Report No. 25666-CL Chile New Economy Study (In Two Volumes) Volume II: Background Documents February 18, 2004 Finance, Private Sector and Infrastructure Latin America and the Caribbean Region Document of the World Bank CURRENCYEQUIVALENTS US$1.00=0.00138Chilean Pesos (March2003) FISCAL YEAR January 1-December31 MAIN ABBREVIATIONSAND ACRONYMS ACTI Asociacidn Chilenade Empresasde Tecnologiasde la Informacidn ASP ApplicationServiceProvider ATCH Asociacidnde Telecentristasde Chile B2B Businessto Business B2C Businessto Consumer CAGR CompoundedAnnual GrowthRate ccs Ca'marade Comerciode Santiago CFT Centrosde Formacidn Ticnica COMET CommercialisingEmergingTechnologies CONICYT ComisidnNacional de Investigacidn Cientipcay Tecnoldgica CORFO Corporacidnde Foment0 de la Produccidn CPP Call Party Pays CRM CustomerRelationshipManagement CTC CompafiiaTelefdnicade Chile e-CRM E-CustomerRelationshipManagement ED1 ElectronicData Interchange ERP EnterpriseResourcePlanning E-SCM E-Supply Chain Management FAT Fondo de Asistencia Ticnica FDI Foreign Direct Investment FDT Fondode Desarrollo de Telecomunicaciones FONCAP FondoNacional de Capacitacidn FONTEK FondoNacional de Desarrollo Tecnoldgicoy Productivo FOSIS Fondo de Solidaridad e Inversidn Social G2B Governmentto Business G2C Governmentto Citizen G2G Governmentto Government GLT Ley Generalde Telecomunicaciones GNI GrossNational Income IADB Inter-AmericanDevelopmentBank IALS InternationalAdult Literacy Survey ICT Informationand CommunicationsTechnologies IMF InternationalMonetary Fund INDAP Institutode DesarrolloAgropecuario INE InstitutoNacional de Estadistica INTEC Corporacidnde InvestigacidnTecnologia IP InstitutosProfesionales IPR IntellectualProperty Rights ISP Internet Service Provider LRIC Long Run Incremental Cost LRTC Long Run Total Cost MINECON Ministeriode Economia MINEDUC Ministerio de Educacibn MSB MicroandSmallBusinesses MSI MillenniumScience Initiative MSMB Micro, Small andMediumBusiness MVA ManufacturingValue Added NOIE Australia's NationalOfficefor the InformationEconomy NPV NetPresentValue OECD Organizationfor EconomicCooperationandDevelopment PCS PersonalCommunicationServices PDF PooledDevelopmentFunds PPP PurchasingPower Parity SENCE , I ServicioNacional de Capacitacibny Empleo SERCOTEC Programa de Fomento Productivo del Servicio de CooperacibnTkcnica SIMCE Sistemade Medicibnde la Calidad de la Educacibn SME . SmallandMediumEnterprises SNED SistemaNacional de Evaluacibn del Desempeiiode 10s Establecimientos Educacionales Subvencionados TFP TotalFactorProductivity TIMSS Third InternationalMathematicsandScience Study TRIPS Trade-RelatedIntellectual PropertyRights UDF Universidad de la Frontera UF Unidad de Fomento UNCITRAL UnitedNationsConferenceon InternationalTradeLaw WEF World EconomicForum WLL Wireless LocalLoop WTO World Trade Organization Vice President: Davidde Ferranti Country Directors: Axel vanTrotsenburg andMyma Alexander Sector Director: DannyLeipziger Sector Leader: Juan Gaviria SectorManager: SusanGoldmark Task Manager: MarialisaMotta CHILE NEWECONOMYSTUDY MAINVOLUME 11 TABLEOF CONTENTS ACKNOWLEDGEMENTS.. .................................................................................................. .i INTRODUCTION...............................................................................................................u .. I.ASSESSMENTOF CHILE'S POSITIONINTHE KNOWLEDGEECONOMY .................................... 1 A. AGGREGATE INDICATORSOFECONOMIC PERFORMANCE ........................................ 1 B. ECONOMIC INCENTIVEAND INSTITUTIONALREGIME ................................................................................................. .............................................. 10 C. EDUCATIONAND TRAINING 23 D. INNOVATIONSYSTEM ............................................................................................................. 35 II. INFORMATIONANDCOMMUNICATIONTECHNOLOGYSECTOR......................SS CHILE'S A. EXCUTIVE SUMMARY ....:............................................................................... .55 B. INTRODUCTION .................................................................................................................... 59 C. ICT, INCOMEGROWTHANDPRODUCTIVITY LESSONSFROM - INTERNATIONAL EXPERIENCE ...................................................................................... 60 D. TELECOMPOLICIESAND INFORMATIONINFRASTRUCTURESERVICESIN CHILE ....................................................................................................................................... 67 E. ICTFOR THE POOR: STRIVINGFORUNIVERSAL ACCESSAND USE..... ...............77 F. GOVERNMENT INITIATIVES TO MOVETOWARDSUNIVERSALACCESSAND USEOF ICT ................................................................................................................................. 82 G. ICTPRODUCTION: (NOT MUCH)POTENTIALFORTHEHIGHTECHNOLGY INDUSTRY INCHILE ................................................................................................................ 99 H. CONCLUSION ........................................................................................................................... 104 III.ACCELERATEE-BUSINESSFORSMALLBUSINESSINNOVATIONANDGROWTH ...........107 A. INTRODUCTION ...................................................................................................................... 107 B. CHILE'S SMALL BUSINESSSECTOR ................................................................................. 108 C. E-BUSINESSFORINNOVATIONAND GROWTH ............................................................. 109 D. ACCELERATING E-BUSINESSDEVELOPMENT ...................................................................... ............................................................. -124 E. CONCLUSIONSAND RECOMMENDATION 138 REFERENCES ................................................................................................................................................. 142 ACKNOWLEDGEMENTS This report was prepared by a team composed of Danny Leipziger, Marialisa Motta, Carl Dahlman, Peter Scherer, Anuja Utz, Douglas Zeng, Aimilios Chatzinikolaou, Charles Kenny, James Hanna and Robert Vickers. The report benefited from background papers prepared by Lauritz Holm-Nielsen, Alejandro Jadresic, Natalia Agapitova, Thomas Nikolaj Hansen, and Patricia Garcia Zuniga. At various stages, Pablo Fajnzylber (World Bank), Eduardo Bitr6n (Fundadibn Chile), Guillermo Perry, Daniel Lederman, Bill Maloney, Juan Gaviria, Susan Goldmark and Luis Guasch (World Bank) provided valuable inputs and advice. Cara Zappala, Mauricio Cifuentes, Katia Nemes, and Julio Gonzalez offered precious editorial and document production support. The report was prepared under the general supervision of Myrna Alexander andAxel van Trotsenburg-Country Directors for Argentina, Chile, Paraguay andUruguay. The team received thoughtful contributions from many Chileans and international experts. Special thanks go to the Secretaria de Economia and the Divisidn de Desarrollo Productivo de la Secretaria for guiding the team andproviding organizational support during the missions; to Fundacidn Chile for organizing a seminar that gave the team the opportunity to receive inputs on the scope and the contents of the work from distinguished representatives of the Chilean private and public sectors; to the Vice Ministerof Economy Alvaro Diaz, Jaime GrC Zegers (Secretaria de Tecnologia de Znformacidn y Comunicacidn), Ricardo Herndndez (Subtel), Alejandro Jadresic and Oscar Cabello (Alfa Centauro) for advice on andcontributions to the ICT chapter; to Carlos Alvarez and Gonzalo Rivas (CORFO) for their advice on the Knowledge Economy Chapter; and to Mario Castillo (CORFO), John Dryden (OECD), Graham Vickery (OECD, Paris), Rafael Hernandez (GICT, World Bank), and Carlos Sanchez (IBM, Santiago) for their help on the section on micro and smallbusinesses. The work also received invaluable insights from a Quality Enhancement Review Panel consisting of Eric Banda (OECD), John Dryden (OECD), Carlos Braga (ISGIF, World Bank), Bill Maloney (LCSPP, World Bank), Harry Patrinos (HDNED, World Bank) and Sebastian Mocorrea (IBM; Latin America Policy Unit). The team sincerely thanks Alain Colliou and Manuel Penalver for their professionalism inorganizing andconducting the QER. Peer reviewers are Jordan Schwartz (PSAPP, World Bank), Carlos Braga (ISGIF, World Bank) andPablo Fajnzylber (DEC, World Bank). i CHILENEW ECONOMY STUDY: INTRODUCTION Background, objectives and scope of the study. Chile faces the challenge of increasing its economic growth rate, which faltered in 1997 after a decade of remarkable 7.7% annual growth. Inthe last two years, the annual growth rate stabilized at around 2.5%,' following a downward trend that seemed steadier than expected. The Chilean Government-aware that increasing growth rates will gain Chile a place among developed nations, reduce the country's povert and improve its sodial indicators-is trying to devise reforms to reinvigorate the economy. The Y objective of this study i s to assess the performance of Chile inareas that could affect productivity and growth in the future. The study does not attempt to stipulate a comprehensive and final set of policy reforms. Rather, it should be considered a first step toward further research intended to support the Chilean Government indevising a reform agendafor the coming years. Organization of the study. The study is divided into three main chapters. The first chapter assesses the performance of Chile in the knowledge economy, where knowledge i s a critical factor for competitiveness and growth. It examines progress to date and remaining challenges with respect to three factors (the knowledge variables): (1) the economic incentive and institutional regime, (2) science and technology, and (3) the education system. The second chapter looks at Chile's Information and Communication Technology (1CT)-the infrastructure of the knowledge economy. The third chapter evaluates the potential use of ICT by local firms, with special focus on micro, small and mediumbusinesses (MSMBs), which represent the bulk of the Chilean productive sector. The focus of the overall analysis is on the role of Knowledge in improving the productivity of the private sector. There are two main reasonsfor the emphasis on ICT compared to the other knowledge factors: (1) given the limited budgetof the study, the team could conduct an in-depth assessment of only one knowledge variable, (2) a complementary Bank study - Closing the Gap in Technology and Education in Latin America - has already evaluated the role of innovation and education in supporting participation of Latin American countries in the Knowledge Economy. Similarly, the study's main focus on improving productivity of the private, rather than the public sector, is motivated by the fact that a recent World Bank Public Modernization loan addresses key issues in improving the effectiveness and efficiency of the Chilean public administration. It is our conviction that the audience of this study would benefit from an integratedreading of all these Bank reports, and that further work could be done to assess how policy recommendations included in various studies could be integrated to support the Chilean Government in designing a comprehensive policy agenda to reinvigorate the economy. ' IMF (2002). * See summary of various growth studies presented at the January 2002 Conference "Natural Resources and Economic Growth in Chile" promotedby the Central Bank, at httr,://www.bcentral.cl/Estudios/Conferencias/2002RN/rmn. htm. 11 .. CHILE NEWECONOMYSTUDY I.ASSESSMENTOFCHILE'SPOSITIONINTHEKNOWLEDGEECONOMY' 1.1. This chapter diagnoses Chile's international competitive position and charts an agenda for strengthening the foundations of its knowledge economy. It uses the `four pillar framework of the knowledge economy' developed by the World Bank as the principal analytical tool. This framework encompassesthe economic incentive and institutional regime, education and training, the innovation system, and information and communication technology (ICT).* The chapter departs from the presumption that the reasonsfor the slowdown in economic growth go beyond the downturn in the business cycle and are linked to structural constraints also. Against a benchmarking assessment of Chile's underlying economic competitiveness for economic growth, the chapter outlines a series of pillar specific actions, predicated on continued sound macroeconomic policies and institutional development, to strengthen Chile's position in the increasingly competitive global environment. A. AGGREGATE INDICATORS OFECONOMIC PERFORMANCE 1.2. Average GDP growth of 6.5 percent p.a. during the nineties places Chile among the very top performing countries globally. The growth rate of 9 percent in exports was respectable but not spectacular, placing Chile ina middle positioninLAC. Chile's GDPper capita, measuredin constant 1995 US$, more than doubjed from 1985 to about US$5,300 in 20003, elevating Chile firmly into the ranks of a middle-income countries. Higheconomic growth with a concomitant fall in unemployment and a rise of 4 percent p.a. in real wages over the last decade translated into major improvements in the standards of living and well being of the population. The share of the population living in poverty and in extreme poverty declined from 38.6 percent to 21.7 percent and from 12.9 percent to 5.6 percent, respectively, between 1990 and 1998.4 Similarly, economic growth has enabled Chile to improve further on its social indicators, which are outstanding among LAC.' Life expectancy and infant mortality rates are OECD levels. 1.3. Chile's success in creating a modern highperformance economy has not come easily. At various stages, painful adjustment measures had to be taken to reign in inflation, bring fiscal deficits under control and counteract severe external shocks. Initially controversial policies were adopted that fundamentally changed the roles of the state and the private sector. Ownership and management of the economy underwent deep transformations. Sweeping reforms in the mid- seventies and mid-eighties, which were refined continuously through the early nineties, ushered This chapterwas preparedby Carl Dahlman, PeterScherer, Anuja Utz, Douglas Zeng, Aimilios Chatzinikolaou. ICT is assessedin Chapter2. Statistical Information Management(SIMA) database, World Bank. International Monetary Fund, 2000. According to the OECD, extreme Poverty is defined as percentageof population livingbelow US$1a day. World Bank Country AssistanceStrategy for Chile, 2002b. The scorecards however, signal a relative slide in Chile's position on the humandevelopment index relative to global performance. 1 in periods of very high economic growth. The meltdown in 1982 -- external shocks caused a cross ownership links throughout the economy -- andsubsequent years of difficult reconstruction chain reactionby feeding througha banking sector with excessive foreign currency exposure and are a constant reminder that sound macro and structural fundamentals are of the essence to sustain economic growth and to guard against the vagaries of adverse external developments. The impressive rate of GDP growth since the mideighties is testimony that Chile has done very well inthis regard. Concerns about Slowdown of Growth 1.4. The declining trend of economic growth since the mid-nineties, however, may signal that the stimulating effects of the earlier privatization and deregulation programs are running their course. These reforms had led to major gains in allocate efficiency across the economy and to remarkable productivity gains in key sectors through use of advanced technology and business practices. An annual decomposition of the impressive high average rates of economic growth during the nineties show marked variations around a clearly declining trend (see Figure 1). Most of the variations can be explained by a combination of external shocks and companion contractionary fiscal and monetary adjustments. While the declining trend reflects slackening of structural supply HighGrowthPeriod:7.7%p.a. 10.0. A 1.5. External factors on balance do not convincingly explain the slowdown inthe performance of the Chilean economy. A cursory assessment points to the following scenario. Global economic growth during 1998-2000 exceeded its average over the previous two decades, whereas Chile's growth fell during these years compared to the average of the two previous decades. Chile has not had difficulties in securing external financing with nominal and real interest rates below the averages of the eighties and nineties, even though capital inflows were weakening towards the end of the decade. The only clearly negative factor was a terms-of-trade decline of 15percent between 1997-1999. 