’s Position in the Knowledge Economy The globalization o f trade, finance, and information has made it easier to narrow knowledge gaps across countries. But the fast pace o f change and the difficulty many developing countries have in getting started may widen the so-called “knowledge divide.” If the gap widens, capital and other resources might flow to countries with a stronger knowledge base, adding to the inequality. There is also the danger o f widening knowledge gaps within countries. For example, the OECD economies worry that the rapid advances in knowledge may hurt unskilled workers and add to unemployment. There i s evidence that technology and technology-related organizational change are widening wage disparities between skilled and unskilled workers, and these impacts are likely to be felt even more in developing countries. Access to education and I C T infrastructure i s far more differentiated, and formal safety nets are less prevalent. Left behind, rural areas and the poor run the risk o f being excluded from the knowledge-based economy. This is why Mexico must position itself to take advantage o f the knowledge revolution and reduce the risks that it poses. In support o f these efforts, the World Bank Institute has developed a framework outlining the main elements that need to be addressed. The World Bank Institute’s interactive web-based tool-the Knowledge Assessment Methodology (KAM)-includes several quantitative and qualitative variables that help to benchmark how an economy compares with its neighbors, competitors, or countries it wishes to emulate on the four pillars o f the knowledge economy. The KAM helps identify the problems and opportunities that a country faces in making the transition to the knowledge economy, and where i t m a y need to focus policy attention or h t u r e investments. As a first step to articulate a strategy for moving forward, we disaggregated the knowledge-based economy and competitiveness into four functional areas: Economic incentive and institutional regime that provides incentives for the efficient use o f existing and new knowledge and the flourishing o f entrepreneurship; Effective national innovation and enterprise upgrading system: a system o f research centers, universities, think tanks, .consulting firms, and other organizations that can tap into the growing stock o f global knowledge, assimilate and adapt it to local needs, and create new knowledge; An educated and skilled population that can create and use knowledge; 9 The K A M (httd/www.worldbank.org/kam) includes seventy-six quantitative and qualitative variables for assessing a country’s position o n the four pillars o f the knowledge economy framework. The methodology ranks 121 countries and 9 country groupings with respect t o each o f these variables. Scores range f r o m 10 for the highest value t o 0 for the lowest. 20 0 A dynamic information infrastructure that can facilitate the effective processing, communication, and dissemination o f information. On the basis o f the four pillars, we have developed an aggregate knowledge economy index and other scorecard indicators for Mexico (see Figure 2.1). Annexes to this book provide a more detailed description o f the methodology. They also compared Mexico to the following set o f countries: 0 United States, Mexico’s main trading partner and a paragon o f the knowledge economy 0 The Republic o f Korea and Ireland, countries that twenty years ago faced challenges similar to Mexico’s and have made meteoric progress toward transformation into a knowledge economy. We also make references to Finnish experience, particularly with regard to the political economy o f transition to knowledge-based development. 0 China, an economic powerhouse, competitor, and new opportunity 0 Spain and Chile, two dynamic (although obviously very different) Spanish-speaking countries. Figure 2.1. A Global View o f the Knowledge Economy Index Global View: Knowledge Economy Index 0 Source : Knowledge for Development Program, WBI, - KAM (www.worldbank.ordkam). Note: The distance from 45 degree line indicates the improvement (above the line) or deterioration (below the line) ofthe selected countries between 1995 and most recent (generally 2003-2004). 21 Figure 2.2 shows the close correlation between the knowledge economy index and GDP per capita. Clearly, the knowledge economy index i s a good predictor o f growth performance. Figure 2.2. GDP per Capita and Knowledge Economy Index, 2002 Regression KEI 2002 and GDP per capita2002 40,000 - 35,000 E 30,000 VI 3 25,000 8 m v) e 20,000 N 0 N 0 r w 0 15,000 i B u 10,000 5,000 0 0.00 1 .oo 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 Knowledge Economy Index 2002 22 On the knowledge economy index as a whole, Mexico does not compare well with its key trading partners or with other Latin American economies. I t i s behind Chile, Argentina (pre-crisis), and Uruguay. In terms o f the four pillars o f the knowledge economy framework presented at the beginning o f this chapter, the performance o f Mexico i s as follows: Economic incentive and institutional regime. Strong openness to competition, but weak o n regulation; improvement o n property rights, but weak o n corruption and government effectiveness. ; 0 Education. Weakest pillar from a long-term perspective; poor access and quality. 0 Innovation. A very weak pillar, particularly for an economy o f its size; 0 ICT: lagging behind leaders in Latin America. Figure 2.3 shows the performance o f Mexico between 1995 and 2003.'' This basic scorecard i s compared with that o f the United States, the leading knowledge-based economy in the world. loThe figure shows the relative performance o f M e x i c o as compared t o 121 countries included in the KAM. A decline in the most recent period can b e attributed t o two factors: 0 The country may actually have lost ground in absolute terms (which often occurs with education enrollment rates); o r The country m a y have made a n improvement but the world as a whole made a m u c h more significant improvement (which often happens with information infrastructure penetration ratios). 23 Figure 2.3. Knowledge Scorecards for Mexico and the United States Mexico GDP growth(%) Internet users per 10,000 peop man Development Index Computers per 1,000 peopl ariff 8, Nontariff Barriers Telephones per I,000 people Regulatory Quality Tertiary Enrollment Rule of Law Secondary Enrollment Researchers in RBD IMil. Pop. Adutt Literacy Rate (% age 15 and above) ~ Scientific and Technical Journal Articles IMil. Pop. Patent Applications Granted by the USPTO IMil. Pop. - ---- most recent 1995 USA GDP growth(%) Telephones per 1,000 people Regulatory Quality Tertiary Enrollment Secondary Enrollment IMil. Pop. Patent Applications Granted by the USPTO IMil. Pop. Normalization Group: All; Type: weighted; Year: inost recent arid 1995 - ---- most recent 1995 Source :World Bank (2006). 24 Figure 2.4. Mexico’s Performance on the Four Pillars of the Knowledge Economy Mexico Econ. Incentive Regime Education Source :World Bank (2005). The Economic Incentive and Institutional Regime: Tariff & Nontariff Barriers, Regulatory Quality, Rule o f Law. Education and Human Resources: Adult Literacy Rate, Secondary Enrollment, Tertiary Enrollment. The Innovation System: Researchers in R&D, Patent Applications Granted by the U S Patent and Trademark Office, Scientific and Technical Journal Articles. Information and Communication Technology (ICT): Telephones per 1,000 people, Computers per 1,000 people, Internet Users per 10,000 people. Figure 2.4 compares Mexico’s performance o n the four pillars o f the knowledge economy framework in 1995 and in 2003. Mexico has shown some improvement o n two pillars (economic incentive regime and education), while on the pillars o f innovation and information infrastructure, the country lost ground. The changes that occurred over time, however, are quite insignificant. Note that when a country’ performance seems o have declined in the most recent period - that is, the scorecard shows it falling behind, as the scorecard shows for some variables for Mexico - this decline can happen for two reasons: 0 A country may have lost ground in absolute terms 0 Even if the country has made a several-fold improvement, it could still fall behind, because the world may on average have improved much more significantly. This often happens with information infrastructure penetration ratios, because o f the very fast rate o f change globally in this sector. 25 Economic Incentives and Institutions What does i t take for a country to realize the potential o f the knowledge revolution? A flexible society and economy with the ability to cope with constant change. This requires economic incentives and institutions that promote the constant redeployment o f resources from less efficient to more efficient uses. And this, in turn, requires good macroeconomic, competition, and regulatory policies. The financial system (including venture capital) must allocate resources to promising new opportunities and redeploy assets from failed enterprises to more promising ones. Conditions must be conducive to entrepreneurship, risk-taking, and the expansion o f small enterprises. Science and industry have to exchange information. Labor markets have to be flexible enough to enable the redeployment o f labor. Finally, social safety nets need to facilitate the constant relocation and retraining o f people for new jobs, and help those hurt by restructuring. The ways people receive relevant knowledge-and the incentives for them to use it-are also affected by the institutional structure o f a society. These interactions are affected by legal rules and procedures; social conventions; markets; and organizations such as firms and governmental and nongovernmental organizations. Equally important are the institutions that govern the rules and procedures in a society, which in turn determine how decisions are made and actions are taken. A k e y feature i s the quality o f government. The integrity and effectiveness o f government determine the basic rules o f a society. Another important element i s the extent to which the legal system supports basic rules and property rights. For example, the creation and dissemination o f knowledge are strongly affected by the degree to which intellectual property i s valued and property owners’ rights protected and enforced. Strengthening the economic, institutional, and incentive regime, which comprises both macro and micro policies, remains a priority for Mexico. Mexico has made improvements in this area since 1995, and continuing progress i s important in order to support reform in innovation and education-drivers o f the knowledge interface and essential in the creation o f a conducive investment climate. Human Resources To tap the potential o f new knowledge and accelerating technical change, an educated and skilled work force i s needed. Ensuring that expenditures o n education are allocated efficiently and that the entire population can participate in the knowledge-based economy requires particular attention. Why? Because education i s the basis for creating, acquiring, adapting, disseminating, sharing, and using knowledge. Basic education increases peoples’ capacity to learn and to use information. But this is just the beginning. I t i s also necessary to have technical secondary-level education-as well as higher education in engineering and scientific areas-to monitor technological trends, assess what is relevant for the firm or the economy, and use the new technologies. The production o f new knowledge and its adaptation to a particular economic setting are usually associated with higher level teaching and research. In industrial economies, university research accounts for a large share o f domestic R&D. Opportunities for life-long learning are also essential. Creating a culture o f continuous learning and openness to new ideas i s critical for a knowledge-based 26 economy. Learning o n the j o b i s not sufficient. Learning in multiple environments (at home, at school, and at work) must be fostered through continuing education courses, self-learning on the internet, and computer-assisted instruction. On the basic scorecard, Mexico scores fairly well on adult illiteracy in relation to i t s per capita income. But i t scores poorly o n secondary enrollment rates and even more poorly o n tertiary enrollment rates, which are below the averages for Latin America as a whole and well below some o f Mexico’s main competitors. This i s o f real concern. Mexico must expand and modernize its education system by, for example, investing in hiring more teachers. Improved pupil-teacher ratios in schools will increase the standard o f education. I nformation Infrastructure The rapid advances in information and communications technologies affect how manufacturers, service providers, and governments are organized-and how they perform. Greater access to I C T i s affecting how people work, learn, play, and communicate. As knowledge becomes a more important element o f competitiveness, the use o f I C T reduces transaction costs and barriers o f time and space. I t also makes possible the mass production o f customized goods and services, substituting for limited factors o f production. Indeed, I C T i s the backbone o f the knowledge-based economy. To support internet-based economic activities, countries need to ensure competitive pricing o f internet services and provide an appropriate legal infrastructure that covers online transactions. On the basic scorecard, Mexico still has a long way to go to fully develop and exploit its information infrastructure. This i s critical because Mexico can speed up its development by harnessing the new infrastructure. The national information infrastructure consists o f telecommunications networks, strategic information systems, the policy and legal frameworks affecting their deployment, as well as the skilled human resources needed to develop and use the infrastructure. An Effective Innovation System A country’s institutions, rules, and procedures affect h o w it acquires, creates, disseminates, and uses knowledge. Today the bulk o f technical knowledge i s produced in developed countries. The disparity in the production o f technical knowledge per capita between developed and developing countries is even greater than the disparity o f income. Fortunately, developing countries do not have to reinvent the wheel: there are many ways for them to tap into and use the knowledge created in developed countries. So a key element o f a developing country’s innovation strategy i s to find the best ways to tap into the growing global knowledge base. Then it must decide where and h o w to deploy its domestic R&D capability. T o create and adapt knowledge requires universities, public and private research centers, and policy think tanks. Nongovernmental organizations and the government are also part o f the innovation system, to the extent that they produce new knowledge. Institutions central to the dissemination o f knowledge include agricultural and industrial extension services, engineering consulting firms, economic and management consulting firms, and government research institutes. 27 The mere existence of these organizations, however, i s not enough. More important i s how effective they are in creating, adapting, and disseminating knowledge to those who put this knowledge to use. This i s why networking i s critical. The effectiveness o f networks-and the incentives for acquiring, creating, and sharing knowledge-are also influenced by economic incentives. Relevant in this regard are policies on importing foreign technology through technology licensing, direct foreign investment, foreign collaboration, and intellectual property. Accelerating the pace o f technological progress for economic growth i s predicated on a supportive process o f helping f i r m s “learn to learn” and o n the availability o f the requisite human capital (World Bank 2003). The coordination o f innovation and education policies i s central. While I C T also will play an important role in the longer term by helping to reduce transaction costs and improve the efficiency o f government, business, and social services, strengthening the I C T pillar i s not a top priority for Mexico under present circumstances. As the knowledge economy pillars are being rebuilt and strengthened, firms are becoming increasingly productive and competitive. In turn, this will translate into higher levels o f competitiveness and economic growth, and hence higher standards o f living-the ultimate objective o f the knowledge economy. On the innovation benchmark, Mexico fares poorly compared to many o f its main competitors. In Latin America, Mexico falls behind Brazil and significantly behind Argentina, Costa Rica, and Chile. 28 Part 11. M a j o r Policy Issues More than business-as-usual i s required to take advantage o f new opportunities. Major reforms are needed to create competitive markets and to make major advances in key h c t i o n a l areas. Toward these ends, we propose the following strategy: Upgrade and improve three key functional pillars o f the knowledge economy- education, innovation, and enterprise upgrading and I C T systems. 0 Finalize broader economic reforms to enhance revenue mobilization and create an even playing field and more contestable markets. Getting institutions right-creation o f organizational capabilities-is central to both prongs. Unlike “stroke o f the pen” reforms, these efforts are often time consuming. M u c h like learning in the sphere o f technology, organizational learning relies on adaptation o f worldwide best practice to local conditions. Given its large existing weaknesses, Mexico faces a challenging policy agenda both in the long t e r m (what should be done) and in the immediate future (what could be done given Mexico’s institutional rigidities and constraints). Recommendations for the short t e r m are informed by Mexico’s Competitiveness Agenda (coordinated by the President’s Office) and tend to be more specific than long-term recommendations. Although this book will not elaborate details o f the institutional and incentive regime in Mexico, a brief summary o f key issues in this area i s offered below. In the short run, there i s significant room for better use o f existing public resources through continuous evaluation o f programs and policies and a better link between performance o f public programs and the amount o f resources allocated to them. In the long run, however, the transformation to a knowledge economy, particularly reform o f innovation and education systems, will require more public resources; this creates urgency for tax reform. In order to enhance the framework for transition to a knowledge economy, the following actions are required: 0 Create an even and business-friendly playing field by enhancing competition, improving the regulatory framework, and focusing in particular o n reduction o f costs (including logistical costs) o f entry, exit, and doing business. Strengthen major factor markets, particularly labor, the financial markets, and the energy market (electricity, gas, petroleum). Improve public governance, with a more transparent rule o f law, efficient judiciary system, and respect for intellectual property rights. 29 Chapter 3 Transforming the Innovation and Enterprise Upgrading System An innovation system consists o f a network o f organizations, rules, and procedures that affects how a country acquires, creates, disseminates, and uses knowledge. K e y organizations for the creation o f knowledge include universities, public and private research centers, and policy think tanks. Private f i r m s are at the center o f the innovation system. If the private sector has little demand for knowledge, the innovation system cannot be effective. Effective R&D-industry linkages are vital to transform knowledge into wealth. Therefore, networking and interactions among the different organizations, firms, and individuals are critically important. The intensity o f these networks, as well as the incentives for acquiring, creating, and sharing knowledge, are influenced by the economic incentive regime in general. This chapter begins with an introduction to Mexico’s performance in innovation. Drawing on tantalizing parallels between Mexico, Ireland and China. W e then outline the main challenges for Mexico’s innovation system. The chapter explains the concept o f an innovation and enterprise upgrading system and why reform i s urgently needed. Important signs o f improvement are described. The remainder o f the chapter discusses the policy agenda by outlining major recommendations, assessing existing programs, and highlighting implementation issues with regard to business R&D and enterprise upgrading. Measures o f Mexico’s Performance in Innovation In innovation, Mexico falls significantly behind Argentina, Costa Rica, and Chile, and follows Brazil. I t i s far behind innovation leaders such as the United States, Finland, or Ireland. Innovation remains an area o f notable weakness for Mexico relative to comparable countries and its innovation performance is very weak for a country o f its size. The number o f researchers and scientists in the population i s also relatively low; probably underscoring the propensity o f the better educated to leave the country. As Figure 3.1 indicates, Mexico is particularly weak in its ability to turn knowledge into business. Mexico scores very l o w on the availability o f venture capital, the administrative burden for start-ups, the science and engineering enrollment ratio, royalties, license fees received, and private sector spending o n R&D. Its l o w score on the level o f entrepreneurship among managers (4.82 compared with 5.02 for China, 6.30 for Ireland, 7.28 for the United States, 6.48, for Chile and 6.41 for Brazil) coupled with a higher than average burden for start-up businesses suggest significant barriers to enterprise development, and particularly to increasing the business birth rate. This is potentially a very serious hindrance to stimulating a knowledge economy since enterprise development i s key to leveraging knowledge for income and j o b creation. 30 Although Mexico starts from a somewhat higher base than some o f the other countries to which it is compared, i t s overall competitiveness has not changed since 1995 (see Figure 3.2). Chile, Argentina, and Costa Rica, however, have maintained their already advanced positions, and Brazil has shown significant improvement. Figure 3.1. Innovation Variables: A Comparison o f Mexico and China, Mexico, China Gross Foreign Direct Investment as % of GDP Patent Applications Granted by the USPTO I Mil. Po and License Fees Payments (S mil) Patent Applications Granted by the USPT yalty and License Fees Payments I Mil. Pop. Private Sector Spending on R alty and License Fees Receipts (S mil) High-Tech Exports as % of Manuf. Exports Royalty and License Fees Receipts /Mil. Pop. Availability of Venture Capital Science 8 Engineering Enrolment Ratio (% of tertiary students) Scientific and Technical Journal Articles I Mil. esearchers in R8D Scientific and Technical Journal Articl earchers in R8D I Mil. Pop. University-CompanyResearch Collabo Enrolment Ratio (% of tertiary students) e for RBD as % of GDP Source: World Bank (2006). 31 Figure 3.2. Global View of Innovation Performance, Global View: liitiovatioii 10 Q- 8- 7- SI ouakia Jordan I c 5- E QI u d c 5- v1 D E 4- 3- 2- 1- 0 I I I I I I I I I 0 I 2 3 4 5 6 7 8 Q 1995 Source: World Bank (2006). Evaluating Mexico’s Innovation Performance A comparison o f Mexico’s innovation performance to Ireland’s and China’s highlights the particular challenges in innovation Mexico now faces. Innovation in Ireland Ireland has demonstrated that a country traditionally labeled one o f the poorest members o f the European Union, highly dependent o n agriculture and low-end manufacturing, can successhlly turn i t s economy into a provider o f high-technology services. Ireland’s transformation i s attributable to sustained and well-targeted investment in education and to a policy fi-amework favorable to foreign direct investment (FDI), notably in the I C T sector. Ireland has one o f the world’s highest net inflows o f FDI (20 percent o f GDP), second only to Sweden. I t has become one o f the most dynamic knowledge-based economies in Europe, and it i s the second largest exporter o f software. Ireland’s GDP grew at an average rate o f 8.9 percent from 1995 to 2002. The “Irish miracle” is not attributable solely to the government’s investment in education and i t s efforts to attract FDI. Substantial EU assistance has helped Ireland target investments relevant to a knowledge economy. Today Ireland i s the headquarters o f many European technology giants, and Dublin has taken advantage o f its well- 32 developed network infrastructure to become the hub for European telephone call centers. The country has thus come a long way from i t s traditional low-end manufacturing economy. To become a full-fledged knowledge economy, however, it has to strengthen indigenous innovation. Ireland was extremely successful in attracting major multinationals, yet their linkages to the Irish economy at first remained limited. In response to this challenge, Ireland both increased investments in education and innovation, and responded with a major concerted effort such as the National Linkage Promotion program (see B o x 3.5). After an initially slow start, multinationals increased local purchases significantly. Since 2001, the attractively l o w wages found in China, India, and Eastern Europe have eclipsed Ireland’s competitive advantages, spurring many global companies to scale back or cancel their plans for Irish operations. Ireland had to fight hard to reclaim i t s status as a major outsourcing destination. By leveraging its work force’s brainpower, productivity, and flexibility, Ireland managed to achieve its transformation to a fully fledged knowledge-based economy. The fruits o f this strategy are becoming evident. A number o f large multinational corporations (MNCs) have already returned, re-located, or planned to relocate to Ireland in the near future. D e l l employs about 4,000 people in Ireland. D e l l began outsourcing to India and elsewhere but discovered that product quality was less than expected. Thus, countries like Ireland, which not only ran strong marketing campaigns but strengthened their knowledge base through concerted investments in R&D and education, have seen large multinationals returning. More importantly, the M N C s are returning to turn out products and services higher on the value chain. Today investment i s going into higher level jobs in pharmaceuticals, biotechnology, and digital media. On the other hand, countries like Poland, not so long ago an attractive location for foreign investment, are beginning to lose their share o f FDI. Because their marketing capacities are weak, they are failing to “sell” their sources o f competitive advantage. This example o f Ireland highlights two problems any country must resolve in order to take advantage o f new opportunities: the “first mover” problem and the concerted action problem. Change begins with first movers (firms and other actors that are the first to recognize and to capture new opportunities). Initially, these firms (like D e l l in our Irish example) tend to be exceptions. The issue is how to make exceptions more mainstream. Scaling up and learning from the experience o f first movers and pilot projects require concerted action. A central objective o f such action is to build constituencies for reform and change. Raising awareness o f what is at stake among key groups creates greater buy-in for the necessary reforms. A related task is institutionalizing effective coordination o f private and public agents. Top-down vision and leadership, implementation, and follow-up are often indispensable for success. The objective i s to create a virtuous cycle o f growth and reform. Success breeds success: first movers become role models, while institutions o f collective action make sure that the success is scaled up. These complementarities are mutually reinforcing; stronger performance on one side creates pressures for performance to improve o n the other side. To compete in the international marketplace, weaknesses in the domestic 33 business environment must be confronted. (Examples include a judiciary incapable o f enforcing contracts and insuperable regulatory obstacles.) As the legal and regulatory environment grows stronger, the private sector “crowds in” firms seeking to profit by creating wealth, and it “crowds out” f i r m s that thrive on opportunistic, rent-seeking activities. This interplay between states and markets helps foster a virtuous cycle-a cumulative, mutually reinforcing process o f knowledge-based development. Innovation in China Such a virtuous cycle is beginning to emerge in China, a country that is now ubiquitous in Mexico’s public debate. As Chapter 2 indicated, China has demonstrated formidable growth in exports. Since 2000, it has significantly outperformed Mexico in growth o f exports. Yet China is consistently below Mexico in all four pillars o f the knowledge economy. What explains this apparent paradox? Four factors are at work. The first i s business orientation. China not only allocates a higher o f share o f GNP to R&D than Mexico (1 percent compared to 0.43 percent), but it outperforms Mexico with respect to these business-related innovation variables: private sector spending o n R&D, administrative barriers for start-ups, availability o f venture capital, university-company research collaboration, science and engineering enrollment ratio (as percent o f tertiary- level students), and articles published in scientific and technical journals. China’s superior performance on these indicators suggests that l o w labor costs are not its sole comparative advantage; China’s innovation climate i s increasingly becoming a comparative advantage as well. Business orientation creates a demonstration effect: knowledge-intensive businesses, in particular those located in science parks, are highly visible, and they are important attractions for scientists and students. For these reasons, business orientation matters. The size o f the economy matters as well. The size o f the Chinese economy i s second behind the United States in purchasing power parity. Because o f its large and rapidly growing market, China i s a magnet for all multinationals, and it has increasingly become a prime location for knowledge-intensive operations as well. Similar to a well- known Indian case, in Mexico a very large number o f wage-efficient R&D researchers and engineers are an important factor in this new trend. N o t only i s China’s performance o n business-related innovation variables better than Mexico’s; China shows more impressive rates o f improvement. Whereas Mexico has made no progress since 1995 in relation to the rest o f the world, China’s position has improved (see Figure 3.2). The critical mass o f business R&D expertise in China i s greatly augmented by 50 million overseas Chinese-the famous Bamboo network. Members o f the Chinese Diaspora have been instrumental in detecting, adopting, and adapting important technologies at home. This advantage o f the Diaspora was not automatic: China is a paragon o f leveraging its scientific and business talent from abroad. Taken together these four factors (business orientation, critical mass, rapid progress, and the role o f overseas Chinese) suggest that China, unlike Mexico, has crossed a threshold o f innovation performance. A virtuous cycle o f growth, when 34 improvements accumulate and one good thing leads to another, has become apparent. The bandwagon effect (every multinational wants to be in China for fear o f being l e f t behind) i s unmistakable. Key Challenges Facing Mexico Mexico is familiar with such nonlinear processes. After a slow start in the 1960s, maquiladoras ballooned in the 1980s and 199Os, creating congestion in the border towns. The challenge in the twenty-first century is to go beyond footloose manufacturing and generate a virtuous cycle o f growth in knowledge-intensive business. Mexico has excellent innovation organizations (such as the Delphi Engineering Center) and world- class researchers (see Chapter 2), but success has not yet bred success. Creation o f a critical mass o f efficient innovation organizations should be one o f the country’s central objectives. This would allow integration into global knowledge- intensive value chains with significant value added generated in Mexico. T o achieve this objective, Mexico will need to transform its innovation and enterprise upgrading system. Defining an Innovation System As noted at the beginning o f this chapter, an innovation system i s a network o f organizations, rules, and procedures that affects h o w a country acquires, creates, disseminates, and uses knowledge. Development o f radical or incrementally new . knowledge i s particularly important in such a system. Traditional measures o f innovation include expenditure on R&D, activity in high-technology sectors (biotechnology, ICT), patenting activity (number, intensity), and researchers per 10,000 population. These indicators proxy the ability to generate new knowledge. However, they are not particularly helpful in understanding h o w a traditional, low-tech manufacturing firm can learn to upgrade its capabilities to compete in a more knowledge-based economy. Rather, these indicators are very often just the tip o f the iceberg (see Figure 3.3). Concealed below i s a layer o f firms, mostly small and medium-size enterprises (SMEs). For them the major issue is acquisition o f basic skills in marketing, design, engineering, and other operational skills rather than technology upgrading and R&D. For these reasons, the traditional innovation system approach might be applicable to a very limited subset o f the economy, such as firms in the export-oriented sectors. I t might also be u s e f i l for setting long-term goals and objectives. 35 Figure 3.3 Learning Capabilities by Type o f Firm Advanced firms Research and technology development rarely present; mostly large firms Technoloeicallv competent firms Design and engineering capabilities rarely present in SMEs TECHNOLOGY UPGRADING REVERSE Minimal technoloev firms ENGINEERING I n SMEs, technician and craft skills sometimes strong, though TECHNOLOGY key skills often absent or weak ACQUISITION ASSIMILATION Survival-oriented enterwises I n SMEs, basic operating skills TECHNOLOGY USE often weak, with limited and AND OPERATION irregular upgrading Source: Adapted from Intarakumnerd et al. (2002, 1445-1457). To be relevant for all firms, this chapter focuses o n the innovation and enterprise upgrading system-a network o f institutions, private and public, that interact in a concerted manner to enhance firm-level learning and improve productivity. Table 3.1 matches suitable policy interventions with the capabilities o f the four types o f firms shown in Figure 3.3. 36 Table 3.1 Instrumenl to Support Innovation r Type of Firm Type of firm Policy objectives Instruments and interventions Survival-oriented T o build basic 0 Business advisory and support services-SME and enterprises competitive capabilities micro enterprise support agencies by fostering awareness 0 Facilitation o f access to finance (including micro o f scope and benefits o f finance) innovation 0 Management and s h l l s development Minimumtechnology T o foster competitiveness 0 Support for business development, diversifying f i r m s agenda by introducing basic customer base innovation skills and 0 Product diversification and quality improvement encouraging adoption and Management and s k i l l s development application o f new ideas 0 Internet-based information services 0 Technology awareness and marketing 0 Support for technology adoption and adaptation projects Cluster-based approaches to stimulating innovation rechnologically T o support market Business development, exports market support ompetent development and entry Internet-based information services enterprises into global value chains Technology transfer support by fostering strategic Incubators and technology parks alliances and certain in- Linkages with academic researchers house innovation Laboratory services and metrology services capabilities Consultancy and technical assistance support--e.g., o n commercialization, IPR, licensing, patenting Supplier development and linkage promotion programs Advanced firms T o move up global value 0 Support for participation in international R & D chains by upgrading in- networks (e.g., EU 6* Framework Program) house innovation 0 Technology and other innovation-based spin-offs capabilities and strategic 0 University-industrycollaboration alliances 0 Support for commercialization 0 Development o f vibrant venture capital industry T o diffuse experience o f 0 T o encourage participation o f national innovation innovation leaders as role leaders in national advisory bodies, technology models for the rest o f the foresight and cluster processes economy 37 The automotive industry represented 14.6 percent o f total manufacturing and 22.1 percent o f total manufacturing exports in 2001. Because it is so important for Mexico, this industry serves as a useful example o f the significance o f gains from enterprise updating (see B o x 3.1). ~ ~~~~~ ~ ~~~~ Box 3.1. Discretionarv Differences among Firms: The Automotive Industrv Differentials in firm performance in the automotive industry tend to be very skewed, with few f i r m s having extraordinary performance, several standard deviations above the mean. Figure 3.4 shows a wide variation o f value added per worker in the motor vehicles and equipment sector. Even controlling for the size o f firms, there i s s t i l l wide dispersion o f productivity. The huge standard deviation shows how much room there i s for improvement. In the case o f small firms, if the largest observation remained constant and the rest o f the f i r m s moved t o the upper limit o f their range, these changes would increase output by more than 37 percent. Figure 3.4. Value addedper F i r m in Mexico’s Motor Vehicles and Equipment Sector, Motor Vehicles and Equipment small 14 I I mmoo mmo iamoo 14m0.o womo MOtOIVehlCleS and Equipment small Source: World Bank staff. Mexico’s Low-Level Equilibrium Trap Mexico, like most o f Latin America, i s caught in a low-level equilibrium trap in innovation and learning. Despite very significant changes in the macro environment and increased competition within the Latin American economies, economic agents (particularly firms) have not been able to shift toward knowledge activities with higher value added. The low-level trap for Mexico can be defined as a relatively stable equilibrium, characterized by the following features: 0 L o w level o f spending on R&D (0.43 percent o f GDP) 0 L o w share o f private sector financing and execution (Figure 3.5) 0 L o w efficiency o f spending on R&D in terms o f measurable outcomes (Figure 3.6). 38 Figure 3.5 Finance and Execution of R&D in Mexico by Sector, 2000 BPrWate .Government DHEls ONmpmfits mForeign Source: OECD (2001b). Lederman and Maloney (2003) estimate that the optimal amount o f investment i s between 4 and 10 times higher than current amounts, and they provide a variety o f reasons for this low-level trap. Perhaps the most important reason i s the lack o f learning capacity to use a technology and develop it h r t h e r in order to converge with innovators. Other reasons include the lack o f competitive pressures, the absence o f well-hnctioning capital markets, limited entrepreneurial capital, unstable macroeconomic growth, and limited access to intermediate inputs. All o f these factors help explain why the technology gap between Mexico and innovators remains significant despite trade, abundant foreign direct investment, significant investment in capital goods, and other existing elements that could spur innovation. Research increasingly shows the relationship between investment in R&D- particularly within the private sector-and improvements in economic growth and productivity. Constant underinvestment not only results in l o w levels o f innovation output such as patenting. I t is also a barrier to increasing growth and competitiveness. 39 Figure 3.6 Efficiency o f Spending on R&D, Selected OECD Firms, 1985-2000 15.00% 10.00% 5.00% 0.00% -5.00% -10.00% Source: Lederman and Maloney (2003). Why does the low-level trap exist in Mexico, and why i s it relatively stable? The majority o f R&D spending and execution i s in the public sector, yet public sector activity i s not particularly relevant for the productive sector, and its efficiency i s low. The private sector, perceiving public organizations as not necessarily relevant to i t s needs, performs innovation activity in isolation or through strategic alliances with foreign knowledge. This relative lack o f stake in a public innovation system removes pressure for reform and improvement. Nevertheless, there are reasons to be hopeful. First, important exceptions (such as the Delphi Technology Center in Ciudad Juarez) signal Mexico’s possible future. The policy agenda i s diffusion and acceleration o f existing positive examples and trends, rather than creation o f things from scratch. Second, the stakes are high and worth pursuing, all vested interests notwithstanding. Reform o f innovation and the enterprise upgrading system would yield dramatic improvement, not change o n the margins. As noted earlier, there i s some indication o f efficiency gains if most firms reach national best practice. Third, i t makes sense to invest in national science and technology capabilities in order to be taken seriously by prospective international partners. Strategic alliances and international networks are the name o f the game, not domestic technological capabilities per se. The notion o f a national innovation system must be treated with caution. Three Isolated Cultures o f Innovation in Mexico Whatever perspective one chooses, linkage and interorganizational networks are the center o f the agenda. Yet the reality in Mexico i s three different innovation cultures, and, accordingly, three isolated innovation systems: universities and research centers (the public innovation system), large export-oriented firms, and survival-oriented SMEs. Box 3.2 describes the role o f these three types o f institutions in Mexico’s automotive sector. 