1.6. The deterioration inthe global economy since early 2001 i s likely to exacerbate apparent structural constraints underlying the declining trend in Chile's economic growth. Empirical studies suggest that the economy i s losing steam not only because of weakness in demand but 2 also because of falling gains in productivity (see Table l).' contributing about 40 percent After to high GDP growth between 1986 and 1995, Total Factor Productivity (TFP), essentially an indicator of innovation capability, accountedfor a mere 13 percent of growth during 1998-2001. Increases mainly in the quality rather than size of the labor force were the main source of economic growth during the seventies until the mid eighties, with capital playing a secondary role and TFP a distant third. The late eighties saw the beginning of a reversal as the relative importance of labor and TFP. In the nineties, TFP became the lead driver with capital a close second and labor a distant third. However, since the late nineties Chile's economic growth has become almost entirely dependent on increasesincapital accumulation for economic growth.6 Table 1. TFPgrowthinChile I I I TFP I (%ofGDP) I Labor I(%of GDP) I Capital I (%ofGDP) I 1976-1980 6.8 3.2 47.1 2.4 35.29 1.2 17.6 1981-1985 -0.1 -2.3 -2,300 1.2 -1,200 1.o -1,000 1986-1990 6.5 2.2 33.85 2.0 30.77 2.2 33.85 1991-1995 7.5 3.3 44 1.4 18.7 2.8 37.3 1996-2000 4.6 1.6 34.78 0.5 10.87 2.5 54.35 1998-2001 2.9 0.4 13.79 0.1 3.45 2.4 82.76 1.8. Knowledge has always been a critical factor ineconomic development. Intoday's global economy, knowledge has become an even more important factor for competitiveness, growth and The figures onTFP inTable 1do not accountfor effects of the downturn inthe businesscycle, which typically depresses TFP growth. Various studies point to these conclusions:Beyer and Vergara, 2001; Schmidt-Hebbel, 2001, Gallego and Loayza, 2002. TFPhas been accountingon average for 50 percentof economic growth inhighperforming economies. * Beyer and Vergara (2001) estimatethe effect of various structural (micro-economic) improvements on economic growth and concludethat modestchanges inpolicies and institutions could increaseChile's economic growth trajectory by between 1- 1.5 percentagepoints. increased welfare. We are in the midst of what could be called a "knowledge revolution" triggered by rapid scientific and technological progress inmany fields such as biotechnology and information technologies, and increased speed in the dissemination and application of knowledge. Reduced transportation and communications costs, and the fact that knowledge seeks larger markets for its application are all features of increased globalization and competition. 1.9. The result of this very dynamic process creates a constant state of restructuring, at global, country, sector and firm levels. While this raises tremendous possibilities for improvement, it also carries risks that countries or firms and organizations will fall behind if they cannot keep up with the rapidchange. 1.10. The term knowledge economy has been coined to reflect this increased importance of knowledge as a critical factor for economic performance. (See Box 1for some of the key trends in the knowledge economy.) A knowledge-based economy is one where organizations and people acquire, create, disseminate and use knowledge more effectively for greater economic and social development. This requires: An economic andinstitutionalregime that provides incentives for the efficient creation, dissemination, and use of existing knowledge. 0 An educatedand skilledpopulation that cancreateanduseknowledge. 0 A systemof researchcenters, universities, think tanks, consultants, firms and other organizations that can tap into the growing stock of global knowledge, assimilate and adapt it to localneeds. 0 A dynamic informationinfrastructure that canfacilitate the effective communication, dissemination, and processing of information. Underpinningthe aboveis the needto coordinate actions across these four pillars, becausethere are strong inter-dependenciesamong them. 1.11. A New Economic Incentive and Institutional Regime. Taking advantage of the potential offered by the knowledge revolution requires a flexible society and economy, able to cope with the need for constant change. This, in turn, requires: (i) effective economic incentive regimes and institutions to facilitate the redeployment of resources from less to more efficient uses; (ii) conditions conducive to entrepreneurship, risk-taking, and the expansion of small enterprises; (iii) sufficiently flexible labor markets to facilitate the redeployment of labor; appropriate social safety nets to facilitate the relocation and retraining of people for new jobs, and help those adversely affected by restructuring; and (iv) legal governance systems to cope with the many demands emanatingfrom such restructuring and redeployment. 1.12. Skilled and Creative Human Resourcesfor the Knowledge Economy. Education i s the basis for creating, acquiring, adapting, disseminating, and using knowledge. Basic education increases peoples' capacity to leam and to use information, as does technical secondary education. Higher education in engineering and scientific areas i s needed to monitor technological trends, assess what i s relevant for the firm or the economy, and use new technologies. The production of new knowledge and its adaptation to a particular economic 4 setting is generally associated with higher-level teaching and research. Creating a culture o f continuous learning and openness to new ideas i s critical for a knowledge-based economy. 1.13. An EfSective Innovation System. An innovation system consists of the network of institutions, rules, and procedures that affect how a country acquires, creates, disseminates, and uses knowledge. Some of the key organizations for the creation o f knowledge include universities, public and private research centers, and policy think tanks, as well as firms, non- government organizations, and the government. Some o f the key institutions for the dissemination of knowledge include agricultural and industrial extension services, engineering consulting firms, and economic and management consulting firms. What is important i s how effective they are in creating, adapting, and disseminating knowledge to the firms, government, other organizations or people who put it to use. Therefore, networking and interaction among the different organizations, firms, andindividuals is essential. 1-14. A Dynamic Information Infrastructure. The rapid advances in ICTs are dramatically affecting economic and social activities, as well as the acquisition, creation, dissemination and use of knowledge. As knowledge becomes more important for competitiveness, the effective use of ICTs reduces transaction costs, time and space barriers, and allows the mass production of customized goods and services, substituting for limited factors o f production. With the use of ICTs becoming pervasive, they now have become an essential infrastructure for 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 to deal with online transactions. It i s also essential to assess the knowledge and skills requiredto design, implement, and use the new ICTs. Box 1. The Growing Importance of Knowledge and Global Trends The OECDusesthe term, "knowledge economy," to draw attentionto the importanceof knowledge in all economic activities. The definition has beenevolving from focusingjust on manufacturingindustriesthat make intensiveuse of technology to including services that are also heavily knowledge based. Some worldwide trends inthis domain are highlighted below: More investmentand trade in intangibles Investmentin intangibles has been skyrocketing.OECD public investmentineducation, in R&D, andsoftware, is almostthe same as that inmachineryandequipment, almosthalf of total investmentsin GDP. Globally, tradeinintellectual property as measuredby royalty and licensefees reportedininternational trade, increasedfromjust over $10billion inthe early 1980sto morethan $60 billion by the endof the 1990s. Butcountry dataon trade inroyalties andlicensing show the largegap betweenhigh-income anddeveloping countries. High- income countries receivealmost 98% of all royalty andlicensingpayments, with low and mediumincomecountriespayingout an amount disproportionateto what they receive. More importancefor educationand training InOECDcountriestheproportionofadultswithatleastasecondaryeducationhasrisenfrom 44% to 72%; andtertiary educationhas doubled, from 22% to 44% over the last generation. According to UNESCO the number of studentsenrolled inpost-secondaryinstitutions worldwide increasedfrom 28 million in 1970to 88 million in 1997. Butthe gap between developing countries anddevelopedcountries widenedfrom 21 to 45 million, eventhough the population of developing countries is larger andgrowing faster. Developedcountries have also beenup-skillinglabor through extensivecontinuing educationboth inuniversities andin firms. Developing;countrieslaginthisrespectas their educationalattainmentsare low, and Box 1.(cont.) the workforce needs retrainingto be competitiveinnew economy. Moreforeign investment Foreign investment, one of the key agents of globalization, i s moved mainly by the desire to exploit knowledge assets on a global scale-technology, management, access to markets, and access to such special resourcesas finance, labor, andnaturalresources. Foreign investment inflows increased 15 times between 1982and 1999. And its share inworld gross fixed capital formation, from 2.6% to 14.3%. Other increaseswere equally stunning:exports of foreign affiliates from 31% of world exports to 46%; sales of foreign affiliates, $13.6 trillion in 1999, from 23% of world GDP to 45%. The value added of these sales in 1999: $3 trillion, roughly 10% of world GDP. In1997the estimated value added of home and overseas production by transnational corporations was $8 trillion, more than 27% of world GDP! They are also estimated to do 75430% of global R&D. More R&D In 1999, for example, spendingon R&D was 2.2% as a whole for the OECD. Of global R&D, 86% i s concentrated inhigh-income countries (with 37% centered inthe United States alone). Multinational companies, now doing R&D incountries other than their home countries, are establishing more strategic alliances-even mergers and acquisitions-to collaborate on technology and acquire technological assets. Also on the rise: intemational collaborations in patentingand technical publications. Inthe OECD, the share of foreign co-inventors rose from 5% inthe mid-1980s to 9% eight years later. Andthe share of scientific publications with foreign coauthors more than doubledfor many OECD countries, to an average of 26% for 1995-97. Thus, all countries need to focus on how to obtain knowledge produced outside their borders. Pn....nn. 111ny7,J D---L 3AAl- 6 BenchmarkingGlobalCompetitivenessg 1.15. Chile has been raising steadily its economic performance in international comparisons. Its GDP per capita i s now the 36th highest among 75 countries globally. This achievement i s underpinnedby strong fundamentals (see Table 2). The rankings show a marked difference between the competitiveness of the public (business environment, public institutions, macroeconomic environment) and private sector (company operations, technology.) Judged by these indices, Chile's public sector competitiveness score i s significantly higher than what might be expected from the country's income level, whereas the private sector indices show that it ranks roughly on par. The wedge has increased between 2001 and 2002. Chile's ranking on the growth competitiveness index (mainly government oriented sub indices: macroeconomic environment, public institutions, technology) jumped a significant position from 27 to 20 among 80 countries. In contrast, the microeconomic competitiveness index (mainly private sector oriented sub indices: company sophistication and business environment) dropped by two positionsfrom 29 to 31. Table 2. Global competitivenessindex rankings, 2002 Source: WEF (2003) ranking covers 75 countries. 1.16. Chile has been loosing some ground to the comparators in WEF's ranking on microeconomic competitiveness (see Figure2), it maintains a relatively stronger competitiveness position overall than the comparators, except for Finland. The charts in Figure 41° show that, in contrast to the relative deterioration in current competitiveness, Chile generally has been advancing the four pillars of the knowledge economy more rapidly than its comparators since 1995. The quadrant in Figure 3 provides a corresponding synopsis of the changes in Chile's performance on the four pillars globally since 1995. It points to marked imbalances. Chile has made major advances in the economic incentive regime and also in education and ICTs. They position Chile in the forefront among comparators. The innovation system remains a laggard in This chapterassessesChile's position inthe threepillars: Economic and Institutional Regime, Education and Human Resourcesand Innovation. The following countries have been selected for benchmarking Chile on account of their success inembracingknowledge economy to gain competitiveness: (i) highincome countries: Finland, New Zealand; (ii)similarincomecountries: Malaysia, Poland: (iii) countries: Costa Rica andMexico. Finland is a LAC leaderglobally inembracingthe knowledge economy and New Zealand is moving quickly from a commodity based to aknowledge basedeconomy (highincome countries); MalaysiaandPolandare similar income countries gaining quickly incompetitiveness; and CostaRica andMexico are advancingquickly inLAC. loBasedon the World Bank KAMmethodology and the SIMA database. Inthe KAM,a set of 70 quantitative and qualitative variables i s usedto benchmarka country's position on the key elementsof the four pillarsof the framework. The methodology consistsof ranking 100countries with respectto each of these variables andgiving a score of 10for the highestvalues and 0 for the lowest. For more information, see http://www. worldbank.org/gdln/kadhtm. 7 comparison to progress inthe other pillars, however. Highquality macro economic policies and effectively functioning institutions are a necessary condition for sustained growth, but they by themselves are not sufficient to generate high rates of growth. The benchmarking diagnostic suggests that imbalances in relative performance among the four pillars do not allow Chile to realize fully potentialsynergies andhence contributions to growth. Figure 2. 1998 I999 2000 2001 2002 Microeco nomic competiti veness +Chile ranking" Costa Rica * - Mexico 1" Malaysia -Poland +Finland -+-New Zealand Source: WEF, 2003. Figure 3. Chile's performanceinthe four pillars(1995 andmost recent) Econ.IncentiveRegime !k.org/gdln/kam. htm) Education l1The Microeconomic CompetitivenessIndex i s to reflect the microeconomic bases of a nation's GDPp.c. and to provide insights into longer-term growth sustainability. Itincludes indicators on the operations and strategyof companies, and the businessenvironment in which they are operating. WEF 2002. 8 : x x : I 0.3 x R x B. ECONOMIC INCENTIVEAND INSTITUTIONALREGIME 1.17. International experience indicates that competitive countries are characterized by effective economic incentives regimes and institutions that foster knowledge creation, acquisition and dissemination, and by economic agents, and organizations that are able to use its results. A country's economic success i s in part determined by the ability to cope with and take advantage of constant change, to shift resources from less efficient to more efficient resources. Sound macro-and micro-economic policies are key prerequisites for the knowledge economy. This section merely focuses on selectedmicro-economic issues.12 PublicInstitutions 1.18. As evidenced by its rankings in Table 2, the quality and probity of Chile's public institutions - predictability, honesty, and transparency - are a cornerstone of Chile's economic success. The high rankings of Chile, above its neighbors and comparable to the OECD countries, reflect political commitment and discipline. Policies have been pursued consistently and contractual obligations have been honored throughout successive administrations; programs are not subject to the vagaries of administrative change. 1.19. Strong property rights, low incidence of corruption, political stability and the firmness in the rules of law are important elements of this propitious picture. Chilean entrepreneursgive the government high marks for low levels of corruption (improper payments related to taxes, public procurement, trade), predictability and consistency of policies and enforcement of the rules of law, placing Chile well ahead of LAC and similar income c~untries.'~However, there i s no reason for complacency as Chile is not entirely immune to corruptive practices and political cronyism, notably at the municipalle~e1.l~ 1.20. The public administration has played a pivotal role in makingChile globally competitive. Rankings in the quality of Chile's public institutions and macroeconomic management, which are identical to the country credit rating, are above Chile's position in relative economic performance (GDP per capita). The significant divergence suggests that Chile's public sector is more competitive than the private sector. Chile's public sector outperforms LAC and similar income countries comparators by a wide margin. Even though Chile does not measure up to Finland and New Zealand15,it i s ranked inclose company with Germany and Japan. 