40 The “Ivory Tower”Science Culture Mexico’s public system for scientific research i s sizeable in terms o f both basic research produced and resources spent, and it can serve as a significant resource for technology development and application within Mexico. The Government o f Mexico increased R&D spending from 4 billion pesos to 18.5 billion pesos during the 1990s. In an index created by RAND (Wagner, Popper, and Horling 2003) to rank countries by science and technology capacity, Mexico ranked a respectable number 50 among 150 countries. In an index o f technology transfer capabilities, Mexico ranked number 4 in 2001. Scientific productivity also shows a strong performance. In terms o f publications in internationally recognized journals, Mexican scientists were prolific during the 1990s in the fields o f physics, clinical medicine, biology, biochemical research, and chemistry. In addition to improving their position in journals, Mexican scientists are collaborating with international colleagues, showing a global awareness o f knowledge creation. These indicators provide evidence o f world-class-level Mexican research and the potential for knowledge creation within academic institutions. Export-Orien ted Pragmatism : Nation a1 and Multinationa1 Big Business The main motor o f growth in the last decade, and the key indicator o f good economic performance from the domestic economy, i s the increase in exports. Table 3.2 shows the Revealed Comparative Advantages (RCA) o f Mexico vis-&vis its NAFTA trading partners. The two largest sectors, in absolute terms for 2000 and in terms o f increase from 1973 to 2000, are road vehicles and telecom equipment, products that are knowledge- based industries. R C A data can, however, create the misleading impression that Mexico has improved its knowledge-generating capability significantly. A closer analysis shows that the vast majority o f exporting i s done by large multinational companies that use Mexico as a manufacturing base for labor-intensive processes, taking advantage o f factor price differentials with the rest o f North America, while performing most knowledge-intensive activities in other countries. These f i r m s operate as export enclaves, with minimal l i n k s to domestic firms. Similarly, larger firms o f Mexican capital have been thriving mostly in sectors where they are exposed to only limited competition (services and resource-based sectors). 41 Table 3.2. The Share in Total Exports o f Commodity Groups in which Mexican Strength i s Concentrated, 1993,2000 (Percent) Commodity group 1993 2000 Mexico is strong Vegetables and fruit 3.6 2.0 Petroleum 13.7 9.0 Manufactures of metals 2.5 2.4 Telecom equipment 8.9 11.6 Road vehicles 13.6 17.0 Furniture 1.3 2.0 Clothing 2.3 5.2 Both countries are strong Power-generatingmachinery 4.9 3.8 Office machines and ADP equipment ~~ 2.9 7.1 Electrical machinery 16.0 15.8 turce: Wagner, Popper, and Horling (2003). Note: Revealed Comparative Advantage (RCA) i s defined as the share o f a product in a country’s total exports divided by the share o f that product in world exports. A value greater than one indicates that the country has a relative specialization in that particular product. “Both Countries are Strong” refers to products with R C A greater than one for the United States and Mexico; ”Mexico i s strong” refers to products for which the R C A for Mexico i s greater than one and for the United States i s less than one. Thus, the large domestic firms, which comprise only 1.7 percent o f all domestic firms, rely heavily o n technology licenses or other types o f assistance from foreign companies, rather than developing their own technology, and multinationals rely o n their parent companies for most R&D activities. Survival-Oriented Micro Firms and SMEs The other 98.3 percent o f Mexican firms are micro f i r m s and small and medium-size enterprises that are in a weak competitive position. Rather than focusing o n innovation, these firms have been surviving and adapting themselves t o a variety o f ongoing changes, including increased competition as a result o f NAFTA; a severe contraction o f the economy in 1995; and virtually n o financing for investment or working capital. Many thousands o f firms have disappeared as a consequence o f these changes. The majority o f remaining firms are just surviving, using most o f their innovation efforts to take reactive measures against changes in the macroeconomic environment, and thereby limiting their growth to retained profits. Constantly adapting in the face o f this environmental instability, SMEs have not been able to realize their important innovation potential. The Problem o f Isolation The first two innovation systems described (science culture and export pragmatism) are relatively strong. They have pockets o f world-class quality institutions, and these institutions are large enough t o reap the advantages o f scale economies. These institutions could easily be inserted into a global innovation system. However, the existence o f 42 institutional sources o f innovation i s not the only concern; a major problem i s the isolation o f these different elements. This lack o f interaction can be seen in a variety o f ways: very limited collaboration between industry and academia, the small degree o f local content in exporting firms, the limited number o f industry consortia, etc. Creating these linkages is at least as important as strengthening the individual elements o f the innovation system. Box 3.2. T h r e e Types o f Players in Mexico’s Automotive Sector The Mexican automotive sector i s composed o f automobile assemblers and auto parts firms. I t accounts for 16.1 percent o f gross manufacturing value added and 2.3 percent o f total Mexican GDP-more than any other manufacturing sector. Despite being a mature sector at the global level, sales increased 2.3 times between 1995 and 2000, and employment increased 1.4 times during the same period, supporting the RCA data shown in Table 3.2. What makes the industry particularly interesting i s the variety o f players with different roles. Unlike the electronics sector, which i s composed o f foreign export-oriented firms, the automotive sector includes both foreign firms, and small, medium, and large domestic firms that sell t o the domestic and export markets. These players create a complex system with strategic complementarities that have enabled the industry to grow. Indeed, this particular industry exemplifies the types o f innovation culture described above. Public innovation system. Disciplines related t o the automotive sector, such as mechanical engineering, electronics, mechatronics, and material science, are strong in universities and research centers in Mexico. However, n o research center or academic institution specializes in research relevant to the automotive sector. The isolation o f the system can be seen in the small number o f f i r m s that collaborate with universities and technology centers-nly 1.5 and 0.7 percent respectively (Constantino and Lara 2000). Large export-orientedfirms. Most large firms, whether foreign (Delphi, Visteon, Federal Mogul) or domestic (Unik, San Luis, Amecom) seem oriented toward the direct and indirect export markets. With the notable exception o f Delphi, which has built a significant capacity for engineering in its Ciudad Juarez facilities, other f i r m s have few research activities. Domestic f i r m s have developed some research capabilities, but they generally s t i l l rely on foreign technology licenses that limit, by contract, their opportunity t o pursue markets outside o f Mexico. Despite this limitation, f i r m s are able to compete at the regional level through a combination o f locational advantages, lower labor costs, and incremental process improvements. Smallfirms. Before the signing o f NAFTA, local content rules fostered the creation and growth o f a variety o f parts suppliers. Since 1994, most o f these firms have disappeared or have been purchased by foreign f i r m s (sometimes their former technology licensors). The few surviving small firms are n o w second- or third-tier suppliers; they tend to concentrate o n small value-added products such as small stamped metal or plastic injection products. These tend to be low-margin commodity products, with high competition. The lack o f specific competencies makes these f i r m s easily dispensable. Despite the large purchase volumes, small and medium firms that start selling to the automotive industry often quit after a few months, prefemng to sell t o less demanding markets such as electric appliances or consumer products. Source: World Bank staff. 43 Signs o f Change and Improvement Within this context o f general lethargy, successful cases o f innovation can be found. This heterogeneity within the system shows that, despite the environment, certain agents have had outstanding performance (we will call them exceptions) or have entered a path that might result in innovative activities (promising cases). I t i s important to identify and understand these cases presented in Table 3.3, both for their relevance and their possible demonstration effects. Table 3.3 Exceptions and Promising Cases o f Innovation at Different Levels Level Exception Promising case Typical case M i c r o level: Delphi Engineering Vitro m Noninnovative f individual f i r m s Center Mezzo level: Jalisco electronics and Isolated agents clusters, networks Monterrey urban software cluster P Public sector level: Science-defined innovation support CIATEQ IMP priorities organizations Individual Firms At the micro level, the firm i s the key unit o f innovation. Investment i s very small, patenting scarce, and individual firms do not interact with other elements o f the innovation system, such as research centers and other firms. In terms o f patenting, comparative advantage lies in traditional sectors, such as processed foods, soaps, paints, and ferrous metals, rather than in sectors that have experienced rapid g o w t h (Lederman and Maloney 2002). With few exceptions, large firms tend to depend o n joint ventures or licensing to obtain their process and product technology. Small firms rarely invest in innovation, as shown by their relatively poor performance. However, some firms have been innovative within this context. The Delphi Engineering Center i s an example. Delphi Engineering Center Delphi Engineering Center i s part o f Delphi Automotive System, the largest automotive parts firm in the world. L i k e most other U.S.-based automotive firms, Delphi established several plants in northern Mexico during the mid-l980s, using the country as a base for labor-intensive manufacturing operations. In 1995 Delphi took a giant step forward by establishing an engineering center in Ciudad Juarez. This center i s primarily involved in doing research, design, and development activities for the corporation. The average Delphi engineering center in the United States employs 500 people; the Juarez facility employed 860 people in 1995 and more than 1,000 in 2004. According to Carrillo and Hualde (1997), the firm cut development costs by 60 percent and delivery time by 20 percent during the first year o f operation. This extraordinary performance has continued. During 2002, Mexican engineers at the center 44 were the main contributors to 50 inventions that received intellectual property protection (35 patents, 14 publications, and 3 industrial secrets). W h i l e assembly maquilas reacted to the strong peso by decreasing their labor force in 2003 and 2004, Delphi Engineering maintained i t s employment level. Other automotive firms such as GM and Visteon are creating or expanding their engineering facilities in the country, at least partly following Delphi’s success. Vitro Vitro i s a domestic firm, and Mexico’s paragon o f innovation. I t concentrates in the production and distribution o f a variety o f glass products, including flat glass, glassware, glass containers, and household products. The firm has been working o n innovation for several decades, developing a variety o f process technologies that have made i t one o f the most efficient producers in the world. Since the market has opened, Vitro has been able to better focus its innovative efforts, master faster production engineering techniques, and adapt its production system to changes required by the export market. According to Dutrenit (2000), Vitro has pursued a dual strategy o f being both technologically independent and a fast follower. This shifting between independence and following has diversified risk, but in many ways it has prevented the firm from realizing i t s full potential. The two competing strategies have created instability in the f i r m ’ s collaboration with research centers and other institutions. However, the firm has shown great potential in operational innovation, and it could become an excellent example o f innovation if its long-term strategy was defined consistently across the organization (Dutrenit 2000,23). Clusters and Networks In successful cases, firms within clusters evoke images o f Silicon Valley or o f Route 128-pockets o f highly innovative f i r m s interacting to create innovation. The clustering o f economic activity at this mezzo level shows agglomeration but limited innovation. Monterrey Urban Cluster Perhaps the best example o f a cluster in Mexico is the city o f Monterrey, located in a barren area with scarce natural resources and an extreme climate. The city i s not a cluster in the traditional sense o f a number o f firms in one industry; rather, it i s an agglomeration o f a variety o f industries with branches o f metal working, machinery and equipment, chemicals, and ceramics. The presence o f these industries has generated urbanization economies that contribute to the welfare o f the region. In addition to multinational corporations, large multi-industry domestic conglomerates contribute significantly to production. Examples include FEMSA (beverages and retailing), AXA (chemicals, metal, auto parts, food), Proeza (food and automotive), Vitro (glass), Cydsa (chemicals, textiles), Pulsar (biotech, financial), A l f a (chemical, food, auto parts), Imsa (steel, batteries), and C E M E X (cement). Some o f these industrial groups acquired two o f the largest national banks (Bancomer, Banorte); thus the city i s currently increasing i t s importance as a financial center. 45 Human resources are developed in 19 universities, the largest o f which is the Instituto Tecnolbgico de Estudios Superiores de Monterrey (Tec). Tec was created in 1943 by Alfa, Vitro, and other leading industrial groups for the purpose o f training high-quality engineers for their firms. Tec remains a leading institution in the country, and, following i t s origins, keeps close contacts with industry. One o f its key functions has been to provide a forum at which local firms, government, and researchers can discuss the future o f the region. This has resulted in a shared vision, and currently all the economic agents are working toward making Monterrey a center for high-tech manufacturing and services. Jalisco Electronics and Software Central Jalisco has been called the Latin American Silicon Valley. I n2004 international companies with manufacturing facilities there included IBM, Hewlett-Packard, NEC, Motorola, Intel, Siemens, Flextronics, Jabil Circuits, and USI. According to the Secretaria de Economia, Jalisco accounts for 35 percent o f production for the largest contract electronic manufacturers, and it creates value added within the region o f 27 percent. This would certainly suggest clustering o f high value added activity. Recently, however, the story has changed dramatically. Firms such as IBM and Motorola, plus many smaller ones, have pulled manufacturing operations out o f the region to take them to China and other Asian countries. When asked why they were moving, one o f the major firms provided three reasons: China’s accessibility to the global market (Mexico deals almost exclusively with the North American market); the presence o f most component suppliers in Asia (proximity to suppliers increases the responsiveness o f the supply chain); and lower labor costs. Even though Central Jalisco’s position as a successful electronics cluster is now being questioned, the region still has a significant concentration o f talent and knowledge in this industry. The state government and local organizations are making strong efforts to convert the low value added assembly jobs into higher value added software development jobs. There i s a good possibility that such a transition will succeed. IBM currently runs a Guadalajara Development Lab, which works on developing AS/400 and Server applications. This facility is one o f the few companies in Mexico to have a C M M 3 certification. A successful conversion into software would not only revitalize the cluster but also provide higher value added and better paying jobs. Innovation Organizations in the Public Sector As noted earlier in this chapter, most innovation takes place in public sector institutions. Who are the clients for these innovations? In some cases, the answer i s the public sector, but frequently the answer i s nobody. Research in Mexico has traditionally been supply driven, with scientists submitting proposals for research grants. Rewards, particularly for researchers in public universities, have been tied primarily to published papers and citations. Joint work with industry has traditionally been penalized by the conservative scientific community. This model has resulted in research that does not necessarily solve any clear short- or long-term needs o f society. The exception, as noted above, i s the system’s relative scientific strength in astrophysics and mathematics. 46 Table 3.4 shows the largest users o f federal R&D resources in the country. Education and energy account for 85 percent o f total expenditure. Within this environment a few institutions have seen the advantages o f cooperating with production agents. Table 3.4 Federal R&D Expenditures in Mexico by Sector and Subsector, 2001 Main sector Main subsectors (percentage o f sector)a UNAM (27.0) Education (62.4) Conacyt (23.8) SEP-Conacyt (22.0) Cinvestav (6.8) Energy (22.4) Pemex‘ (32.4) Instituto de Investigaciones Electricas (8.3) Instituto de Investigaciones Nucleares (6.9) Agriculture and rural (49.3) Others (15.2) Health and social security (19.7) a. The subsector percentages o not total 100 percent because only the m a i n subsectors are included. Source: CONACYT (2002). CIATEQ The Centro de I n f o r m a c i h Cientifica y Tecnolbgica (CIATEQ) is a notable exception to the usual isolation o f public sector innovation support organizations. I t is a research center located in Queretaro with the mission o f “helping f i r m s increase their productivity and international competitiveness, and providing technological solutions in mechatronics and related disciplines, through highly qualified personnel and cutting edge technology.” This mission statement clearly sets CIATEQ apart from other centers, for which research i t s e l f i s the primary objective. CIATEQ provides specialized services such as special machinery design, fabrication, and automation; metrology services; product prototyping; design and development o f casting and metallurgic processes; and design o f electronic systems for measurement and control. I n order to be close to i t s customer base, CIATEQ i s located within industrial parks rather than near universities, where most other research centers are located. In 2001, CIATEQ generated 47 percent o f its total budget through fees from client firms. The C I A T E Q model has been so successhl that branch centers in the states o f Aguascalientes and San Luis Potosi have opened. Most o f the expenses for constructing the branch centers were paid by the state governments, which saw great value in having such services in the states. 47 IMP In the energy sector, the largest research institution is the Instituto Mexican0 del Petroleo (IMP). I t i s an important generator o f academic publications, with 630 papers published between 1981 and 2000. Between 1996 and 2001, the IMP requested 96 patents, the largest number filed by any Mexican institution. However, this number o f patents i s small compared with the largest foreign requestor for Mexican patents; Proctor and Gamble requested 2,6 15 patents during the same period. Another weakness i s that virtually all o f IMP’S innovation i s done for a single client, PEMEX, the state-owned o i l monopoly. The impact o f IMP o n Mexican society would be greatly enhanced if it were to diversify its clients, including the private sector. Agenda for Transforming Mexico’s Innovation System Mexico’s strategic objective should be a dramatic increase in productivity through knowledge-based integration into global value chains and participation in knowledge networks. A more dynamic and flexible innovation system i s needed, one led by private demand and responsive to private sector needs. Strong academic-industry linkages are an important part o f international knowledge networks. In the short-term (2005-2007), the policy agenda should focus on formulating a cohesive strategy, improving incentives, and increasing the role o f the private sector in public programs. Formulating a Cohesive Strategy The government has created myriad policies and policy instruments for scientific research, technological development, and innovation. Diffuse mandates, overlapping functions, and bureaucratic considerations have complicated strategy formulation and policy coordination. There is a need to centralize innovation policy and assignment o f funding. Currently, C O N A C Y T manages about 36 percent o f the funds for public R&D and technology upgrading. Out o f these funds, less than a third i s for productive innovation. Both figures should be increased significantly, making C O N A C Y T a hub for interorganizational and private-public alliances. As a first step toward greater cohesion, the government should make a thorough evaluation, preferably using cluster analytical concepts, o f its policies, programs, and funding. This audit by domestic as well as international experts should be o f high technical caliber, independent in order to avoid capture by vested interests; and representative through collaboration o f important Mexican stakeholders. The audit should include the locus for effective decision making and alignment o f management responsibilities with accountability for results. The budgeting process should be based on clear priorities. ; Improving Incentives To improve incentives for innovation, linkages between business and R&D can be strengthened in four ways. First, the government should restructure intellectual property rights. (Mexico remains the only OECD country where the researcher on a public institution does not have a legal mechanism to claim the upside potential o f his or her invention. Second, public institutions should reward staff for success in productive 48 research projects and linkages with the productive sector. Third, rules for the allocation o f public funding for R&D should be introduced that favor consortiums between universities and private firms, and between private f i r m s and SMEs. Finally, funding should be targeted to sectors known for excellence and strategic value. Increasing the Role o f the Private Sector Private sector participation in the design and implementation o f public programs must be increased. Although the situation i s improving, Mexico’s private sector role, both in financing and execution o f research and development, i s below the standards o f comparable countries. The private sector takes a comparatively passive stance on using product and process innovation as a strategic tool for business development. The reasons for this seem to be weaknesses on the supply and demand sides. Drawing on Conacyt’s A V A N C E and other programs, the government could enhance its catalytic function by (i) supporting research and training linked to joint ventures between international and domestic technology companies; (ii) prompting international technology companies to create research teams in Mexico through staff exchange schemes; ( iii) moving science and technology researchers from government institutions to companies through specific public-private incentive programs; (iv) leveraging innovation spillovers from FDI through targeted investment promotion; and (v) expanding programs supporting innovation start-ups with matching grants through private venture capital firms and incubation assistance. The main thrust o f the innovation policy agenda i s to promote concerted action in interorganizational networks (see B o x 3.3). The private and public sectors will need to work together to overcome what m a y be low-level technological equilibrium traps in most sectors o f the economy. Entrepreneurs have been reluctant to become involved in domestic research and development institutions because o f their apparent inadequacies; nonbusiness institutions have been reluctant to develop capabilities because o f lack o f apparent demand. Catalyzing interventions can be instrumental to overcome this reluctance. The challenge i s to make public science and technology endowments more business relevant, and to shift from an emphasis on domestic science and research to closer integration with international research institutions, particularly those o f Mexico’s NAFTA partners. This requires the cooperation o f diverse stakeholders. Universities and public research institutes need to overcome narrow academic interests and adopt a more prominent commercial orientation in their efforts to develop cutting-edge service capabilities and generate additional funding. Firms need to seek a more proactive interface with the domestic research establishment. Long-term collaboration will enable firms to improve competitiveness and access domestic R&D. Finally, the government needs to promote alliances and joint ventures by buying down initial launch costs. This will ensure that public-funded research generates economic benefits. 49 Box 3.3 Innovation through Interorganizational Networks T w o analytical constructs drawn from management science-clusters and supply chains, also known as value-added chains-describe linkages that promote innovation. Economic activity i s not coordinated solely through signals generated by an impersonal marketplace; economic activity also involves direct coordination through face-to-face communication. Clusters are groups o f firms, research centers, and universities that cooperate in a specific area o f business in order to achieve economies o f scale and scope. Innovation clusters are formed to conduct knowledge-intensive activities. A value-added chain i s one o f vertical linkages. I t describes the full range o f activities required t o bring a product or service f r o m conception and design, through the different phases o f production (involving physical transformation and the input o f various producer services), marketing, and delivery t o final consumers. A value-added chain i s usually defined for particular products (automobiles, electronics, garments, pharmaceuticals), but it typically crosses different industries, and each stage o f production i s much more closely linked with upstream and downstream industries on the chain than with other producers in the same industry. Source: W o r l d Bank staff. Evaluation o f Existing Institutions, Policies, and Initiatives Figure 3.7 Institutions Involved in Innovation PUBLIC FEDERAL GOVERNMENT I I Ministry o f Economics ICRECE. C O M P D ) IMP1 PRIVATE IMP 1 I 11 p+-=, Infotec I Energy ININ Firms I Ministry Cenam MNCs Domestic Groups SMEs Ministry o f Agriculture Others I I Capital Goods Suppliers I 1 ADIAT CONACYT Federal-State EIIlCalmecac Consulting firms State Governments State Councils for Science and Technology PRIVATE PUBLIC 4 D Source: W o r l d B a n k staff. Note: See acronym list at the beginning o f the report for complete names o f agencies. 50 Mexico’s innovation and enterprise upgrading system i s composed o f private as well as public institutions (see Figure 3.7). Several public institutions participate in R&D-related activities. A s shown in Table 3.4, education receives the greatest share o f resources related to R&D (62.4 percent) followed by energy (22.4 percent). Most o f these resources are for basic research, but a wide variety o f programs focus on enterprise support. Table 3.5 shows the number o f federal enterprise support programs by type and organization. Table 3.5. Number o f Federal Enterprise Support Programs, by Type and Organization, 2001 SEMARNAT 2 2 3 Other SHCP STPS 1, SECTUR 14 SEP 4 2 Enterprise support programs vary widely. There are 98 “legacy” programs from 11 different institutions, plus an additional 3 1 new programs (not including 20 additional ones on institution attributes and databases). State and local programs also must be taken into account. Aguascalientes i s one o f the most active states in terms o f enterprise support programs; i t has 53 support programs dealing with similar issues; In total, there are more than 400 enterprise support programs at the federal and state levels. The design o f each program i s the responsibility o f the relevant ministry. Even though the budget i s centrally approved by the federal Congress, which in theory should evaluate trade-offs in the use o f total resources, there is virtually no coordination among programs. Each program has its own budget, infrastructure, and human resources; several programs have overlapping objectives. Few enterprise support programs are directly related to technical innovation per se. Nevertheless, many have an indirect impact on technological capabilities, since they are geared toward upgrading the quality o f inputs for production. For example, all o f the 51 programs related to training are important for building human capital, for either general tasks or industry-specific knowledge. Similarly, a number o f NAFIN and Bancomext programs help firms to acquire machinery and equipment. Traditionally, programs directly targeted toward technological improvement have been rare, and they have lacked continuity. For example, the Programa de Modemizacion Tecnologica (PMT) ran only for two years. However, as part o f a restructuring effort, PMT was recently replaced by several programs o f the Fondo Sectorial o f Secretaria de Economia, Conacyt, and Avance. The new Economia and Conacyt programs-Economia with the Asesores Tecnologicos Empresariales (ATE) and Consultoria Especializada en Tecnologia; and Conacyt with its Fondos and Avance-are directly relevant to innovation (see Figure 3.8). Figure 3.8 Convergence o f Enterprise Support and Innovation Programs Economia Consultoria Fondos Especializada en Sectoriales Traditional Tecnologia I Scientific Enterprise Development support Source: World Bank staff. O f particular relevance for firm innovation are the new Conacyt programs o f Fondos Sectoriales, Fondos Mixtos, and Avance. With these programs, Conacyt is using i t s experience in evaluating science and technology projects to generate projects that can solve specific problems. These programs are described below: Fondos Sectoriales are created with matching funds from Conacyt and different ministries, which, in some cases, already have resources for technological development. Each ministry defines priorities that need to be researched and requests proposals from scientific, technology institutions and firms. The funds currently operating are Semarnat (environment), Sagarpa (agriculture and rural), Semar (marine), Sedesol (social development), Economia (mostly for private development projects), Conafovi (housing), Conafor (forestry), Salud (health), SEP (education), Sener (energy), SCT (communications), Segob (government), and Asa (Airports). These sets o f h n d s have replaced the traditional Science Support program that once supported research projects. Research for pure science i s now supported by the SEP-Conacyt sectoral fund. Fondos Mixtos are joint funds with a Mexican state, instead o f a ministry; each state defines a set o f research needs to be addressed. O f the 32 state 52 governments (including DF), 25 have a fund operating; most have already selected their first set o f projects. The speed o f formation o f the 25 fondos shows the growing awareness o f the importance o f Science and technology at the state level. These funds have the additional advantage o f promoting decentralization o f research. Traditionally, most o f Conacyt’s resources have stayed in Mexico City, specifically at UNAM and PN. Indeed, 48.6 percent o f National System o f Researchers are going to Mexico City institutions. Fondos Sectoriales, by contrast, has a natural tendency to disperse funds more widely. Programa Avance (Alto Valor Agregado en Negocios con Conocimiento y Empresarios) provides last-mile financing to help translate scientific and technological developments into products, processes, and services with market potential. This fund supports the development o f basic engineering o f products and processes; construction and testing o f the last round o f prototypes; and market testing. The find also provides financial and technical support for patent registration. Examples in Mexico o f innovations going from the lab to the marketplace are very few. This program intends to create a critical mass o f successful cases that will spur more firms to follow suit. The “last mile” concept should be viewed as an entry point for facilitating interactions between research organizations and industry. To produce a significant effect, however, a profound reform i s needed to enhance research organizations’ incentive to cooperate with industry. In the short term, we recommend allocating a larger share o f resources to facilitating such interactions. In the long term, Avance should be transformed into one key element o f the still nascent venture capital industry. I t is clear that Conacyt i s attempting to make science more relevant to industry. Some o f the funds experienced operational problems at the beginning, but the importance o f creating funds that respond to the needs o f a specific sector or state i s increasingly being recognized. This i s a great step forward. Correct evaluation, translated into design and operational improvements, could transform the supply-based science system to one that i s based on demand. Despite the government’s efforts to address the private sector’s problems with innovation and enterprise upgrading, firms, particularly domestic firms, have not been doing very well. Are the programs, in fact, improving private sector performance? Unfortunately, formal program evaluations are rare and are not always rigorous. The new budget law requires public entities to evaluate all o f their public programs yearly, but n o standard methodology i s applied. Moreover, the institutions themselves pay for the evaluations o f their programs, which could bias the results. Table 3.6 shows SME programs with deficient evaluations. O f eleven programs analyzed, there were no reported evaluations for three o f them. O f the remaining eight, only one (CIMO) was analyzed using quantitative quasi-experimental methodologies. For this program, STPS (the ministry that runs the program) found a significant increase in employed personnel and productivity; the World Bank (2003a) analysis o f the program 53 found no significant effects o n productivity. The rest o f the programs were evaluated with qualitative surveys, only one o f which used a control group. The lack o f apparent improvement in the innovation performance o f firms suggests that a top-down effort to coordinate legacy programs is o f critical importance. A concentration o n fewer but more effective and efficient programs is advisable. 54 Table 3.6 Program Evaluations PROGRAM RESULTS OF EVALUATION CONOCER Greater labor mobility and promotion under non- Consejo de Normalizacidn y Certijicacidn de traditional criteria. Competencia Laboral Greater multi-functionality for the workers. 0 Increased interest in participating in NCCL, including the provision for the worker to pay the cost o f certification. 0 N o effect on real remunerations o f workers. 0 Better personal assessments o f workers. N o increase in employee-perceived capacity or autonomy o f decision making. Perceived greater support for the training. 0 N o perceived better quality and relevance o f the training. 0 Mixed results for labor relations. CIMOI P A C 0 (Period o f analysis 1991-1993.) 8.5% growth in Programa de Calidad Integral y employment (-1.0% for control group). 10% growth in Modernizacidn/Programa de Apoyo a la remuneration (same as control group, though level o f Capacitacidn payment in C I M O 14% less) Period o f analysis 1993-1995.) N o positive statistical effect on employment. N o positive statistical effect on remunerations. 7.7% growth in productivity (6.6% in' control group). Firms with training plans were 4.4% more competitive than those without. CRECE (Results not statistically robust.) 7.1% increase in Centro Regional para la Competitividad operating profits; 16.8% increase in employment; 10.7% Empresarial fiscal and parafiscal impact. FIDECAP (2002.) Qualitative surveys o f participating firms in 18 Fondo para la Integracidn de Cadenas states. Productivas FAMPYME (2002.) INP-Economic, Administrative and Social Fondo de Apoyo para las Micro, Pequerlas y Research Center, 2002. Qualitative surveys o f participating Mediana Empresa f i r m s in 18 states. MEX-EX Mkxico Exporta N o record o f evaluation. PATCI N o record o f evaluation Programa de Asistencia Te'cnicay Camparla de Tmaeen PMT (2002.) CONACYT, 25 case studies. Programa de Modernizacidn Tecnoldgica PAIDEC (2002.) CONACYT, Information on a pilot case. Programa de Apoyo a Proyectos de hvestigacidn y Desarrollo Conjuntos ource: World Bank staff 55 Innovation and Business R&D Agenda: ImplementationIssues Concerted action to overcome the widespread organizational isolation o f research organizations, education organizations, and the productive sector i s essential for transforming the Mexican economy to a knowledge economy. Hence the issue o f linkages and networks is a central thrust o f the action agenda. The first priority i s to support a number o f private-public programs that show tangible results for private sector stakeholders. Such initiatives would build credibility for reform efforts and show both national and global stakeholders that Mexico’s innovation organizations do matter. The following initiatives are recommended: Build a shared vision o f Mexico as a knowledge economy through a technology foresight process led by the private sector. Certain industries (auto parts and plastics) and regions (Monterrey and Chihuahua) have already demonstrated the importance o f long-term objectives and strategic planning. An initiative at the national-level would be very useful. Improve the design and implementation o f decentralized funds. The sectoral and regional funds are an excellent way to help ensure that innovation is relevant to the private and public sectors. T w o immediate actions could improve operations: help users identify their research needs and create teams o f evaluators who understand the needs o f researchers and knowledge users (see B o x 3.4). Engage successful Mexicans abroad in “brain circulation” networks. Millions o f Mexicans live in the United States, and many have become successful entrepreneurs, managers, and politicians. Many o f these people s t i l l have a strong Mexican identity, which could be used as the basis for an international knowledge network. Speed up formation o f the venture capital industry on both the supply and demand sides (see Table 3.7) and establish a champion organization to support technology entrepreneurship. Proyecto h o v a r could provide early stage funding and networks to companies in Monterrey and eventually other regions o f Mexico with high growth potential (see Figure 3.9). Private investors from Monterrey industrial groups and financial investors, and individuals and funds from the United States, could hold controlling interest, while government donor funds would act as catalysts. Entrepreneurship support could include networking events, training for Mexican fund managers, and policy/advocacy hnctions. To generate adequate deal flow from local and U.S. sources, hands-on management and high value-added services (such as mentoring and networking) from fund managers, limited partners, and investors will 56 be crucial. Proyecto Innovar could be a powerful entry point for a second-generation (NAFTA-plus) agenda.' Figure 3.9 Proyecto Innovar as a Possible Hub of U.S.