1.21. Chile's international reputation notwithstanding, Chilean entrepreneurs do not give the public administration a clean bill of health. They are not satisfied with the performance of the parliament, courts, health system and also the government generally. Thus, while muchhas been accomplished inmodernizing Chile's public sector, more needs to be done in the opinion of the private sector.I6 Among the significant pending reforms are the privatizations of additional infrastructure and utility services, strengthening of regulatory oversight, further progress in l2The coverage is not complete. Among others, there may be scope for improvement incompetition policies, market regulations and public expenditures to increase productivity inresource use. 13Basedon surveys by World Bank: Batra, Kaufmann and Stone, 2002; WEF 2002. l4Financial Times, November 21, 2002. l5 WEF, 2003. l6 Marcel. 1999. 10 decentralizing public functions from a strong centralist tradition and improvements in the efficiency of public resource allocation. Specifically, doubts have been raised about unsatisfactory returns on large scale subsidiesfor the agricultural sector. 1.22. Improving administrative efficiency remains a continuing objective of the government. An important feature is the emphasis on introducing advancedinformation systems. Perhaps the best-known e-government initiative i s the online income tax system, which i s a greatly simplifying tax procedure for individuals andbusinesses. A new electronic system of purchasing and outsourcing i s expected to increase the information flow between government offices and private suppliers and to generate greater transparency. The system will not only notify potential providers by email about forthcoming purchases but also publicize individual bid awards with the corresponding rationale. (See Chapter 11). 1.23. Key among the tasks ahead are creating integrated financial management and effective humanresource systems. The heterogeneity of management information systems, lack of inter- connectivity among government agencies and limitations inherent in the existing cash control system are constraining the government's overall responsiveness and agility, and collaboration across agencies. Similarly, more emphasis on structured career development and competency levels17of civil servants may help increase the efficiency of public transactions. BusinessEnvironmenP 1.24. The quality of Chile's business environment i s ranked(31Stposition) roughly on par with Malaysia, Hungary and Brazil, but below Canada and Australia. The deterioration in Chile's position relative to the comparator countries since 2000 points to the importance of intensified efforts at raisingthe quality of the businessenvironment closer to that of macro-policies (13) and public institutions (19)". Corresponding measures should be complemented by incentives to strengthen corporate structures and strategies. The need for stronger initiatives is borne out by findings of aWEF econometric analysis that the stateof Chile's businessenvironment continues to be more advancedthan the sophistication and quality of company operations. 1.25. The intensity of localcompetition and openness of its domestic market, as reflected inthe WEF survey, would seem stronger in Chile than in all comparators. On the other hand, Chile is trailing its comparators in the effectiveness of anti-trust policies. Circumstantial evidence of market behavior in Chile would suggest that a review of competition policies i s warranted. Chile's overall tax burden (total tax revenues as a share of GDP ) i s higher than that of its comparators. The employee contribution to social security equivalent to 20% of GDP places Chile in the very top tear of countries covered by the IMD. The tax burden i s of concern to Chilean entrepreneurs, as reflected in survey interviews. The recent tax reform, which will increase corporate taxes inan offset to lowering personal income taxes for stimulating consumer demand, may have influenced this assessment. On the other hand, firms gave highmarks for tax administration. l7The low ranking ofcompetencylevels of public officials (55) contrastssharply with the highaggregaterankingof public institutions (18). WEF, 2003 l8DatafromIADB 2001a; Batra, Kaufmann, and Stone, 2002; WEF 2002. The quality of the businessenvironment is acompositeof indicators of public and private interventions andhence only partially undercontrol of the government 11 1.26. Business regulations are among the weak spots of an otherwise rather business friendly environment. The costs and time required for company registration in Chile i s high for many aspiring new entrants. They are significantly above levels in OECD countries and comparable income countries outside Latin America. Starting a business in Chile requires 10 different procedures, taking at least 28 businessdays and US$620 in fees, the equivalent of 13 percent of GDP per capita." The corresponding figures for Canada are 2 procedures, 2 days and US$280, equivalent to 1 percent of GDP per capita. Aware of the importance of business dynamics, the government has engaged the private sector in a consultation process to reform the registration processand formulated an action program, which i s under implementation. 1.27. Chile's legislative andregulatory framework for corporate governance has beenupgraded inrecent years. Chile has set the standards for the Latin American region at large." However, surveys convey conflicting opinions on businesspractices. On the one hand, results indicate that unofficial payments to government officials are significantly lower than in the LAC and similar income countries comparators. Chilean firms are exemplary in complying with their tax obligations. They stand out not only in Latin America but also are said to report more truthfully than many European companies. Yet, unfair or corrupt business practices seem to impose some costs on Chilean companies. While Chile ranks somewhat better than LAC and Malaysia, and i s on par with Poland, it i s far behindhigh-income countries. 1.28. Effective patent rights are important to accelerate knowledge absorption and transfer through technology contracts. Chile has a full legal framework with legal bodies to protect successful investments in research and development. However, the IPR Act does not allow university ownership of research." There are clear proceedings for granting patents, trademarks, utility models and industrial designs, as well as the apportion of the rights to an invention. A private management system for collecting copyright fees is providedby law. A special Court,of Appeal for matters concerning industrial property has been set up to review, confirm or revoke decisions of the administrative authority. However, Chile's IPR ACT reportedly i s not yet fully WTO TRIPS conforming, despite several recent revisions. Among others, protection of confidential test data and enforcement against piracy and counterfeiting is inadequate. Generally, the administration and enforcement if IPR would need to be strengthened in Chile and the backlog of pendingpatent applications red~ced.'~ Trade 1.29. Chile's trade regime is among the most open internationally. The free-trade agreement with the EU, signed in May 2002, and a similar agreement expected with the US will open the domestic markets further and enhance local competitive pressure -- and arguably act as an additional safeguard against contagion from neighboring countries in the perception of the international financial community. Trade weighted import tariffs are slated to fall to an average Djankov, LaPorta, Lopez de Silanes, and Shleifer, 2002. 'khile scores well oncompliance with OECD Principles for corporategovernance,scoring `observed' or `largely observed' on 14of 23 principles. No Principle is deemed `not observed'. Fremond andCapaul, 2003. 22World Bank, 2002a. 23Holms-Nielson, L.et.al. 2002. 12 of 3.5 percent by 2003 from 6.6 percent in 2000. Over the past decades, Chile has become closely integrated inthe world economy (see Table 3). 2000 16.24 65.57 I 83.47 1 80.43 80.28 84.90 28.42 FuelandMineral 1990 55.14 1.93 43.28 20.38 19.97 5.05 9.61 ExportsI Merchandise Exports 2000 46.49 1.38 10.99 10.67 9.94 6.59 6.88 1.30. Yet, the share of trade in GDP of 62 percent in 2000 trailed all comparator countries. Similarly, Chile's share of exports in goods and services was lower than in the comparators, other than Poland. Chile's share of exports in GDP declined between 1990 and 2000, whereas the comparator countries, except for Poland, achieved dynamic growth. Chile was unable to compensate the decline in fuel and mineral exports with increasesin other sectors. Chile stands out among comparators inits dependence on this sector for its export performance. Conversely, Chile ranks last in this set of economies in the share of manufacturing in exports, notwithstanding the sector's relative dynamic export growth. 1.31. Concentration of exports in primary products, and to a lesser extent also in key trading partners, makes Chile's economy more vulnerable to external market fluctuations (Figure 5). Ores and minerals still accounted for 42 percent of Chile's exports in 2001, even though their share had come down by 11percentage points since 1990. Generally, exports are concentrated inlow dynamism and low technology content products, which places Chile at the bottomof the LAC scale inboth~ategories.~~Yet, this classification i s misleading since Chile usedknowledge effectively in becoming a world class competitor in supposedly low technology sectors (see Box 2 on the copper andBox 9 on the fruit industry). 1.32. Expectations of a continued slowdown in global demand for copper, environmental constraints to the expansion of aquaculture and increasing competition in the international wine markets suggest, aside fromthe repercussion of the crises inArgentina and Brazil, that it may not be possible to sustain the high rates of export growth of the nineties.25 While the free trade agreements will engender new dynamics, help to create new opportunities for export 24IADB ,2001a. 25Bitran,2002a. 13 diversification, there i s room for further efforts in creating opportunities for promoting export diversification and seizing market niches. Figure5. ExportTrends ChileTrendsof Exports 1980-2001 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 -Agriculturalraw materialsexports[X of merchandiseexports] -Foodexports[A of merchandiseexports) -Fuelexports[X of merchandiseexports] Manufacturesexports[X of merchandiseexports] Oresand metalsexports[A of merchandiseexports) - -Exports of goodsandservices[A of GDP) Source: WorldBank SlMA database Box 2. Copper IndustryinChile Chile's copper industry exhibits critically important traits of the knowledge economy. Copper i s consideredatraditional low-tech natural resourcecommodity, which explains the very low ratings of Chile inthe technology contentof its exports. Yet, it was the application of advancedknowledge inprospecting, organization, extraction, processingandtransportation that made Chile a competitive force internationally. Innovation andtechnological change reportedly accountedfor morethan a third of the impressiveincreaseinlabor productivity during the nineties. The ability of the miningsector to attract ahighly qualified labor force was both effect andcause of this achievement. The miningsector has ahigherpercentageof workers with more than 13 years of schooling than any other major sector inChile. Source: International Labour Organization, 2001a. Foreign Direct Investment 1.33. Chile has attracted large amount o f foreign direct investment (FDI) on account of its transparent and stable legal and economic environment, and abundant natural resources. FDI almost quadrupled over the last decade to US$40billion. It accounted for 63 percent of gross 14 capital formation and US$2,600 per capita in 1999, by far the highest in LAC and among the highest worldwide.26 After steady increases since the early nineties, FDIpeaked in 1999 with a substantial decline inthe following years. Chile i s a top performer in outward direct investment also. Next to Argentina, Chile has the largest absolute stake among LAC countries in gross outward FDIstocks with US$18.2 billion in 2000, which is equivalent to one third of total gross inwardFDIstocks. 27 1.34. Between the early and late nineties, the sectoral composition of FDIshifted from mining to utilities and communication as the leading sector (see Figure 6). The share of miningin FDI declined from 58 percent to 24 percent, while electricity, gas and water increased from 1percent to 27 percent. Duringthe same period, the participation of financial services inFDIrose from 11 percent to 27 percent. Following these shifts, almost three quarters of FDI now has a distinct domestic market orientation while export oriented FDI (essentially mining but also some in foods and agriculture) has fallen to a quarter. However, FDIin services most likely contributed to strengthening export competitiveness by improving the cost effectiveness of related supporting services. Figure6. Chile: Sectoraldistribution of FDIinflows 1996-2000 FDls in commodity based industriesstill dominatetotal FDI Inflowsin late Paper and 1990s (1996-00) Other manufactures 1% Electricity,Gas and Water 27% Communications FinancialServices 7% Source: Department of Foreign Affairs and Trade,EconomicAnalytical Unit, Australia. 1.35. Chile has been an overachiever in attracting FDI. Using indices from the WIR 28as a guide, Chile attracted much more FDIthan would be expected on the basis of relative GDP. Its position on the FDI performance index (17'h) contrasts with its ranking on the FDI potential index (47'h) for 1998-2000. The sharp recent decline in FDIflows, however, may suggest that Chile's superior enabling environment (i.e. liberal regulations for capital movements, predictability and reliability of policies and the ability to enforce contracts), i s not sufficient to 26 WEF, 2002. 27 The paceof outward private Chilean direct and portfolio investmenthas acceleratedover the last decade, reaching 36% in 1999-2000. IMD,2002. 28 UNCTAD, 2002. 15 ensure continued highrates of investment inflows. Chile may be facing constraints in absorptive capacity. The miningsector, which has been accounting for the bulk of FDI, lacks new projects and has largely reachedthe investment technology frontier inexisting operations. 1.36. FDIcontributed 7 percentof total domestic Chilean R&D. Ithas hada significant impact on productivity inmining(embodied technology in imported capital), banking (management and process improvements), and infrastructure services (a combination of both). However, there is little evidence of externalities on the rest of the economy, notably in manufacturing and agriculture. Generally, foreign investors have not shown much interest in transferring technology or teaming up with local companies for joint technology development. Instead, they have largely used or adapted processes and products that existed already in the foreign parent companies or their brancheselsewhere. 1.37. New opportunities will have to be found to regain high rates of FDI and to focus it in areas of strategic need and advantagefor Chile. The challenge is to benefit from the resources of transnational companies and to identify production niches that would allow Chile to tie into global value chains. FDI could play a larger role in strengthening and diversifying Chile's exports, acting as a conduit for technology transfer and leveraging international expertise into spillovers for the domestic economy. TargetingFDIhas become international practice. The case for intervention i s strongest for new export oriented industries and new technology-intensive industries. 1.38. There are obvious risks involved. Faulty interventions are worse than neutrality: resources may be focused on attracting investment that does not materialize, efforts and resources may be devoted to seeking the wrong types of firms, or firms that would have invested inany event. Theserisks canbereducedby institutingFDIpromotionas acontinuous processof relationship building that fits into a clear plan of creating sustained advantage over time, and i s aligned with national priorities. Chile appears to have the requisite sophisticated technocratic institutions to set policy goals and operate instruments efficiently for an active industrial policy.29 1.39. Ireland's National Linkage Program (See Box 3) is an example of a successful government program to leverage high performance FDI promotion into strengthening local technology capabilities in electronics, and other sectors. The Linkage programwas not designed to be a substitute for existing programs. The goal was to focus resources on selected companies and individuals that had been clearly identified for potential success. Selected companies were fast tracked by fine-tuning existing programs to suit immediate needs. System integration was an essential aspect of the Linkage program. A decisive political mandate enabled the creation of balanced multi-skilled and -taskedteams. Picking winners -the underlyingthrust of the Linkage program - before the race is notoriously difficult. Mistakes were made but the impressive aggregateresultsjustify the risk taken and validates the approach adopted. 29 I nLeipziger and Petri(1993),the authorspresent a succinct summary of opportunities and pitfalls of industrial policy interventions and stress the importance of capabletechnocratic public institutions. 