-Mexico Innovation Networks Mexican industrial groups Government/donor US InvestorsNCs Proyecto lnnovar I I Fondo lnnovar 1 Entrepreneurship trainingheworking I Fondo lnnovar 2 Fund manager trainingheworking Chapter 6 continues the discussion o f the NAFTA-plus innovation agenda. W e propose a private-public hub for international innovation networks to be broadly similar to Fundacion Chile (see Box 6.2). 57 Box 3.4. lmproving Decentralized Sectoral and Regional Funds Sectoral and regional funds established by federal ministries are increasingly becoming the main channel for allocating public funds. Strategically, this i s precisely the way to go: allocate public funds o n a demand-driven, decentralized basis while improving the design and implementation o f the funds. Stronger incentives are needed to engage international players, bring specialized expertise in project design (the Argentina Technology Fund provides up to $20,000 t o SMEs to enhance the quality o f their funding applications), and learn from successes and failures, which implies a need for early and continuous evaluation. Over the medium term, the multitude o f funds should be consolidated with clearly specified priorities and operating procedures. Interorganizational and private-public projects are t o be particularly encouraged. A good example in this context i s Tekes, the National Innovation Agency o f Finland. I t funds industrial projects as well as projects in research institutes, and it especially promotes innovative, risk-intensive initiatives. M o r e information i s available at http:llwww. tekes . f i e n d . A priority for Mexico i s to encourage international research and technology upgrading projects, particularly with high performers in the United States and Asia. While assistance fi-om the United States similar to EU structural funds i s highly unlikely, NAFTA might consider putting matching funds into jointly funded projects in applied research. One example o f such joint collaboration- the United States-Mexico Foundation for Science-recently celebrated its ten-year anniversary and established a good track record o f useful initiatives. Source: World Bank staff. 58 Table 3.7. Venture Capital in Mexico: Supply and Demand Supply: The availability of venture funds i s limited, and the institutional infrastructure i s weak. Constraints and opportunities Initiatives under way Appropriate legal structures for the creation o f venture funds are lacking, NAFIN i s heading a reform and the problem o f double taxation exists. Investment vehicles are needed to effort t o streamline the Mexican structure tax-transparent venture funds. These funds could be structured in legal-regulatory framework for Mexico or offshore in another jurisdiction. The tax transparency o f the establishment o f venture funds. investment vehicle i s particularly important for developing a base o f institutional investors in this asset class. The legal system does not allow flexible and enforceable contracts between The Mexican L a w on Insurance venture funds and investors. The lack o f protections for minority rights, and Companies permits the Ministry their poor enforceability in the Mexican courts, hinder venture investing. o f Treasury to specify the asset Aspects o f capital distribution, including redemption rights, warrants, stock classes in which insurance options, and dividends, are also prohibited or restricted under Mexican law. companies may invest their reserves; Treasury has recently There are few venture investors and trained fund managers. Mexico’s active included, for the f i r s t time, venture funds manage only a total o f $362 million. venture capital as a permitted class. The potential for Mexicans residing abroad t o invest and mentor local f i r m s i s largely untapped. F e w Mexicans return home to invest in or create early- stage companies. I n India and China, strong networking groups work to link N e w legislation o n Corporate potential investors and mentors with small companies. Governance and Institutional Investors i s being drafted. It Institutional investment in venture capital i s weak. Institutions such as will include arrangements for pension funds, which comprise the bulk o f venture investment in markets Mexican pension funds. such as the United States, are virtually absent in Mexico. T h i s i s because o f legalhegulatory constraints and the lack o f perceived investment opportunities. For example, pension funds must obtain legislative approval on a case-by-case basis before they can invest in venture capital funds. Insurance companies have a very l o w limit o n such investments. Foreign ownership i s restricted in certain industrial and service sectors. Mexico has one o f the most stringent foreign ownership regimes in Latin America. There are severe restrictions across a wide range o f sectors, in which investment i s possible only with the permission o f the National Foreign Investment Commission. Government support for venture funds has been overly directive. Financial support provided by the government for the creation o f venture funds has typically been directed at specific regions and/or sectors, restricting the scope o f activity o f the funds. Given the general lack o f early-stage financing in the country, a broader and less directed approach i s advisable. Management o f these funds should be selected v i a a competitive process that encourages international participation in the fund management company. 59 Demand: The environment for entrepreneurship i s weak, resulting in few potentialhigh-growth start- ups suitable for venture capital funding. Enterprises are constrained by traditional business values and an A new law-Ley de Sciencia y unwillingness t o take risks. Despite high levels o f entrepreneurial activity Tecnologia-encourages the (1 8 percent o f the population), investors and entrepreneurs remain focused linking o f new technologies o n traditional business approaches, which are less growth oriented. with business ventures in order t o promote commercialization Entrepreneurial networkmg and “angel” investing; are weak. Local and o f scientific research. Conacyt national groups that foster networking among entrepreneurs, angel investors, i s implementing the law. and venture hnds are few in number. Networking linkages with Mexicans living abroad (for example in Silicon Valley) are also weak. Endeavor, an entrepreneurship- support NGO active in Latin Training for entrepreneurs and SMEs remains weak. Training and education America, has initiated activities tailored to the needs o f entrepreneurs i s in an incipient stage in Mexico. in Mexico with the support o f Business education i s directly primarily toward management o f established leading Mexican industrial companies and traditional family businesses. groups. Endeavor facilitates mentoring and networking Public research institutes and universities are largely isolated from the between start-ups and angel private sector. Most research and development in Mexico i s undertaken at investors. public sector universities and institutes, which face high barriers to entrepreneurship and linkage with the private sector. I T E S M has launched an entrepreneurship education program. Source : World Bank staff Enterprise Upgrading and Linkages Agenda: Implementation Issues This section i s about the mundane but critically important agenda o f enterprise upgrading. Whereas the previous section focused on advanced and technologically competent enterprises (the tip o f the learning pyramid presented in Figure 3.3), here we focus on “minimal technology” firms and survival-oriented enterprises, largely SMEs, and to some extent on technology-competent firms (the base o f the pyramid). Promotion backward linkages i s a main thrust o f enterprise upgrading agenda. To increase local sourcing, there i s a need for more active dialogue with multinationals to create supplier development programs. Well-designed supplier development programs put the private sector in the driver’s seat and serve as a springboard to address numerous constraints faced by private business. Ireland i s a paragon o f developing national linkage programs that are efficient and driven by the private sector (see B o x 3.5). 60 Box 3.5 Ireland’s National Linkage Program (1987-1992) T o deepen FDI involvement in the country and leverage the technology then being used to develop an indigenous technological capability, Ireland’s Industrial Development Authority (IDA) designed and implemented a National Linkage Program in 1987. The three main stakeholders in the program were government, industry (primarily multinational corporations), and small and medium-size enterprises. The government provided the political imperative and charged the various state agencies with cooperating with the program. Eight agencies contributed staff and assistance, in part to help SMEs navigate the bureaucracy when seeking the best and most appropriate assistance. The availability o f staff members from each agency made it possible t o fast track many applications for assistance and to tailor services to the specific needs o f both the customers and their suppliers. The principal sector targeted was electronics, since it was the largest and most dynamic and had the greatest propensity to source locally. Its cooperation was sought, and the MNCs, through the Federation o f Electronic Industries, contributed resources t o the program costs in the initial two years. Companies were lobbied at high levels by senior agency executives and government ministers to support the objectives o f the program. Incoming companies were introduced to Linkage program executives so that local sourcing opportunities could be discussed and developed. M N C s were also asked to provide technical assistance, in association with state technical agencies. A rigorous assessment procedure was used to select participating SMEs. Existing or potential capabilities were evaluated against perceived supply opportunities. The assessment included a detailed examination o f financial management and o f the f i r m s ’ potential. National Linkage Program executives developed close relationships with key MNCs. Because o f the number o f agencies involved in the program, a well-balanced and multifaceted team comprising experts in management, business development, technical issues, accounting, and banking’ was the key to success. This array o f s k i l l s allowed the team to carry out the initial assessment and selection o f suppliers (in close cooperation with MNCs). , I t also made possible early-stage development workshops with the SMEs. From 1987 to 1992, locally sourced materials in electronics increased from 9 percent to 19 percent o f MNC purchases. While the total population o f M N C s in Ireland was about 900 in 1992, approximately 200 proved t o be effective participants in the program, with both accessible purchases and a willingness to support. The core group o f 83 supply companies participating in the program, o n average, outperformed other similar companies dramatically. This can be attributed to the selection process, intensive support, and interaction with demanding customers who forced the supply companies into a competitive mode. Over the period, these companies showed the following performance improvements: average sales growth o f 83 percent; average productivity improvement o f 3 6 percent; and average employment growth o f 33 percent. Source: World Bank staff. 61 Mexico has a variety o f programs, national and subnational, to develop clusters, value chains, and other networks. The need for concerted action i s well recognized, yet the results o f these many programs are often disappointing. Why i s this so? Developing a new institution to facilitate linkages and interorganizational networks i s an investment characterized by lags and risks. A learningperiod is the lag between investments and outcome. This lag can be quite long and requires patience and follow-up, which many programs are not designed to sustain. L e t us illustrate the concept o f a learning period with the example o f supplier development and subcontracting. The advantages o f subcontracting are well recognized: better suppliers, lower transaction costs, and lower input costs. In supplier development, a buyer (usually a large firm) invests in the organizational and technological development o f a supplier (usually an SME), with the expectation that both o f them will benefit. The key to supplier development i s the switching period, after which the benefits will be higher than the cost o f subcontracting. The switching period can be quite long, and the success uncertain (see B o x 3.6). Companies are thus reluctant to develop suppliers on their own. However, the uncertainty and the length o f the switching period can be reduced through the introduction o f specialized expertise in supplier development and effectivepublicprograms o f SME support. Both exist in Mexico, but they are in a short supply- 62 Box 3.6 The Switching Period in Supplier Development in the Mexican Garment Industry In a series o f interviews in 1998 with brand-name American manufacturers, a large clothing retailer described the lag between the time it starts working with a potential Mexican partner and the time its receives the first order. This period i s usually at least one year and often one-and-a- h a l f years. Supplier development i s a two-stage process that begins with a half-day visit. This i s followed by full-day evaluations, which serve as a diagnostic tool as well as the basis for a business decision. If the parties agree t o go forward, the American partner then undertakes t o teach the Mexican company h o w t o meet i t s standards. In a series o f exchanges, Mexican personnel are virtually tutored by their American counterparts, sometimes in Mexican plants, sometimes at the American customer’s facilities in the United States, and often in both places. One large shoe company, when i t began sourcing in Mexico, opened a permanent office in Mexico City; i t has two engineers working out o f that office who are permanently assigned to each plant. The switching period for organizational learning can be illustrated by the following graph: Benefits Learning benefits Learning costs Time Switching period Source: Duran (1997). If the switching period is fairly long, the linkage promotion programs should be fairly long to ensure continuous improvements. World experience shows that to be effective in promoting linkages and networks, interventions need to be cumulative, customer oriented, and collective (the Triple-C approach): Cumulative. One-off improvements are not enough; to remain competitive, firms must be able to change and develop in response to new market conditions and new opportunities. The objective should be to help generate this capacity within groups o f firms, so that in the long term public support i s no longer needed. 0 Customer-oriented. Efforts must be driven by the needs and demands o f the customer. This forces firms to face up to underlying problems o f competitiveness. The most 63 successful interventions are those that help firms to learn about their customers, and then introduce the changes and innovations needed for them to meet market demands. Collective. Outside assistance should be directed at groups o f enterprises rather than individual firms. This means working with business associations, producer groups, and other industry alliances. Where these do not exist, support can be linked to the formation o f such groups. Collective assistance has two advantages: it i s more cost effective than assisting enterprises individually, and i t promotes constructive relationships among firms. This can improve their efficiency and increase the potential for learning from each other. Other factors in the success and acceleration o f linkages and enterprise upgrading include: Reliance on a set of metrics to measure the performance ofprograms. Performance-oriented, incentive-driven programs. Incentives induce self-selection among firms, helping those that help themselves and suggesting exit to those that cannot, because o f internal or external factors, improve. Entrepreneurial management. Successhl organizations supporting technology and SMEs are often initiated by social entrepreneurs-individuals with unusual problem- solving and management skills. The success o f a support agency is predicated on such an entrepreneurial manager at the top. Successful organizations tend to evolve from a reliance on a key manager to a robust organization with efficient corporate governance. Cost recovery. A successful support organization should aim for eventual full cost recovery. Follow-up techniques (benchmarking). Successful programs use benchmarking indicators to diagnose where firms are, what they need to do to improve, and what the alternatives are for those unlikely to survive. Use o f ICT. ICT can leverage the effectiveness o f linkage programs. Efforts are needed to develop internet portals and internet immersion institutes, improve access to the internet, and train firms accordingly. A number o f these initiatives should be developed at the state level and coordinated at the federal level. Client participation in program design. Clients not only need to pay for the services o f the support organization; they also need to participate in the design and evaluation o f programs. To ensure that they do, SME programs should never be run by governments (whether federal or subnational), but rather by an autonomous private management contractor working in cooperation with the government but maintaining its independence. 64 As noted earlier, successful programs link assistance with performance. For SMEs, in particular, a touch o f realism i s essential. They need help to identify their possibilities and potential as well as assistance with exit for firms that are not viable. Chapter 6 continues a discussion o f the linkages agenda and proposes a National Linkage Promotion program for Mexico, both as a springboard for transition to a knowledge economy and as a ‘litmus test’ o f national concerted action. 65 Chapter 4 Enhancing Education and Skills This chapter makes two major claims. First, in the short-run, Mexico has a critical mass o f educated professionals and “blue collar” workers who can serve as a springboard for the country’s transition to a knowledge economy. Yet in the long run (and this i s our second claim), human capital may significantly impede that transition. Consequently, a comprehensive reform o f Mexico’s education system i s urgently needed. It will invariably take time to implement such far-reaching changes and for them to start producing results. This i s all the more reason to begin now. The chapter begins with an assessment o f Mexico’s performance in education and notes its deficiencies in human capital formation. The imperative o f lifelong learning i s explained and the major challenges currently facing the education system outlined. Detailed recommendations for improving basic, secondary, and higher education and for fostering lifelong learning are then presented. The chapter concludes with a step-by-step ‘education agenda and evaluation o f the needed initiatives at the local, state, and national levels. BenchmarkingMexico’s Performance in Education: A Comparison of OECD Countries In efforts to improve its educational system, Mexico has made impressive strides. Average years o f schooling increased from 4.77 in 1980 to 7.23 in 2000, about the same level as in Spain and higher than in Italy, Portugal, and Turkey (see Table 4.1). Mexico, however, i s at least four years behind Canada, N e w Zealand, Norway, Sweden, and the United States. In addition, Mexico’s illiteracy rate during this twenty-year period declined sharply (from 8.5 percent to 2.8 percent) for youths between the ages o f fifteen and twenty-four. The challenge i s to expand educational services to meet Mexico’s rapid demographic growth. With a population nearing 100 million, the country i s projected to continue growing at 1.5 percent a year (World Bank 2003b). This posits a very significant challenge in the long term. On such basic indicators as adult literacy rate, pupils per teacher, and secondary enrollment, Mexico scores poorly compared with Ireland and the Republic o f Korea (see Figure 4.1). Even less satisfactory is Mexico’s performance o n more advanced indicators o f a knowledge economy such as tertiary enrollment, extent o f staff training, availability o f management education, and professionals and technicians as a percentage o f the labor force. When compared with the rest o f the world, Mexico’s position i s even more sobering (see Figure 4.2). Mexico i s far behind Chile, Argentina, Uruguay, and East European economies. Neither has Mexico kept pace with Brazil and Peru. While Brazil, for example, has shown significant improvement since 1995, Mexico’s progress has been quite modest. 66 Table 4.1. Average Years o f Schooling o f Adults in OECD Countries, 1980-2000 Source: World Bank (2003b). Following the Knowledge Assessment Methodology (World Bank 2005), Figure 4.2 divides the world’s education performance into four broad classes: very low, low, “entry level,” and G-7 levels o f human capital endowments. “Entry level’’ endowments are characteristic o f upper middle-income economies that are starting to compete on knowledge and innovation and not on low labor costs alone. These are most E C A countries, Taiwan (China), and Southern Cone countries in Latin America. G7-level o f human capital endowments are in OECD countries (with the exception o f Mexico) and certain recent entrants into the European Union such as Poland. While the criteria distinguishing one class from another are necessarily arbitrary, the message for Mexico is clear: given its GDP per capita and geographical proximity to the United States, i t should have at least “entry level” endowments. In reality, it i s far below that level. 67 Figure 4.1 Mexico’s Education Performance Mexico Adut Literacy Rate (% age 15 and above) erage Years of Schooling Availability of Management Educatio econdary Enrollment Extent of Staff Training Tertiary Enrollment Quality of Science and Math Education Life Expectancy at Birth (years) 8th Grade Achievement in Science Internet Access in Schools 8th Grade Achievement in Mathematics ~ Public Spending on Education as % of GDP Prof. and Tech. Workers as % of the Labor Force Korea, Ireland Adult Literacy Rate (% age I 5 and above) erage Years of Schooling Availability of Management Educati condary Enrollment Extent of Staff Training Tertiary Enrollment Quality of Science and Math Education Life Expectancy at Birth [years) 8th Grade Achievement in Scienc ern& Access in Schools 8th Grade Achievement in Mathematic blic Spending on Education as % of GDP Prof. and Tech. Workers as % of the Labor Force Source : World Bank (2006) 68 Figure 4.2 Mexico and the World: Education Q- 8- y k d;; Russia %land Japan U SA d a Argentina + Ireland Korea 7- Slovakia c 8- Brazil c (Y Y w 5- c 8 a 4- 3- India 2- ’/ 1- Pakistan I I I I I I I I 0 1 2 3 4 5 B 7 8 9 1995 Source: World Bank (2005). Source : Knowledge Assessment Methodology (KAM) (www.worldbank.ora/kam) Lifelong Learning: A Prerequisite for Participation in the Knowledge Economy One prerequisite for Mexico to successfully participate in the global knowledge economy i s a supply o f workers whose training adequately matches the world’s shifting demand for certain skills. These “knowledge workers”-encompassing a country’s entire labor pool and representing the gamut o f professions and skills-possess a level o f learning that allows for the rapid adoption and absorption o f new technologies. As a result, education in a knowledge economy becomes an unending process that complements and reinforces previous formal academic studies or vocational training to form a cycle o f lifelong learning (LLL). The knowledge economy relies o n labor with so-called conceptual skills, skills that go beyond rote memorization and concrete reasoning. Particularly needed i s the ability to 69 problem solve in teams and to be creative. Higher order skills related to logic and abstract reasoning are increasingly important as well. Mexico’s labor force must possess a malleable knowledge base that allows workers to access new learning opportunities throughout their life span. Only then can the country expect to synchronize workers’ skills with the rhythms o f the global knowledge economy. An advisable framework for life-long learning de-emphasizes formal education venues-whether in primary schools or tertiary institutions-and focuses o n meeting the learners’ needs from the cradle to the grave. There must be better integration o f formal and informal learning channels and a more cohesive alignment o f the different components o f a national education system (see B o x 4.1). T o meet the life-long learning challenge, Mexico must rethink its education strategy, not simply reform the current education system. The greatest obstacle faced by Mexico and many developing countries i s learners’ inability to move freely in and out o f the education system at different points. Such movement would foster a more proactive accumulation o f knowledge and help workers meet social, economic, and cultural exigencies without sacrificing learning in the process. Box 4.1. Structure of Mexico’s Education System Preschool and Primary Levels 0 Pre-escolar: Federal programs for children ages four and five. Roughly 15 percent o f eligible children are not enrolled. 0 Primaria: Includes all schools with grades one through six and at least one instructor per grade. 0 Multigrados: One-room schools with one teacher for all primary grades. Multigrade schools can also have several teachers, but each teacher must teach more that one grade. Middle School Grades (Grades 7-9) 0 Secundarias: Schools that enroll n o m a 1 students, many o f whom are preparing to enter university upon graduation. 0 Tecnicas: Vocational training institutes for students who plan to enter the work force upon graduation. 0 Telesecundarias: Rural schools that use televised curriculum to achieve distance learning. High School (Grades 10-12) 0 Preparatorias and Bachilleratos: Upper secondary schools for youth who are going to college. Students must choose one o f four academic tracks: physics-mathematics, chemistry-biology, economics-business administration, or the humanities. Tecnnologicas and Comercios: Schools to prepare students for a particular vocational career. Source: U.S. Department o f Education (1999). If Mexico fails to devise an educational model that allows for lifelong learning through formal, informal, and nonformal formats, many workers m a y find themselves with obsolete training given the country’s present pace o f integration with the global knowledge economy. The case o f the robust maquiladora manufacturing industry, currently the most 70 dynamic sector in Mexico, illustrates the earnings gap that emerges when workers lack lifelong learning skills in an industry that i s highly integrated with the global markets. Since the mid-1980s, the most qualified workers have been acquiring the bulk o f average earning increases achieved through improved productivity at the expense o f unskilled laborers (see Figure 4.3). For example, white-collar employees in maquiladoras (that is, the sector's equivalent to knowledge workers) have been constantly increasing their earnings share relative to blue-collar employees, up from three to one in 1988 to more than four to one in 2000. Figure 4.3. Ratio of Yearly Remuneration, White-collar to Blue-collar Workers in Mexico's Maquiladora Manufacturing Industry, 1988-2000 MEXICO MAQUlLADORA MANUFACTURING INDUSTRY p 3.10 4 1 I I - 2.90 2.70 ! I L-."" I 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 YEAR Source: Authors' own calculations based on INEGI (2001b). Extrapolating this experience o f workers within Mexico's maquiladoras to other sectors would suggest that as the country increasingly competes in the global knowledge economy, widening wage disparities will further marginalize labor without lifelong learning skills. However, the targeted expansion o f Mexico's supply o f knowledge workers will enable its economically active population to successfully adopt, adapt, and build upon new technologies as they are developed, consequently upgrading their skills on a continual basis. As a result, the current skills-technology gap between North-South countries could even be narrowed through individuals and firms in the developing world moving from knowledge absorption to knowledge creation-an advancement promoted and furthered by having workers with skills for lifelong learning. 71 Recommendations for Improving Basic and Secondary Education Although there is vast room for improvement on numerous indicators o f educational quantity (such average years o f schooling), Mexico’s main priority i s to improve educational quality and equity. Following are recommendations that would advance this goal: Encourage continued education. The continuous cycle o f economic slowdowns over the past thirty years has pushed many young adults out o f the education system and into the labor market to support their families. f educational facilities and promotion practices. A rigid Streamline the system o organization o f basic and secondary schools has not motivated students to advance in their studies Provide accessible schools for small communities in a cost-effective manner. Although 75 percent o f Mexicans live in urban conglomerations, there is a significant dispersion o f the population among rural areas. In fact, there are 199,396 towns and villages with fewer than 2,500 inhabitants (INEGI 2001a). Target the needs o f minority groups. The delivery o f educational services must be tailored to each o f Mexico’s multiple and distinct indigenous groups (roughly 14 percent o f the population). Promote the enrollment o f females. Local traditions have tended to devalue the education o f women in Mexican communities despite the continued rise in the rate o f participation by females in the labor force. By 1999 the rate o f participation was 33 percent (World Bank 2003b) The suboptimal performance o f the Mexican education system at the highest levels o f learning will be an impediment for converting large sectors o f the labor force into knowledge workers primed for lifelong learning. Instilling logic and reasoning skills among students-a task largely associated with education acquired at least through the secondary level-will be a determining factor in h o w well Mexico competes in the global knowledge economy. The country’s difficulties in delivering improved outputs to a greater share o f Mexicans at the secondary and tertiary levels can be attributed to three principal sources: l o w attendance levels, high dropout rates, and a l o w supply o f schools at the. secondary and tertiary levels. A s Table 4.2 illustrates, completion rates for students at higher levels o f education decline geometrically, with only 3 1.5 percent o f 18-year-old Mexicans graduating from secondary school; the average for OECD members i s 54 percent. In the number o f graduates finishing their secondary education, Argentina (40 percent), Brazil (57 percent), and Chile (35 percent) also surpass Mexico ((OECD 2003b) 72 Table 4.2. Schooling Completion Rates in Mexico and Dropouts per Year, b y Age Group 12 year-olds 2,185,691 2,111,820 96.6% n.a. 15 year-olds 2,090,034 1,327,965 63.5% 230,477 18 year-olds 2,088,225 658,800 3 1.5% 222,672 Equity: Making Education Accessible for Everyone The Mexican government has attempted to address these deficiencies in i t s education system by changing i t s approach. Instead o f the traditional approach o f simply building more schools, i t has begun to support various strategies aimed at creating an educational environment that i s accessible and equal for all Mexican students. Mexico has launched “Opportunities” (Oportunidades), a federally funded initiative to keep youth in the education system. The program, a reworking o f the PROGRESA program founded in 1997 under President Ernest0 Zedillo, provides cash incentives to low-income families that send their children to school. Each month a transfer payment i s made to households from Mexico’s lower socioeconomic strata, as long as their school-age children attend school and make periodic visits to community health centers. The program also has a gender component that specifically targets girls. Dropout rates are higher for girls than boys at the secondary level. The low completion rates for women in the secondary education cycle have resulted in higher illiteracy rates and lower average years o f schooling for females than males in Mexico. The average years o f schooling for Mexican female adults are 6.88 years compared to 7.59 years for males. There i s similar inequality in illiteracy rates for women over fifteen years o f age (10.5 percent) when compared to men (6.5 percent) in Mexico (World Bank 2003b). Opportunidudes has boosted attendance rates among students in the regions where the educational incentive program has been implemented. In addition, the government’s program o f community-based schools and its network o f distance learning centers in isolated rural areas have extended the education system’s reach to the country’s geographically dispersed population. Another important initiative is Telesecundarias, a federal program that provides lower secondary education to over one million Mexican students in scattered communities (including in the United States) through closed-circuit classes. Since the program was created in 1998, enrollment has grown 78 percent to nearly 150,000 students. This increase accounts for 46 percent o f the growth in Mexico’s overall enrollment figures for secondary education during the same period. Despite these successful policy interventions, serious deficiencies in Mexico’s education system remain. For example, the government’s strategy o f enlarging Mexico’s 73 enrollment must include a consideration o f why students are not attending the schools that already exist in their communities. In Puebla, a city in central Mexico with about 1.7 million inhabitants, nearly 12,500 children between six and fourteen years o f age (6 percent o f the eligible primary school population) are outside the system, although almost 100 percent o f these children live near a school. At present no systematic efforts are being made-either at the federal or local level-to rectify this problem o f underutilization o f facilities by the communities they are meant to serve. The targeting o f the school-age population could be a low-cost complement to the government’s expansion o f educational services into rural and low-income areas to increase learning opportunities for Mexican students. Quality: Ways o f Assessing Mexican Schools The most important source o f information regarding the quality o f education in Mexico i s the yearly exam taken by over six million basic education students whose teachers have applied for the Carrera Magisterial, a federally funded program that l i n k s promotion and salary increases to improved academic performance by their classes. The greatest value o f this exam is in comparing the relative quality o f education in Mexican schools. International evaluations-such as the OECD’s Programme for International Student Assessment (P1SA)- tend to be more adequate for comparative assessments o f the quality o f basic education in Mexico and other countries. Another test, the Trends in International Mathematics and Science Study (TIMSS), can b e used for international comparisons o f knowledge economy skills. First administered in 2000 to OECD and nonmember nations, the Programme for International Student Assessment (PISA) aims to assess how well students have acquired the knowledge and skills required for full participation in society. Participating students are restricted to those finishing their country’s compulsory education cycle, and testing i s focused o n mathematical and scientific literacy (OECD 2001a). As a result, the exam is considered a good benchmark for analyzing whether graduating students have acquired the skills associated with the global knowledge economy (in other words, whether graduating students have the scientific and mathematic acumen needed to analyze, reason, and communicate ideas). 74 Table 4.3. Programme for InternationalStudent Assessment, 2000 Results for Selected OECD Countries Mexico I 422 1 387 I 422 1 546 557 552 Highest (Finland) (Japan) (Korea) 396 334 375 Lowest (Brazil) (Brazil) (Brazil) On the whole, Latin American students have tended to perform poorly o n such international tests, a trait evidenced by the performance o f Mexican students o n PISA 2000 (see Table 4.3). Mexico had scores significantly below comparative income countries such as Poland and Latvia. Poland's scores were 479 (reading), 470 (math), and 483 (science). Latvian students performed less well, scoring 458 (reading), 463 (math), and 460 (science). From Latin America, Argentina, Peru, and Chile also participated in PISA (some participated in 2000; others in PISA+, which i s considered the same examination but i s taken by many more countries). Among Latin American countries, Mexico i s one o f the best performers.' While Mexico's performance relative to other Latin American countries i s encouraging, its performance compared to its NAFTA and OECD partners i s cause for concern. Mexican students' weak showing o n the math component may suggest that they lack the skills needed to compete in a knowledge economy. When Mexico i s compared to other OECD countries using socioeconomic and cultural indicators, Mexico fares poorly. Among Mexican students, 74 percent have mothers who achieved only a lower secondary education or less (the average among other OECD members i s 32 percent). When data o n Mexico are disaggregated by socioeconomic group, more acute educational inequalities become apparent. For instance, Mexico's score in PISA's reading literacy component improves from 422 to 459-while scores decline in other OECD countries-when compared to member students from a similar socioeconomic and cultural cohort. This result is determined using OECD country averages for test scores as well as for socioeconomic and cultural indicators for the thirty-member group. This divergence in the ' Among 41 countries Mexico ranked 34th in reading, 35'h in mathematics, and 34" in science. Among five Latin American countries, Mexico ranked 1" in reading (Mexico, Argentina, Chile, Brazil, and Peru), 2"d in mathematics (Argentina, Mexico, Chile, Brazil, and Peru), and lst in science (Mexico, Chile, Argentina, Brazil, and Peru). 75 quality o f schooling among social classes poses another significant obstacle for preparing Mexico’s labor force to participate in the global knowledge economy. Equally daunting for Mexico to tackle is the regional variation in students’ performance. The relative ranking among states for the last six applications o f the Carrera Magisterial exam has changed little: Nuevo Lebn, Tamaulipas, and Distrito Federal have been the steady “best performers,” with results remaining above 102 points; Coahuila, Tlaxcala, and Colima have been the steady “worst performers,” consistently scoring 98 points or lower. Scores are calculated using a median score o f 100 and a standard deviation o f 10. Exam results also show variations within regions and between types o f schools. Urban schools on average score 4.5 points higher than schools in rural areas for the period studied. Qualitative differences between schools are also evident when analyzing states based on socioeconomic indicators. The results o f the Carrera Magisterial suggest that with the correct allocation o f existing government resources and with better delivery o f educational services, Mexican public schools could provide the same high-quality learning experience for all o f their students, regardless o f district. I t should be noted that “model” public schools (that is, the best performing) are working with basically the same infrastructure, salary levels, curriculum, textbooks, and training programs that are available for other schools. As a result, institutional practices within schools should be studied so that the day-to-day routines o f successhl facilities can be identified and their positive experiences disseminated to other schools. This idea i s behind two o f Mexico’s major initiatives in education-Escuelas de Calidad (literally “quality schools”) and the Consejo Nacional de Foment0 Educativo (CONAFE). The first initiative began in 2001 with 2,200 schools. This program supports the adoption o f “best practices” by providing up to US$30,000 for schools in urban areas to implement self-designed programs. With the support o f school authorities, students, teachers, and parents, the program i s designed to improve the physical infrastructure o f each school and its pedagogical equipment. The only hindrance for expanding this innovative scheme i s the requirement that schools be in states that are willing to co-finance federal support, at a ratio o f two to one. CONAFE, the “National Council for the Promotion o f Education,” was established in 1971. I t provides extra resources to schools that enroll disadvantaged students. CONAFE’s compensatory education programs n o w support more than three m i l l i o n students in pre- primary and primary education, and about one million students in telesecundaria education, or secondary education delivered via satellite television to remote schools. Results o f recent evaluation (Shapiro and Trevino 2004) show that CONAFE’s compensatory programs are effective and well targeted. At the primary and secondary levels, CONAFE significantly improved students’ exam performance and decreased inequality between CONAFE and non-CONAFE students. These results were robust even when controlling for relevant background variables. CONAFE appears to b e more effective in math instruction at the primary level and in Spanish instruction at the telesecundaria level. 