16 Box 3. Lessons of National Linkage Program inIreland Ireland's Industrial DevelopmentAuthority designed and implementeda National Linkage Program(1987- 1992) to leverage spillovers opportunities arisingfrom a highly successful FDIpromotion strategy inorder to develop indigenous technological capability. The Programhadthree mainstrands: 0 developing indigenous suppliers - a rigorous assessment and selection procedure was usedto select participatingcompanies. This included an analysis of existing or potential capabilities against perceived supply opportunities, an assessment of financial strength and of management capabilities 0 government - created the political mandateand charged the various State Agencies to support and co-operate inorder to fine tune and streamline the services available to industry inaddition to providing substantial fundingfor the Program 0 industry the Programtargeted the major multinationalexportingcompanies operating in - Ireland- the principal sector was electronics, but also targeted were health, food and drink, consumer andengineering. Over the 1985 to 1992period, foreign affiliates operating inIreland increased their localpurchasesof raw materials from IRE438m. to IRE81lm. andtheir purchases of services from IRE980m. to IR%1,461m Evolution of the Linkage Concept Towards the end of the 1990sthe impact of globalization and the shift inFDIfrom manufacturingto services has ledto the following developments inthe linkage concept: 0 the major thrust inthe development of indigenous firms i s to buildtheir capacity to compete globally andnotjust as sub-suppliers to multinationalslocatedinIreland. Enterprise Ireland (the SMEAgency) has a BusinessLinkage Teamfocussed on linking Irishsuppliers with opportunities inthe global marketplace inmultiple sectorsincludingservices. Ithasdeveloped an online database of over 3,000 Irishcompanies with sub-supply capabilities available to International buyers. 0 as the profile of new FDIhas shifted from manufacturingto services, similarly the higher value sub- supply opportunities have widened to include knowledge based services such as intellectual property advice, high-level technological support and content creation indigital media. Intandem Irish flourish. development policy has shifted to create an environment in which such highlevel activities will Source: Don Kelly: Backward Linkages Ireland, Presentationat the International Seminar onAdvances in theIntegrated Supply Chain ManagementProgram, Mexico City,March 14,2001 1.40. Other examples of successful FDIpromotion and alignment with national development priorities are Costa Rica3' and Malaysia31, aside from doubts about the benefits of heavy public high tech infrastructure investments. Both countries adopted variations of the linkage approach to attract high tech transnationals for export growth and local technology supplier development. CORFO's (Corporation for the Promotion of Production) fledgling program to scan and attract selected foreign companies is pointed inthe right direction and effectively managed. However, it i s constrained in its mandate and limited by a relatively small budget. It could be expanded and leveraged in a more concerted and deliberate strategy to promote knowledge driven FDI 30 Raghavan,2002. 31 UNCTAD,2002. 17 activities and promote technology spillovers in areas of emerging competitive advantage for Chile, aligning support for FDIclosely with national development priorities. Generally, Chile could extend eligibility of funding under its various support programs for local companies to cover also foreign companies, provided that there are clearly demonstrable benefits and externalities. Labor Markets3' 1.41. The slowdown in economic activity has lead to a sharp increase in unemployment of the labor force, largely in construction and manufacturing. Opinions differ about possible exacerbating effects of Chile labor legislation and practices on unemployment. Some scholars argue that labor reforms over the past two decades have created rigidities that contribute to high unemployment (see Box 4). Job protection has increased, now ranking among the highest internationally, with adverse effects particularly on employment of new entrants into the labor force. Further, the increase in the nominal minimumwage by 40 percent since 1999 has cooled the willingness o f firms for new hiring. A reform of labor regulations under consideration, including a switch of collective bargaining negotiations from the firm to the industry level, would risk stifling the labor market and increase cost pressures on less productive companies. Box 4. Chile's labor market key changesinrecent years - Labor reduction marketfluctuations are connectedboth to the business cycle andto the flexibility of Government labor marketpolicies. Much of the decline inemploymentinthe last few years inChile canbe explainedby the sharp downturn intwo sectors of the economy: construction and manufacturing. In 1999, employment inthese sectors fell morethan 20%percentand 10%respectively. Becausethe two sectors together account for 30% of non- agricultural total employment, changes inemployment flows inthese two industries are largely responsiblefor the increasein aggregate unemploymentand mightexplain its persistence. The two sets of labor reforms introduced over the past two decadeshavecreated rigidities that must contribute to maintaining the country's highlevel of unemploymentby alteringthe labor matchingprocess through an increaseinthe labor costs which, inturn, has reducedincentivesto hire. While the reduction of payrolltaxes andthe decentralizationof bargaining hadthe effect of increasinglabor marketflexibility, increasedjob protection and high minimumwages have most likely hadthe opposite effect. Recentstudies have demonstratedthree interestingfacts inthis regard. First,job protection has increasedinChile sincethe early 1980sandremainsamongthe highestininternational comparativeperspective. Second,job security policies inChile havehada substantialimpact on the level and distribution of employment, becausethey have adverselyaffected employmentof young workers. Third, the 1998 Governmentincreaseof minimumwages by 40% innominal terms over three years (25% real) has hada negative impact on employment, especiallyamong young workers. Sources: Luzio, IMF,2002; Bravo and Contreras,2002; Edwards and Cox Edwards, 2000; Pages and Montenegro,2000; and Mizala, 1998. 32Draws on IADB, 2001a; WEF, 2003. 18 1.42. Hitherto, unions do not seem to have exerted strong influence on private wage settlements and employment conditions, mainly because of low coverage rates and firm based wage negotiations. Chile has a median positioninterms of labor costs with significant variations in the rankings of various indicators. Wages in Chile appeared aligned well with worker productivity prior to the recent increasesin minimumwages.33The rankings compare to those in similar and high-income comparator countries but are above those in LAC. While Chile ranks above its comparators inthe flexibility of hiringand firing practices, it scores low on companies' ability to adjust working hours in line with business fluctuation. Limited unemployment insurance i s a hurdle to more flexible labor management practices. Regarding overheads, Chile has a median position in the cost of contributions to social security but it ranks in the upper bracket interm of mandatoryjob security provisions. 1.43. International comparisons of labor productivity suggest that worker motivation, quality of management and work practices are important in explaining cross-country differences in labor productivity. Managers and employees differ quite sharply in their views on quality of labor relations in Chile. Chile's company executives rated labor relations as being highly productive and concluded that workers identified with company objectives, ranking Chile inthe forefront of comparator countries. In contrast, employees are rather critical of management and working practices, placing Chile inthe bottompart of LAC. Inthisvein, morethan70percentofemployeesconsiderthatcareersuccessdependsonrelations and only about 55 percent believe that working hardactually guarantees success. These findings suggest that there is ample scope, and need, for Chile's entrepreneursto improve labor relations. CapitalMarkets 1.44. Seed and risk capital investing instruments are not readily available in Chile, a strong banking sector and ample liquidity notwithstanding. Lack of a strong venture capital (VC) industry i s considered by many observers as a serious constraint to developing Chile's knowledge economy. The successful Yozma VC program in has demonstrated the critical importance of skill and expertise intranslating scientific and technological advances into projects and experience to manage and market them. The ability of the VC industry to incubate the business of domestic upstarts, match them with international firms and make them succeedin the market place has proved to be as important, if not more so, than the provisionof funding. 1.45. The government is working on pertinent legal and institutionalreforms in order to create more dynamic capital supply. They include initiatives to establish a new stock market for emerging companies, strengthening shareholder minority rights, allowing stock options, reducing taxes on cross border financial intermediation and allowing pension funds to undertake higher risk investments. Implementation of these measures should increase liquidity in the capital market and facilitate sound private sector risk financing. However, these measures by themselveswould not be sufficient to create a VC industry. The role of four `risk capital funds', designedas a conduit for pension funds to invest inmedium and small companies, has remained 33Assessments of the impact of minimumwage increaseson cost competitivenessare not available. 34Gil and Teubal, 2002. 19 limited. They have not moved to upstream venture capital financing. The reasons have to be seen inconstraints on boththe demand and the supply side (see Table 4). 1.46. Chile appears to have in place some of the other endowments neededfor venture capital development - strong contracting procedures and property rights, honest and effective courts, sound institutional infrastructure - but may lack three key elements: sufficient supply of innovative high risk high return projects, a critical mass of entrepreneurs, and specialized financial intermediaries. It is possible that Chile faces a Catch 22. Entrepreneurs will emerge if there are promising investment opportunities and specialized financial intermediaries to help them get on the road. Unless there are able risk taking entrepreneurs, promising investment opportunities will not be seized andventure capital firms will not come to the plate. 1.47. Present government assistance through CORF035to leverage the equity of private investors and managers in venture capital funds through subsidized loans (in the form of preferred equity with a cap on returns) appears to address the least important of the weak links in developing a venture capital industry inChile. Lack of demandfor CORFO's funds may well be grounded in systemic problems possibly related to weak competition policies, onerous regulations for start-ups and a culture that militates against taking risks because of low tolerance for business failures. Creating effective business entry and exit conditions, and entrepreneurial development programs would be among the important framework parametersfor venture capital development. Similarly, the government could help infacilitating collaboration between foreign and domestic interests in starting new companies, and joint ventures between domestic and foreign funds to attract international VC experienceto Chile. 35CORFO's Venture Capital Program is designed inline with international best practice. Gilson, 2002. 20 Table4. Constraintsto development of the VC industryandinitiativesundertakenby the Government Constraints Initiatives under way 1. Supply: LimitedavailabilityofhighriskcapitalandVentureCapitalfinancialintermediaries Small size and lack of liauiditv of the capital market: The market CaDitalmarket reforms: capitalizationof Chile's stock exchange is $74 Billion. (The market cap. of the NYSE andNASDAQ are $11.1trillion and IPOLaw (2000): impacts market $5.1 trillion, respectively.) The small size of the market reduces liquidity by encouraging new agents to exit options, especially IPOs, for VC investors. enter the stock market. Reformof Capital Market Law (2002): increasesliquidity of the capital market by: (i)establishing anew stock market for emerging companies (SMEs); (ii) eliminatingtax oncapital gains for high-turnover stocks and for short sales of bonds and stocks; and (iii) reducing taxes on cross-borderfinancial intermediations. Legal impediments for inflows and outflows of capital and orofit: Legal reformoncaoital flows (2000): Changesto DecreeLaw Law 600 obliges equity investments to remaininthe country for at 600, allowing foreign capital to enter and exit Chile freely (if leastone year. under Chapter 14). Lack of risk caDital and financial intermediaries: Only about 1% PensionFundLegal reform (1989): Law 18/815 allowed of pension fundinvestments (totaling $31 Billionin2001) are pension funds to invest up to 5% of their capital inFIDEs directed to VC Funds.VC Funds and private equity companies are (Fondo de Inversionpara elDesarrollo de Empresas).There also limited (most private equity investment in Chile comes from are currently ten FIDEs,disposing approximately $10-$50 neighboringcountries). Million. To date, FIDEs' performance has beenpoor. CORFO Venture CaDitalProgram-CaDital de Riesno (2001). Patternedafter the US andIsraeli models, this programprovides matchinggrants to private V C funds. It i s a well-designed but only a few VC Funds haverequested financing from the Program. Small size and remotenessof the countrv. Chile is smaller than its Government initiatives to promote Chile abroad: Recenttrips of neighbors anddistant from investorcountries (the USA and Government representativesto the USA, Europe and Asia to Europe). Investors who are far away are not likely to be interested create international strategic alliances and encourage FDI. unless the local company needsat least $10 Million. 2. Demand: Companies' traditionalcorporate structuresand lackof entrepreneurialculture Firms' traditional ownership structures: Unwillingness (and lack EntreareneurshiDand management programs: Introducedin of laws andenforcement mechanisms) to grant special rights to various universities. minority shareholders (essential for VC to take off), lack of employee ownership model through stock incentiveprograms, and lack of highly trained andinnovative managementteams. Lack of an entreureneurial culture. The overall culture is Government advertising camDaigns: e.g., "Piensa Positivo" conservative.The economic attitude is risk-averse. The Chilean campaign. education systemis insufficiently geared towards providing entrepreneurial skills. The programs of Chile business schools are not advanced. English skills are low. Note: This table is not exhaustive in its indicative overview of constraints and initiatives underway. Sources: Based on Baltinand Bell, 2001; Fischer, Lopez, and Paiva, 1999;Pascual and Stockton, 2002; World Bank, 2002a. 21 Policy Recommendations 1.48. There are no apparent major weaknesses in the overall economic incentive and institutional regime. The policy framework is sound and public sector institutions are highly competitive. However, there is scope for a more proactive government approach in some areas to strengthen business fundamentals, particularly with a view towards export diversification and enterprise development. 1.49. Integrating foreign direct investment strategically into long-term national development priorities. Chile has been an overachiever inattracting FDI. However, the lack of significant forward or backward linkages and technological spillover from FDI, combined with the recent decline in inflows, may call for a more proactive government stance in targeting technology and export oriented FDI,beyondthe limitedpromotionprogram of CORFO, by 0 leveraging the knowledge andexpertise of transnational to tie Chile more effectively into global value chains through export niche market development; 0 broadening options to attract FDImore aggressively by extending the eligibility of fundingfrom the various support programs for localcompaniesto foreign affiliates, providedthere are clearly demonstrable direct benefits or externalities; 0 beyondprovidingmarket andbusinessinformation, promotingthe creation of networks between foreign affiliates and local suppliers, upgradingof domestic supplier products, andintegration of foreign affiliates into domestic clusters; 0 encouraging `knowledge intensive' FDIto act as a key conduit for transfer of technology, expertise and skills; 0 usingmatching grants more extensively as the preferred policy instrument to buydown the cost of transnationals opening or expanding affiliates inChile, including inkind contributions interms of infrastructure and local experts; and 0 avoiding the risk of targetingby focusing the promotion carefully on strategic FDI aligned with Chile's development objectives andby institutingpromotion as a continued processof relationship-building that fits into a clear planto creating sustainedadvantages over time. 1.50. Fostering an entrepreneurial innovation culture. A strategy to promote dynamic entrepreneurship should beviewed as a social investment with a long-term perspective. Chile will depend increasingly on new business ventures and knowledge based companies in driving the economy and strengthening its competitiveness. Actions are warranted on various fronts: Improve the general environment for developing business dynamics. The effectiveness of competition policies needs to be reviewed andenabling business exit and entry conditions need to be established. On a more social level, an apparent aversion against risktakingbecauseof low tolerance for risktakingneedsto be addressed. 