76 Through its support o f CONAFE’s compensatory programs, the World Bank is achieving i t s goal o f improving and expanding educational quality in Mexico. In 2002 the government began another important initiative to improve the quality o f public schools. I t created an independent evaluation agency called the Instituto NacionaZ de EvaZuaci6n Educativa (INEE). A school’s assessment is based o n its curriculum, the level o f internal and external efficiency, the long-term and positive effects o f its learning methods, and equity issues. Through an agreement with state governments, all information is made public about primary, secondary, and upper secondary schools evaluated by INEE. The program, an initiative o f President Fox, i s aimed at allowing for a transparent review o f the quality o f the nation’s education system, including current programs for community, indigenous, and adult education. Recommendations for Improving Higher Education Tertiary education in Mexico historically has been the domain o f the middle and upper classes, creating and perpetuating equity asymmetries among the country’s different social groups. Students study at public or private institutions, either universities, teachers’ colleges, technological institutes, or technological universities. In terms o f institutional preference, the majority o f Mexican students (64 percent) can be found in government-funded schools that are overseen either by federal, state, or autonomous authorities (see Table 4.4). Table 4.4. Higher Education in Mexico: Institutions, Students, and Teachers, 2000-2001 Federal government 14.4% 9.4% 17.0% 13.6% State government 13.3% 6.2% 5.6% 4.4% Autonomous 3.6% 34.8% 46.1% 45.9% Private 68.8% 49.6% 3 1.3% 36.1% TOTAL 100.0% 100.0% 100.0% 100.0% Source: Secretaria de Educacidn Publica (2001). Until recently in Mexico, the state was the sole supplier o f higher education. This situation created an undersupply o f education that i s evident in the recent and rapid burst in demand for private universities and technological schools. W h i l e enrollment in the federal and state system increased by 32.7 percent between 1990 and 2000, private schools experienced a 165 percent surge in the number o f attending students. This booming demand, coupled with lax government regulations, has prompted more private facilities to start operations. Out o f the 1,062 new higher education schools created between 1989 and 1999, 74 percent were categorized as private. 77 A s Mexico prepares its students to compete in the global knowledge economy, a set o f key issues must be addressed in planning the future growth o f higher education and ensuring equal access. The following are points to consider: The mismatch between coursework, skills, and labor market conditions. The geographic distribution o f existing and future facilities. 0 The static socioeconomic characteristics o f entering students. 0 The quality o f private higher education. Financing options for higher education. 0 The ties between universities and industry. Match Coursework to Labor Market Demands All students, regardless o f their course o f study, must learn h o w to absorb and use knowledge. Rather than mandating specific career paths, the government should put mechanisms in place to ensure students entering a particular field have the skills demanded by a knowledge-economy labor market. Mexican students, like many o f their Latin American counterparts, have selected the humanities as a preferred course o f study. Yet Mexico, like most Latin American countries, does not have a deficit o f individuals enrolled in science and engineering programs in relation to the total number o f tertiary students (de Ferranti et al. 2003). Despite its l o w per capita income, Mexico ranks near the mean for OECD members in the percentage o f its graduates coming from engineering and basic science programs (see Figure 4.4). Only Turkey has a lower per capita income, based on Purchasing Power Parity (PPP), than Mexico when considering figures for 1990. Even relative to its NAFTA country partners, Mexico exceeds the share o f graduates receiving degrees in scientifically skilled professions in both Canada and the United States (20.4 and 15.8 percent, respectively). Moreover, based o n income level, Mexico falls near the median for the number o f scientists and engineers i t has when compared to Australia, Canada, Norway, and the Republic o f Korea, and when compared to other Latin American countries. 78 Figure 4.4. University Graduates in Engineering and Basic Sciences, 2000 42.5 40.0 37.5 35.0 32.5 Note: The t e r m “graduates” refers to students completing tertiary level studies in one o f the following fields: enginnering; manufacturing and construction; life sciences; physical sciences; mathematics and statistics; or computer sciences. Source: OECD (2002a). Rather than trying to generate more graduates from a particular field, tertiary education in Mexico should focus o n instilling all students with higher order skills, such as problem-solving and reasoning that are prerequisites for successhl participation in a knowledge economy. In the United States, heightened demand for laborers with this type o f knowledge-regardless o f their academic background-has been a product o f the increased use o f technology in the workplace. As a result, any graduate who i s able to adopt and adapt new knowledge is valued rather than only those possessing specialized, “scientific” skills. According to recent surveys in Thailand and Costa Rica, employers are less concerned with workers’ concrete skills than with their general education level and ability to learn on the job. In Thailand 70 percent o f employers in manufacturing industries and 100 percent from the services sector rated a worker’s “ability to learn” as an important factor in his or her being hired. In Costa Rica, twice as many employers from the technology sector were likely to favor an employee with “learning speed” over one with “specific knowledge.” Not all fields o f study in Mexico, however, may be transmitting such skills needed for lifelong learning and working in a knowledge economy. By their nature, Mexican universities tend to prepare ready-to-use professionals rather than multiskilled graduates. 79 Moreover, schools’ rigorous coursework and concrete skills-specific cumculum are directed at a population (18 to 24 years o f age) that, in many cases, may not have the maturity or the information to make sensible career decisions based on labor market conditions. U p o n completing the upper secondary level, graduating students must decide which type o f Mexico’s four tertiary schools they want to attend. The high degree o f specialization o f these programs prevents a student from being exposed to other options or freely moving to another course o f study. As a result, such an educational structure may not be the best way for Mexico’s youth to develop the skills, knowledge, and attitudes associated with lifelong learning. Instead, one option could be to include a more general, liberal arts component in universities’ educational programs for those students who are not certain which profession they want to enter. In this manner, students would be able to advance their learning while at the same time remaining eligible to enter a more career-oriented program within the university at a later time. Balance the Geographic Distribution of Tertiary Schools During the past decade, the Mexican government has improved the geographical distribution o f university and tertiary schools. Today every state, even the sparsely populated ones, has at least one institution o f higher education. As a result, opportunities for tertiary learning are no longer concentrated in the largest urban areas (Mexico City, Guadalajara, Monterrey, and Puebla); rather, they are more equitably distributed across the country. More balanced distribution i s desirable because higher education i s rooted in local communities, and strong tertiary schools tend to have a positive impact on local economies However, the heightened profile that Mexico City exerts politically, economically, and culturally in the country has created obstacles for expanding higher education to other regions and to all students in Mexico. With 18 percent o f the total population and 23 percent o f the country’s wealth, Mexico City serves as an attractive location for tertiary schools. As a result, one-third o f all graduate school enrollments (32.3 percent) can be found in the capital’s universities. Most o f the country’s higher level research also i s conducted in this one city. Almost 50 percent o f the more than 8,000 researchers registered with the National System o f Researchers (Sistema Nacional de Investigadores, SNI) are in Mexico City; slightly more than 29 percent o f these researchers are affiliated with the Universidad Nacional Aut6noma de MCxico (UNAM). A total o f 45 percent o f researchers in Mexico City are associated with one o f the city’s three principal research institutions-UNAM, Universidad Autbnoma Metropolitana (UAM),and Instituto Polite‘cnico Nacional (IPN). To overcome the prominence that Mexico City plays in higher learning, educational policies should target state universities and efforts to make them stronger. One way to diffuse the spread o f knowledge and balance the education provided to all students regardless o f their home institution is the Programa de Mejoramiento del Profesorado (PROMEP), a government initiative for the professional improvement o f teaching staff at public universities. By 2001, this program had granted 3,371 scholarships to full-time professors to attend Mexican universities (7 1 percent) and international universities (29 percent). As a result, more than 1,000 professors have already received a doctoral or masters degree. 80 Moreover, this increased demand for graduate level courses has helped create 6,23 1 new f i l l - time teaching positions at universities. Diversib the Socioeconomic Profile of Students Currently, Mexico enrolls too few tertiary level students to have a work force ready to compete in the global knowledge economy. L i k e most developing countries, Mexico has an education system with spending skewed toward the tertiary level where students from higher income brackets excessively outnumber those from the lowest socioeconomic strata (see Figure 4.5). According to UNESCO and World Bank data for student expenditure as a share o f per capita income, Mexico spent 45.2 percent o f educational funding at the tertiary level, 13.8 percent at the secondary level, and 11.8 percent at the primary level. -- Figure 4.5. School Enrollment, by Age and Income Group 100% 1 - ’*age go r 9 80% 60% 40% 20% 0% I I I I I I I 1 5 15 25 35 45 55 65 75 85 95 Income percentile Source: INEGI (2000). 81 Such regressive spending patterns have led to a de facto educational subsidy for Mexican university students from already economically mobile backgrounds. Among OECD countries, Mexico and the Slovak Republic devote the most to higher levels o f education. While the average member spends 2.2 times more per student at the tertiary level than at the primary level, Mexico and the Slovak Republic respectively spend 3.6 and 3.8 times more. As a result o f these distributional inequalities, the Mexican government should search for policy interventions that encourage the enrollment o f low-income students at the tertiary level. One option i s to decrease the opportunity cost associated with higher levels o f learning for such students given the tradeoff many must make between work and school. Unlike most OECD countries, the majority o f Mexico’s public universities do not accredit part-time enrollment programs for college students. This characteristic i s in contrast to the increasing number o f tertiary institutions abroad that offer part-time course options (evening, weekend, and summer) to encourage working adults to continue their education. In the case o f Finland, more individuals are enrolled in nontraditional, continuing education programs at the tertiary level than students who are completing full-time, university coursework. An increased supply o f continuing education programs in Mexico would go far toward encouraging more people to enroll and remain in the country’s higher education system by decreasing the opportunity cost o f learning. Improve the Quality of Private Higher Education The country’s largely unregulated network o f private universities accounts for an important share o f Mexico’s matriculation growth at the tertiary level. Such facilities have been increasing steadily in number since the 1990s as deregulation encouraged privately run schools to step in and fill the unmet demand for higher education in Mexico. Small in size and offering a relatively low-cost structure, these new institutions have been a welcome innovation, making tertiary level learning more accessible to more Mexicans. However, there are concerns about the rigor and quality o f the courses at private universities; few official mechanisms exist to assess them. States should seek out policies that promote private sector participation while permitting government oversight o f private schools’ efforts to prepare their students for lifelong learning. Currently, Secretaria de Educaci6n Publica (SEP) i s the only agency that confers official recognition o n higher education programs by evaluating whether the institution has adequate facilities and faculty (based on size and credentials) and is meeting minimum course-load requirements and sequencing. However, the SEP does not consider the quality o f educational outcomes (such as test scores and completion rates). There i s also some evidence that small private universities are misleading the SEP to gain accreditation based on inputs rather than outputs. Despite the lax criteria for accreditation, most private universities have not even gone through the process o f government review. Only 90 out o f approximately 1,200 private higher education institutions in Mexico have been accredited to date. With the rapid rise o f private universities in the country, the need for quality control i s increasingly acute. 82 The significant costs-both direct costs (public and private) and indirect costs (personal income forgone)-associated with pursuing higher education require that there be industry-wide standards and mechanisms for quality control (see B o x 4.2). Attempts to improve the monitoring o f educational inputs and outputs at private schools in Mexico have been mixed at best. Apart from the SEP’s accreditation o f private universities, the Federation o f Private Higher Education Institutions (FIMPES) does have in place a voluntary quality control procedure for education providers. Yet neither the SEP nor ANUIES (the National Association o f Public Higher Education Institutions) has developed a similar accreditation system for a school’s faculty and staff. Box 4.2 Higher Education and Quality Control Mechanisms in Chile and Brazil T w o emerging mechanisms for controlling the quality o f higher education are government accreditation programs and the required submission o f transparent information about the learning outcomes o f private school graduates. Chile has created a successful accreditation system to regulate i t s heterogeneous offering of private tertiary facilities. While accreditation i s voluntary, more than 35 private universities and 106 programs have been or are currently being reviewed. The positive response to the government’s policy may be because the evaluation procedure i s transparent, nonbureaucratic, and voluntary. Brazil has created a university exit exam; graduates from more than a dozen degree programs must take this exam, regardless o f whether they attended private or public schools. This national exam, also called the ProvEo, has grown in reach and respect since it was first made mandatory in 1996. Test results for each institution are made public as a way for incoming students to evaluate a university’s educational services, learning environment, and reputation. I Source: World Bank staff. I Expand Financing Optionsfor Higher Education The expansion o f higher education in Mexico has been hampered by the four obstacles described above: the mismatch between coursework, skills, and labor market conditions; imbalance in the geographic distribution o f educational facilities; the static socioeconomic characteristics o f entering students; and shortcomings in private higher education. Another obstacle i s the inability o f many students from middle- and low-income households to afford the upfront costs now associated with enrolling at the tertiary level. The government alone i s unable to bear the burden o f funding the higher education o f more students given the magnitude o f resources needed to make tertiary learning accessible to everyone. Already the Mexican state i s dedicating nearly 23 percent o f all government spending to education, with over one-fifth o f this funding earmarked solely for universities.* More government expenditures are not the solution to the financing short-fall from increasing * For more indicators, see http://wwwl .worldbank.org/education/edstats/. 83 university enrollments. Instead we recommend creative partnerships with the private sector to address this problem. Examples from other countries have shown that private funding o f student loans for tuition fees and housing costs can lower the economic barriers to expanding higher education. I n Chile the government i s using various schemes including income- contingent loans (state and bank funded) to give the financial means to students that otherwise would not be able to study at a university. One type o f loan i s called university credit, an income-contingent loan that i s paid back and calculated at a fixed payment or 5 percent o f income, whichever is lower. A real interest rate o f 2 percent begins accruing as soon as the loan i s disbursed. The Corfo credit i s a loan made by banks at up to a 9 percent real interest rate for a maximum o f fifteen years. Such cost-sharing programs promote efficiency in financing advanced vocational programs and tertiary level studies in developing countries, although they require additional policy interventions to ensure that they do not inhibit low-income students from studying. Dividing the cost burden o f higher education between the student, the state, and the private sector creates an efficient and equitable funding scheme because all learners are made at least partially responsible for the cost o f their o w n studies. I t is thought that by making marginal cost payments toward their education, students make better learning choices and become more dedicated to completing their studies. I n theory, cost-sharing programs also promote equity because those who benefit from an education are the ones directly paying for it. Four financial instruments for implementing cost-sharing schemes are traditional student loans, human capital contracts (graduates agree to pay a percentage o f their income for a specified amount o f time), the graduate tax (a set tax applied to income following graduation), and income contingent loans (graduated loan payments based on salary level). Unfortunately, private financial intermediaries play a very limited role in providing students with h n d s in Mexico. Costs are shared mainly through a combination o f government outlays and self-funding. The government has created a fairly successful student loan program called the Sociedad de Foment0 a la Educacidn Superior (SOFES). Funding for SOFES i s a tripartite arrangement o f the federal government, universities, and the World Bank. The loan program was originally created through FIMPES, the umbrella group that represents private universities in Mexico. Founded in 1998, SOFES n o w works with forty universities across the country to provide unsubsidized loans each year to 10,000 Mexican students that are financially unable to continue their higher education. Participating universities act as the conduit for SOFES funds and are responsible for administering the loans. Nonperfonning loans cannot exceed more than 10 percent o f any university’s portfolio; if they do, schools must pay SOFES the difference or leave the program. Some states have launched their own loan programs to help local low-income students continue their education. For example, the Instituto de Crkdito Educativo del Estado de Sonora has supported needy students in the northwestern state o f Sonora since 1981 by relying on the local government’s participation for funding. However, the obvious limitations o f such public loan initiatives mean that a larger role o f private financial intermediaries in Mexico i s needed to give more students financial access to higher education. First, the demand for student borrowing naturally has exceeded the available supply o f government spending. Second, international examples from developing countries show that when the public sector has become exceedingly involved in 84 supplying loans, l o w cost recovery becomes chronic due to student defaults and the government’s subsidization o f below-market interest rates. Unfortunately, asymmetrical information between the lender and borrower, the lack o f collateral, and a still nascent and stable financial system have prevented until now the entrance o f private commercial banks into Mexico’s student loan business. Improve Linkages between Universities and Industry Closer ties between companies and universities could ensure a better match between what students are being taught and what the labor market needs from its workers. There can be improved synergies in tailoring university curricula to needed skills by involving leading firms in course selection and school decision-making. In Mexico’s system o f technical universities (universidades tecnoldgicas), local companies have become actively involved in designing specific programs and in providing apprenticeship-like positions for students. This partnership could be a model for other private sector-school partnerships. Since 1994, technical universities have been growing steadily in number. By 2003 fifty-three technical universities were in operation. They provide two-year technical programs (the degree i s called Te‘cnico Superior Universitario, TSU), and their educational model has been emulated by other tertiary education providers, including private facilities like the Universidad Tecnoldgica de Celaya and the Universidad Interamericana del Desarrollo. Government guidelines can go far to foster such linkages. Having teachers and researchers leave the ivory tower and get in touch with industry’s everyday realities are a valuable means for encouraging lifelong learning by both professors and their students. Studies have shown that such symbiotic partnerships help to bring fresh, relevant curricula into the classroom. Moreover, the fomenting o f ties between universities and the business community i s a way to keep schools involved in, and caring about, local affairs. To build these bonds, many publicly funded universities may need to review their current charters and regulations. School administrators and faculty need the right incentives to create the channels for an exchange o f ideas and knowledge. Policies that Foster Lifelong Learning Promoting policies that allow tertiary schools to better serve their students and expand their academic offering i s part o f rethinking how a country’s education system can best prepare its citizens for lifelong learning. An LLL framework provides individuals throughout their lives-from early childhood to retirement-with a spectrum o f formal and informal learning opportunities. The approach i s based on the centrality o f the learner and involves collective exchanges between the firm, the economy, and society-at-large. Formal schooling lays the groundwork for a lifetime o f learning. The model in this way prepares workers with the skills they need to meet the rapidly changing demands o f the global knowledge economy. Learning institutions and programs in Mexico, to promote lifelong learning, must 0 Shift their emphasis from teaching vocation-specific skills to giving students better-developed capabilities for learning new skills. Vocational education should be increasingly postponed to higher levels o f education (for example, from 85 secondary to upper-secondary schools) in countries where such enrollments are high. 0 Revise school curricula to teach higher-order cognitive skills that aid learning, problem-solving and analysis, rather than focusing o n rote-memorization, simple literacy, and specific facts or equations. Adopt assessment mechanisms (for example, a school accreditation program, exit exams, and quality assurance systems) to ensure that students make a smooth transition from formal education to the workplace, and vice versa. Promoting Trainingfor Work As international experience shows, training is critical for workers if they want to b e able to continually compete in the global knowledge economy and not find themselves one day with obsolete skills. Given the education levels o f the current supply o f labor in Mexico, workers will require scaled-up training at various points throughout their economically productive lives to keep pace with labor market changes. M a n y countries, both industrial and developing, already have designed new policies to foster in-service training among companies including payroll-levy training funds, tax incentives for employer-sponsored training, and state-funded individual learning accounts (ILAs) for employees seeking additional skills. Fortunately, Mexico has some o f the infrastructure and training networks in place to promote the expansion o f on-the-job training. By the 1 9 9 0 ~ ~ many Mexican firms were already providing external training-through private companies, industry associations, and government training centers-to their workers. One study showed that the average years o f schooling for a Mexican worker in the 1990s raised the likelihood that the worker would receive on-the-job training (Acevedo and Tan 2002). This lends empirical support to the theory that increased education and training are complimentary and correlated factors for a cycle o f lifelong learning. In other countries, governments have been able to increase employee-targeted training policies by using the following incentives aimed at the private sector: Levy-grant schemes. Government administrators use earmarked levies to provide grants to employers for state-approved training programs (as in Singapore and previously in the United Kingdom). 0 Levy rebate schemes. Employers are partially reimbursed for approved employee training programs by drawing against their payroll levies (as in Malaysia, Nigeria, and the Netherlands). Levy exemption schemes. Employers are made exempt from tax payments if they spend a given percentage o f their payroll on training (as in France, the Republic o f Korea, and Morocco). 0 Tax incentives. Tax incentives are given to approved employer training programs that are financed with general government revenues (as in Chile and previously in Malaysia). 86 0 Entitlement schemes. Employees are entitled over their lifetime to govemment funds (usually vouchers or loans) for additional training to be spent as they determine (as in Austria, Kenya, Paraguay, and the United Kingdom). Individual learning accounts. Individual learning accounts provide individuals with discretionary training funds partially financed by the state, employers, and employees (as in the Netherlands, Spain, and previously in the United Kingdom). These schemes have been used with success in both industrial and developing countries. For example, Brazil has a system o f national training organizations that receive their funding from the general payroll taxes paid by companies. The transfer is equivalent to roughly 2.9 percent o f a company’s wage bill. In turn, these organizations run training centers that offer specialized courses and sponsor apprentice programs with participating firms using a cost- sharing structure. Since 1970 France has required enterprises with more than ten employees to earmark 1.5 percent o f their payroll and reinvest it in on-the-job training-either by offering internal programs or by contracting out to third-party organizations. The program is considered extremely responsive to the changing needs o f the labor market because employers can choose the employees and type o f training to be undertaken. Apart from these incentive programs, some countries use grant matching schemes to increase the level o f training o f their workers. Programs in Chile and Mauritius rely on the private sector to administer such initiatives and have reaped positive results. I n Mexico govemment policies to increase company investments in employee training have been correlated with a reduction in enterprise failures. As a result, grant matching programs have supported the development o f a training culture in Mexico by providing an incentive and a means for enterprises to invest in employee training. A similar phenomenon has been noted in Asia. For example, most Japanese company managers, as part o f their responsibilities, must teach training seminars and regularly engage workers in informal training. I n the Republic o f Korea, the Basic L a w for Vocational Training has promoted a strong culture o f in-company training. Northern European countries (for example, Germany, the Netherlands, and Scandinavia) as well as countries in Latin America (for example, Brazil and Chile) have also established training programs that rely o n private sector participation. . A grant-matching scheme alone will not necessarily lead to an expansion o f the market for employee training services. One impediment arises when grants are restricted to state-run training institutions because the private sector will lack the incentives to provide similar services or augment existing services. Particularly important i s the way funding for training programs i s spent. Funds should support activities that strengthen and diversify the supply o f training to stimulate market demand for these services. The Mexican government has managed to promote these goals with its Integral Quality and Modernization Program (Programa Calidad Integral y Modernizacibn, CIMO). To improve the productivity o f employees at small enterprises, the program hires private training consultants. Funding o f the program is split between govemment and private training institutions (see B o x 4.3). Because o f the nature o f vocational education in Mexico and other Latin American countries, training programs outside the workplace have been uncommon. Students enter vocational institutes at an early age (secondary school) and begin a course o f study that emphasizes 87 specific j o b skills rather than skills that will develop the faculties for higher order learning. As a result, tertiary level learning and specific skills training rarely have been combined outside the workplace and are still treated as mutually exclusive forces in secondary education. This disconnect partially explains the inadequacy o f training in Mexico. Only one-tenth o f the economically active population in Mexico receives any kind o f regular training. Unless a major shift in education policy occurs, laborers cannot expect to keep up with technological advances and will not be able to succeed against s t i f f international competition. While basic education marks an important starting point for worker training, the skills and knowledge o f Mexico’s labor force must move beyond this level if lifelong learning is to occur. Moreover, as examples from Sub-Saharan Africa show, even the learning o f basic skills i s impeded when the work force targeted for such training i s not literate or lacks a primary.school education (Oxenham et al. 2002). Box 4.3. Mexico’s Proactive Approach to Supporting Small and Medium-Size Enterprises T h e Integral Quality and Modernization Program (Programa Calidad Integral y Modernizacidn), or CIMO, has proven effective in reaching small and medium-size enterprises (SMEs) i n Mexico since i t was established in 1988. Under the direction o f the secretary o f labor, the program helps SMEs upgrade workers’ skills, improve the quality o f production, and raise overall productivity. The program was set up initially as a pilot project to provide subsidized training to small and medium-size enterprises but quickly expanded in focus when it became apparent that the lack o f training was only one o f many factors contributing to l o w productivity. By 2000, CIMO was providing an integrated package o f training and industrial extension services to over 80,000 SMEs annually and involving 200,000 employees from different sectors and companies. Since then, private sector interest has grown in the program and now more than 300 business associations participate in CIMO, up from 72 in 1988. All states and the Federal District have at least one C I M O unit that i s staffed by three to four administrators. Most units are housed i n the offices o f local business associations. T l u s structure promotes fruitful synergies between companies’ needs and participating C I M O f m . Staff members organize workshops o n training and technical assistance services, identify potential training consultants at the local and regional levels, and actively seek out SMEs for collaborative endeavors. CIMOs work with interested small and medium-size enterprises through a cost-sharing program that provides training assistance and an initial diagnostic evaluation o f the participating fm n two directions. First it i s assisting groups o f . Currently, C I M O i s expanding i t s support i SMEs with specific sectoral needs. Second, it i s providing an integrated package o f services including information o n new technologies, production processes, internationally accepted quality control techniques, and marketing strategies. Evaluation studies in 1995 and 1997 found CIMOs to be a cost-effective method for assisting small and medium- size enterprises. Over a period o f three years, the studies tracked two groups o f SMEs: one with f m that participated in C I M O in 1991 or 1992, and another with a broadly comparable control group o f enterprises that had not participated. C I M O firms tended to have lower performance indicators than nonparticipating f m ,but, by 1993, labor productivity had either caught up or exceeded that o f the control group. Other performance indicators showed similar improvements. For example, a company’s participation in the program increased i t s profitability, sales, capacity utilization rates, and wage and employment growth; participation reduced the f m ’ s labor turnover, absenteeism, and product rejection rates. Source: World Bank (2003a). Cornbating Illiteracy As i t attempts to teach its citizens lifelong learning skills, Mexico must resolve one key issue: the great number illiterate and uneducated adults, or its rezugo educutivo. More than 36 million Mexicans over the age o f 15 are illiterate, have dropped out o f primary school, or 88 have not completed their secondary education. O f the total adults that fall into the rezago educativo in Mexico, roughly 6.6 million are illiterate, 11 m i l l i o n are literate but have not completed primary school, and another 18 million have not finished their secondary education. Despite Mexico’s deepened integration with NAFTA and the global economy during the 1990s, the number o f out-of-school adults actually rose, calling into question the ability o f the country’s economic advances to overcome chronic failings o f the education system. With more than 55 percent o f Mexicans over the age o f 15 falling within the rezago, aggressive policy strategies must b e directed at encouraging enrollment in continuing education programs and in skills training programs for adult students who are balancing work and study. The persistence o f the rezago i s a reminder that educational reform has yet to h l l y benefit large swaths o f the lowest income quintiles and most marginalized segments o f the population. The majority o f Mexico’s illiterate and poorly educated adults can be found in the states o f Chiapas, Oaxaca, Guerrero, Hidalgo, Veracruz, Puebla, and Michoacan. Children in these states leave school out o f economic necessity to support their families. In rural areas, most adults classified within the rezago are from economically poor indigenous communities that rarely have benefited from improvements in the education system and continue to face a fbture o f extreme poverty. Most o f this subgroup i s over forty-five years o f age and female, creating overlapping problems o f gender, age, and ethnicity biases that corrective education policies must address. In urban centers, the socioeconomic profile i s slightly different. Adults are literate but have not completed their secondary education. They range between the ages o f fifteen and forty-five and surprisingly maintain jobs in the formal economy. Reducing the number o f adults that find themselves among this rezago will be critical if Mexico aspires to effectively compete in the global knowledge economy. Policy interventions will have to be targeted at dealing with the rezago by focusing upon Mexican workers who are literate but have not yet completed their secondary education. Nevertheless, the financial feasibility o f increasing resources dedicated to addressing this problem i s doubtful. I n spite o f the increasing number o f Mexicans falling into the rezago, government spending shrunk during the past decade, declining 3.2 percent annually in real terms as a share o f total public education expenditure. Given this budgetary reality, innovative methods will be needed to combat the country’s out-of-school population without raising government spending. For example, if the number o f yearly certificates granted by the National Institute for Adult Education (Instituto Nacional para la Educacidn de 10s Adultos) was doubled, the rezago population would arrest its increase. The program, administered by Secretaria de Educacidn Publica, SEP, provides Mexicans over the age o f fifteen with the chance to learn basic literacy skills and to finish their education (primary or secondary). I t also has a component for indigenous students, who are between the ages o f ten and fourteen and have left school, to continue their education in their native tongue. The government i s currently piloting a promising initiative called Community Plazas (Plaza Comunitarias), or PCs. Administered through the National Commission for Lifelong Learning and Training (CONEVYT) the program uses a competency-based curriculum, multimedia equipment (educational satellites, video, and internet), didactic materials, and tutors to help adults who want to learn h o w to read and write 89 or would like to complete their education to the primary and secondary levels. President Fox has set the ambitious target o f establishing 20,000 PCs from the current 600 by the time he leaves office in December 2006. Mexico’ s Policy Agenda in Education The key for Mexico’s education system lies in assisting policy innovations at the local level to expand their reach for a nationwide reform. President Fox and his predecessors have attained quantitative and qualitative advances that can provide the base for building an equitable education system that gives all students the lifelong learning skills essential to compete in the global knowledge economy. But further reforms will require all stakeholders-teacher unions, university faculty, students, and leaders in the private sector- to participate in locally driven strategies to best leverage expenditures for the delivery o f quality and accessible educational services in Mexico. I n this sense, reforming Mexico’s education system is less about increasing government spending than about changing institutional practices. Given the level o f current educational expenditures, Mexico should be achieving better results for its students in both qualitative and quantitative terms. As a share o f its gross domestic product, Mexico spends nearly as much o n education (4.42 percent) as Australia (4.49 percent), Germany (4.64 percent), Italy (4.55 percent), and the United Kingdom (4.47 percent), but these OECD countries produce students with more average years o f schooling, higher literacy, and lower rates o f r e p e t i t i ~ n . ~ More strikingly, Mexico dedicates a larger share o f national income to educational expenditures than the Republic o f Korea (3.75 percent), a country with a highly educated labor force considered able to compete in the global knowledge economy. Based on principles o f lifelong learning, a reformed education system would incorporate successful new approaches and pilots in pedagogy into an integrated system o f lifelong learning at the national level. I t would also tap private sources to finance the expansion and improvement o f educational opportunities. By providing multiple pathways to learning, Mexico will enable its people to learn continuously through life. Its subsystem o f tertiary education would have multiple qualified service providers and sources o f financing. In the medium tern, actions should focus on three major areas: increasing coverage and quality in basic and secondary education; expanding access to higher education; and accelerating the transition to lifelong learning. Basic and Secondary Education A minimum standard o f achievement in basic and secondary schools must be ensured and access to upper secondary and vocational education expanded. Through promising programs such as the Escuelas de Calidad program, Mexico can improve the years in school and skills o f its labor force. Strengthening incentives to expand enterprise training and to enrich adult education, particularly at the secondary level, will reduce the undereducated adult population. 