0 Broaden the base of future dynamic entrepreneurs. Disseminating positive role models to engender an entrepreunirial vocation couldbe an important element of a strategic approach. It would also include programs throughout the educational and training institutions to promote motivation and competenciesto become an entrepreneur. Further, opportunities could be pursuedto facilitate the development of entrepreneurial networks and buildingof business teams. 22 0 Strengthen entrepreneurial culture at the company level. This would include privileging meritocracy over seniority, reviewingthe benefits of separatingownership and managementfunctions more clearly, andcreating opportunities to develop entrepreneurial careers (outsourcing etc.) 0 Reducethe comparably highcosts and time required for settingup new companies, by for example, extending its recent initiativeto allow businessregistration on the Internet by creating a single contact point for business registration, establishing a single business identificationnumber system, and issuinga single businessregistration form. 0 Promote the development of a VC industry with supporting technology and business capabilities. The government would need to act both on the supply and demand side. Recent legal and regulatory initiatives to strengthenthe capital market and CORFO's risk capital programs are not sufficient. A broader approachi s called for to foster the preparation of highrisk-highreturn projects (e.g. measuresto shorten the maturation period of new business ideas, entrepreneurial development) and creating specialized financial intermediaries (e.g. competitive initial cost buy downs to prompt foreign VC funds to start affiliates inChile). Also, possibilities shouldbereviewedto enable domestic start-upsto access suitable international VC companies abroad. 1.51. Promoting a flexible and productive labor market. Growing unemployment calls for special attention of the government, the business sector and organized labor. This would go beyond initiatives at reskilling and retraining, which are necessaryandinclude 0 maintaining restraint inraisingminimumwages further after major recent hikes and allowingfor flexibility indetermining entry salaries for new entrants into the workforce; 0 vetting the proposed reformof labor regulations, including among others a switch of collective wage bargaining from the firmto the sector level, inorder to avoid stifling the labor market andincreasing cost pressure on less productive companies; 0 extending unemployment insurance to foster more flexible labor management practices andreducethe cost of mandatoryjob security provisions; and 0 promotingmore cooperative andproductive labor relations to boost worker motivation, quality of managementand work practices. Investing inthe education of managers and unionleaders, and creating forums for dialogue both at intra- andinter-firm levels would be steps inthe rightdirection. 1.52. Revising the Intellectual Property Rights Act. The IPR Act, revised repeatedly to comply with WTO TRIPS regulations, still does not provide adequate protectionfor confidential test data nor enforcement against piracy, copyright violations and counterfeiting. Further to revising andratifyingthe IPRAct, the government should step upefforts to 0 modify IPRAct to permit universities and public institutions to appropriate benefits of commercial applications of their research; 0 strengthenlegal proceedings against serious PR violations; and 0 upgradecoordination of police and customs to stop counterfeit importation. c. EDUCATION TRAINING AND 1.53. This section examines the state of education and training in Chile and the challenges it faces in assuring that its people have the needed skills and competencies to participate in the 23 knowledge e~onomy.~'The knowledge economy demands a new set of new competencies that include ICT skills as well as soft skills such as problem-solving and analytical skills, group learning, ability to work with others in a team-based environment, communication skills, and so on. While these skills were previously required of persons mainly inmanagerial positions, in the emerging knowledge economy, they are increasingly important for all workers. Overview 1.54. Following the reforms of the early 1980's, Chile's primary and secondary school system was divided into four categories: (i) public schools administered by the municipalities; (ii) private schools receiving public subsidies; (iii)private schools based entirely on parental contributions; and (iv) corporation schools, which are secondary technical-professional schools administered by business corporations. By 1996, public schools and private schools with public funding accounted for the bulkof enrollment with 55 percent and35 percent of total enrollments, respectively. 1.55. The tertiary education systemunderwent a profound change in1981 following a series of structural and financial reforms. As a result, the number of higher education institutions grew from 8 to 257, encompassing 68 universities (public and private), 70 professional institutes (private), and 119 technical training centers (private). The core education system i s supplemented by a pre-school program that targets children up to five years old and training- programs for young people and adults who have left the formal full-time education system. 1.56. The Ministry for Education (MINEDUC) i s responsible for establishing the general guidelines for the education system. As a consequence of the large-scale decentralization processinthe early 1980s, there was a devolution of administrative responsibilities and decision- making powers from the central authorities to local ones and education institutions. The outcome of this process, however, has been mixed. While the decentralization of primary and secondary levels has paved the way for more flexible managementof the education sector, many education institutions have not been up to this task. In some cases, this has left the administration of schools in a void, a problem that has been further aggravated by the fact that the transfer of responsibilities has not been met by a corresponding rise in funding. Moreover, the decentralization process has in many cases failed to create a clear division of responsibilities between municipalities and local schools. Further, the government has to some extent remained in control of teachers' salaries and contracts, which has made it difficult for local school administrators to hire and lay-off teachers according to changes in local demand. Still, the system has become more flexible with the adoption of the 1995 Teachers' Statute, which allows local authorities some flexibility in staff management.38 1.57. MINEDUC manages tertiary education through the Higher Education Division (DIVESUP) and a Higher Council for Education has been set up to monitor the sector. The higher education sector i s also decentralized and many of the tertiary education institutions 37Draws on Aranedaand Marin, 2002; Hansen, Holm-Nielson, and Garcia Zuniga, 2002; and other references, 38 Iti s important to notethat policy formulation also happens under influence from other stakeholders. The Teachers' Union (Colegio de Profesores), for example, is a major player with regard to primary and secondary education. Major stakeholdersat the tertiary level include the Commission for Scientific and Technological Research(CONICYT), the Council of Rectors(25 traditional universities); Consejode la Educucidn Superior Privudu (council of higherprivate education); andCONIFOS (professional institutesand technical training centers). 24 operate with extensive autonomy vis-&vis the central government. But, not all of them have sufficient capacity for self-governance, which has led to the development of a rather heterogeneous tertiary sector. The responsibility for adult training programs and lifelong learning rests with the Ministry of Labor and its affiliated body: The National Training and Employment Service (SistemaNacionalde Capacitacidn y Empleo--SENCE). 1.58. Public expenditure on education as a percentage of GDP has maintained an upwardtrend and represented 3.7 percent of GDP in 1998, which i s low as compared to an average of 4.2 percent for low and middle income countries, and an average of 5.6 percent for high income countries. Public expenditures have mostly been allocated for primary and secondary education. However, the relatively low share of public expenditures has been compensatedby the highlevel of private fundingthat representsalmost 2.7 percent of GDP, higher than in other LAC countries and surpassing an averageof 1.2 percent of GDP for OECD countries. The massive expansion in tertiary education has primarily been financed by the private sector: government funding as share of total tertiary fundingdropped from 100percent prior to the reforms of the early 1980s, to only 27 percent by 1990. Primary and SecondaryEducation 1.59. Chile has attained almost universal participation in primary education, with gross enrollments above 100 percent in 1998. In secondary education, it also has made impressive progress, increasing its share from 53 percent in 1980to 87 percent in 1999 (Figure 7). 1.60. The internal efficiency of the school system has also improved: the repetition rate for primary education decreased from 8 percent to 3 percent between 1990 and 2000, and the dropout rate decreasedfrom 2.3 percent to 1.3 percent. For secondary education, the repetition rate decreased from 12 percent to 7 percent, and the dropout rate from 7.4 percent to 4 percent during the same period.39 Interms of equity, whereas primary enrollment is evenly distributed, inequities remain in secondary education. Enrollments at the primary level do not vary significantly between urban andrural areas; however, they do at the secondary level. 1.61. Chile has been at the forefront among LAC in terms of developing and participating in quality assessments. The need for developing quality assessments was in part created by the liberalizationof the education system and the ensuing decentralization, which created a demand for quality monitoring of public and private schools alike. As a result, Chile today has access to a fairly wide selection of data on student performance. Measures and incentives to improve outcomes in~lude:~" 0 National evaluation: a comprehensive standardizedtesting system-Sistema de Medicidnde la Calidadde la Educacidn(Slh/lCE)-assesses Spanishandmath skills every two years for students in4" and 8thgrades. Infact, the Spanish and Math abilities of 4thgraders in PrimaryEducation SecondaryEducation 1990(%) 2000 (%) 1990(a) 2000 (%) Participationrate 94 91 I1 84 Repetitionrate 7.8 2.9 12.4 6.5 Dropout rate 2.3 1.3 1.4 4 25 municipal schools have made significant progressover the last years according the SIMCE assessment. 0 Rewards: a national systemof performance evaluation for government-funded schools- SistemaNacional de Evaluacidn del Desempeiiode 10s EstablecimientosEducacionales Subvencionados(SNED)-provides bonusesto all teachers ina school on the basis of student outcomes. Figure 7. Gross enrollment ratios for primary andsecondary education, 1980 vs. 1999 % 125 PrimarySchool Gross Enrollment Ratios(%) *Malays$ +New Zealand +Poland 110-- - - - 105-- - -- 100----- 95-- - - - 904 1980 1999 Source: SIMADatabase, TheWorldBank 2003. 1980 1999 Source: SIMADatabase, The WorldBank 2003. 0 Positive discrimination: a government programknown as P900 Programme targets assistance-from new textbooks and materials to professional supportfor teachers-to the 900 poorest primaryschools. 1.62. Notwithstanding the above improvements in the quality of education, Chile lags behind many middle and high-income countries. Chile's performance in the Third International 26 Mathematics and Science Study (TIMSS) of students at the eighth grade was poor especially compared to more developed countries (35`h among 38 countries). One critical factor i s the perceived lack of confidence of Chilean teachers to teach their specific subject matter. Twenty four percent of Chilean math teachers and 40 percent of science teachers reported low levels of confidence against 5 ercent of teachers from other countries. The math and science curriculum i s also outdated: in 8`i! grade, Chilean students were taught less algebra, geometry, chemistry, and physics than students from other countries inthe study. However, Chile has been makingefforts to improve the quality of education, movingfrom a focus on inputsto a concern with outcomes. 1.63. Thus, interms of impartingskills for the knowledge economy, Chilean students need to be taught new ways to learn at the primary and secondary levels, which inturn demands teaching strategies that focus on discussion and the handling and interpretation of information. These skills are instrumental for students to function effectively and flexibly in the knowledge economy. Greater efforts are possible to develop the rational capacities of thinking and learning among students and equipping them to "learn to think." This will require new pedagogical methods of teaching as well as increasedattention to teacher development. Teachers need to be trained to spend less time on instruction and to devote the greater part of their efforts to the facilitation of learning, with more emphasis on application^.^^ It must be noted that efforts have been put in place, such as the MECE Bhsica and MECE Media programs, to address the above concerns.42 These initiatives will needto be evaluated to assess progress made, Tertiary Education 1.64. Chile has witnessed a significant increase in tertiary education, with participation rates increasing from 12percent in 1980 to 37 percent in 1999 (see Figure 8). This i s partly the result of an increaseinsupply of higher education that now includes universities, professional institutes (Znstitutos Profesionales-IP) and technical training centers (Centrus de Formacidn Tk~nica-CFT).~~ university education i s still considered to be of better and higher quality But 41 A complementary input would be the further introduction of ICTs ineducation. The issue of computer and ICT educationand skills is taken up inthe chapter dealing with the informationinfrastructure. 42 The MECE BAsica(MECE) and MECE Media programsare World Bank supportedprojects that haveexplicitly targetedthe needfor quality improvements at the primary and secondarylevel. These projects havedone so by providing, inter alia, funds for hiring new teachers, teacher training, textbook materials, inventory for classrooms and capacity building. Inaddition, to integrateanddeepen the elementsof reform already inplace, the FullSchool Day Reform, launched in 1996, extendedthe school day to give students more time for learningand extra-curricular activities and to give teachers more time for planning, teamwork and training. 43IPS(Institutos Profesionales) deliver 4 year programsand are authorizedto award professional certificates inany field they want to, excluding the 17fields requiringinaddition an academicdegreeto be warded which are only awardedby universities. IPSare all private and do not receive public funding. One of them, Instituto Nacional de Capacitacidn (INACAP), was formerly State owned and was the main technical vocational educationand training provider inthe country. During the 1980's it was transferredto a especially creatednon-for-profit private corporation, whose Board of Directors includes the most important industry and commerce associationinChile. INACAP is today by far the biggestIP inthe country, with more than 60,000 students. CFTs (Centrosde Formacidn Tkcnica)offer two-year technical vocational programs that award a Higher Technical Levelcertificate. These are private institutions that haveto be accreditedby the Stateto deliver their programs accomplishing certain formal requirement regarding staff, infrastructure, etc. A prerequisite for a certificate of this levelto be awardedis that students must attendaprogramlasting at least 1,600 hours. 27 than that provided by IPSand CFTs, for a variety of reasons: (a) university degrees are more esteemed than non-university degrees. Employers have more confidence in these degrees as proxies for skills and competencies; (b) technical vocational programs delivered by CFTs and IPSare viewed as dead-ends as their certificates do not have formal value for higher levels of education; (c) CFTs do not receive much public funding as compared to most universities, so paradoxically it is more affordable to attend a university than to pay fees for CFTs; and (d) curricular guidelines andeducation quality monitoringare, ingeneral, non existent for C F T S . ~ ~ Figure8. GERfor tertiary education, 1980vs. 1999 % Tertiary Gross Enrollment Ratios (%) 1980 1539 'DBtatoryeaP1lSa0and 1W 7 W B "rsd Source: SIMADatabase, The World Bank 2003. 