3 Numbers are calculated according to expenditure levels in 1999, See httD://wwwl .worldbank.ora/education/edstats/. 90 The government, schools, and communities should work together to make sure that students have proper facilities (for example, science and computer labs, internet access, libraries) and good instructional materials. If a rich learning environment i s to be constructed for all students in Mexico’s primary and secondary schools, teachers must be given reward incentives to improve their teaching methods, their punctuality, and their absentee rates. The quality o f the country’s education system and access to i t also can be improved by instituting 0 School-based and locally --devised techniques to assist students at risk, trim dropout rates, and ensure a more fruitful relationship between students and teachers; 0 Incentives that can increase the quality o f teaching and learning at schools such as linking funding with educational outputs and offering parents vouchers to send their children to the local school they choose; 0 Evaluations to assess the quality o f learning and use o f the results to assist communities, schools, and policy makers in decisions on education; 0 Adult education programs to diminish the weight o n Mexico and the economy from i t s rezago population by expanding and enriching learning opportunities with content and skills relevant for the knowledge economy. Higher Education To expand access to higher education, a dramatic change i s required in how the government finances its universities, given the high per student spending at this level and the regressive and distributional effects that this policy has had o n the entire education system. Students who can afford to pay higher tuition fees should do so, thus enabling schools to increase their support for those coming from lower socioeconomic levels. Wider and more equal access to higher education in Mexico also could be promoted through the creation o f a state-supported market for student loans. Rather than being the sole lender, the government could implement a cost-sharing scheme that provides loan guarantees for students and their families who are unable to borrow under normal market conditions. As a result, the following actions to reform Mexico’s tertiary institutions are recommended: 0 Rely much more on private financing o f higher education. Scholarship programs, such as the Programa Nacional de Becas para la Educacibn Superior (Pronabes), will never resolve the problem if more attention i s not devoted to the creation of a local market for student loans. Income-contingent loan schemes4 should be emphasized as a way o f financing o f higher education. 0 Strengthen university-industry collaboration. University-industry linkages through competitive funds can ensure that students have a more productive entry into the j o b market and give universities access to new sources o f financing by providing a channel to sell their services and knowledge (that is, administrative and research capabilities) to the private sector. 91 0 Introduce flexible and part-time higher education programs that encourage students to leave or re-enter the system as needed. University laws should allow students who have l e f t the system to reinitiate their studies without costly make-up sessions. 0 Evaluate and scale up initiatives at the state and national levels that grant greater autonomy to tertiary schools in managerial, financial, and pedagogical matters. Without this change, university structures will not be sufficiently responsive to the ever-evolving needs o f industry and the economy. Lifelong Learning To accelerate Mexico’s transition to life-long learning, distance education models and pedagogy pilots at the local level should be diversified. Many promising initiatives in this area must be evaluated in order to scale up and spread local innovations. As a next step, we recommend bringing key stakeholders together to design the architecture o f an integrated system o f lifelong learning. Standards must b e developed concerning certification, accreditation, testing, and evaluation, as well as recognition o f prior learning . First, there needs to be standardized mechanisms that accredit prior learning and vocational qualifications that can be applied toward an adult student’s educational advancement. Second, vocational counseling and information on career paths and earning streams must be put in place to reduce the opportunity cost and perceived barriers o f adult students wanting to advance their learning later in life. In Mexico, C O N E V Y T can facilitate this process by certifying the quality o f different public and private providers and offering funding resources for returning students. Other specific changes should include An overhaul o f the curriculum and institutional models that are used in adult education. The design o f learning systems must capture the demands o f the labor market and students for targeted and relevant educational services. 0 Creation o f a transparent system that can retrain workers for re-entry into a changing marketplace. Various government agencies, the private sector, and workers must come together to design a retraining and certification system that accredits workers based on their skills and competencies. Introduction o f clear regulations and accreditation procedures for long distance learning programs. To lend value to such services in rural communities, the government must create regulations that accurately evaluate the educational outputs o f new learning initiatives involving information and communication technology (ICT). 0 Creation o f a coherent and nationwide quality assurance system in Mexico. This feedback mechanism will serve as the conduit for providing adequate and timely information to firms, workers, and governments about the quality o f educational services and outputs. Such a system i s essential if the country hopes to tailor the learning skills o f its population to the demands o f the global knowledge economy. Undertaking Reform o f Mexico’s Education System Going forward, Mexico’s second-generation o f educational reforms must reallocate current spending to make i t more demand driven and results-oriented to ensure students gain the 92 skills required for lifelong learning. Yet a reform strategy that promotes a shift in institutional practices inevitably encounters barriers. Mexico’s education system, like any bureaucratic structure, has tended to be resistant to dramatic change. This resistance to reform at the national level suggests that it i s more advantageous to incorporate stakeholders in bottom-up, incremental policy interventions. By working along the margins o f reform with key players, it i s possible to sideline vested interests and make them a part o f the solution rather than the source o f the problem. International experience shows that the best cases o f educational reform have been largely a local affair scaled up to the national level. The school, rather than a government’s education ministry or municipal secretariat, has been the center o f change and the forum for stakeholders’ dialogue. T o improve the quality o f learning programs, schools must assume a more active role in fomenting bottom-up change and garnering support for their strategies at all political levels. A country’s education ministry must avoid the pitfall o f blocking reforms and learn how to empower local schools to identify their needs and solidify solutions for them. Such a decentralized structure o f reform cannot be based o n a pre-conceived blueprint. I t i s a learning process. Competent supervision and monitoring at the national level are needed to foster changes by local schools and their staff. The k e y for success i s to focus o n classroom and school dynamics; teachers and students alike must be viewed as learners and community members as strategic partners. As the passage o f tuition fees at the University o f Sonora showed, parent and community participation can improve outcomes and lead to a commitment to policy reforms long after a political administration leaves power. This civil society involvement is particularly essential in rural areas, given the relatively high opportunity cost associated with a household’s schooling o f its children. In practice, effective participation means assigning a real and lasting role for parents in education decision making at the local level. I t i s essential that education inputs meet community interests. Committed champions in Mexico have initiated local changes by building coalitions with key stakeholders. One example i s the decision to impose tuition fees during the 1990s at Mexico’s historically free universities. This decision produced uniquely different results based on how the measure was executed at the local level (see B o x 4.4). In this sense, the central issue i s h o w to scale up successful local outcomes so they can b e replicated at the national level. 93 Box 4.4. Achieving Change at the Margin: Charging Tuition Fees at Mexican Universities Until the country’s educational reforms in the 199Os, the Mexican Constitution provided for free public education at all levels. State-run universities and tertiary institutions were known as bastions o f heavy government support, despite the distorted share o f funding dedicated to Mexican students at this level compared to funding o f students in primary and secondary schools. A large share o f university students came from high-income backgrounds; they entered Mexico’s low-cost, high- quality public universities after graduating from private secondary schools. Nevertheless, university students fiercely resisted any form o f cost sharing. When the National Autonomous University o f Mexico (UNAM)tried to impose a tuition hike in 1999, many o f i t s 270,000 students boycotted classes. The walkout was supported by the faculty. Classes at Mexico’s largest university were suspended for nearly a year in response to the rector’s call for a US$lOO increase in fees from the eight dollars students were paying annually to study. The University o f Sonora in northern Mexico, however, had a strilungly different experience. It succeeded in passing tuition fees because o f the skillful way the administration carried out the policy change. The university introduced a new cost-sharing scheme in 1993 by explaining to staff and students that without supplementary resources the school’s reputation for quality teaching and learning would be endangered. Instead o f arbitrarily imposing the fees, the school’s rector slowly built consensus and heard the community’s concerns. After initial resistance, including a widely publicized 2,000-hlometer march by protesters from Hermosillo to Mexico City, students accepted the administration’s decision as a way to give the school an injection o f fresh funds. The university set up a participatory process to determine how these resources would be allocated and promised that new spending would be directed at initiatives to improve equity and quality at the school. Since 1994, every student has been paying about US$300 in fees to support such programming. A joint student-faculty committee administers the funds, which are used to provide scholarships for low- income students, refurbish classrooms, modernize computer labs, and purchase textbooks and journals. All spending decisions are extremely transparent and posted at the beginning o f the academic year so students know exactly how their fees were spent. Source: World Bank (2002). Bottom-up pressures are also important forces f o r reform, particularly in r e f o r m i n g the dominant position o f the national teachers’ union in Mexico, the Sindicato Nacional de Trubajudores de la Educacidn (SNTE). A k e y player in Mexico’s education system, the SNTE has almost 1.5 m i l l i o n members and i s the largest trade u n i o n in Latin America. Since 1992 the SNTE has bilaterally negotiated national issues with the federal government and local matters with each state government. During this period there have been instances o f successful collaboration w h e n improving the education system was the c o m m o n goal f o r b o t h state authorities and u n i o n leaders. A s long as the dialogue between t h e government and SNTE has remained respectful, educational problems usually have been resolved and qualitative reforms reaped locally. W h i l e these local initiatives are an important starting point, they m u s t b e supported at the national level. As M e x i c o evaluates i t s competitive edge and readiness to enter the global knowledge economy, the retooling o f i t s education system through incremental changes will increasingly become the means to achieving m o r e structural, substantive, and s t i l l delayed educational reforms. As Figure 4.6 indicates, the three most important forces o f change are market pressures, government regulations and incentives, and partnerships between the p u b l i c and private sectors to resolve particular problems on a case-by-case basis. A l o n g the 94 margin where all these forces overlap, institutional autonomy i s produced and supported by the improved practices, funding, and information that underlie the education system. Figure 4.6 Forces for Change in Reforming Education Regulations and Incentive Licensing Civil service rules Financial and budgetary Competitive assurance Participation Partnerships Demand and Demonstration Market Stakeholder consultations Competitive delivery of Cases education programs by Boards of trustees - Linkages with industry a variety of providers Global labor market Source: Adapted from the World Bank (2000a). 95 Chapter 5 Updating the ICT Infrastructure in Mexico Mexico’s information and communications technologies (ICT) sector has grown substantially during the past decade. The telecommunications component o f the sector has grown at a rate that is four times faster than the economy as a whole. In 2004, the GDP indicator for the telecommunications sector grew 22.6 percent, compared to a national GDP growth rate o f 4.4 percent. This growth rate can be attributed to a variety o f factors, including an ambitious e- development program. Launched by President Vicente Fox on his inauguration day, e-Mexico has won numerous international awards for e-government initiatives. Despite the achievements o f e-Mexico and associated programs, many important challenges remain- most notably the unfinished agenda o f establishing a better regulatory framework and more effective and up-to- date institutions to address interconnection, pricing, universal access, and the dominance o f the telecommunications market by Telmex. Despite these challenges, a second wave o f I C T investors i s beginning to make tentative forays into Mexico’s I C T sector, attracted by the large unmet domestic demand, strong linkages to the U.S. market, and the opportunity to purchase discounted assets o f the financially troubled I C T companies that first challenged Telmex during the late 1990s. According to the World Economic Forum, Mexico ranked 44th out o f 102 countries in the 2003-2004 Network Readiness Index (NRI), as can be seen in Figure 5.1.’ This index is a widely recognized measures o f a country’s performance with regard to I C T readiness and usage. Among Latin American countries, Mexico i s ranked third from the top, after Brazil (30th) and Chile (32nd). The NRI is a composite index comprised o f several subindices. Mexico’s l o w ranking o n the Market Environment Subindex’ and the Political and Regulatory Subindex3 highlight the progress the country still needs to make in using I C T to transform itself into a knowledge e ~ o n o m y . ~ *The Network Readiness Index (NRI) i s defined as “the degree o f preparation o f a nation or community to participate in and benefit from I C T developments.” The NRI not only provides a model for evaluating a country’s relative development and use o f ICT, but it also allows for a better understanding o f a nation’s strengths and weaknesses with respect to ICT. The Market Environment Subindex assesses “the presence o f the appropriate human resources and ancillary businesses t o support a knowledge-based society. The forces that p l a y a n important role in determining the market environment for ICT are varied and include fundamental macroeconomic variables like GDP and impodexport, commercial measures l i k e availability o f funding and skilled labor, and the level o f development o f the corporate environment. ” 3 The Political and Regulatory Subindex measures “the impact o f a nation’s polity, laws, and regulations, and their implementation, o n the development and use o f ICT.” 4 As the source for information in this paragraph, see Dutta, Lanvin, and Paua (2004). The website for the W o r l d Economic Forum i s www.weforum.org. 96 Figure 5.1 Network Readiness Index, 2003-2004 100 I 9 0 1 80 70 60 50 40 30 20 10 0 On the Market Environment Subindex, Mexico ranked 55‘h, the second lowest rank (after Turkey with a rank o f 57) among OECD countries. The Republic o f Korea (19), Japan (7), United States (2), and Singapore (1) had much higher standards. In Latin America, Mexico ranked lower than Chile (3 l),Brazil (34), and Costa Rica (42). Similarly, o n the Political and Regulatory Environment Subindex, Mexico ranked low. I t was 59‘h, the second lowest ranking among OECD countries, only ahead o f Turkey (73). Among Latin American countries, Mexico ranked lower than Chile (18)’ El Salvador (40), Brazil (43)’ Dominican Republic (49, Trinidad and Tobago (47), Jamaica (50), Uruguay (53), and Costa Rica (57) o n the Political and Regulatory Subindex. Clearly, Mexico needs to address these political and regulatory environment issues if it hopes to develop an attractive and competitive I C T market. Three primary variables shape the development o f a knowledge economy: access to I C T infrastructure, innovation, and competition. This chapter describes notable trends in Mexico’s I C T market with respect to these variables. I t then assesses govemrnent and private sector initiatives to strengthen the country’s information and communication technologies. Recommendations are presented at the conclusion o f the chapter. ICT Performance in Mexico In this section we examine trends in I C T spending, I C T prices, and in the use o f the Internet, fixed line and mobile telephones; fiber optic networks; cable TV; and international long distance service. The dominance o f the incumbent Telmex i s also examined. 97 ICT Expenditure In the past decade, Mexico’s I C T market gradually opened up to competition and foreign investment. According to the telecommunications regulatory agency (Comisih Federal de Telecomunicaciones or COFETEL), from 1999 to 2003, more than US$20 billion were invested in the telecommunications sector alone. In 2003, a time o f significant contraction in the global telecommunications industry, investment in the Mexican telecommunications sector represented around US$2.3 billion. Figure 5.2 Benchmarking Mexico’s ICT Performance GIo ba I View: Information Irifrastructure IC Q 8 SI ouakia 1 7 c e c QI 0 2 5 c v) 0 1 E 4 3 2 I 0 I I I I I I I I I 1 2 3 4 5 6 7 8 Q 1995 98 Telephones per 1,000 people ICT Expendture as % of G in Telephone Lines per I000 People E-Government Service obile Phone per f ,000 People International Telecommunications, Cost of Call Computers per I,000 people Internet users per 10,000 people TV Sets per 1,000 People Internet Hosts per Daily Newspapers per 1,000 People Source: World Bank (2006). Despite the impressive growth in absolute levels o f investment, Mexico’s I C T performance, when benchmarked against other countries, leaves considerable room for improvement (see Figure 5.2). Spending o n ICT in Mexico as a share o f GDP appears much less remarkable when those expenditures are compared to I C T spending in countries with similar GDP. As Figure 5.3 illustrates, Mexico’s level of I C T expenditure (3.1 percent) i s significantly below OECD countries such as Japan (7.4 percent), the United States (8.8 percent), or N e w Zealand (10 percent). I t is also nearly h a l f that o f Chile and Brazil’s rates o f 6.7 percent and 6.9 percent respectively and lower than the rates of Argentina, Peru, and China at 5.7 percent, 6.9 percent, and China 8.4 percent respectively. As a growing number o f studies have found, countries with higher levels of investment in I C T experience higher economic and social development growth (OECD 2004). Therefore, i t i s imperative for Mexico to pursue a more aggressive agenda with respect to investment in this important sector. 99 Figure 5.3. ICT investments as a share of GDP 2003 12.0 y =9E-05~f 5.3607 R2= 0.1935 Singapore 10.0 n h + USA -0 on 8.0 6 i 3 6.0 k e, F 4.0 *+ +Mexico 2.0 0.0 0.0 5000.0 10000.0 15000.0 20000.0 25000.0 30000.0 35000.0 40000.1 GDP per capita PPP Source: World Bank, S I M A database, 2005. Penetration and Digital Divide Between 1998 and 2004, the number o f fixed lines in Mexico almost doubled from 9.9 million lines to more than 18.1 million, with an average annual growth rate o f around 10 percent and a fixed line penetration rate o f 17.1 telephones per 100 people in 2004. Although this growth has been significant, it is substantially below the rates found in other OECD countries (see Table 5.1) Although in 1991 Mexico, Brazil, and Chile had comparable fixed telephone penetration levels, during the following decade, Mexico’s growth levels were significantly lower than those o f Brazil, Chile, and other OECD countries. [Table 5.1 near here] With respect to I C T use as reflected in the number o f Internet users per 100 inhabitants, Mexico’s growth rate was lower than that o f Chile and the Republic o f Korea. From 1998 to 2003, Mexico increased the number o f Internet users per 100 inhabitants nearly tenfold (from 1.3 users to 12 users), while Chile’s usage grew more than 15 times, from 1.7 to 27.2 Internet users per 100 inhabitants (see Figure 5.4). In Korea, the number o f Internet users per 100 inhabitants increased from 6.8 users per 100 people in 1998 to 61 percent o f the population by 2003. 100 Figure 5.4 Internet Users per 100 Inhabitants, Mexico, Chile, and the Republic o f Korea, 1998-2003 60.0 - 50.0 - 40.0 - 30.0 - 27.2 20.0 - 10.0 - 0. I 1998 1999 200 2001 2002 2003 Source: World Bank, SIMA database, International Telecommunications Union (ITU), 2005. Similarly, initiatives aimed at increasing Internet penetration in Mexico must also be linked to efforts to increase Mexico’s l o w level o f personal computer penetration. Mexico has far fewer personal computers per 100 inhabitants than Chile (11.9 PCs per 100 inhabitants) or Costa Rica (almost 20 PCs per 100 inhabitants). The Republic o f Korea, Singapore, and the United States have much higher penetration rates, with more than 50 PCs per 100 inhabitants. Indeed, on a wide range o f I C T indicators, Mexico lags behind other OECD countries (see Table 5.1). 101 Table 5.1 ICT Indicators, 2003 Internet users Cellular Main lines Total telephone per 100 per loo subscribers per per 100 subscribers per 100 Country in habitants inhabitants 100 inhabitants inhabitants inhabitants Argentina 11.2 8.2 17.8 21.9 39.6 Brazil 8.2 7.5 26.4 22.3 48.6 Chile 27.2 11.9 51.1 22.1 73.2 China 6.3 2.8 21.5 20.9 42.4 Costa Rica 28.8 19.7 18.1 27.8 45.9 Ecuador 4.6 3.1 18.9 12.2 31.2 Ireland 31.7 42.1 88.0 49.1 137.1 India 1.7 0.72 2.4 4.6 7.1 Israel 30.1 24.3 96.1 45.8 141.9 Japan 48.3 38.2 67.9 47.2 115.1 Korea, Rep. of 61.0 55.8 70.1 53.8 123.9 Malaysia 34.4 16.7 44.2 18.2 62.4 Mexico 12.0 8.2 29.5 16.0 45.4 Peru 10.4 4.3 10.6 6.7 17.3 United States 55.6 65.9 54.6 62.4 116.9 Source: World Bank, SIMA database, International Telecommunications Union (ITU), 2005. The digital divide within M e x i c o i s another major challenge. As in Figure 5.5 illustrates, the major cities have m u c h higher penetration levels for m a i n line telephones than the rest o f the country The Federal District has nearly 35.4 m a i n lines per 100 people; southern states have far fewer lines: Chiapas (3.9 m a i n lines per 100 inhabitants), Oaxaca (4.7 m a i n lines per 100 inhabitants), and Guerrero (7.6 m a i n lines per 100 inhabitants). N o t only do large numbers o f Mexicans lack access t o critical I C T infrastructure; the cost o f accessing this infrastructure i s m u c h higher for inhabitants o f the poorer regions. 102 Figure 5.5 Regional Distribution o f Main Lines per 100 Inhabitants and GDP per Capita, 2004 36 1 D~ Federal NUWO L d n 04 0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 Source: COFETEL. presentation at Regulatel meeting "Reuni6n de "Corresponsales" y de coordinadores de AU de cada uno de 10s 19 miembros de Regulatel," Peru, Januuary 2005. Mobile, Data, and Cable TV Mexico's mobile sector has grown at an explosive annual rate o f nearly 100 percent since the mid-1990s. Compared to other Latin American and OECD countries, however, cellular penetration levels in Mexico are still l o w (see Table 5.1). Growth was driven by the speed and efficiency with which the government allocated spectrum from 1996 to 1998; competition; the introduction o f calling-party-pays policy by the regulator in 1997 and 1998; and the widespread adoption o f pre-paid calling cards. Penetration o f wireless services was greatest in areas where fixed services had not expanded, including low-income areas. The major challenges facing the sector are the declining average revenue per user (ARPU), which i s mainly attributable to the popularity o f pre-paid calling plans; quality o f service and consumer complaints; industry consolidation; creation o f incentives to provide Internet services using wireless technologies; and extending service to rural and low-income areas. Mexico's high-speed fiber optic networks that carry the traffic for telecommunications and I C T service also have grown dramatically since the sector opened to competition in 1996. In 1993, Mexico had about 15,000 kilometers (Km) o f fiber optic networks operated by Telmex; in 2003, i t had about 112,000 Km o f fiber optic networks operated by at least six different companies. Another aspect o f broadband access infrastructure in many countries i s cable and paid television. The number o f paid television subscribers in Mexico grew from 18.1 subscribers per 103 1,000 inhabitants in 1996 to around 43.8 subscribers per 1,000 inhabitants by the end o f 2004 (see Figure 5.6). Figure 5.6 Paid TV Subscribers per 1,000 Inhabitants in Mexico, 2004 42.9 43m8 Source: COFETEL website, http://www.cft.gob.nw’ivb2/COFETEL/COFE Estadisticas de telecomunicaciones 2 Last accessed April, In 2003, several dozen cable television companies, out o f 7 13 paid television concession holders, applied for a concession to provide data and telephone service over their cable networks. Approximately twenty companies have been granted authority to carry data.5 However, to date, no cable television company has been granted a concession to provide voice services; neither has Telmex been granted a license to deliver cable services. The Comisi6n Federal de Telecomunicaciones (COFETEL) and Secretaria de Comunicaciones y Transportes (SCT) have not granted any such licenses. Allowing entry into voice telephony by cable companies would increase pressure o n COFETEL to allow Telmex to similarly enter the cable TV sector. As can be seen in Table 5.2, more than 60 percent o f Mexican consumers who have high- speed access to the Internet do so through cable networks, and cable television companies have more than 70 percent share o f the total paid television market. Telmex, which dominated fixed line and mobile networks, does not compete in the paid television market, although it has successfully gained a significant and growing broadband market share through its asymmetric digital subscriber line (ADSL) services. Interview with COFETEL authorities. 104 2001-2006 Dominance of the Incumbent Telmex clearly dominates the long distance, local, and cellular telecommunications markets (see Table 5.3). I t provides service to more than h a l f o f all dial-up Internet accounts and more than a third o f high-speed Internet access accounts. Its share o f high-speed Internet accounts increased significantly during 2002. ~ ~~~ Table 5.3 Telmex Market Shares M a r k e t sector M a r k e t share Sector Market share Int. long distance (2003) 61.3% Internet access: 56-kbps dial-up (2002) 51% Cellular (2005) 75% Internet access: 128 kbps and above 37% (ADSL, cable TV, etc) (2002) Telmex’s market share in the international sector in 2003 was about 66.6 percent- often cited as an argument that Telmex i s too dominant. As Mexican authorities have pointed out, Telmex’s market share after five years o f competition is comparable to the five-year benchmark o f other countries (see Figure 5.8). Indeed, a recent survey o f eighteen countries found that the average five-year incumbent market share benchmark is 64.5 percent. What is remarkable about Telmex i s not that it is dominant in one market segment, but that it has retained, and in some cases increased, its market power in a number o f sectors, causing ripple effects on access, innovation, and prices. 105 Figure 5.7 Incumbent Market Share after Five Years of Competition USA 183.3 Phillipines ‘9 Dom Rep Korea Mexico Average Australia Malaysia Denmark Israel Chile-1 47.3 0 20 40 60 80 100 7te: The average i s based o n data from eighteen countries that report market share informat n for markets opened for at least five years. Source: Telegeography (2005). Telmex’s net profit margin and earnings per share from continuing operations i s more than twice that o f i t s closest rival (see Table 5.4). Telmex i s also far ahead in operating income as a share o f revenues compared to other U.S. and British companies. This data indicates that, if anything, the gap in telecommunications services between Mexico and developed countries i s widening. 106 I Table 5.4 Financial Performance of Telecommunications Companies, December 2004 Argentina I TeleNorte, I $73.4 1 37,690 I $4,833.8 I $128 1.5% I $0.19 Brazil (2003) [ Source: Hoovers Inc. Detailed Annual Reports. All based on December 2004 reports. See Iittp:!!www.hoovers.com, last accessed April 2005. * 2003 Prices Prices are a critical indicator o f the success o f telecommunications and I C T policies. What follows is an overview o f the prices o f k e y telecommunications and I C T infrastructure in Mexico. Table 5.5 Telephone Tariffs in Mexico, 1995-2003 Tariff ($) Connection charge Business line Residential line Monthly subscription fee Business line Residential line Local call (3 minutes. USD) Source: World Bank, SIMA database, International Telecommunications Union (ITU) 2005. The basic installation fee for residential users has fallen dramatically, as have business installation charges. In 2003, the basic monthly tariff was about $14.5 for residences and $18.3 for businesses, and the local calling charge was about 14 cents for each call. Prices in Mexico are much higher than in similar countries (see Table 5.6). All calls originating in the public network in Mexico are subject to the basic 14 cents calling fee; in most Latin American countries, however, telephone charges are based on usage, and in the United States local calls are covered by the monthly recumng charge. Businesses in Mexico pay the basic 14 cents calling fee, but residents pay only 107 for calls exceeding 100 per month. Telmex reports that approximately half o f the residential customers make fewer than 100 calls per month. Even so, these charges are much higher than during the period o f state-ownership. Table 5.6 Local Prices for Telephone Services in M e x i c o and O t h e r OECD Countries, 2003 Business telephone Residential monthly Residential telephone Cost of three minute monthly subscription telephone connection charge local call (US$) Country (US$) subscription (US$) (US$) Mexico 18.35 14.51 104.73 0.14 Argentina 12.94 4.56 5 1.72 0.02 Chile 9.20 9.20 43.95 0.10 Brazil 13.71 7.72 13.81 0.05 Rep. o f Korea 4.36 4.36 50.35 0.03 United States 42.40 24.75 40.76 0.00 El Salvador 1.62 0.95 6.86 0.01 Source: World Bank SIMA database, International Telecommunications Union (ITU), 2005. Calling charges from a wire-line telephone are 14 cents plus 26 cents per minute, but from mobile to wire-line they are about 23 cents per minute. The difference in these charges arises from access and interconnection charges, as explained below. Although domestic long-distance and international calling rates have fallen dramatically, they are s t i l l high (14 cents plus an additional 20 cents per minute for domestic long-distance). Outgoing international calling charges are 14 cents plus an average o f 50 cents per minute. Incoming international calls typically are priced at the official settlement rate. The OECD estimates that among i t s member countries, Mexico has the second highest international calling prices for businesses and the third highest for residential customers, even though Mexico is one o f the organization’s members with the lowest income.6 Calling prices are strongly influenced by access charges that must be paid to Telmex for the local component o f a call. These charges supposedly differentiate between recovering the cost o f physically interconnecting separate networks (interconnection) and the “contribution” o f various competitive services to recovering the cost o f the local network (access). The tariff (at 3 cents per minute in 2000) i s still substantially above estimates o f the actual costs o f interconnection, including the cost o f terminating or originating a call (at most 1 cent per minute). The interconnection charges apply to each end o f domestic long-distance calls and to one end o f international calls. They also apply to calls between two competing local carriers, except for fixed access carriers, if (i) they offer service in at least 40 percent o f the local market, and (ii) the traffic between the two carriers is not “unbalanced.” If both conditions are met, there i s n o interconnection charge- “bill and keep” then applies to each carrier for all the calls that originate in i t s network. If the local competitor does not satisfy these conditions, the competitor OECD (2003). 108 must pay Telmex the long-distance interconnection fee o f 3 cents per minute for calls that it originates. At the same time, the competitor i s paid only 1 cent per minute for calls that originate in Telmex and terminate in the competitor. Since the local carrier must pay extra to Telmex for interconnection if a call lasts five minutes for local calling, competitors have a strong incentive not to compete for customers who are likely to have a long connect time with Telmex customers, such as customers who use the Internet. For calls from wire-line to mobile telephones, 6.3 cents per minute must be paid to Telmex for billing and interconnection. The price is 40 cents for the first minute (the 14 cents call charge plus 20 cents per minute to the mobile carrier, plus the 6.3 cents per minute) and 26 cents per minute thereafter. The difference between the interconnection charge for mobile phone service compared to other services i s not cost based, and the part that is intended to recover billing costs constitutes double charging. Billing costs are already part o f the costs o f local service that underpin the prices for installation, monthly access, and the 14 cents usage charge per call. Because this interconnection charge i s so high, it strongly discourages the use o f mobile telephones. The price for access to an Internet service provider (ISP) is simply the 14 cents local charge (paid in addition to the monthly fee that the ISP charges for i t s services). Alternatively, a customer can buy Telmex’s bundled service o f a computer, a modem, and its affiliated ISP for a hook-up fee o f about $100, a monthly charge o f about $40, and the same usage charge o f 14 cents per connection. Businesses that generate large amounts o f long-distance and international data traffic, typically lease two types o f data or circuit services-ne to carry the traffic from their offices to the switch o f the long-distance carrier (the local loop) and one for the long-distance portion. The long-distance price in Mexico compares favorably with the long-distance price in other countries; the price o f a local loop in Mexico, however, is much higher than the price in most comparable countries in Latin America (see Table 5.7). The installation or nonmonthly recurring charge for a local loop with E-1 capacity in Mexico i s $19,669, more than twice the price charged by Telmex’s competitors, and more than six times the price charged in Buenos Aires. Similarly, the monthly recurring charge for a Telmex E-1 local loop i s more than t w i c e what a new entrant charges in Mexico City; i t is more than 40 percent more expensive than the monthly recurring charges in Argentina and Brazil and more than four times as expensive as in Chile. 109 Table 5.7 Local Loop Prices for Carriers, 2002: E-1 CAPACITY I Consumers in remote rural areas not directly served by Telmex can make calls through Telecomm, a quasi-private company overseen by the Secretaria de Comunicaciones y Transportes. However, Telecomm i s not a carrier, and it must pay Telmex to transport signals from its hub near Mexico City to the final destination. Telecomm i s not considered a public operator and does not have an interconnection contract with Telmex. Telmex considers Telecomm a “large user.” Telecomm also does not receive the access charges from incoming international calls. As a result, Telecomm’s tariffs to users are high for the remote rural consumer (see Table 5.8). Telmex, in contrast, does not charge for incoming calls. Telecomm has tried without success to establish an agreement with long-distance carriers that would allow it to create a “calling-party-pays” system. Thus, ultimately, people in small (and poor) communities pay more for the same service than people in larger (and richer) communities. Type of call Telmex rate per minute Telecomm rate per minute without VATa without VATb National calls 20 cents 40 cents Calls to USA $1.04 $1.04 Incoming calls __ 20 cents International Long-Distance Service Over the past ten years, international long-distance traffic in Mexico has represented a large amount o f flows especially coming from the United States. This has translated into enormous income for the Mexican operators, especially for the incumbent, Telmex. The government has allowed the Mexican operators to negotiate with U.S. carriers, although they were required until recently to comply with proportional return rules. These rules essentially enabled Telmex, as the dominant Mexico operator, to set the per minute charge (known as the settlement rate) U.S. or foreign operators had to pay Mexican operators; the amount would then 110 be redistributed to Mexico operators according to each operator’s share in the international long- distance market. This permitted a relatively high settlement rate. The heavy incoming traffic (see figure 5.8) put millions o f dollars in the pocket o f the Mexican operators. After years o f controversy over this issue, a dispute resolution case was brought before the World Trade Organization (WTO) in 2004 (see B o x 5.1). This case was the first telecommunications dispute resolved by the WTO. The WTO decided, in summary, that Mexico’s settlement rate and proportional return rules were inconsistent with its WTO commitment and that Mexico needed to put in place new rules for international telecommunications. The WTO agreed, however, that Mexico could continue to prohibit international simple resale. COFETEL is in the process o f modifying its rules and regulations to make them consistent with the WTO decision. Figure 5.8 International Long-Distance Traffic, 1998-2004 (Million I 7000 minutes) 6000 5000 4000 3000 2000 1000 0 I 1998 1999 2000 200 1 2002 2003 2004* *January to September 2004 Source: COFETEL website. See htto:/iwww.cft.~ob.mx/wb2/COFETEL!COFE Estadisticas de telecomunicaciones 2, last accessed Apri1,2005. 