1.65. Thus, the diversification process of the tertiary education sector has not been entirely successful. The reforms created a massive growth in the number of private tertiary institutions and have led to widespread duplication leaving universities and CFTs competing for the same students rather than developing complementary programs. Moreover, the enrollment figures indicate a lack of success among many of the new institutions. Whereas university enrollment has increased markedly, total enrollment in CFTs dropped from more than 77,000 in 1990 to approximately 50,000 in the late 1990s, arguably due to reports of low-quality standards of these institutions. The lack of systematic quality assessments of tertiary level institutions has meant that CFTs have been operating with outdated curricula, implying a lack of progression and integration between secondary and tertiary technical programs. This does not leave much of an educational or economic incentive for secondary graduatesto enroll inthese institution^.^^ 1.66. The above points to the very heterogeneous quality of the tertiary education sector, which can be argued is the result of a flawed quality framework. For example, the absence of systematic quality assessments prevents policymakers from identifying the strengths and weaknesses of the tertiary education system. But some progress has been made in recent years 44In 1998 the Chilean government implemented a six year project (MECE-SUP) to improve the performance of higher education inthree key dimensions: coherence and efficiency; quality andrelevance; and equity. 45The 1998 World Bank supported Higher Education Project addressesseveral of these shortcomings. Itpromotes a more level playingfield by providing for public subsidies, which inturn is expected to promote quality at private institutions. The project also addressesthe overlaps between the different programs and institutions. 28 with the decision to make the Higher Council for Education be responsible for developing a coherent and all-encompassing quality assessment system comprising universities, IPS, and CFTs. These efforts are being encouraged by the World Bank supported Higher Education project which promotes the adoption of a flexible accreditation system, which should allow authorities (and students) to monitor and benchmark higher education institutions more closely. So far the results are encouraging: the changes seem to have stimulated a sense of competition between the different higher education institutions, which in turn gives them an incentive to improve the quality and relevance of their programs. 1.67. Regarding equity, gains in enrollment and educational attainment at the tertiary level have not been equally distributed in Chile, and major imbalances exist across income quintiles andbetween the urban and rural areas. Only 15 percent of university students, for example, come from the poorest 40 percent of families. This follows from the fact that the poorest income quintiles cannot afford to enroll inthe new private universities and find it difficult to be accepted to public universities, which are highly elitist interms of academic admission criteria.46 1.68. And, despite their prestige, in terms of developing skills for the knowledge economy, Chilean universities do not appear to have sufficiently oriented their curricula (which remain academic and rigid) towards developing "knowledge technicians" that are required by industry. This also calls for encouraging the development of soft skills such as teamwork, networking, language, and knowledge sharing skills at higher education institutions. In addition, education and business partnerships are scarce, and there are no mechanismsfor systematic feedback from the private sector to indicate the kind of knowledge and skills that are needed by the economy. Initiatives should be launched to increase the flow of information between the university and enterprise sector, as integrating the demands of the market into the education system will be important for Chile's transformation to a knowledge economy.47 Skills Neededfor the Knowledge Economy 1.69. Chile's transition to the knowledge-based economy will be determined to a large extent by its ability to manage complementarities of the education and innovation systems. The strength in the relationship between education and innovation i s a critically important factor in determining productivity increases and income growth. Harnessing technology-skill complementarities will require skill-upgrading through a sharper focus and expansion of education. Policies to increase education levels are tantamount to good innovation policies. Education policies in Chile should have increased supply of educated and trainable workers to 46A numberof policy initiatives havebeenlaunchedto mitigate the imbalancesat the tertiary level. The above- mentionedBank supportedHigher Education Project (1998),for example, has contributed to the development of a new studentloansprogram for low-income students intertiary education. Moreover, student grants have been provided within the framework of the SistemaNacional de Financiamiento Estudiantil (National Systemfor Student Finance). Still, these schemes havearguably beeninsufficient to make low-income students enroll, seeing that many loans only cover part of the costs leaving the students with the challenge of financing living costs during the studies. 47One initiative, proposedby the Universidad Adolfo IbQiiezand Universidad de Chile to generatecontinuous and relevant information on the supply and demandtrendsinthe labor market, was scheduledto begin in2002. 29 firms as a major explicit ~bjective.~'This section looks at Chile's stock of human capital to assess the extent to which it is contributing to developing the knowledge economy. 1.70. Higher-order skills. The opening up of the Chilean economy has strengthenedthe need for high-order skills that include logical reasoning, independent judgment, and the abilities to work in teams. These skills include the ability to performindependent analysis, adapt quickly to new situations, and interact with other persons on a professional level. However, such skills, which are characterized by flexibility, analytical thinking, and rapid learning do not seem to be very prevalent. Chile was the only country in LAC to participate in the OECD's International Adult Literacy Survey in 1998.Results of the IALS, however, show that only 20 percent of the Chilean population has reading comprehension sufficient to deal with the "demands of everyday life and work in a complex advanced society." Chile thus needs to foster the development of these skills among the population, especially in older workforce (which makes the case for intensifying training efforts targeted to them). It also should continue participating in international comparative tests such as the IALS that address not only academic skills but also generic competenciesneededfor the knowledge economy.49 1.71. Hard skills. Hard skills, such as those displayed by physicians, engineers, agronomists, biologists, technicians etc. are in strong demandin developed knowledge economies. Chile has been highly successful in deploying hard skills for competitive advantage in the development of its natural resources. However, many sectors notably in services, are under funded in hard skills, and hence constrained in the applications of modern technology. If the overall technological level of the economy were raised and were new technologies integrated into all sectors, it would stimulate a virtuous circle of demand for the "knowledge workers'' and "knowledge technologist^"^^ who are flexible, analytical, and can be the critical driving force for innovation and growth. 1.72. At the research level too, even though Chile's endowment of researchers i s well above the average for Latin America, a wide gap exists between it and more developed economies such as Spain, where the ratio of researchers i s three times higher than in Chile. One possible explanation for this trend might be that research programs in Chile are chiefly associated with careers in universities and research institutions. Chile will need to make Ph.D. programs more attractive by aligning them with the needs of the private sector and the economy. This move requires a reform of higher education programs and more productive interaction between universities andprivate sector, perhaps promptedby some public programs. 48 See the World Bank Report "Closing the Gap inEducation and Technology inLatin America" for aconceptual framework and discussion of the relationship betweeneducationand technology. World Bank, 2002a 49 Chile has declined to participate inthe new Adult Literacy andLife-skills Survey (ALLS). 50 According to Drucker (2001), "at present, the term, "knowledge worker" is widely used to describepeoplewith considerabletheoreticalknowledge and learning: doctors, lawyers, teachers, accountants, chemical engineers. But the most striking growth will be in"knowledge technologists": computer technicians, software designers, and analysts inclinical labs, manufacturing technologists, and paralegals. These people are as much manual workers as they are knowledge workers; infact, they usually spendfar more time working with their hands than with their brains. Just as unskilled manual workers in manufacturing were the dominant social and political force inthe 20th century, knowledgetechnologistsare likely to becomethe dominant social-and perhaps also political-force over the next decades." 30 Learning and Training 1.73. Training initiatives are neededbecauseof the obsolescenceof specific skills acquired on the job. In Chile, the government (SENCE) i s directly involved in providing incentives for enterprise-basedtraining. It does so by administering a tax incentive scheme for company based training, that is, for firms that directly provide or contract registered providers to develop training programs for their workers and by providingother public funds for special disadvantaged groups (see Box 5). With the introduction of accreditation systems in 199Os, the skills that workers acquire through on-the-job training or experience can be certified, thus becoming transferable. SENCE estimates that participation in company-based training have increased from about 100,000 in 1980 to more than 620,000 in 2000.5' However, despite its expansion, the tax rebate schemehas had some limitations. 0 Participation intrainingthrough this scheme i s still low: only 11.5 percent of the employed work force participated init in2000. 0 Only 14.9 percent of the companies contributing to the training levy-rebate scheme make use of its trainingbenefits: this raises questions regarding the effectiveness of the system to encourageand stimulate participation intraining. Most companies using the training system are large ones that cover less than 10 percent of the labor force. Micro-enterprises represent approximately 82 percent of total enterprises but their participation rate intraining i s only about 0.4 percent. The situation i s reversed for the 0.4 percent of large enterprises that take up about 83 percent of the training. This represents a serious imbalance that questions the effectiveness of the scheme. There seems to be an emerging consensus that training provision i s insufficient with regard to quality and relevance, that is, it i s not aligned with the needs of firms and i s not effective in producing the skills needed by the labor market, due to: (a) lack of information between the supply and demand side of training in terms of competencies that need to be developed in the workforce; (b) no explicit standards to judge the quality of provision; (c) mechanisms used by the government agency managing the income tax rebate system to approve training providers are formal and bureaucratic; and (d) danger of the training system ending up teaching remedial skills, a task for which it is not well prepared andwhich duplicates at a highercost what should have been taught in schools. ''This trend can be explained by the changes in the business environment and the necessity that most companies face of improving their work force skills and competencies. Most of the demand is concentrated inlarge companies usually working with world-class standard^.^' Most training also goes to the higher educated, more qualified, and administrative type workers and not so much to the blue collar workers as is evidenced by the occupational level o f workers participating inthe training in2000: Top managers (4.4 percent), highlevel professional (16.6 percent), middle managers (8.7 percent), ClerWadministrative (32 percent), qualified workers (30.1 percent), semi-qualified workers (5.4 percent) and unqualified workers (2.8 percent). 31 Box 5. The Chileantrainingsystem The training systeminChile i s regulated by the Sewicio Nacional de Capacitacidny Empleo (SENCE) under the Labor Ministry. SENCE i s apure regulator that does not own or operate training facilities. The training systemhas two components. 1.TrainingTaxRebateScheme(Companybasedtraining). Companiesareallowedto deduct costs incurred intraining their workforce from their annual taxable income up to a maximumof 1percent of their total payroll value, with a minimumthat favors small firms. Businessespresent their training programs to SENCE, and if the programs meet quality and relevance criteria, the firms receive a tax rebate that covers a portion or the total training programcost depending on the trainees' salaries (below a certain salary SENCEcovers all of the training cost). This operational mode makes full use of the variety of training providers available inthe market, and lets firms choose the content of their training programs according to their needs. Smaller firms that do not have the managerial structure neededto design training programs can use intermediate organizations as brokers with training providers, and these activities also benefit from the tax rebate. 2. FONCAP(FondoNacionalde Capacitacibn). The 1997 reformcreated a special fund called FONCAPcomprisingtwo branches: (1) A special direct subsidy for small andmicro enterprises aimed at compensating the low proportionof these companies usingthe tax rebate scheme. The subsidy covers 80 percent of the training costs and companies have to assume the remainingcosts. The purchasing decisionremains on the companies. (2) A special fund to finance training programs intended for groups of the populationunder threat of unemployment or other forms of social exclusionthat can be mitigated by developingemployability and/or basic occupational skills inthe targeted population (as for example, Chile Joven). Thus, the tax rebatescheme will needto be improved to encouragesmall andemerging companies to invest intraining for their workforce. One way to do this would be to differentiate the tax rebate scheme accordingto size, and creating performance-based accreditation systemsfor institutions providing training under the tax incentive and/or the FONCAPprograms. This includes partneringwith the private sector to develop a competency framework that encouragesthe development of skills that are relevant for the economy and creatinga skills certification system (see experience of Fundacidn Chile in Box 6). 