111 Box 5.1. Telecommunications and the WTO: The Case of Mexico The fust case o f WTO dispute resolution o n telecommunications services (and, indeed, on services generally) was n 2000 by the United States. In August 2000 i t requested consultations o n Mexico’s obligations and initiated i commitments on basic and value-added services under the General Agreement o n Trade and Services (GATS) Annex o n Telecommunications and the Reference Paper. Successive rounds o f consultations did not resolve the issues raised, and in April 2002 the WTO established a dispute resolution panel to examine the complaint. After meeting several times with U.S. and Mexican government representatives and with ten third-parties having an interest in the case, the panel issued i t s final report to the parties in March 2004. The panel’s decision was not appealed to the W T O Appellate Body. The WTO’s Dispute Settlement Body unanimously approved the panel report in June 2004, and by July 2005 the parties had agreed o n a plan to redress the underlying problems. Mexico had undertaken specific commitments under the GATS Articles XVI (market access), XVII (national treatment), and XVIII (additional commitments, comprising the Reference Paper). With respect to the services at issue, the United States claimed that Mexico had Failed to ensure that TELMEX, the largest operator, interconnects U.S. suppliers on a cross-border basis on cost-oriented, reasonable rates, terms, and conditions. Failed to prevent anticompetitive behavior, as regulations empower TELMEX to lead a cartel that fixes rates for international interconnection and restricts supply. Failed to ensure access by U.S. suppliers to public telecommunications networks inMexico, thus preventing them from providing nonfacilities-based services withm Mexico (through commercial agencies or “comercializadoras”) and simple international resale (through cross-border leased circuits). T h e dispute was largely driven by economic factors. Although Mexico’s international long-distance market had been open to competition since 1997, by 2000 TELMEX’s market share s t i l l exceeded 60 percent and was rising again. n Net international settlements from US. operators to foreign correspondents reached a record lugh o f $2.8 billion i 2002, about 20 percent o f which was paid to Mexican operators. Although settlements had been declining since 1998, they remained h g h compared to competitive markets and about double the Federal Communications Commission’s benchmark for U.S. operators sending traffic into Mexico. Illegal bypass reportedly resulted in TELMEX losing in 2003 around $230 million or 20 percent o f its revenues from incoming U S calls.’ The agreement reached between Mexico and the United States i n April 2004 called for the following actions: W i t h two months o f adoption o f the panel’s report, Mexico will revise i t s international long-distance rules to allow competitive negotiation o f settlement rates by eliminating uniform settlement rates, proportional returns, and the requirement that the operator with most outbound traffic negotiate the settlement rate o n behalf o f all Mexican operators. Within thirteen months, Mexico will have in force regulations to license “comercializadoras” allowed to resell international switched telecommunications services provided by Mexican concessionaires. Mexico w i l l continue to have the right to restrict international simple resale (use o f leased lines to carry cross-border calls). The panel report was adopted in June 2004. T h e agreed implementation plan i s well under way. Rules for international telecommunications services. N e w international rules applicable to all telecommunications services were approved by Comisi6n Federal de Telecomunicaciones (COFETEL, the regulatory authority) in June 2004 and published in August 2004. The old uniform settlements and proportional return rules have been abolished. N o w Mexican operators o f international long-distance services are free to negotiate individually the terms and conditions o f interconnection with foreign operators, including prices for incoming and outgoing traffic. Foreign operators decide to which Mexican operator they wish to deliver their traffic for temination in Mexico. Thus Mexican operators can compete effectively with one another in the large wholesale market o f terminating incoming traffic. International simple resale. Mexico continues to prohibit international simple resale, as agreed. The new rules for international telecommunications services are clear on this, both in the explanatory notes and the rules themselves. International interconnection can only take place at gateways approved by COFETEL. Only Mexican companies that have concessions to install, operate, and exploit public telecommunications networks authorized to provide international services can receive authorization to set up international gateways. 1. Telmex Annual Report 2004. 112 Mexico’s Regulatory Framework The government, through the Secretaria de Comunicaciones y Transportes (SCT), i s responsible for monitoring the compliance o f Telmex with its concession obligations. I t also i s responsible for gradually rebalancing Telmex’s highly cross-subsidized telephone tariffs to prepare the company and Mexico’s telecommunications markets for competition that was set to begin in mid-1996. Telmex’s tariffs were not fully rebalanced by the end o f its monopoly, in part due to the 1994 financial crisis. The failure to rebalance Telmex’s tariffs planted the seeds for subsequent challenges. Ever since Congress began debating the new telecommunications law in late 2001, the SCT and the regulator, Comisi6n Federal de Telecomunicaciones, have been reluctant to take action on controversial issues such as unbundling, collocation, and resale regulation. COFETEL, however, has acted on‘a number o f low-key, though important, issues such as numbering, dominance rules (now frozen due to legal challenges), tariffs, and local loop competition. Because o f political opposition, the new telecommunications law was never passed. Thus, COFETEL was left without a strengthened regulatory framework fostering independence and institutional credibility. The 1995 Federal Telecommunication Law called for the creation o f a regulatory body as part o f the SCT, but the law did not specify the powers and authority o f the regulator. A s a result, SCT drafted a presidential decree that created COFETEL o n August 9, 1996, as a regulatory body. It has a chairman and three commissioners without set terms who are nominated by, and can be removed at the will of, the SCT Secretary. Between 1996 and 2004, COFETEL was led by four chairmen, and it has not had the stability needed to create a strong new institution capable o f regulating a complex and powerful industry. COFETEL lacks adequate enforcement powers and independence. One o f the main reasons for its lack o f independence i s that i t does not have powerful leadership that can make independent decisions without political pressures. The head o f the COFETEL i s nominated without a fixed term o f office. A recent institutional analysis o f the Water, Energy, Financial Services, and Telecommunications agencies concluded that a regulatory leader i s urgently needed to legitimize these regulatory entities (OECD 2004b). Mexico has several fairly effective quasi-independent regulatory bodies that can be used as models for the establishment o f a more independent and effective COFETEL. One o f them i s the Comisi6n Federal de Competencia (COFECO). This Competition Agency, created through the Federal Competition Law, has legal powers that give independence and autonomy to the regulatory agency. I t i s headed by a board whose members enjoy ten-year staggered terms. 113 Interventions and Programs Supporting I C T Infrastructure Despite the ongoing debate on whether or not to modify Mexico’s telecommunications law, the government and the private sector have taken a number o f notable steps to foster innovation and growth in the I C T sector. The following i s a brief overview o f some o f these initiatives. e-Mexico In his address to the nation on December 1, 2000, President Fox stated the objective o f e- Mexico: “to use the revolution o f information and communications to project a national character and reduce the digital gap between Governments, companies, homes and individuals, with a reach to the last corner o f our country.” The e-Mexico Project has three major initiatives: (i)the connectivity initiative to extend broadband Internet access to 10,000 locations throughout the country; (ii) the applications initiative to develop applications in education, health, small and medium-size enterprises (SMEs), and e-Government; and ( iii)the implementation initiative to build telecenters, access points and local area networks in schools, health centers, community centers, municipalities, and associations o f producers. The e-Mexico program hopes to build on the existing capacity o f the telecommunications infrastructure (100 percent digital), to use this infrastructure to deliver applications, and to provide government services in I C T directly to citizens. The e-Mexico coordinator reports directly to the SCT Secretary. A high-level official in the Office o f the Presidency is also partly responsible for monitoring implementation. e-Mexico has a small staff to coordinate the activities o f other secretaries and ministries responsible for e- education program, e-commerce, and e-Government. One o f the e-Mexico coordinator’s tasks i s to act as a catalyst for the line ministries in their efforts to develop specific projects. These projects range widely from developing Web pages to implementing programs to deliver and procure education and government services through the Internet. Mexico’s information technology industry has been very supportive o f the e-Mexico initiatives developed by the Secretary o f the Economy to support the Mexican software industry. The Secretary o f the Economy has developed similar programs aimed at using I C T to increase the competitiveness o f Mexican companies in more than six key industries. After nearly two years o f preparatory work, e-Mexico initiatives started operating in 2002. That year the government allocated nearly $75 million for the first o f three stages o f the e-Mexico connectivity program. A partial subsidy was given to a private sector company to provide broadband connectivity to 3,200 Centros Comunitarios Digitales (CCDs), or digital community centers, connected via a V S A T satellite network. After extensive studies, the e-Mexico program on September 3, 2002, issued a request for proposals to establish 2,443 CCDs nationwide, especially in Mexico’s poorest rural areas. Each C C D would have at least three computers with high speed connectivity. The service provider had to promise to manage and run these systems as well as provide a range o f services. The government subsidizes these CCDs in two ways. First, i t provides free high-speed connectivity via satellite transponder capacity “reserved” by the SCT for five years for “social purposes” from Satmex when i t was privatized, and from the concessions o f the satellite service providers. The winning bid must pay for the cost o f installing the VSAT antennas and the equipment to run the CCDs. Second, the government provides a one- time payment to the C C D service provider to help offset the capital costs o f building the V S A T 114 antennas and C C D equipment. The service provider was also guaranteed that each C C D would be paid $30 a month by the school or municipality where the C C D was based. On December 3, 2002, Interdirec was selected as the winner o f the first C C D program. I t outbid proposals from Telmex and Avantel. Interdirec i s a relatively small company that has been using innovative wireless technology to provide distance education and Internet access in several Mexican communities. By 2003, the first 3,200 CCDs were installed in all the municipalities o f the country. In 2004, two more biddings o f 2,000 CCDs each were launched by the SCT. The winner o f both biddings was Telmex. By the beginning o f 2005, 7,200 CCDs had been installed around the country. For 2006, the SCT expected to have more than 10,000 CCDs installed in the municipalities. Fondo de Cobertura Social de las Telecomunicaciones In 2002, the Congress authorized a US$70 million budget to develop a fund to foster access to telephones in rural and low-income areas-the Fondo de Cobertura Social de las Telecomunicaciones (FCST). A committee with representatives o f the public and private sectors was established to oversee the FCST. COFETEL developed both a study to determine which localities would benefit from the fund as w e l l as a feasibility study. The uniqueness o f this fund i s that its objective i s not only to install public telephone lines; i t s primary purpose i s to increase telephone penetration through residential lines in rural localities with more than 500 inhabitants. Specifically, the objective i s to reduce the access gap o f localities with the least telecommunication coverage around the country. The FCST was designed to use at least 70 percent in residential fixed lines (with any technology) and up to 30 percent in public telephone lines. The establishment o f the FCST as Mexico’s first universal access fund is an important development. However, the FCST depends entirely on arbitrary budgetary allocations instead o f on an annual assessment on the revenues o f telephone companies o f 1 percent to 2 percent as i s the case with similar funds in Brazil, Colombia, and Peru. I n the United States, telephone companies are collectively assessed by several universal access funds an average o f 2 percent to 5 percent o f revenues. I n 2002, the FCST was allocated $70 million, and in 2003 it was allocated less than h a l f the 2003 amount. The I T U estimates that in 2003 Mexico’s telecommunications sector had revenues o f around $17 billion, which means that a 1 percent tax on Mexican telecommunications companies would raise about $170 m i l l i o n for universal access programs on a sustainable basis. Such an assessment would provide sufficient funds to put in place a more effective, comprehensive, and sustainable universal access program. In 2004, a first bidding o f approximately US$30 million was made, and use o f radiofrequency spectrum (1.5 Ghz) was launched. This bidding included around 3,930 localities that will benefit around 3.2 m i l l i o n inhabitants. This first bidding i s expected to provide around 125 thousand lines; 30 percent o f the cost o f each line will be covered by the Fund (capital investment) and the rest by the winning operator (operating costs). The operators will charge only the outgoing calls through a prepaid calling card scheme; the installation fee and the telephone device will be covered by the Fund. The Fund will cover the f i r s t 30 percent o f the lines demanded in each locality; the rest will be covered by the operator entirely or by incoming competitors. 115 The bidding was allocated in March 2005 to the lowest cost offered by the incumbent Telmex, which i s expected to start expanding the service in these localities. A new bidding is expected to start in June or July 2005. e-Government The Mexican government has implemented the following initiatives to provide different types o f on-line services to its citizens. System for Government Procurement (www.conipranet.nob.nix). This system enables government purchasing departments to publish all their procurement needs, including products, services, leasing, and public works. Potential suppliers may access this information and bid for specific contracts using the same portal. There were almost 28,000 public bids conducted using Compranet in 2003. Today 100 percent o f all public bids are registered o n Compranet, and 40 percent o f them were totally conducted via Internet (64 percent o f value). During the first half o f 2004, another eighty government agencies joined the Compranet system. Univocal Registry o f Authorized Persons (Registro Unico de Personas Autorizadas, RUPA). This registry has the purpose o f enrolling citizens who often work with many government agencies and will issue them a univocal identification number that will be used as the only identification required to work with government agencies. The decree mandating the creation o f this registry was published in M a y 2004. The Ministry o f Finance worked with the Ministry o f Public Function (SFP) to define the rules and standards for the advanced electronic signature to be used across all government agencies (and the related procedures and technology). RUPA will be consistent with these regulations. Citizenportal of the Federal Government. The portal www.gob.mx i s part o f the e-Mexico system and the “Presidential Agenda to promote better government. It i s one o f the most noticeable achievements o f the government’s digital strategy. Daily, www.aob.mx receives 12,000 visitors. It is a “world-class”’ e-Government portal at the national level. The portal has been acknowledged internationally and was awarded the first place o f the 2004 Stockholm Challenge Award for e-government category. www.nob.mx represents a single access point to all levels of government services and provides answers to the informational needs o f the community. Tramitanet. This subportal (www.tramitanet.aob.mx) consists o f an on-line catalog o f federal and some state transactions (“tramites”) made available on the Internet. For each tramite, information is provided about procedural steps, , required documentation, location and working hours o f the government office, and the cost o f filing and/or complying with the proceedings. The new regulatory framework mandates that electronically generated and submitted federal tramites be accorded the same legal value as tramites conducted by traditional methods. Federal tramites can be “signed” with a basic certificate for high security certification procedure administered by a government entity or notary public. To obtain a certificate, an individual or corporate representative must first appear physically before the certifying authority for the purpose o f “binding” the user’s identity. Unfortunately, this legal certainty is not available for all 116 state level tramites because some o f them do not have the legal frameworks in place to support electronic forms and proceedings (digital signature, data messages, etc.). e-Government ut the State and Municipal Levels. The states o f Puebla, Sinaloa, Aguascalientes, Baja California, and Coloma are the leaders in e-Government. Coloma has leveraged scarce resources to offer digital services, deploying interactive kiosks developed locally. Puebla has partneredwith a private company to issue driver licenses. Inmost o f the states participating in e- government, the person in charge o f I T reports directly to the governor. Most states, however, have not made the most o f the federal government’s infrastructure to offer better services to their constituents through the use o f technology. To assist them, the federal government has provided a portal (www.e-1ocal.aob.nix) to enable municipios and states to strengthen their institutions and share good practices. Concession Requirements Before 2002, the year the Fondo de Cobertura Social de las Telecomunicaciones (FCST) was created, Mexico did not have an explicit universal access program for increasing access to telecommunication services. I t only had the programs contained in Telmex’s concession requirements, the Telecomm payphone program, and concession build-out requirements in other carrier concessions. The FCST has been an important first step to implement universal access. When Telmex was privatized in 1990, it was given a six-year exclusivity period. As part o f its concession requirements, Telmex was required to comply with certain network expansion needs by 1995. It had to expand the number o f telephone lines nationwide by 12 percent each year; provide telephone service in population centers greater than 5,000; and offer rural telephony via payphones in population centers greater than 500. The Telmex concession required the company after 1995 to comply with four expansion programs negotiated with the Secretaria de Comunicaciones y Transportes. Telmex complied with its concession requirements. Since 1999, the SCT has not imposed new build-out requirements on Telmex, although Telmex must continue to provide services to all areas where it currently provides services as a result o f its concession requirements. The SCT has not imposed new universal access requirements o n Telmex as part o f an effort to undercut Telmex’s opposition to SCT and COFETEL initiatives to increase competition. Policy Agenda for ICT Infrastructure Although they contribute to the development o f a knowledge economy, e-Mexico, FCST, and related connectivity programs do not address the most important challenge: dramatically increasing and expanding private sector provision o f I C T infrastructure in Mexico. Meeting this challenge would require a level playing field, elimination o f entry barriers, healthy competition, and increased access to ICT services. Following are nine recommendations to facilitate the achievement o f these goals. 117 1. Rebuild the credibility, effectiveness, independence, and transparency of COFETEL. In order to create a level playing field, the Mexican government must make institutional changes in the Comisi6n Federal de Telecomunicaciones. Despite a promising beginning, the commission i s a weak regulator that does not inspire the confidence new entrants need to invest in this sector. This has become the single most important barrier to I C T growth in Mexico. Congress should adopt amendments to the Federal Telecommunications L a w that would make COFETEL as independent and transparent as the Comisi6n Federal de Competencia. Congress, however, should set aside amendments concerning more technical issues-such as interconnection, tariff, and unbundling-which could be better addressed by a more effective COFETEL. A s amended, the law should remove the ability o f the SCT to oversee COFETEL and, equally important, mandate that COFETEL immediately adopt and follow transparent decisionmaking procedures. The Comisi6n Federal de Telecomunicaciones should have the power to develop and implement i t s own regulations and not simply be responsible for implementing those developed and approved by the SCT. Its chairmen and commissioners, nominated by Congress, should be appointed for fixed terms, and should be removed only for gross ethical violations. To send a dramatic and clear signal that there i s an institutional break with the past, Congress should direct COFETEL to report to the Secretariat o f Economy. This proposed change could have the added benefit o f increasing coordination between COFETEL and COFECO-the telecommunications and competition regulators. COFETEL must have adequate financial resources. Congress should make sure it can finance itself through fines and license fees. The commission also should be held accountable to Congress for its annual budget. Making COFETEL a more effective regulatory agency with increased autonomy and transparency will not only strengthen COFETEL. I t also will reduce the ability o f disaffected parties to misuse the judicial system to reverse or delay regulatory decisions through the use o f amparos. 2. Simplify and streamline the licensing regime for new entrants. This recommendation, and recommendations 3 and 4, will help eliminate entry barriers and foster competition. Mexico’s current concessions, permits, and licensing regime is complex and imposes burdensome information requirements that cause unnecessary delays, not only for new entrants, but also for current concession holders who simply wish to amend their existing concessions. Mexico would be better served by adopting a simplified licensing regime, along the lines adopted by the European Union, Argentina, Chile, or Peru. A company wishing to provide domestic voice service, or a concession holder seeking to add services to its concession, needs to provide extensive financial, business, network, and technical information to SCT and COFETEL. The entire process takes at least nine to twelve months, and the legal fees are considerable. I n sharp contrast, class licenses in Europe in most cases are granted automatically or within a period o f weeks. Simplified licensing regimes for value-added services are needed to foster the development o f I C T service providers and applications. In Europe the licensing process i s usually a simple process o f self-certification. In Peru, the value-added service application is a simple two-page document, and registration i s typically granted within a couple o f weeks. Although some o f these barriers may have served a purpose before Mexico’s transition to a more competitive telecommunications market, it i s time Mexico followed international best practice with a more streamlined and simplified licensing regime that operates within a stipulated period 118 o f time. Such an approach would enable COFETEL to devote more staff and resources to revising and updating regulations and taking action against monopolistic behavior. 3. Eliminate requirements to register contracts with COFETEL for all but the incumbent. Currently, concession holders must submit all o f their draft contracts to COFETEL for i t s approval before they present them to new clients. The approval process for the generic contracts can take months, and COFETEL sometimes uses this time to impose additional regulatory requirements o n certain services. These requirements hinder the ability o f companies to rapidly introduce and tailor new services and contracts for clients. If the contract that i s signed deviates significantly from the generic contract approved by COFETEL, the company can incur legal problems. All interconnection agreements between concession holders must also be approved by COFETEL before they can go into effect. While imposing such requirements on an incumbent carrier may prevent monopoly activities, their imposition on new entrants contributes to delays and uncertainty regarding new I C T services that may not neatly fit into the regulatory classifications o f COFETEL. International best practice allows nondominant companies to freely enter into and modify contracts with their clients. 4. Eliminate legacy voice-centric regulations. A significant number o f COFETEL regulations, concerning international long-distance and interconnection rules, for example, focus o n the provision o f voice services and leave much ambiguity with regard to the rights o f companies that provide data and corporate services. COFETEL should issue resale regulations to enable any service provider, not just companies with voice concessions, to lease and resell capacity from other companies. Such regulations are permitted under the 1995 Federal Telecommunications Law. In the past the commission’s refusal to issue resale regulations may have encouraged companies to invest in infrastructure earlier. Today such regulations mainly act as an entry barrier to new operators that can package services to serve small businesses and other niche markets. While voice-centric regulations need to be eliminated or revised, new regulations are needed to foster and ease the interconnection o f data networks. Other voice-centric regulations are requirements imposed on the concessions granted to backbone operators. They are required to certify that none o f their customers is carrying voice traffic which terminates or originates on the network o f a Mexican operator that has a long- distance license. Such a requirement is an attempt to force backbone companies to police their customers in order to reduce voice-over-the-Internet (VoIP) traffic. In most OECD countries, VoIP traffic i s classified as a data service and i s unregulated. A s a result, VoIP in OECD countries has grown dramatically. More recently, COFETEL has proactively enforced its regulations by shutting down companies that carry VoIP traffic but that only have value-added licenses. 5. Require automatic review o f regulations. Every two to three years COFETEL should review its regulations. Those that hinder competition, market entry, price reduction, and network expansion in response to changes in technology and market conditions should be amended or eliminated. 119 W e have recommended actions to eliminate entry barriers and foster competition (Recommendations 2-5). Our final recommendations are intended to promote equity and increase access. 6. Foster broadband deployment and reduce local loop costs through competition. n markets with more than one provider o f local loops, the price and quality o f service improve I dramatically. The government should foster increased local loop competition by promoting the provision o f service to business and residential consumers by cable television service providers, by wireless local loop providers, and by data service providers. 7. Build consensus for universal access, establish a universal access tax, and rebalance tariffs. The government should undertake a consensus-building campaign o n the priorities for universal access. I t should consult with state and municipal authorities, identify and remove legal, licensing, and regulatory barriers to private sector participation, and ensure provision o f service to underserved communities and to small businesses. The e-Mexico initiative i s a unique approach to provide broadband infrastructure and services in rural areas. I t can lead to innovative I C T programs that promote economic development and improve education. As noted earlier, the e-Mexico connectivity and FCST programs do not constitute a comprehensive and sustainable universal access program. In order to reduce the digital divide within Mexico, Congress should establish a neutral universal access tax (capped at 1.5 percent), finish rebalancing tariffs, and transform the FCST into a sustainable universal access agency housed within COFTEL. The Fondo de Cobertura Social de las Telecomunicaciones should be given the mandate to develop an effective and comprehensive universal access program using the FCST funds. As previously noted, a 1 percent tax on the revenue o f Mexican telecommunications operators could raise approximately $170 million for universal access, more than twice the 2002 congressional appropriation for the FCST, and nearly six times the congressional appropriation for FCST in 2003. All government programs to increase access to I C T infrastructure-including the e-Mexico connectivity initiative, Telecomm’s rural telephony program, and Sepomex’s I C T program-should be reviewed and modified by FCST as appropriate. Ideally, all three programs would be part o f the hnd since this would allow better coordination between them and avoid duplication o f efforts. FCST could be made a part o f the new COFETEL, or it could be a part o f the new I C T Secretariat. If the latter i s the case, the FCST Agency and COFETEL need to be given explicit mandates. FCST could be responsible for developing and implementing policies dealing with the allocation and administration FCST resources, while COFETEL could be responsible for developing regulations and enforcing them. 8. Eliminate cross-subsidies. COFETEL should undertake a transparent and public initiative to determine whether Mexico’s current interconnection and tariff regime contains cross-subsidies between services and companies. Where cross-subsidies exist, COFETEL should decide whether they should be phased out, as well as h o w to replace them with more transparent programs that will foster competition. This initiative should examine the Telmex public payphones program in towns with populations between 500 and 2,500, and the Telecomm rural telephony program, to determine whether the programs are financially self-sustaining, whether there are tariff or regulatory 120 barriers to the independent h c t i o n i n g o f the programs, and whether a review o f their cost structure is needed to distribute the costs equitably. Reaching the underserved with low-priced efficient service is the goal. Conclusion In conclusion, Mexico’s telecommunications sector grew considerably as a result o f the privatization o f Telmex in the early 1990s and o f the gradual sector liberalization that began in 1995. The Fox administration efforts to transform Mexico into a knowledge economy, mainly through its e-Mexico initiative have also resulted in notable improvements in e-government. However, Mexico lags behind all OECD countries and many Latin American countries in terms o f wide-spread access to telephone and broadband internet infrastructure. Though Mexico has introduced limited regulatory changes to make its regulations consistent with the WTO ruling, it has failed to introduce broader changes that are required in order to enable Mexico to use ICTs as a tool to transform its economy. Furthermore, this report finds that Mexico’s regulatory framework and institutions are quite weak and have not only failed to foster competition, but that they put in place regulations that foster anti-competitive behavior and protect the dominant operator. Although they provide important contributions toward the development o f a knowledge economy, e-Mexico, FCST, and related connectivity programs do not adequately address the most important challenge-that o f dramatically increasing and expanding private sector provision o f I C T infrastructure in Mexico. To do requires more effective regulatory frameworks and institutions that will establish and safeguard a level playing field, eliminate entry barriers, and foster healthy competition, and increased access to I C T services. 121 Part 111. Implementation Options Recall from Chapter 1 the parable o f two farhily-owned firms that were once identical. Then one began growing rapidly, while the other could barely survive. All o f a sudden, the story-set in Latin America-takes a magically realistic turn: a high and benevolent government official sees (at a glance) what the government ought to do: help the struggling firm escape its vicious circle and participate in learning networks. Given the similarities o f the firms, and the demonstrated success o f one, the failure o f the other looks more like an accident than like destiny. Surely the role o f government, in parables and reality, i s to protect citizens and their crucial projects from avoidable accidents? The government may have good intentions, but getting from the general idea of what to do to the specifics o f how to do i t i s another matter. A young official, clear- minded and innocent o f all o f the past missteps o f economic development policy, i s charged with figuring out “the how.” She quickly notices subtle but relevant differences between the two neighboring firms. The successful firm had access to capital at a crucial moment through the owner’s r i c h uncle; the owner o f the failing firm was not favored by rich relatives. Regional banks and government lending programs had so much trouble assessing the prospects o f turning the struggling firm around that they hesitated to make a loan. With regard to the skills o f the owners o f the firms, the story is similar. When it comes to hands-on experience with garment making, both owners are alike. But the successful one has five more years o f formal schooling (the rich uncle again) and so can read-with a facility that the other owner lacks-manuals on factory layout, plant organization, the correct way to sew a new kind o f fabric, and accounting. The official i s bewildered. The list o f remedial measures the struggling firm should take in order to succeed is the result o f cursory inspection. I s it sufficiently complete? H o w would one know? Suppose that the official, pressed for time, decides that the cursory list i s complete enough for starters. What should the sequence o f measures be? Plainly, i t is impossible to change everything at once. Change must be incremental. Some steps may be preconditions for the success o f others, so the steps toward change cannot be ordered haphazardly. It makes sense to offer literacy training before providing finance, so current reading could inform the use o f the fresh money. On the other hand, wouldn’t the credit, and the restructuring it enables, create a sense o f urgency and opportunity that would motivate attention to remedial reading classes? What about doing both steps simultaneously? And what about reform o f the domestic thread cartel, if the domestic producers really are engaged in unlawful collusion (and if the government can do something about such things)? As soon as these questions are formulated, they tangle into a Gordian K n o t that we will attempt to disentangle in this part . 122 Chapter 6 Towards National Vision and Leadership Examples o f Best Practices: Finland, Ireland, and the Republic of Korea Finland, Ireland, and the Republic o f Korea have engineered successful transitions to knowledge-based economies. In all these cases, national economic crises compelled diverse actors to implement a new agenda through national agreements o n goals and mechanisms to move forward. The crises also prompted policymakers and private sector leaders to lengthen the time horizon o f the policies adopted. Thus, Nokia-Finland’s first mover toward an innovation-based economy-dramatically increased R&D investments. Finland responded by increasing public R&D and transforming the innovation system to fit business needs. Members o f parliament took courses and went o n study tours demonstrating the need for the new agenda. National public innovation organizations played a crucial role by transforming technology into businesses and ensuring a critical mass o f demonstration cases. Ireland also exemplifies a successful combination o f top-down and bottom-up policies. I t invested in education and R&D infrastructure in the 1980s and then undertook drastic policy changes beginning in 1987. To complement its top-down policies, Ireland instituted pragmatic bottom-up programs-regional partnerships to mitigate high unemployment and a program to expand national-supplier linkages from foreign direct investment (FDI). The Republic o f Korea’s powerful national vision, initiated by a private sector champion, was advanced through effective government coordination (see Box 6.1). 123 Box 6.1. The Republic o f Korea’s Transition to a Knowledge Economy: from Vision to Implementation In 1998, in the wake o f a financial crisis, the Republic o f Korea officially launched a national strategy to become a knowledge-based economy. The initial impetus came from the private sector-the Maeil Business Newspaper-which concluded in 1996, even before the crisis, that there was an urgent need for a more coherent vision o f the future o f the Korean economy. This newspaper launched the “Vision Korea Project” as a national campaign in February o f 1997, and it developed the f irst Vision Korea Report. Eventually, the government-the Ministry o f Finance and Economy-became the main champion o f the policy agenda for the knowledge economy. The Korean Development Institute, a so-called system integrator, coordinated the work o f a dozen think tanks. A joint report by the World Bank and the Organization for Economic Cooperation and Development (OECD) outlined concrete steps for reforms in the various policy domains. Progress was monitored closely. As a result, inertia or resistance was identified and addressed. Korea’s knowledge strategy o f April 2000 evolved into a three-year action plan for five main areas: information infrastructure, human resources, knowledge-based industry, science and technology, and elimination o f the digital divide. To implement the action plan, Korea established five working groups involving nineteen ministries and seventeen research institutes, with the Ministry o f Finance and Economy coordinating the implementation. Every quarter, each ministry submits a self-monitoring report to the Ministry o f Finance and Economy, which puts out an integrated report detailing progress. The mid-termresults and adjustments to the plan are sent to the executive director o f the National Economic Advisory Council, which reports o n the progress o f implementation and gives an appraisal o f the three-year action plan to i t s advisory members. Source: World Bank staff. Lessons for Mexico Three lessons from Finland, Ireland, and the Republic o f Korea are relevant for Mexico. First, simple institutional recipes do not exist for concerted action. Mexico will need to devise i t s own recipe for a knowledge economy. Given its great regional diversity, Mexico’s regional and state-level policy initiatives can be a key entry point for a knowledge-based economy. Mexico has already advanced quite significantly in that direction. Subnational initiatives (for example, the Monterrey knowledge Technopolis) are important springboards for more systemic reform agendas. Second, even when major crises call for urgent economic transitions, countries must “prepare the bases.” This essential preparatory stage can be seen in the initial Vision Korea Report and in Finland’s major effort to facilitate and accelerate business R&D. Third, although major reform efforts from the top are vital, they may not provide the all-important impetus for transformation. Concerted effort must evolve. Bottom-up experiments in Mexico, already well under way, must mature. These transitional stages then must proceed to concerted efforts. (The knowledge strategy in Korea is one example.) 124 Toward Concerted Action To move forward, Mexico needs to implement major reforms. The reform agenda i s as challenging as the institutional impediments to reforms. The economic agreements (Los Pactos)’ o f the eighties were good examples o f pragmatic institutions to carry out economic liberalization and contain inflation. The new agenda built around a concept o f knowledge may need a similarly far-reaching mechanism. For lack o f a better title, w e can call this a Knowledge Economy Pact. Such an agreement would entail a combination o f top-down and bottom-up policies, and, unless there i s a wake-up call o f a crisis, it i s likely to evolve gradually,and over time. Drawing on a diversity o f best practices, w e suggest that Mexico construct its Knowledge Economy Pact in three stages: the immediate agenda, the medium-term agenda, and the long-term agenda. Table 6.1 presents in detail these agendas with regard to innovation and enterprise upgrading, education, and I C T infrastructure. The art and craft o f policymaking i s about sequencing the various horizons o f a policy agenda in a virtuous circle o f growth and reforms (see Figure 6.1). To get around the many institutional rigidities impeding progress, Mexico must create momentum for change by fostering stakeholders’ awareness; reach consensus on how to tackle key obstacles at the national level (to enhance demand for an institutional change); and then move ahead with concrete, manageable bottom-up approaches that can serve as demonstration projects to move the larger agenda. 1 The f i r s t Pacto was ‘PACTO DE SOLIDARIDAD ECONOMICA’(December 1987- December 1988); it was replaced by ” PACTO PARA L A ESTABILIDAD Y E L CRECIMIENTO ECONOMICO’ ( PECE) from January 1989 to 1992. 125 Figure 6.1 Virtuous Circle o f Growth and Reforms AGENDA IMMEDIATE MEDIUM-TERM AGENDA DEMONSTRATION PROJECTS CRITICAL MASS OF CHANGES LONG-TERM AGENDA SENSE OF URGENCY STRUCTURAL REFORMS Source: World Bank staff. Sequencing the Policy Agenda When viewed together, the immediate, medium-term, and long-term dimensions o f a policy agenda for the knowledge economy present a comprehensive strategy for reform over time. Immediate Agenda Building awareness o f the need for innovation; developing a system to monitor progress, and implementing new pilot projects are the main tenets o f the immediate agenda. Mexico i s already engaged in significant new initiatives on innovation, education, and ICT. Because o f the sheer diversity o f new programs, priority should be given to monitoring and evaluation. Evaluation should be viewed as a valuable management tool to help improve performance, not a way to assign blame for failures and problems. Such forward-looking evaluations are crucial to proceed to the next stage o f consolidation when diverse pilot projects are aggregated at the regional and sectoral levels. Bottom-up initiatives must be complemented with top-down efforts. A massive campaign should be launched to raise awareness o f the urgent need for reforms and the high pay-offs that can follow. The government can champion a search for pragmatic, step-by-step reform strategies and ways to monitor progress and set priorities. Global 126 strategic consultancies could be contracted to lend additional credibility to these efforts. They can help adapt global best practices to Mexican reality. Table 6.1. Implementingthe Transition: Sequencing Policy Agenda in Innovation, Education, and ICT Stage o f the policy agenda Benchmarks for innovation Benchmarks for education Benchmarksfor ICT and enterprise upgrading Immediate agenda Develop and implement Develop new innovative projects Reduce perceptionof regulatory private sector-led technology of life-long learning, relying on paralysis; increase regulatory Top-down: projects (Programa Avance); ICT; introduce new pedagogical transparency and strengthen Build awareness; promote a sense of introduce sectoral and methods; improve involvement sector regulator; identify and urgency; develop a national system o f regional technology and of stakeholders in learning and assess the supply and demand monitoring; evaluate ongoing pilot innovation funds. teaching. barriers to increased access and projects. use of ICTs; share results with key stakeholders to generate Bottom-up: dialogue on overcoming the Undertake new pilot projects. barriers. Medium-term agenda Strengthen innovation Bring key stakeholders together Implement second-generation linkages with the U.S.and and design the architectureo f an ICT access programs (scale up Canada; implement integrated system of life-long with a focus on poor states); Top-down: technology foresight processes leaming; scale up promising develop and implement Put in place the system for monitoring with regional and private programs such as Escuelas de programs to foster greater progress toward a knowledge economy; sector leaders; establish a new Calidad, Consejo Nacional de demand for ICT by business, link projects to budgetary priorities; demand-driven and private Foment0 Educativo (CONAFE); government, and the education institute a shared vision of Mexico as a sector-led mechanism to introduce income-contingent sector; establish a universal knowledge-basedeconomy (“Mexico allocate public funds for loans to facilitate private access fund. 2025”); scale up and consolidatenational innovation and upgrading; financing of higher education programs that receivedpositive establish Fundacion Mexico, and initiatives in life-long evaluation. adapted from the model of learning. Fundacion Chile. Bottom-up: Implement state-level knowledge economy initiatives. Long-term agenda Engage in major reforms; Engage in major reforms; change Create a more even and change incentive structure for incentive structure for education contestable playing field, with innovation so that business providers (e.g., curbing the strong regulatory capabilities Reduce the power of dominant players; R&D reaches at least 50 power of unions); create a (e.g., Telmex becomes less introduce a new incentive structure. percent of total budget and the national life-long leaming dominant). structure of R&D spending system with a multiplicity o f becomes less concentrated qualified service providers and Eestablisha strong and (e.g., UNAM becomes less sources of financing. independent sector regulator; Source: World Bank staff. 127 Medium- Term Agenda The agenda at this stage focuses first o n pragmatic actions not requiring parliamentary approval that can yield results in the medium term. Mexico’s Competitiveness Agenda, elaborated by the government in 2004, i s comprehensive and w e l l thought out. I t addresses the knowledge economy from this medium-term perspective. Particularly in the areas o f education and innovation, government programs that have received positive evaluation yet have remained relatively small could be scaled up and consolidated. In collaboration with federal ministries and state governments, C O N A C Y T has established a diversity o f sectoral and regional funds.. These funds could be consolidated with clearly specified priorities and operating procedures. Interorganizational and private-public projects are to be particularly encouraged. A good example in this context i s Tekes, the National Innovation Agency o f Finland. I t funds industrial projects, as w e l l as projects in research institutes, and especially promotes innovative, risk-intensive projects. In education, promising programs include Escuelas de Calidad, Consejo Nacional de Foment0 Educativo (CONAFE). Income-contingent loans can facilitate private financing o f higher education and life-long learning initiatives. The government also should bring key stakeholders together to design the architecture o f an integrated national system o f life-long learning. Issues to be addressed include the following: accreditation o f multiple providers, certification o f prior learning, vocational qualifications, vocational counseling and information on career paths and earning streams, quality o f different public and private providers, and financing mechanisms. The successful transitions in Ireland, the Republic o f Korea, and Finland (see Chapter 3) indicate that actions designed to yield immediate results should be complemented by longer term efforts, with results bearing h i t after 2007. These actions prepare the bases for a major concerted effort-an effort that articulates a shared vision o f Mexico as a knowledge-based economy, an effort that has a visible and tangible demonstration effect by consolidating existing initiatives. “Preparing the bases” recalls the Japanese proverb: “A vision without an action is a dream. An action without a vision i s a nightmare.” Collaborating with private sector champions and civil society, the federal government can begin to formulate a compelling yet realistic vision o f Mexico as a knowledge-based economy. Its objective i s to shift gears from business as usual to a more urgent concerted action. Building awareness would create a vivid image o f what i s at stake for every Mexican-the poor, the middle-class, and members o f national industrial groups and multinational corporations. The experience o f Korea (which has a centralized economy) exemplifies h o w a shared vision can emerge from outside the government as the result o f by private sector champions and the media (see B o x 6.1). 128 Box 6.2. The Fundacidn Chile Model and its Relevancefor Mexico One o f the most successful attempts in the Latin American region to establish national “antennae” for new technologies i s Fundaci6n Chile, originally a joint effort between the Chilean government and the U.S. firm ITT, but n o w largely autonomous. Fundaci6n Chile uses four main techniques in i t s technology transfer and dissemination work: (i) it captures and disseminates technologies to multiple users though seminars, specialized magazines, and project assistance; (ii) i t develops, adapts, and sells technologies to clients in the productive and public sectors, both in the country and abroad; (3) it fosters institutional innovations and incorporates new transfer mechanisms; and (iv) it creates innovative enterprises, almost always in association with companies or individuals. The creation o f demonstration companies by Fundaci6n Chile has had a mixed record with some successes and some failures, but overall the companies have been effective in disseminating new technologies. The companies are transferred to the private sector once the technologies have been tested in practice, and their economic profitability has been established. One o f the most successful cases exemplifies the successful development o f a knowledge cluster. The salmon industry, in a period o f ten years, grew to become a dynamic export sector. By 2004, Fundaci6n Chile had launched 61 such ventures, three quarters o f which have been sold to private investors. The six leading companies have generated more revenues than the total cost o f investment into companies by Fundaci6n Chile to date. The systemic technology focus o f Fundaci6n Chile includes biotechnology, management, environment, financial engineering, and information. Recent focus areas include forestry genetics and DNA vaccines for aquaculture. Fundaci6n Chile has also identified the links needed to transform developing clusters with comparative advantage into a business practice. The clusters include the agribusiness, marine, tourism (agro/eco), forestry, and wood processing sectors. Fundaci6n Chile i s a powerful private organization that performs all o f the functions o f the project cycle, from identification o f market niches t o creation o f f i r m s that can take advantage o f opportunities. It i s an innovation system as it should be, a l l under one roof. Foundation Mexico, described earlier, can be thought o f as a reinvention o f Fundaci6n Chile in the Mexican context. K e y features o f Fundaci6n Chile’s success and their relevance in Mexico are presented in Table 6.2. Table 6.2 Fundaci6n Chile as a Model for Fundacih Mexico f Fundacidn Chile Factors contributing to the success o Relevancefor Mexico An entrepreneurial, highly paid, and highly professional A shortage o f top-notch managerial teams; achieving management team established over the course o f many this feature o f Fundaci6n Chile would be a challenge years. but a challenge that could be met. Arms-lengths relationships with the government; Critical for second-generation NAFTA; will establish operates as a business, not as a public sector an important precedent in governance. organization. Private shareholders that do not expect an immediate A litmus test for the new generation of private-sector return and tolerate risks (oligarchs with a strategic champions. agenda). Source: World Bank staff. I 129 The central objective o f the “preparing the bases” stage is to package isolated efforts to achieve a tangible and visible demonstration effect. For instance, a private-public bridge organization, Foundation Mexico, could scan new opportunities and put them into practice. One model for such an organization i s F u n d a c i h Chile (Box 6.2). Two adaptations o f this model, however, would be needed. First, the hypothetical Foundation Mexico must have a much more decentralized structure (the hub o f a network o f innovation organizations rather than a mini-innovation system under one roof). Second, Foundation Mexico would need a closer link with the United States, with U.S. technology leaders playing an active role in terms o f management, generation o f deal flow, and contribution to the capital endowment. Provided efficient leadership and management from the private sector, such a Foundation could become a symbol o f success in technology and innovation alliances with the United States and Canada. For Monterrey’s leading industrial groups, a vibrant and commercially successful Foundation Mexico could become a flagship organization o f knowledge economy, just as the Monterrey Institute o f Technology, created in 1943 by Monterrey’s industrialists, was at that time a symbol o f Mexico’s industrialization. Another example i s Monterrey Knowledge Technopolis -- an initiative championed by the state government and private sector leaders to transform Monterrey into a knowledge-based economy. The Monterrey Knowledge Technopolis already meets three important prerequisites as a crucial pilot o f the knowledge economy agenda: highly promising institutional experiments in many areas (see B o x 6.3); a sense o f urgency for change, and private sector and public sector leadership. The current focus o f the Monterrey Knowledge Technopolis i s on infrastructure; there are plans, for instance, to create technology parks for companies. While infrastructure is important, so i s building an environment for knowledge-based entrepreneurship by improving in the quality and private sector orientation o f education systems and facilitating innovation networks between Mexico and the United States. Cross-border ties can be strengthened through research, technology, and education consortia. Promotion o f Diaspora networks can encourage successful Mexicans living abroad to invest and/or set up shop at home. Both Proyecto Innovar (see Chapter 3) and Fundacion Mexico could become hubs o f innovation, bringing together Mexico and its NAFTA partners to put technology into business. The start-up costs o f technology development would be higher for Fundacih Mexico; i t could invest its own resources in identification o f new market niches and invest in applied R&D to transform opportunities into commercial projects. In both cases, the government o f Nuevo Leon in collaboration with federal agencies, such as C O N A C Y T and the Ministry o f Economy, would facilitate private sector leadership in building an environment for entrepreneurs. Leading Mexican organizations and U.S. partners, working together, can stimulate cross-border innovation. Private sector champions willing to contribute their time and financial resources will be crucial. Private- public consultations can help transform the personal visions o f the private sector champions into specific projects. 130 ?ox 6.3 Monterrey Institute o f Technology and TecMilenio: Educational Spin-offas a Model o f Life-Long Learning The Monterrey Institute o f Technology in Mexico i s a premier private education organization with 33 campuses across the country. I t i s a franchise system o f local campuses each financed and governed by local leaders in the private sector. The Virtual University, a worldwide leader in distance learning, has championed a continuing education agenda throughout the Spanish- speaking world, malung inroads into such giant markets as China. T o reach poor students, the Institute launched a spin-off-TecMileno (Millennium University). I t offers the high quality o f education associated with the Tec de Monterrey brand yet at dramatically lower costs. By M a y o f 2004, approximately 10,000 students had enrolled; per student costs were approximately three times lower than in the parent organization. Several factors make it possible to dramatically reduce costs without compromising quality. The curriculum i s designed and often delivered by managers o f private sector firms. With some o f these firms, TecMilenio shares offices, so students and teachers can work, learn, and teach in the same location. T o have the best professors and best courses available for students, distance education i s highly utilized. Pedagogy i s based o n problem solving and conceptual tests. Yet testing i s standardized and centralized. Remuneration o f the teachers depends o n the testing results o f the students. A small management structure draws o n carefully selected professors from Tec de Monterrey staff and translates industry needs into pragmatic curriculum. This curbs professors’ vested interest in using the same teaching materials they have for decades. Content i s determined by industry needs. By year 2010, TecMilenio plans t o have reach an enrollment o f 100,000 students. TecMilenio draws on the strengths o f its parent organization, Tec de Monterrey, while avoiding many o f the rigidities o f established organizations. Indeed, TecMilenio is evolving into a model o f “lean and mean” model o f low-cost learning. Source: W o r l d Bank staff. Long-Term Agenda Economy-wide changes at this stage lead to a national accord o n the knowledge economy. As w e discussed earlier, Mexico requires major reforms in education, innovation, I C T infrastructure, energy, labor, and the financial markets. The reforms will need t o create an even playing field t o ensure efficient entry and exit o f diverse service providers. Strong regulations are needed to maintain service and guarantee conformity with minimum standards. The agenda includes curbing the power o f the teachers’ unions; creating greater incentives to reward educational quality; improving standards o n certification, accreditation, testing, and evaluation, as well as recognizing students’ prior learning. I C T infrastructure reforms would create a more open marketplace and develop incentives for new entrants, reducing the dominance o f Telmex. Labor market reforms would ease employment protection provisions, establish revenue support systems in the case o f j o b loss, and modernize the collective bargaining framework. Implementation o f this agenda requires a major concerted effort. The challenge here i s to proceed with major reforms and create a new governance structure for private- public collaboration. A knowledge economy accord (Pucto) can be seen as a postcorporatist agreement facilitating cooperation between the national government, the private sector, and subnational entities. 131 Strong, high-powered incentives are often required to motivate private actors to engage in concerted action and create organizations that serve public or club goods rather than private interests. Quasi-rents-rents contingent o n performance and private-to- private collaboration-provide such an incentive (see B o x 6.4). Public subsidy in a well- designed supplier development program i s an example o f such quasi-rent. Private companies take the lead and share the major risk by jointly developing their SME suppliers. Yet the state might be willing to raise returns o n its investment in supplier development by subsidizing, for instance, continuous retraining o f workers, but only under certain conditions. The supplier program must actually deliver results in terms o f new SME suppliers developed, and their level o f employment and productivity. Thus, there i s a subsidy, but i t is contingent on the willingness o f large firms to organize a group o f potential suppliers, invest managerial time, and reform procurement procedures to open them up to new entrants. Rent opportunities, to be captured, require a lot o f the firm in terms o f thinking, doing, and risk taking. Consequently, there are not many takers: rent opportunity i s not necessarily a strong enough motivation to induce firms to do new things. Allocation o f quasi-rents i s therefore by self-enforcement and self-selection. Rather than the government picking winners, private agents choose to participate o n the bases o f their capability and propensity to innovate. 132 Box 6.4. Quasi-rents as a Motivation for Concerted Action The success o f Japan, the Republic o f Korea, and other Asian high-performers i s well known. While state activism has undoubtedly played a role, the particular aspects o f state intervention that were useful rather than counterproductive are debatable. An increasingly influential market-enhancing view pioneered by M. Aoki (1995) singles out government as a facilitator o f market institutions and o f concerted action t o create such institutions. Patents-temporary protection granted in exchange for successful commercialization o f R&D-is an example o f quasi-rents; i.e., rents contingent o n performance. Quasi-rents seem to be important when private risks are high, concerted action i s difficult, and high-powered incentives are required to elicit action. The major issue i s whether the government i s capable o f enforcing its o w n rules, to make sure that additional incentives are actually contingent o n performance rather than o n traditional lobbying. T o prevent self-dealing, it may be necessary to require substantial private effort before any government involvement becomes a possibility. Perhaps the best-known example o f quasi-rents i s export promotion in Korea. The government subsidized export credit to firms, but only o n the condition o f strong export performance. This system i s difficult to replicate. I t requires unusually strong monitoring and implementation capabilities o n the part o f government. In the age o f the knowledge economy, products and processes change so quickly and continuously that picking winners becomes more and more difficult. The challenge now i s t o pilot decentralized mechanisms based o n quasi-rents, as a motivation for private actors to innovate and engage in the creation o f new institutions that deliver public goods. I Source: Aoki et al. (1997). One example o f such new generation o f programs i s a pilot supplier development program into a national supplier development program that is broadly similar to the Irish linkage program discussed in Chapter 3. The outcome o f such a program i s improved quality, technology, and marketing and design capabilities o f suppliers, and a better quality o f inputs for buyers. For instance, a pilot application o f supplier development methodology prepared by NAFJN and UNDP, which involved five large Mexican buying firms and 24 SMEs as their strategic suppliers, resulted in the course o f a year in significant gains for small suppliers and large buying companies. The thrust o f the methodology is a coordinated private sector driven provision o f technical assistance (ranging from simple auto-diagnostics to ISO9OOO/ISO 14000 certification), and capacity building for small suppliers. The pilot group o f SMEs recorded a 46 percent increase in labor productivity, a 26 percent reduction o f inventories, and a 10 percent cost reduction; large buying companies reduced payment periods to small companies by 75 percent and increased the productivity o f their purchasing departments by 30 percent. To achieve those gains, buyers and suppliers relied upon, and adapted to their o w n needs, the whole gamut o f SME assistance programs. Hence a pilot supplier development initiative would provide a powerful impetus to redesign the public enterprise support infrastructure. The initiative would establish a coherent system o f supplier development with clear rules o f responsibility and accountability for private actors (buying companies, their suppliers, and financial institutions), state governments, and federal agencies. The 133 proposed system combines technical assistance and access to finance components at three levels: the company level, the regionalhluster level, and the national level (see Figure 6.2). On a company level (micro-level initiatives), interested large buying companies are starting to form institutes o f supplier development as a technical assistance vehicle, andor Fideocomisos AAA (company-level trust funds to finance suppliers). The proposed initiative would not finance the private institutes, but it would provide assistance to help redesign and fine-tune company-level supplier development efforts. On a clusterhegional level, large buying companies, in collaboration with Secretaries o f Economic Development o f state governments, would form small, private- sector-managed cluster institutes for supplier development (in the auto parts and fiutliture sector, for instance) to serve the collective needs o f a cluster. State governments and buying companies would provide financing for the institutes. On a national level, knowledge creation and the dissemination o f policy knowledge would be provided as a public good. T w o technical working groups (finance and technical assistance) would be formed to coordinate development and testing o f new products, and to monitor and evaluate the outcomes and impacts. The initiative would have an internet-based monitoring and evaluation module to facilitate documentation o f private and social gains from supplier development efforts and sharing o f experiences. As documented experience o f supplier development initiatives accumulates, a Private-Public Advisory Council, consisting o f top private and public leaders, would be formed to provide strategic direction to supplier development. 134 Figure 6.2. National Supplier Development Program Source: World Bank staff. National vision and leadership are key, but they cannot be constructed overnight. The concluding chapter o f this book explores Mexico’s regional diversity as an advantage t o be explored in the country’s transition t o a knowledge economy. 135 Chapter 7 Regional Leadership in the Transition to a Knowledge Economy This chapter shows how regional dynamics can become an entry point for a transition to knowledge-based economy. A taxonomy o f Mexico’s regions i s presented, and policy agendas are offered for each o f the four types o f states: advanced states (also described in the chapter as fragile leaders), emerging leaders, lagging states, and “dormant potential” states. In conclusion, the chapter outlines a new system for promoting subnational initiatives to enhance knowledge-based competitiveness. Mexican States and their Policy Agendas To capture diverse regional agendas that lay out transitions to a knowledge-based economy, we performed a modified knowledge assessment and constructed a knowledge economy index for each state. The knowledge assessment methodology and a construction o f an aggregate index follow the national methodology o f four pillar framework. I t is based o n 30 variables such as adult literacy and secondary enrollment for education pillar; patents for 1,000 people for innovation pillar, telephones lines per 1,000 people for ICT pillar. Yet it differs from i t in two features. We omitted the incentive regime pillar mainly because we lacked relevant data. W e added the economic performance pillar that includes such variables as GDP, FDI per capita, human development index, manufacturing productivity and number o f businesses per 1,000 people. As in national knowledge assessment methodology, variables are not weighted. Annex 6 provides more detailed description o f the variables. . The knowledge economy index i s closely correlated to a state’s GDP (see Figure 7.1). Figure 7.2 shows Mexican states divided (somewhat arbitrarily) into four groups: 0 The most advanced states (by the level o f the index) in central and northern Mexico; 0 “Emerging leaders,” central states with less-developed knowledge infrastructures but advancing rapidly; 0 Lagging states: southern states that are the worst three performers; 0 “Dormant potential” states that are below average but higher than the lagging states. Below we outline four regional policy agendas (see Table 7.1). All four agendas agree on the need to marshal existing knowledge assets (such as universities and research centers) to develop technology and technical assistance for addressing local needs and opportunities. 136 Figure 7.1 Mexico : Regional Knowledge Index and GDP per capita 5,000 1,000 5,000 LOO0 5,000 1,000 5,000 1,000 5,000 0.00 1 .oo 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 Knowledge Index (most recent) Source : World Bank Institute, Knowledge for Development Program, Knowledge Assessment Methodology, www.worldbank.orekam. 137 Figure 7.2. Knowledge Index by Mexican States Source: Staff calculations. Most recent year refers to 2001. Note: The distance from the 45-degree line indicates the improvement (above the line) or deterioration (below the line) o f the selected Mexican states between 1995 and 2001. T h e more advanced regions are concentrated toward the northeast quadrant o f the graph. 138 Table 7.1 F o u r Types o f States in Mexico and F o u r Policy Agendas Type o f state Source o f g r o w t h Promising M a j o r issue o r Policy recommendations Entry points a features threat Fragile National big Monterrey as an industrial A threat from low- Two-prong strategy: Develop leaders business hub o f Mexico cost countries : To take advantage o f Monterrey as a (mostly concentrated in exodus o f geography (proximity to the knowledge northern mature industries; Monterrey Institute o f footloose United States and Canada) technopolis states a n d maquila industry Technology as a model o f businesses improve infrastructure and Distrito and multinationals. private sector-driven decrease logistics costs; Promote supplier Federal) higher education and life- Increase the knowledge development long learning content of exports by program with big developing effective national business educational, innovation and and multinationals enterprise upgrading institutions Emerging Major Guadalajara as education, Exhaustion o f cost- Make a major stride in Deepen and leaders multinationals and culture, and based FDI : coverage and quality of strengthen (central and their value chains; manufacturing center o f transition to higher education knowledge-based central- emerging Mexico cluster-based clusters northern knowledge and growth Accelerate cluster processes states) service-intensive Technology development by enhancing academia- clusters centers o f General Motors industry linkages and in Toluca, IBM in efficient ‘bridge’ Guadalajara, GE in organizations Queretaro, and Motorola in Puebla “Dormant Natural resources “Transformando Volatility and (in Diversify the economy and Develop potential” (in particular Campeche” as a private- states such as increase value added o f infrastructure for a states mineral wealth) public effort to move up Zacatecas) decline natural recourses by retirement (Zacatecas, value chains and bring associated with the improving investment community (health Michoachn, knowledge-intensive reliance on mineral climate services and Hidalgo, business resources and engaging in investment leisure industry) Campeche, promotion and linkage Veracruz, Little pressure to promotion initiatives Utilize remittances San L u i s grow and reform : for community Potosi, migration o f infrastructure and Tabasco, reasonably micro-enterprise Nayarit, educated labor to development Durang) the United States. Lagging Tourism; Tourism development Increasingly Four-prong strategy: Develop viable states isolated industry disintegrating from strengthen the rule of law local suppliers for (Chiapas, enclaves Fondo Chiapas as a the rest of Mexico and increase credibility of a public sector and Oaxaca, controversial but public sector; strengthen large private firms; Guerrero) promising attempt at local public institutions support eco- concerted action through training and tourism based on twinning arrangements; cultural heritage improve quality o f basic and natural beauty education and reduce rezago endowments; educativo; accelerate local exploit the pockets o f vitality through potential o f careful private sector-driven counter cyclical interventions. tropical agriculture Source: W o r l d B a n k staff. 139 Fragile leaders Growth during the past ten years has come from f i r m s taking advantage o f NAFTA, using Mexico as an export base to sell to the North American market. However, Mexico has been losing i t s preferential trade status vis-a-vis other l o w labor-cost countries. As a result, many o f the firms, particularly in the electronics and garment sectors, have been emigrating to countries with lower costs. Fragile leaders (mostly northern states and Distrito Federal) face the challenge o f reinventing themselves in the context o f growing global competition (see B o x 7.1 for an illustration). They have the most advanced knowledge endowments o f any states in Mexico, but some o f them are losing their competitive edge. Border states have grown on the basis o f l o w labor costs and proximity to the United States. A s the result o f growth, they face congestion and higher wages. The exodus o f maquilas to China signifies erosion o f traditional competitive advantages and calls for a two-prong approach: take advantage o f geography (proximity to the United States and Canada) by improving infrastructure and decreasing logistics costs; 0 increase the knowledge content o f exports by developing effective educational, innovation, and enterprise upgrading institutions. Employment and growth have been generated by two quite different types o f agents. The first i s : national big business (with its capital in Monterrey), concentrated mostly in mature industries. Multinationals and maquilas comprise the second type o f agent. The issue with multinationals and maquilas i s l o w local content and (with very few exceptions, such as Delphi Engineering Center) a virtual absence o f innovative activities. T o increase local sourcing, there is a need for more active dialogue with multinationals to create supplier development programs. Well-designed supplier development programs put the private sector in the driver’s seat and can overcome numerous constraints faced by private business. Ireland i s a paragon o f developing efficient private sector-driven national linkage programs (see Chapter 3, Box 3.5). Monterrey-the industrial, financial, educational, and technological capital o f northern Mexico-symbolizes that region’s increasingly fragile success and is the k e y to its future. Monterrey i s home to national big business, Mexico’s largest private university (Technologico de Monterrey), and many other important institutions. Local businesspeople with national influence and an international perspective have spurred growth. The global expansion o f C E M E X and Latin American expansion o f F E M S A (Foment0 Economico Mexicano) became examples o f how to put knowledge to work in mature industries. Yet other mature industries (glass, steel, textiles, and petrochemicals) face significant challenges in transitioning to a knowledge-based economy. A point o f departure in this transformation is that Monterrey has many links to the United States, and especially to Texas. In this context, the government o f Nuevo Le6n i s developing a project o f regional integration o f Nuevo Leon with Texas and with the northeastern Mexican states o f Coahuila, Tamaulipas, and Chihuahua. At the center o f the program is Monterrey: Knowledge Technopolis, an initiative designed to take advantage o f the intellectual capital o f eight o f the best higher-education schools and research centers located in the city. Among these are the Tecnol6gico de 140 Monterrey and the Universidad Aut6noma de Nuevo Le6n. Together, these institutions can foster the development o f networks and intellectual capital, and thereby serve as the state’s innovation system. The aim i s to eventually develop a Latin American Route 128. This transformation will require concerted action by economic groups, technology and educational organizations, and the government. This i s not an easy task, yet the transformation o f Monterrey i s a litmus test for the whole o f Mexico. Mexico’s industrial transformation at the turn o f the twentieth century started in Monterrey; now, at the beginning o f the twenty-first century Monterrey can become a springboard for transformation to a knowledge-based economy. Box 7.1 Transition to Knowledge Economy: Example of Aguas Calientes Nation-wide agenda o f transition can be illustrated by the example o f Aguas Calientes. Aguas Calientes went through three quite distinct periods o f growth: 0 1970s. Mexico made the best o f import substitution during the 1970s. I t provided physical infrastructure to attract national firms, and the first multinational (Texas Instruments) arrived in 1979. 1980s and 1990s. Mexico sought good quality education and labor stability. Following passage o f the North American Free Trade Agreement (NAFTA) in 1994, a major expansion o f multinationals occurred in Aguas Calientes. Early 2000s. Emergence o f knowledge-based NAFTA agenda: promotion o f linkages, cluster and supplier development. (See Figure 7.3) Figure 7.3. Timeline of Transition to Knowledge-basedEconomy in Aguas Calientes 1970 1975 1980 1985 1990 1995 2000 2010 2020 . , . , ’. . . .. Source: SEDEC (2002). 141 DEmerging Leaders The states categorized as emerging leaders fall into two categories. The states in the first category, such as Jalisco, Guanajuato, Puebla and Queretaro are located in the center and center-north o f Mexico. They are characterized by high education and knowledge endowment, yet they face a lower level o f industrial and urban congestion than do the northern states. The emerging leaders signal Mexico’s future, as exemplified by the technology development centers o f major multinational corporations: General Motors in Toluca, IBM in Guadalajara, GE in Queretaro, and Motorola in Puebla. To take advantage o f the presence o f these MNCs, the government should put at the forefront o f the policy agenda the facilitation o f innovation clusters. This implies major advances in the coverage and quality o f higher education, and the enhancement o f academia-industry linkages and efficient bridging organizations. Cooperation i s at the center o f the art and craft o f facilitating innovation clusters. The emerging leaders have already demonstrated their capability for collective action, particularly under the guidance o f experienced tutors (see Box 7.2). The priority now i s to strengthen networks o f technology development organizations that are efficient and demand-driven. W e refer here to incubators to promote university-industry linkages, sectoral and industry technology development centers, and the venture capital industry. Second category i s the states such as Quintana Roo, Yucatan and Morelos which have both relatively high educational level and significant natural endowments. Those states were able to capitalise o n its endowments by attracting investments into service sector (tourism), agricultural processing and maquila investments. 142 Box 7.2. Adoption o f Organizational Knowledge: Innovative Supplier Development Program In 1996, eleven large companies in Guadalajara (domestic and multinational) signed a two-year voluntary agreement with Mexico’s Secretaria de Medio Ambiente, Recursos Naturales y Pesca. The agreement was t o mentor small suppliers in implementing environmental management systems (EMS). Each company invited two or three small suppliers t o participate in the pilot. The large companies and the W o r l d Bank provided the SMEs with funding for E M S training and implementation support. A team o f consultants-from two local universities and a foreign environmental management consulting firm-delivered the services. The a i m was t o adapt for small and medium-size enterprises the I S 0 14001 environmental management systems model originally designed for large firms; and evaluate the applicability o f the model and the sustainability and replication o f the pilot partnership. By late 1998, virtually all participating SMEs had made major advances in the implementation of I S 0 14001, in the reduction o f pollutants, and in their ability t o use general management systems. Based on this experience, the national government has begun to consider new environmental protection legislation. The success o f this supplier development program can be attributed t o four principal factors. First, the invitation to participate usually came from the mentor company rather than from the government or university. M o s t SMEs indicated that this was a vital source o f motivation and cooperation. While all participating firms had some sense o f ownership in the project, the presence o f a large company “champion” provided important assurance that their dedication was not misplaced. Second, the use o f the consultant network provided resources otherwise unavailable t o SMEs and even to many large firms. The network in effect provided a rapid response system; a diverse group o f experts drew o n one another’s s h l l s and knowledge to resolve local issues. Third, representatives o f local and national environmental authorities, although they attended the pilot’s sessions mainly as observers, contributed to the success o f the program. They focused managers’ attention o n the program, and prompted many o f them t o learn about the benefits and drawbacks of different standards and enforcement actions. Fourth, beyond the training in technical issues, the use o f benchmarks and an iterative, collaborative review process was beneficial. I t demonstrated new forms o f cooperation to participants at all levels and improved the information basis o n which they could build the next round o f efforts. I Source: W o r l d Bank staff. 