32 Box 6. System for certifying workplace competenciesin Chile FundacidnChile has developed a programto evaluate andcertify job skills. The program, which i s being led with the government (SENCE) andrepresentativesof the private sector, is designed to respondto the following: Few clear signals to thejob market and to education andtraining systems about the knowledge, skills and behaviors neededby industry; Low company satisfaction with the supply of available training, especially the lack of pertinence to their needs; Formal education certificates that do not guarantee that a person can performjob functions with the appropriate skills requiredby the employer; Skilled workers lacking informal education do not have mechanisms that recognize the learning acquired from their work experience, which affects theirjob mobility and careers. The programincludes the design and implementationof competency standards development, assessment guidelines and the institutional arrangements neededfor the system to be accountable and legitimate. The main outcome of this pilot programwill be a proposal for institutionalizing the system andreforming laws, makingpossible the use of the tax rebate scheme not only for training butalso for assessment andcertification of workplace competencies. A crucial aspect for sucha system to be successfulis for it to be perceived by employersas adding value, andbeing highly flexible, responsive, basedon internationalbenchmarks and cost-effective. The first implication of this principle i s that the system will not cover every occupationalarea but only those for which demand i s mature or near to. Feesfor assessment andcertification will be charged to applicants by accredited awardingbodies and assessment agencies. Employers will cover the costs involved by themselves or makinguse of a demand subsidy (probably a tax incentive); workers from medium and small companies will have a special government subsidy. A workplace competency system can providecriteria and mechanisms to externallyjudge technical vocational and training providers' performance interms of learning outcomes. Learners who have completed trainingllearning modules delivered by a technicaltraining center can be externally assessedto assess whether they have actually acquired the relevant knowledge, skills, and competencies. The successful introduction of ajob skills certification system can therefore bring the following benefits: Employers will have defined and acceptedstandards for personnel recruitment and selection processes will become more efficient. Current andfuture employees will have the meansto certify the acquired knowledge, skills andbehaviors developed throughout their working lives, improvingpossibilities forjob mobility within or between different sectors. Training agencies will have validated information to offer programs that are relevant to the needs of the market andare of highquality. The certification system will provide incentives for the formal education andtraining sector to align itself with the requirements of the work world. Source: Fundacidn Chile (http://wWw.fundch.cVfundch Uindex i-cfm); background paper by Araneda and Marin, 2002. Policy Recommendations 1.74. In moving forward, Chile could consider reinforcing actions along two paths: a) combining educational reforms oriented towards raising participation, equity, and quality at the school and higher education levels with lifelong learningand training programs that can provide 33 the labor force with the necessary skills to be fully engaged the knowledge economy; and b) coordinating effectively the many innovative yet frequently fragmented initiatives in a coherent strategy across the education system that includes both public and private universities, and establishing stronger links between the tertiary and secondary education levels. Key recommendations are presentedbelow. Making education responsiveto the needs of the knowledge economy: 0 introduce materials and methodsto teach students "how to learn" instead of providing occupation-specific knowledge; 0 continue participating ininternational comparative tests that address not only academic skills but generic competencies neededfor the knowledge economy. 0 improve further the quality of learning outcomes at the primary and secondary level by focusing teaching practices on enhancements of the learning environment, and on problem solving and analytical skills; 0 evaluate results of the new science curriculuminprimary and secondary schools with focus on hardand higher-order skills (MECE-Bftsica andMECE-Media) for possible replication, if successful, on abroader scale; and 0 use tests to assess ways for upgrading the skills of teachers and strengthentheir confidence. Developinga framework for competencyand performance of tertiary education across institutions: 0 use an evaluation of the results of the 1998 World Bank HigherEducation project for systemic insightsto improvethe quality of tertiary education; 0 level the playing field of universities, professional institutes and centers of technical formation by makingcertificates credible proxies for skills and competencies; and 0 institutea coherentquality assessment andperformance tracking system. Aligning the skillquality of labor supply with demand: 0 promote university-industry partnerships and strengthening partnerships betweenlocal and foreign universities; 0 expand exchangeprograms for Chilean studentsandprofessors and attract renowned foreigneducational institutions to open branches inChile; 0 enhance information on skill remunerationpatterns and create feedback loops for developing education and training curricula that better meet the needs of the private sector; and 0 expand and strengthenthe skills certification system. Upgradingand targeting training programs: 0 raise awarenessof small businessof the importance of training and available opportunities; 0 improvethe tax rebate scheme with abias infavor of small companies for investingin training of their workforce; 0 evaluate systematically outreach and quality of current trainingfor a stronger interface between firms and training institutions; 0 create performance-based accreditation systems for institutions providingtrainingunder the tax incentive and/or the FONCAP programs; and 34 leverage public andprivate efforts, with the state funding the development of trade level competency standards and firms offering incentives, supportedby government matching grants, for workers to obtain certification. D. INNOVATION SYSTEM 1.75. Innovation is the key to producing and processing knowledge. A nation's ability to convert knowledge into wealth through innovation determines its future. As mentioned in the beginning of this chapter, an innovation system consists of the network of organizations, rules, and procedures that affect how a country acquires, creates, disseminates, and uses knowledge. Key organizations for the creation of knowledge include universities; public and privateresearch centers, and policy think tanks. Private firms are at the center of innovation system. They are the locus of productive transformation. The innovation process is not effective unless it creates and satisfies demand for knowledge, unless it translates into productivity growth. Networking and interactions among the different organizations, firms, and individuals are critically important. InstitutionalFramework 1.76. Responsibility for formulating and overseeing Chile's strategy for scientific and technological development i s vested formally with two bodies: the National Commission for Science and Technology (CONICYT) and the Presidential Scientific Advisory Commission. Absence of clear mandates, political considerations and limited budgets, compounded by overlapping functions, have limited the effectiveness of both in providing clear strategic directions andcoordination among pertinent government agencies. While there are detailed plans and objectives, a clear strategy, with priorities that would be bindingon public agencies, has yet to be developed. Mechanisms for advice, funding, management, execution and performance oversight are not aligned. Ineffect, the Ministry of Finance i s setting priorities by deciding on budget allocation. 1.77. The government has developed myriad policies, programs and policy instruments for scientific research, technological development innovation and diffusion. Figure 952gives an overview of major funding instruments. FONDECYT, FONDEF, FONDAP, FONTEC and the Millennium Science Initiative (MSI) report to various ministries and operate rather independently. A systematic evaluation of these instruments is readily available only for M S I and the CORFO managed PROF0 program. The evaluation of MSI shows significant improvements in the productivity of Chile's top researchers in terms of publications and increased opportunities for training and scientific collaboration. However, there i s no information on potential, or actual, applicability of technical papers and university collaboration for productive purposes. 1.78. COW0 has been transformed from holding company of public enterprises to the main policy instrument of the government to promote productivity growth in the private sector. CORFO has become an increasingly important player in funding and brokering technology and 52The table is intendedto give an overview of the diversity of governmentfunding mechanisms.Itis not comprehensive. 35 innovation related business services. CORFO's diversified programs53address a gamut of issues from marketfailures to informationasymmetry, notably for SMEs. 1.79. New government programs inresponseto emerging needs frequently are beingbuilt into the existing system without a prior assessment of the suitability of existing organizational structures and management responsibilities. The recently created National Program for Prospective Technologies (PNTP) reflects this tendency. The purpose of PNTP i s to identify, build consensus, and promote technologies of critical importance for Chile's economic competitiveness in the long-term. It is part of the Program for Technology Development and Innovation in the Division of Productive Development in the Ministry of the Economy. While the government obviously felt the need for institutingsuch a program - which indeed could be of importance indeveloping a technology framework for public private sector interface -- it stopped short of giving it the administrative profile, links andbudgetto be successful. 53Aside from FONTEC(Figure 9),COW0 operates various technology diffusion programs and dedicated programs for venture capital financing (Table 4), foreign direct investment promotion, and technology innovation supplier development. 36 1 1 1 I 1I 7 I I l I .........t.. U Resource Mobilization and Use 54 1-80. After rapid increases between 1988 and 1993, the resource envelope for R&D in Chile has been stagnating at a plateau of about US$450 million, the equivalent of US$29 per capita (see Figure 10). This compares with US$42 per capita in Brazil and US$36 per capita in Argentina. Chile devotes about 0.6 percent of GDP to R&D, about a quarter and half of efforts in Finland and New Zealand, respectively. Chile also ranks below Poland but ahead of L A C comparators and Malaysia. Figure10. R&DexpendituresinChile I R&DexpendituresinChile in 1 5 0 0 1 , 35 450 30 Mil400 lio 350 25 199 E 9 300 20 2 2 250 $U 15 s S 200 150 10 100 50 5 0 0 Source :Instituto Nacional de Estadisticas(INE) 1.81. The government is by far the largest financial contributor to R&D in Chile. Including R&Drelated outlays for higher education, it accountedfor roughly 72 percent of total funding in 1999, roughly in line with Latin American averages but significantly above the averages of OECD countries. The share of private domestic sector financing, while increasing fourfold during the nineties, still reaches only 21 percent. Foreign investors have contributed the remainder, roughly 7 percent. Private sector shares in Brazil and Argentina are 31 percent and 26 percent, respectively. Chile's public sector plays an even larger role in the execution than financing of R&D. Government researchinstitutions and universities, with roughly equal shares, manage almost 90 percent of Chile's R&D budget. In contrast, the private sector i s the driving force inthe OECD countries with a share of between 50 to 70 percent of R&D resources. 1.82. Chile is not alone in investing less in innovation than would be warranted by economic rationale, Econometric analysis by Lederman and Maloney (Figure 11) on the returns to investments in innovation makes a strong case for a very sizeable increase in Chile's R&D budget. Usingthe returns of investment inphysical capital as a benchmark, Chile' optimal level of R&D investment should be about twice as much as it i s currently. However, the first priority 54Draws on Holms-Nielsenand Agapitova, 2002; WEF, 2003; World BankSIMA database, 2003. 38 would be on utilizing limited funds more effe~tively~~and on increasing the role of the private sector. Both on account of financing and execution, the participation of the private sector in Chile i s below standards in similar and high-income countries. The revealed lack of real commitment of Chilean entrepreneurs contrasts with the importance they have given, in survey responses, to R&D and innovation as a major source of generating revenue for their enterprises. Figure11. Estimatedreturnsto R&DExpendituresandR&Dgap - _ 2000 7000 12ow 17WO 2.2000 Constant 1995 PPPUS$ /-Returns to R ~ ---Returns D to Investment -----R&D/lnv 1 Source: World Bank, 2002. "Closing the Gap inEducation andTechnology inLatin America." Innovation Capacity 1.83. Chile's entrepreneurs consider their country to compare well in its technology position among 75 countries globally. The respective ranking places Chile ahead LAC and similar income comparators, and close to New Zealand. Finlandi s in a category of its own as arguably the world leader in the focus on R&D. Chile's companies are spending relatively more on R&D than their peers in Latin America and relatively more firms in Chile have R&D facilities than their peers in LAC. In contrast, Chilean companies have recorded fewer product and process innovations than their peers.56This finding points to a comparatively low effective use of Chile's limited innovation endowments. It also points to the need for evaluating carefully the benefits andcosts of in-house R&D programs vs. outside purchase of technology. This issue is of some importance for the orientation of public R&D policies. 1.84. Chilean entrepreneurs have been pointing to inadequacies in the business relevance of domestic R&D capabilities, and lack of cutting edge expertise and skills as a major constraint to 55InChile, 60 percentof the budget are devotedto basic research, without any missions orientation, comparedto an average of 15 percent in OECD countries. 56Anllo and Raffo Indicios. httD://www.redhucvt.oasor~/r~cvt.Indicadores/Com~arat~vos/44.xls 39 inn~vation.~'Chile's endowment of scientists and engineers (369 per million inhabitants), notwithstanding a 40 percent increase in the nineties, i s a mere fraction of endowments inhigh- income countries, but also significantly lower than in Poland and Costa Rica. Furthermore, few scientists andengineers are employed inproductive activities. Two out of three S&T researchers are located in universities, with weak links to business, and only 6 percent operate in private companies. This compares to more than a third in leading OECD countries with a tradition of close firm-university collaboration in research.j8 The opportunity costs of having a high proportion of scarce research skills in non-productive activities are substantial. The flexibility for transfers to places of highesteconomic and social return will needto be improved. 1.85. There are few collaborative arrangementsof significant size between private firms, public research institutes and universities. Chile ranks below comparator similar and higher income countries. Only 25 percent of firms surveyed had entered contractual agreements with universities and 14 percent with public research institutes. This may be a consequence of the apparent low regard entrepreneurs have for the quality of domestic R&D facilities, lower than their peers in comparator similar (except Malaysia) and high-income countries. An important shortcoming are inadequate links of both Chilean companies and universities with international technology providers -- Chile's `technology antennas' to the global knowledge markets need to be powered up. Chile has been relying heavily on FDIas a source of new technology. However, surverys indicate that both Malaysia and Poland are more aggressive in tapping FDI for technology transfers than Chile. 1.86. Government science related support programs have strengthened Chile's intrinsic capacity for research. The number of articles of Chilean researchers in scientific publications rose by 40 percent during the last decade. Adjusted for population size, Chile measure up well among LAC, being number one in the Science Citation Index and number 3 on the French Scientific Database. Universities have been accounting for more than 90 percent of Chile's scientific publications. However, bibliometrics do not say much about innovation, i.e. the process of transforming knowledge generation into knowledge utilization. 1.87. Patent statistics are among the most widely used indicators of innovationcapacity. They are presumed to reflect the relevance of research in the commercialization of new products and processes. Econometric analysis shows that Chile, in international comparison, i s not efficient intranslating its R&D investment into patents (see Figure 12). The numberof patentsgrantedby Chilean authorities has been on a declining trend since the seventies. Underlying this trend i s a sharp fall inthe granting ratio, which offset anincreaseinpatent applications. 1.88. The dominant share of non-resident applications and higher granting ratio (non-residents 17 percent vs. 9 percent for residents) reflects Chile's increasing reliance on foreign technology transfer. Time consuming procedures (2-4 years) and high costs (US$5,000 - 10,000) of patent approvals would seem to act as a disincentive notably for resident researchers to apply for patents. Conversely, weaknesses inthe IPR Act reportedly are stifling the transfer of technology 57 Benavente, quotedIndustrialSurvey1996-1999. 58Brunner, 2002. 40 from abroad. While the Act has been strengthened various times to comply with WTO TRIPS requirements, it still does not provide effective enforcement againstpiracy and ~ounterfeiting.~' 1.89. Overriding academic interests, narrow disciplinary approaches and centralized bureaucratic approval processes continue to stifle a stronger university orientation towards economic productivity and continue to separate the processes of research discovery from commercial application. There i s not much collaboration and exchange between the technological institutes and universities or among individual researchers in Chile.60 The competitive design of public research grant applications generally favors single companies over consortia. This has contributed to a zero sum competition game, rather than creating a conducive environment for partnership. It has also a build-in bias towards established applicants at the expense of new entrants. Promoting new ideas and out of the box thinking may require a more pro-active stance. One possible approach would be to link PTNP's task of identifying and promoting critically important technologies (Para. 1.85) with competitive incubation of novel thinkers and upstartservice providers. Figure 12. R&Defficiency, 1985-2000(% deviationfrom OECD average) 10.00% 5.00% 0.00% -5.00% ._.