143 “Dormant Potential ” States “Dormant potential” states depend almost exclusively o n low-value added natural resources. The resources can be abundant, and the states relatively prosperous (such as Tabasco, Campeche, and Veracruz), or in decline (such as mining in Zacatecas). As a consequence o f their relative decline, Zacatecas and Michoacan are characterized by very high labor migration to the United States and very high per capita remittances. Diversification o f local economies to move to higher value-added exploitation o f natural resources, services, and manufacturing is a main policy objective in those states. Knowledge-based services such as higher brand tourism (Box 7.3) can provide new employment possibilities for the labor force that currently emigrates to the United States. Some o f dormant potential states are characterized by the vicious circle o f l o w expectations, l o w demand for institutional change, and thus l o w investments and outcomes. To break this pattern from the private sector side, first movers-firms that enter new markets and do things differently-are paramount. Traditional top-down industrial policies to attract investments have a decidedly mixed record. In contrast, successful “light touch,” bottom-up interventions (in countries as diverse as Brazil and EU latecomers) suggest the following entry points: investment promotion (which includes promotion o f entry o f new national and global players). supplier development (particularly in states with natural resource wealth, such as Campeche and Tabsaco). Promotion o f microbusiness. Facilitation o f rural-urban linkages. Facilitation o f demand-driven business development services for SMEs. Public procurements as a means to develop local SMEs. Some o f the states are starting to move decisively in these directions. Transformando Campeche i s a promising private-public effort to develop high value-added services and manufacturing. Innovative programs to leverage donations o f migrants’ clubs in the United States have become best practice all over the world. (The clubs collect for community infrastructure development in the home communities.) In three-for-one programs, for instance, every peso o f these collective remittances i s matched by one peso o f federal and one peso o f state contributions. Hence, every peso o f a migrant generates three pesos o f investment. There are many promising beginnings. The challenge i s to transform promising pilots into a sustained effort to improve public service delivery, education, and the investment climate. 144 Box 7.3. Culture as a Key Intangible: Potential of High-Value Added Tourism Mexico has made significant progress in exploring i t s tourist potential, although it s t i l l lags significantly behind from countries such as Spain, France, and Italy. From a knowledge economy perspective, it i s important to note that tourists come to those countries not only to see a new destination but to taste and immerse themselves in a unique culture and history. Following those examples, Mexico needs to move to higher value-added tourism, which i s mainly about intangibles: reputation, exploration o f local culture and history, and sophisticated marketing capabilities on a global scale. Creation o f a “sense o f belonging”- ties to an ethnic, ,cultural, or religious community-is an important motivation for participating in such tours. For instance, local history tours can be developed in the states o f Michoacan and Zacatecas. The way history i s packaged into tourism in Annapolis, Maryland, i s one example. Such tours (along with tequila tasting and other higher value-added services) can be developed jointly and marketed first to Mexican migrants in the United States. T h e U.S.-born children o f Mexican migrants may prove to be a sizeable entry point for “nostalgia tourism.” Favorable conditions for the expansion o f North American retirement communities already exist in San Miguel de Allende and Cuernavaca. Engineering a resurgence o f Mexico’s once famous movie industry i s yet another opportunity. As always, private actors will need to assume major risks in exploring commercial opportunities related to such intangibles, but the state has a role to play in enhancing a favorable investment climate and bringing in international expertise to convert opportunities in commercial services. Source: World Bank staff. Lagging States Analysis o f knowledge endowments shows three southern states (Oaxaca, Guerrero, and Chiapas) t o clearly b e lagging states. T h e states face the most basic agenda o f building robust institutions. To that end the f o l l o w i n g four-pronged strategy i s recommended: Strengthen the r u l e o f l a w and increase the credibility o f the p u b l i c sector; Strengthen local p u b l i c institutions through training and twinning arrangements; I m p r o v e the quality o f basic education and reduce the “rezago educativo” (educational gap); Accelerate local pockets o f v i t a l i t y through careful private sector-driven interventions. In these states, the issue o f leadership, both private and public, l o o m s as the most significant challenge. Entry points to unleash private sector dynamism and to demonstrate tangible results are paramount, but they require patience and careful m o n i t o r i n g to transform good intentions into robust institutions. M a n y initiatives in the past (such as Fondo Chiapas) were w e l l conceived and showed substantial promise, but because o f weak management and p o o r monitoring by stakeholders, the promise was never realized. A s entry points f o r the lagging states, one can suggest the development o f viable local suppliers f o r public sector f i r m s and large private f i r m s as w e l l as eco-tourism based o n cultural heritage and natural beauty endowments. 145 Other countries under similarly adverse circumstances have demonstrated tangible improvements in areas traditionally believed to have little promise. The key to successful programs is clear leadership, capable o f breaking the grip o f entrenched interests, and governance structures that can unleash bottom-up initiatives. Chiapas has recently developed a number o f initiatives to strengthen local government capacity, such as a network o f e-government kiosks to speed the delivery o f public services and reduce corruption. These initiatives need to be evaluated and expanded. Institutional Design o f a National System to Promote Transition to Knowledge-based Economy A diversity o f innovative local initiatives exists in Mexico. Many o f them have been described in preceding chapters. What is sorely needed i s a robust mechanism to facilitate, monitor, and scale up these initiatives as a new role for federal government. The challenge o f such new governance structures i s not unique for Mexico. All countries, including OECD economies, face i t quite acutely. OECD economies such as Ireland, Finland, or the Republic o f Korea, and emerging economies such as China, have become examples o f so- called pragmatic agendas that put innovations in governance at the center o f policymaking and implementation. A favorable climate for institutional innovation i s one pillar o f the new pragmatism, which entails, inter alia, the capability for evaluation, and in particular, the ability to distinguish between successes and failures, and the ability to scale up successes. Designing a system o f new institutions consistent with the knowledge- driven NAFTA agenda i s an open-ended process based on a diversity o f institutional innovations. Every detail o f the second-generation NAFTA institutional architecture cannot be planned now. The details can be discovered only through careful, and carefully monitored, experiments. A national system to promote local initiatives i s likely to rely on the following building blocks: a federal private-public governance council that endorses proposals to promote knowledge-based competitiveness o f states and firms; a network o f top-notch managerial teams that design and manage competitiveness programs; first-rate managers similar in caliber to the technocrats who negotiated NAFTA; a mechanism to scale up and diffuse good projects; allocation o f resources contingent on the results o f evaluation and continuous monitoring; technical assistance, particularly to weak actors (less-developed states and SMEs), to prepare knowledge-based projects. 146 T h e basic institutional architecture o f a national system to facilitate, evaluate, and scale up l o c a l innovations may take various f o r m s but should comprise these elements: 0 A distinct regulator and financier at the national level; An independent management unit; 0 A diverse array o f national and international service providers. A National Advisory Council A distinct regulator and financier at the national l e v e l are needed. Ideally, a private-public council with substantial private sector participation would define the rules o f t h e game (in a statement o f policies and operating procedures) and ensure t h e satisfactory functioning o f those procedures. A national institution with a leadership mandate in this area, such as the Secretary o f Economy, c o u l d h e l p by pooling experience, so that successful innovations are rapidly i d e n t i f i e d and failures are quickly exposed; it would p r o v i d e the common infrastructure needed by all regional economies. Major organizations such as Bancomext, Consejo N a c i o n a l d e Ciencia y Tecnologia (CONACYT), Nacional Financiera (NAFIN), and Secretaria d e l Trabajo y Prevision Social (STPS) would b e represented on the c o u n c i l to h e l p ensure, among other things, that distinct public entities do not o f f e r similar programs with d i f f e r i n g subsidy rates. Private sector participation i s essential to ensure transparency, with conflicts to b e resolved by t h e presidency. T h e council would accelerate the formation o f champions and managers to create n e w programs and organizations (see Box 7.4). Box 7.4. Scan Globally; Experiment Locally: Developing Managerial Capability Transition t o knowledge-based economy needs t o be supported by a corps o f men and women, comparable in terms o f talent, training, and dedication to those who directed opening to trade, privatization, deregulation, and the negotiation o f international treaties with the United States and the European Community. The nucleus o f the group would be people who have already emerged from states, such as Jalisco and Chihuahua, which pioneered the process o f concerted problem solving. This nucleus would be supplemented with new recruits drawn from recent university graduates, Mexican nationals working in international agencies, and those with master’s degrees and PhDs returning f r o m study abroad. The salary scale and reward structure should be competitive with the private sector, and for the nucleus o f experienced state officials, they should be paid an amount o n a par with the salary for the position they presently hold. Initial training for this group could follow the model Harvard University has developed for the orientation o f newly elected representatives and senators in the U.S. Congress. That model i s used to train the newly appointed staff o f international agencies (for example, the director general o f the International Labor Organization. A four-week program organized and led by a Mexican university i s envisaged. While the program would draw primarily on Mexican university faculty, it might be supplemented by guest lectures by business leaders, government officials, and foreign experts. The Harvard model focuses o n classroom training in economics and management. The Mexican model should also include direct exposure in the field to operating programs in several different states- and in at least one developed country, such as in the United States, and one developing country, such as Chile. The training o f recruits should expose them to this valuable international experience. I Source: W o r l d Bank staff. 147 To allocate funds among the states, the National Advisory Council could rely o n matching grants from the federal government, implement a ranking system based o n measures o f economic performance, or encourage competition for open-ended projects. Matching grants Under the current matching grants program, the federal government agrees to match every peso, up to a certain limit, that state governments dedicate to economic development projects. Those projects are decided in collaboration with private actors, o n the condition that thee actors match the state contribution as well. The idea i s simply that if the regional government and economic actors are willing to put their own money at risk to finance the projects they define together, then the federal government can assume that their choices are well considered, and add its backing as well. The advantage o f this method is that it imposes some discipline o n project selection, with almost no increase in red tape. The economic actors, public and private, at the regional level are given an incentive to sort through their priorities and start looking for potential problems; and the federal government limits itself to ratifying their provisional decisions as they emerge. One shortcoming o f the program i s that it foresees little sharing o f experience at the national level. The lack o f formalization o f experiences weakens decision making o n projects. Word o f success presumably gets around, but the process o f deliberation about prospective projects and projects that are, in fact, working remains a black box from the official point o f view. Political and bureaucratic meddling i s discouraged, but at the price o f a kind o f willful ignorance concerning what the actors might be learning. The second drawback o f the matching grants approach i s that it funds those who are on the verge o f funding themselves. I t thus comes close to violating the fairness requirement, even though its operation is nothing but even-handed in the way it treats like contenders for funds. The business climate ranking system The second framework for allocating funds among the states also imposes discipline o n project selection while holding bureaucracy and the politics o f clientelism in check. However, it does this, not by ratifying the actors’ decisions, but by providing information on economic performance that causes actors to reff ect o n the possibilities in new ways. The crucial idea could be the creation o f a league o f regional economic performance.] Projects would be ranked based o n these benchmarks o f performance: 1. Business registration - cost (for all areas, cost includes time, and formal and informal types o f payments and contributions, including bribes), procedures required, and delays; 2. Business licensing - numbers and types required, cost, time, and payments required; 3. Obtaining business premises - procedure, costs, constraints, delays; 4. Import and export regulation, customs procedures, costs, delays; 5. Product inputs and equipment certification - types, incidence, procedures, costs, delays; 6. Tax administration - requirements, constraints, costs, and number o f taxes and forms; 148 7. Business inspections - types (and agency responsible), costs, number, process followed. Competition for open-ended projects This third framework uses benchmarking to select projects and to force discussion about the criteria o f project selection. Very generally, it operates on two levels. At the top level, a committee o f the relevant government entities and qualified private actors, domestic and foreign, collaborates with potential users to establish the criteria for participation and the initial metrics by which applications are to be ranked. At the bottom level, project groups compete to present projects that score highly under the emergent criteria. After each round o f projects, the selection criteria and benchmarks are adjusted to reflect improved measures o f performance and a richer understanding o f success. At least two variants are imaginable, depending on whether projects concern states or other broad jurisdictions o f government o n the one hand, or groups o f firms typically operating in many different political jurisdictions on the other. Consider, as an illustration o f the first possibility, a national program to improve the business environment along the seven dimensions listed above. As the states, by their particular regulations and practices, define distinct business environments, the collaborative elaboration o f benchmarks and selection criteria will necessarily entail a joint effort by representatives o f the states, national institutions, and private sector. Project funds are then allocated to states according to the criteria and actual rankings; states will allocate the funds they have received to individual projects, applying the national procedures and criteria where appropriate, and augmenting them with local ones, as required. Competition for funds drives efforts to improve. States that do not rank well initially-and projects within high-ranking states that fare poorly in early selection rounds-will be eligible for technical assistance according to criteria established, again, through national and local collaboration. The types o f technical assistance, and the level o f funding, will be adjusted in a rhythm synchronized with the revisions o f the performance metrics and selection criteria. The disadvantage o f this open-ended program regards governance. The criteria selection committee creates opportunities for abuse that are avoided in both the matching grant and business climate benchmark schemes. The dangers can be mitigated, in part, by emphasizing procedures: making the use o f transparent methods for selecting program officers and project members a formal criterion for selection, and then using the information that these procedures produce to identify suspect operations. Again, the nature o f the projects themselves, and the information they produce about interim results, reduce the threat o f corruption or cronyism. The active involvement o f outsiders with incentives to denounce collusion can help as well. An Independent Management Unit To ensure that there i s no conflict o f interest in funding decisions, the unit responsible for administering resources and intermediating between supply and demand ideally should be independent and follow transparent operating procedures for resource allocation. The 149 resource allocation procedures should be designed to minimize any tendency toward corruption and clientelism. The procedures could follow the principle o f first come first served, to attempt to lessen discretion in the allocation o f subsidies, or they could stipulate a more elaborate contest where entrants (enterprises and associated public and private service providers) would have to explain their accomplishments to date and how they could become stronger through activities they propose. The management unit also might actively promote the benefits o f utilizing support services and offer advice (for example, on how to decide the type o f service that would be most beneficial). Currently, there are at least two management unit models in Latin America: (i) an externally hired contracting company under a management service agreement (usually backed up by the resources and reputation o f an international consultancy) and (ii) an independent local institution with complete financial and operational autonomy from the government. W e envision a somewhat different model, which stresses the re-direction of existing institutions. The local management unit could be a committee composed o f representatives o f existing service organizations, potential new entrants, and qualified representatives o f private firms (such as the director o f the purchasing department o f a multinational, with long experience in new supplier relations). National and International Service Providers National and international service providers are usually private sector consultants, but they could be service providers from the public sector, as long as they charge for their services and compete o n an equal basis with private providers. To ensure that any service provided to the enterprises i s relevant and needed, enterprises should contribute a strong share o f the financing themselves, typically at least 50 percent, toward the cost o f fees and expenses associated with external support services. Conclusion Although stakeholders may agree that certain characteristics, such as a decentralized and demand-driven mechanism, are desirable, different approaches in different localities under one umbrella demonstration program should be tested. (For example, using an existing or restructured institution as the management unit could be tested and compared to using an external contractor as the management unit.) Following preparatory discussions in various localities, Caintra may be determined an appropriate choice as a management unit in Monterrey. On the other hand, in a region with weak local institutions, the independent management unit might be a private contractor from a foreign country. (It then would progressively substitute local staff for foreign staff as knowledge i s transmitted.) As a general rule, institutional creativity i s the name o f the game. A transitional scheme may be required to gradually transfer financing and service provision from the federal level to the subnational level and to independent service providers. Many elements o f the proposed mechanism already exist. Fondos mixtos y sectorides promote local initiatives. CONACYT, the Ministry o f Economy, and other federal agencies reach out to movers and shakers in the private sector. 150 The transition to a system o f new capabilities and institutions, consistent with the knowledge-driven “NAFTA plus” agenda, i s an open-ended process. I t involves diverse institutional innovations designed to generate credible commitments among stakeholders. I t would be impossible to describe every detail o f the architecture o f the knowledge-driven NAFTA. An exciting if pragmatic agenda lies ahead for Mexico. Such an agenda can only be developed by Mexico itself. Our objective was to provide input to the evolving debate by calling attention to the stakes, the issues, and the accomplishments to date. The challenge now is to transform many promising discrete initiatives into a critical mass o f changes that will trigger Mexico’s rapid transition to a knowledge-based economy. 151 Annexes 1. Theoretical Framework for Growth Projections 2. Knowledge Assessment Methodology (KAM) 3. Comparator Scorecards for Mexico, United States, Republic o f Korea, China, and Ireland 4. Data for the Scorecards o f Mexico, United States, Republic o f Korea, China, Ireland, and Spain 5. Performance, Economic Incentive Regime, Governance, Education, Innovation, and Information and Communications Technologies: Scorecards for Mexico, United States, Republic o f Korea, China, Ireland, and Spain 6. Variables for State-level Knowledge Assessment 152 Annex 1:Theoretical F r a m e w o r k f o r G r o w t h Projections Decomposition o f Economic G r o w t h Theoretical F r a m e w o r k In this total factor productivity decomposition exercise, w e consider a neoclassical aggregate production function that accounts for the quality o f labor. For simplicity, we assume a human-capital augmented version o f the Cobb-Douglas production function along with perfect competition and,constant returns to scale Y A K" (HL)'-" where Y i s the level o f aggregate output K i s the level o f the capital stock H i s the level o f the human capital stock L i s the size o f the labor force A i s total factor productivity a i s the share o f capital in national income Taking logs and time derivatives and rearranging, leads to the estimate o f growth rate o f total factor productivity with human-capital augmentation: f - a I?- (1- a @ + i ) where k represents the growth rate o f variable X Following Woessmann (2000), we specify human capital stock to have the Mincer specification with the simplest form being where r is the market returns to education S i s the average years o f schooling 153 Data Sources Real GDP (in constant 1995 US$) and labor force figures were taken from the World Development Indicators 2003. The capital stock was constructed using gross capital formation (in constant 1995 US$) obtained from the World Development Indicators 2003. The perpetual inventory method was used with an assumed depreciation rate o f 5 percent. To calculate the initial value o f the capital stock, we used the average growth rate o f gross capital formation for the first 5 years and applied the formula for the sum o f an infinite geometric progressive series. Estimates for the returns to education for Ireland, South Korea, Mexico were taken from Bils and Klenow (2000). In the case o f Finland, there i s no available data o n the returns to education. As such, we used as a proxy the average o f 17 high-income countries for which there was available data provided in Psacharopoulos (1994). As for the average years o f schooling, we used the simple average o f the estimates obtained from Barro and L e e (2001) and Cohen and Soto (2001). Note that given that data for the average years o f schooling were available only on a decade basis, we used interpolation by growth rates to obtain annual estimates o f the average years o f schooling in order to construct the human capital stock on an annual basis. The estimates for the labor shares in national income for South Korea and Finland were taken from Gollin (2001), while that for Ireland and Mexico were taken from Bemanke and Gurkaynak (2001).' Results Table X presents the results o f the TFP decomposition. Our annual growth rates o f TFP were averaged to produce decade averages2. Annual Growth Rates of Total Factor Productivity (in percent) Ireland Finland South Korea Mexico 1961-1970 2.8691 0.5301 0.2922 1971-1980 2.8346 1.3350 -0.1400 0.4048 1981-1990 2.2632 0.9824 2.8704 -2.5922 1991-2000 4.2404 1.5278 1.8207 -0.1286 The estimate for labor share for Ireland, South Korea, Finland and Mexico was 0.750, 0.796, 0.680 and 0.59, respectively. The capital shares were obtained by taking 1 and subtracting the respective labor shares. * Note that for Ireland, gross capital formation data were not available prior to 1971. As such, the average annual growth rate o f TFP for the period 1971 to 1980 for Ireland in the above table i s in fact the average for 1972-1980. 154 Projections In this section, we produce some projections for Real GDP per capita for Mexico for the years 2001 to 2020 using different assumptions for the growth rate o f TFP. With reference to Figure X, Projection I plots the path Mexico’s Real GDP per capita would take if the TFP growth rate were to take i t s 1991-2000 average value, i.e. -0.13 percent per annum. Projection 2 plots the path Mexico’s Real GDP per capita would take if the TFP growth rate were to take 2 percent annum, which i s close to the 1991-2000 decade average for South Korea. Projection 3 plots the path Mexico’s Real GDP per capita would take if the TFP growth rate were to take 3 percent annum, which i s close to the 1961-1970 decade average for Finland. Lastly, Projection 4 plots the path Mexico’s Real GDP per capita would take if the TFP growth rate were to take 4.25 percent per annum, which i s approximate value o f the 1991-2000 decade average for Ireland. Note that for all 4 projections, capital, labor and human capital were all assumed to grow at their 1991-2000 average growth rates for Mexico, which are 3.32 percent, 2.75 percent and 0.92 percent, respectively. 1-5 23,500 US - Mexico: Real GDP Per CaDita Alternative Proiections 2001 -2020 -Actual 21,500 -Projection - 1: 0.13 % TFP Growth -Projection 2: 2% TFP Growth (South Korea) 19,MO ........................... -Projection 3: 3% TFP Growth (Finland) -Projection 4: 4.25% TFP Growth (Ireland) 17,500 ........................................ 15,500 ...................................................................................... 13,500 ..................................................................... .................. 11,500 ..................................... ........................................ 9,500 . ... ... ... ... ... ... ... ... .. 7.500 i 1995 2000 2005 2010 2015 2020 Year 155 Alternative Methodology An alternative methodology for computing TFP involves not explicitly accounting for the contribution o f human capital as a separate factor o f production. This implies that the effects o f human capital are aggregated into total factor productivity. From a conceptual standpoint, this methodology is more consistent with the Knowledge Economy framework, which asserts that the contribution o f knowledge to economic growth encompasses the contributions from economic and institutional regime, innovation and technological adoption, I C T infrastructure and human capital. As in the first methodology, w e consider a standard neoclassical aggregate production function that assumes a Cobb-Douglas specification together with perfect competition and constant returns to scale: Total factor productivity (TFP) is then derived as the residual after accounting for the contribution o f labor and capital to aggregate output. More specifically, Next by taking logs and time derivatives, and then rearranging, we obtained the estimate o f growth rate o f total factor productivity: f - a K - (1- a)i where 2 represents the growth rate o f variable X Table below presents the estimates o f the growth rates o f total factor productivity resulting from this second growth decomposition exercise. The annual growth rates o f TFP were again averaged to produce decade average^.^ For t h i s second decomposition exercise, recently updated data from the World Development Indicators 2005 were used. Real GDP was in constant 2000 US. dollars, whereas in the first decomposition exercise Real GDP was in constant 1995 US. dollars. Also, the capital stock here was constructed using gross FIXED capital formation (in constant 2000 US. dollars), which excludes net inventories as a part o f investment, making i t a more appropriate series for the construction o f capital stock. 156 Annual Growth Rates of Total Factor Productivity (in percent) Ireland Finland South Korea Mexico 1961-1970 3.03 2.08 1.01 1971-1980 3.15 1.86 I.48 0.90 1981-1990 2.74 1.68 4.28 -1.69 1991-2000 4.48 1.58 2.36 0.22 2001-2004* 1.42 2.49 -1.41 1991-2004** 1.54 2.39 -0.24 A summary table below summarizes results of productivity estimates o f other authors (see general bibliography for references), 157 nations of Total Factor Productivity Decline in Mexico Key findings (2002) - TFP in Mexico and C h l e dropped during the 1980s. Output in Chile returned to a growth path, bui Mexico never recovered, and two decades later it s t i l l i s 30 percent below the trend for Latin America. - Comparative evidence does not support the notion that t h s recovery was due to exports or to largc external debt. - The differences in economic performance in Mexico and Chile can be explained by the different timing oj structural reforms in the two countries. - The crucial difference in performance i s explained by the reform o f banking and bankruptcy laws. I Bosworth -The economic collapse in Mexico o f the early 1980s created a persistent disequilibrium situation in which large portions o f the labor force are effectively underemployed. -After 1988 the growth in output was barely adequate to match the expansion o f factor inputs, and there was little or n o increase o f capital. -Despite an enormous expansion o f foreign borrowing, Mexico has been unable to generate an expansion o f capital stock commensurate with the growth in the labor force. -TFP reflects greatly increased allocative inefficiencies; an excess supply o f workers has pushed workers into jobs below their normal s k i l l levels since the 1980s. -There has been a failure o f investment despite reform measures; Mexico needs a much higher level o f investment if it i s to provide the future capacity to sustain growth. - Mexico needs ways to smooth the flow o f jobs from the informal sector (low technology) to the formal sector. -TFP growth was faster when Mexico was “reformed”; in fact, average TFP growth has been negative in Lederman the periods o f no reform, possibly due to the fact that recessions have been frequent during t h ~ time. s (1 995) -Measured growth in productivity i s subject to the effect o f short-term fluctuations, which can obscure the impact o f reforms on long-run economic Performance. Hallberg, Tan: -For the manufacturing sector as a whole, TFP growth accelerated between 1993 and 1995, from an and Koryukin- annualized growth rate o f 0.6 percent to 13.8 percent. Subsequently, TFP growth rates declined, to 1.3 (2000) percent in 1995-1996, and turned negative in 1996-1997. -Nonexporters had less TFP growth than exporters during this period. -Learning through exporting i s taking place. While the immediate productivity gains from exporting are modest, sustained productivity gains accrue as experience accumulates. Overall, firms learn and improve productivity through experience with exporting, specifically with years o f experience as suppliers. -Firm-level productivity i s improved by investments in worker training and implementation o f quality control practices. L6pez-Cordoba -Mexico’s total factor productivity performance from the early 1980s through the mid-1990s was rather (2002) disappointing, with average annual growth between -1 and - 2 percent. -Exporting does not have a positive effect on TFP growth; in fact, being an exporter appeared to be negatively correlated with productivity growth. -There i s strong support for the view that trade competition fosters improvements in productivity, but there i s at best scant evidence that improved access to more and better intermediate inputs translates into productivity growth. -Foreign capital participation reduces productivity, but FDI in industries in which a plant has backward or forward linkages has a significant and positive effect. -The source considers only labor productivity. (2003) -Schooling has a high impact on wages and productivity; the slow growth in labor productivity in Mexico could be the result o f the l o w education level. -Investment in human capital magnifies technology-driven productivity gains, but Mexico has not invested enough in human capital. -Findings suggest that training obtained outside o f firms increases productivity, but Mexico has underinvested in outside training, as can be seen by the high percentage o f in-house training. 158 References Barro, Robert J. and Jong-Wha L e e (2001). “International data on educational attainment: updates and implications.” Oxford Economic Papers, Vol. 3, pp. 541-563. Bernanke, Ben S. and Refet S. Giirkaynak (2001). “Is Growth Exogenous? Taking Mankiw, Romer and Weil Seriously.” National Bureau o f Economic Research Working Paper 8365, July. Bils, Mark and Peter J. Klenow (2000). “Does Schooling Cause Growth?” American Economic Review. Vol. 90, No. 5 (December), pp. 1160-1183. Cohen, D a n i e l and Marcel0 Soto (2001). “Growth and Human Capital: Good Data, Good Results.” Technical Papers No. 179, OECD Development Centre, September. Gollin, Douglas (2001). “Getting Income Shares Right.” Working Paper, Williams College, January. Psacharopoulos, George (1994). World Development. Vol. 22, No. 9, pp 1325-1343. Woessmann, Ludger (2000). “Specifying Human Capital: A Review, Some Extensions and Development Effects.” K i e l Institute o f World Economics, Working Paper 1007. G e l , Germany. 159 Annex 2: Knowledge Assessment Methodology (KAM) The KAM i s a user-friendly tool designed by the World Bank Institute to help client countries assess their ability to compete in the global knowledge economy (World Bank 2005). I t estimates a country’s preparedness to compete in the knowledge economy through a series o f relevant and widely available measures. A set o f 76 structural and qualitative variables (available for 121 countries) benchmarks h o w an economy compares with other countries. The KAM helps to identify the problems and opportunities that a country faces, and where it may need to focus policy attention or future investments. The unique strength o f the Knowledge for Development (K4D) methodology i s its cross- sector approach that enables the user to take a holistic view o f a wide range o f relevant factors rather than focus only on one area. The 76 variables serve as proxies for the four areas (pillars) that are critical to the development o f a knowledge-based economy: economic and institutional regime, education, innovation, and information and communications technologies (ICTs. Also included within the 76 variables are several measures that track the overall performance o f the economy. Normalization Procedure for the K A M 1. The raw data (u) i s collected from World Bank datasets and international literature for 76 variables and 121 countries. 2. Ranks are allocated to countries based o n the absolute values (raw data) that describe each and every one o f the 76 variables (rank u). Countries with the same performance are allocated the same rank. Therefore, the rank equals 1 for a country that performs the best among the 121 countries in our sample on a particular variable (that is, it has the highest score), the rank equals to 2 for a country that performs second best, and so on. 3. The number o f countries with worse rank (Nw) i s calculated for each country. 4. The following formula i s used in order to normalize the scores for every country on every variable according to their ranking and in relation to the total number o f countries in the sample (Nc) with available data: Normalized (u) = 10*(Nw/Nc). 5. The above formula allocates a normalized score from 0 to 10 for each o f the 12 1 countries with available data o n the 76 variables. 10 is the top score for the top performers and 0 the worst score for the lagging economies. The top 10 percent o f performers receive a normalized score between 9 and 10, the second best 10 percent receive allocated normalized scores between 8 and 9, and so on. A s mentioned earlier, more than one country can be allocated either the best or worst normalized scores. The 0-10 scale describes the Performance o f each country on each variable relative to the performance o f the rest o f the country sample. More information o n the KAM, its functionalities, technical notes, data sources, and a user guide are available on i t s website: www.worldbank.org/kam. 160 Annex 3: Comparator Scorecards for Mexico, United States, the Republic of Korea, China, and Ireland Mexico GDP growth(%) United States GDP growty%) Internet users per 10,000p e o p l e A H u m a n Development Index Hernet users Der 10.000 Dmde AHuman Devehment hdex Computers per 1,WO peop riff8 nontarlff barriers Computers per 1,000peo iff 8 nontariff barriers Telephones per 1,000 people RegulatoryQMlliy Telephones per 1,ooO people Regulatory Quatty Tertiary EnrOllment Rule of Law Tertiary Enroiiment Rule of Law Secondary Enrollment Researchersh RBD /million Secondary Enrollme searchers in R8D / million Adult literacy rate (% age 15 and above- Scientific and techrkal purnal arllcles /mlpqr.Adunliteracyrate(%age15andabov ientlfk and technicsljournalsltiiks / Pat& applications granted by the USPTO / mil pop. Patent applicetims granted by the USPTO ImH pop. South Korea . China GDP growth(%) GDP growth(%) Mernet users per 10,000 p Development hdex Mernet users per 10,000 pea n Dev-ent W x Computers per 1,WO peop riff 8 nontariff barriers Compblers per 1,000 pco rlff 8 mntartff barriers O Telephones per 1, M peaple Requiatory Gudby Tekphones per 1,000 pe Regulatory ckralty Tertrwy Enrollment Rule of Law Teii!ary Enrol R*e 01 Law Secondary Enrollme esearchers in R8D lmllion Secondary Enrollm searchers VI R8D / m Oam Ad* Iteracy rate (%age 15 and above) cientiftc and technicalpima1articles I mil pop W l t literacy rate (% age 15 and ab ntiftc and technical purnai amcks / mi pop Patent applicationsgranted by the USPTO/ MI pop Patent applications granted by the USPTO I mll pop IreIand Spain GDP growth(%) GDP growth(%) Mernd users per 10,Doo peopl uman Development hdex Merne?users per 10,ooDw p l an Development hdex Computers per 1 ,OW people Tariff 8 nontariff barriers Computers per 1,000 pe riff 8 mntilfl barriers Telephones per 1 ,OW people Regulatory Qualty Telephones per 1,000 people RegulatoryQuellty Tertiary Enrollment Rule 01 Law Tertiary Enrollment Rule of Law Secondary Enroilme esearchers in R8D /minion Secondary Enrollm searchers m R8D Imillion Adult Meracy rate (%age 15 and ab nttftc and techntcalpurnal atticles lmd pop Adub Yeracy rate (% age 15 and I m d t e c h c a l purnai articles I C mll pop Patent applicationsgranted by the W T O / MI pop Patent appliahms granted by the USPTO Iml pop - - - - - 1995 most recent 161 I I . . or- c\1 W 92 w m 3 TF 0 -m gz r-(D Q, I I .. zz b- 0 " 9 r-r- $& .. . d 2s 2: a22 m r - or- O b . . . . . . 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