__I_ Source: Bosch, Lederman, and Maloney (2002) 59International Intellectual Property Alliance, 2001. 6oMullin,Adam, Halliwell, and Milligan, 2000. 41 1.90. Chilean researchers generally have not been active in collaborative efforts with foreign researches institutions or joint ventures of foreign and domestic firms. However, there are signs that international contacts of Chilean researchers are intensifying. An outstanding example is the agreement of the Fundacidn de Chile with seven private non-profit research agencies in the US and Japan to promote joint research in agriculture, aquaculture, forestry and food processing. The model is interesting in that it focuses foreign counterparts to work with their Chilean counterparts on problems relevant to Chile. The agreement is designed to facilitate technology transfer to Chile and to enable applications of research to product development and commercial use among small and mediumenterprises.61 Technology Transfer andDiffusion 1.91. Transfer and diffusion systems are important instruments to transform knowledge into innovation and to develop concepts into business. This i s particularly important in countries like Chile that are catching up and learning from the leaders through imitation and adaptation. Chile has been relying primarily on embodied technology in imported goods and services, and on FDI as main conduits for technology transfer from abroad. However, this transfer has been focused on selected sectors, mainly commodities and utility services, without much spill over for the economy at large. Licensing and royalty payments have been of lesser importance. Chile ranks at the lower end among largerL A C countries inpayment for licenses and also royalties.62Lastly, Chile has made very little use of transferring technology by attracting expertise and skills from abroad. 1.92. The government has been according priority in its innovationbudget to the generation of knowledge through research and development. In addition, it operates sectoral and systemic knowledge diffusion programs. The government approach has an almost exclusive domestic focus. The opportunity of higher returns from a stronger outward orientation through scanning and tapping international knowledge and promoting links with the international knowledge community should be explored. As a result, Government supported knowledge dissemination programs would most likely gain ineffectiveness. 1.93. The National Institute for Agricultural Development (INDAP) manages the agricultural extension program. It covers the bulk of the cost of technical service provision, with farmers expected to contribute the remainder. INDAP has the final word in the selection of service providers and technology. The program has evolved from promoting increased yields of basic commodities to assisting in the implementation of both "hard" and "soft" management technologies and innovation. The program reportedly has had positive results in increasing production quality and output. However, improvements have been largely input driven with limited effect on raising productivity, and hence income.63 A major weakness of the program i s its supply orientation, which i s reflected in inadequate participation of farmers in the decision- makingand supervision process, lack of incentives for superior results, andwith it deployment of highly skilled professionals. As a consequence, many farmers apparently have been unwilling to pay their contributions. 61Holms-Nielsen. L.,Agapitova, N. 2002. 62Hansen, Agapitova, Holms-Nielsen, and Vukmirovic, 2002. 63Bebbington and Sotomayor, 1998. 42 1.94. The Program of Technical Services for the Promotion of Productivity (SERCOTEC) i s geared to improving management and competitiveness of small and medium enterprises. SERCOTEC in many ways functions as a knowledge broker. It reportedly has been effective in improving the operations of its clients, using a broad array of programs and instruments. However, surprisingly there apparently has not been as much demand for SERCOTEC's services as one would expect from the challenges that are confronting the SME sector. Reported weaknesses in SERCOTEC's mode of operation include lack of incentive based outsourcing of brokerage and management functions, and effective organization of SMEs inclusters for gaining economies of scale. 1.95. The Promotion Program (PROFO) for SMEs i s among the best-organized and successful government diffusion initiatives. Point of departure for the program was the presumption that isolation rather than size i s the main problem of SMEs. It was decided therefore to transfer public resources to groups of companies rather than individual firms. To be eligible under this CORFO supervised program, companies in similar lines of business or locations have to constitute themselves as legal associations under independent private management. Once accredited, these associations have accelerated access to the gamut of the national extension infrastructure, including the NationalTechnology Development Fund, ProChile etc. A thorough independent evaluation has demonstrated significant improvements, measured against a non- participating control group of companies, in organization, accumulation of human capital and also in innovation of products and processes. It was estimated that the program generated an IRRof 21percent and an increaseinvalue addedof 14percent of participating companies above the control CORFO's technical assistance fund (FAT) has a similar service brokerage functionbut i s dedicated mainly to individualcompanies. 1.96. Generally, international experience suggests adherence to some best practice criteria in designing diffusion programs:65(i) customer focused, demand driven and result oriented; (ii) broad based, including both off-the-shelf as well as sophisticated tailor made technologies; (iii) beyond technical problem solving to encompass training, management and networking; and (iv) strong linkages with all technology related service providers and networks between service providers and users, includingtie-ins with international technology sources. Adequate resources, linkages and leverage points are neededto reach scale economies in working with large number of clients. A review of current programs against these criteria would be a startingpoint to leadto performance improvements and buildup of professional expertise. 1.97. The Fundaci6n Chile has been rather successful in combining business innovation and incubation (see Box 7). Unlike CORFO, it i s able to take direct equity stakes -risks and rewards -inthisprocess. Launchedinpartwithgovernmentfunding,thecharterandcapitalendowment of the Fundaci6n allows it to engage in a large range of activities including research, promotion, financing and management. Its mission i s to contribute to the innovation in markets for goods and services and to transfer technologies aimed at providing Chile with added economic value. The Fundaci6n i s not subject to bureaucratic constraints of public institutions nor to specific lines of business and short-term earnings pressures of private companies. Its institutional setting has attracted high caliber staff and outstanding management. The Fundaci6n has set an example for 64BenaventeandCrespi, 2001. 65Drawson IADB, 2001a. 43 effective international outreach and usage of international knowledge as well as contacts for business purposes. 1.98. Drawing on Chilean country experiences, the government could review possibilities to embody key features of the Fundaci6n prototype in the governance of its innovation related programs, agencies and funds. In essence, it would imply increased managerial independence and market exposure. The rationale for such a move would be a commitment to strengthen Chile's ability to: (i)tap more effectively into the growing global knowledge stock; (ii) strengthen the financing system for transforming an idea into a business proposition, project launch and ultimately mature company; (iii) create opportunities by identifying market niches for diversification and missing links for cluster development; (iv) incubate innovative business by organizing consortia of domestic firms with international technology companies; (v) set-up and manage, as appropriate, new companies with built-in international expertise to address technological constraints of resource based industries; and (vi) deepen foreign market penetration by strengthening quality control, auditing, certification and accreditation procedures incooperation with pertinent internationalauthorities. Box 7. FundacidnChile-A pathbreakerintappingtechnologiesand sparking innovations FundacidnChile is a privately-owned, non-profit technologycentercreatedin 1976with a mandateof developing innovative businesses andprogramsby transferringtechnologies. Its missionis to contribute to the innovation in markets for goods and servicesandto transfer technologiesaimedat providing Chile with added economic value. It focuses on improving the technicalperformanceof economically important sectors by tapping first-class global technologiesincreatingnew companies andjoint ventures. Its technology transfer mechanismsinclude: R&D andadaptationof foreign technologyfor product andprocess innovation, Promotion of technology "consortium for pre-competitive horizontal R&D'. 0 Technological antenna andtechnologydiffusion to SMEs 0 Institutional innovation (orientedto reducing transaction costs, marketdevelopment inincomplete markets, public-privatepartnershipfor institutional development) The systemic technology focus of FundacidnChile includesbiotechnology, management, environment, financial engineeringandinformation. Recentfocus areas include forestry genetics andDNA vaccines for aquaculture. FundacidnChile has developedthe identification of missinglinksfor developingclusters with comparative advantageinto abusiness practice. The clusters include the agribusiness, marine, tourism (agro/eco), forestry and wood processingsectors. The Fundacidnapplies the `missing link' concept also insupporting educationand humanresourcesdevelopment. FundacidnChile has beenquite successfulinincubatingnew ventures through entrepreneurshipand technological innovation. By 1999, it hadlaunchedthirty-six such ventures. Seventeenhavebeen sold. The six leading companies havegeneratedmorerevenuesthanthe total cost of the Fundacidnduringits existence. Source: Bitran, 20026. 44 InnovationNetworks 1.99. Chile has developed successful innovation networks of international repute. Yet, the private sector at large i s not networked -- it i s not poised to create economies of scale and scope for innovation and competitiveness through supply chains and clusters. Collaborative efforts among firms, and between them and domestic research institutions and universities are exceptions. Forward and backward linkages between larger companies, notably foreign affiliates, and smaller firms remain weak. 1.100. Applying cluster analytical tools would help public and private Chilean stakeholders to pinpoint opportunities for vertical and horizontal integration through joint business initiatives and supporting government actions. It would provide insights into the effective design and implementation of conventional innovation policies through a systematic analysis of strengths, weaknesses, opportunities and threats (SWOT) of functional and geographical business interrelations. Findings from cluster analysis can be used to accelerate the rate of innovationby leveraging inter-firm synergy and connections to non-market institutions (e.g. universities, laboratories, network brokers) irrespective of whether firms are part of concentrated regional agglomeration. Chile could use cluster analysis to identify co-dependencies among businesses, links between them and local suppliers of inputs and services, and technology gaps indomestic value chains (see Box 8). 1.101. The strategy of creating networks as an approach to innovation policy is easy to understand but rather challenging to implement successfully if the aim i s to develop high-octane clusters. The creation of effective horizontal networks of SMEs for critical mass, e.g. PROFO, i s an organizationally demanding but ultimately low risk endeavor. Obvious risks and limited success however, advise strongly against attempts to create high tech clusters from scratch through catalytic government programs. International experience shows that private companies typical have taken the lead in creating an initial critical mass, with the public sector in a supportingrole of providing `public goods' services and facilitating infrastructure. While Chile does not offer promising prospects for creating high tech clusters, there i s potential for developing resource based innovation clusters and export niche markets as part of global value chains. 1.102. The tale of two clusters in Chile -- one with potential realized (fruit industry) and one with potential inwaiting (forest industry) - reveal critical aspects of private sector leadership and government interventions in creating resource based clusters (see Boxes 9 and 10). The development of a fruit industry cluster in Chile's Central Valley -- almost against the odds from limited initial endowments other than favorable agro-ecological conditions and farmers willing to become entrepreneurs -- into the world's largest fresh fruit exporter owes its success to three critical government in initiatives: (i) pro-active interventions to assist private business in acquiring, adapting and extending fruit technology initially developed inCalifornia; (ii) systemic interventions to remove the explicit and implicit export bias that had constrained agricultural exports and to streamline export procedures; (iii) investment interventions in infrastructure development to lower the cost of logistics. The government effectively supported virtually all aspects of production (innovation, organization, process, packing and storing) and infrastructure (banking, telecommunication, domestic transport, port operation, international shipping). 1,103. In contrast, the Maule Region has yet to capitalize fully on its strong comparative advantage for the wood industry. Opportunities for creating synergy and economies of scale 45 have not been realized for lack of competitive company interaction and networking. The wood industry has not developed structured collaborative arrangements with local research institutes or universities. There are no organized channels to access and transfer advanced technology for improving forest resources, production processes and product standards. The wood industry has not organized itself effectively and there havebeen no catalyzing government interventions. 1.104. The formation of innovation and cost factor driven global production chains opens possibilities for small companies to become niche players and link into international markets. Closer public private collaboration in scanning opportunities and preparing domestic companies to seize opportunities for critical integration would be an important step in diversifying Chile's export. The Mexican supply chain pilot program yielded high returns in coordinating public innovation based programs to link small suppliers with large end producers (see Box 11). While this program focused on large domestic firms, its underlying strategy applies also to linkages with transnationals. 1.105. Buildingdynamic networks -vertical or horizontal, spatially agglomerated or dispersed - depends critically on a range o f specialized consulting services. They would include technology transfer and commercialization; legal services on patents and trademarks and business association (licensing, franchising, joint ventures etc); quality certification: accounting and auditing for small firms; industrial design for creation o f new products; industrial engineering for upgrading current and designing new production processes; marketing and branding. The government could review possibilities to push for scale and resource pooling in developing readily available highquality services. Box 8. Clusters -concepts and characteristics I.Analytical Constructof Clusters The theory of clustersi s basedheavily on notions of extemalities andeconomicsof scale, cooperative competition, andcollective efficiency. It i s widely heldthat areinforcingprocessof initialinnovation, subsequentdiffusion andcompanionspill over effects will takeplacemorereadily amongacriticalmass of actorslocatedinclose proximity and leadto increasingratesof return on innovation. Leadingproponentsof new growth theory emphasizethe notion that localization of economic activity andcompanioncaptureof knowledge spillovers are important generatorsof productivity growth. Clusters are groups of firms, research centers, anduniversities that cooperateina specific line of businessinorder to achieveeconomies of scale and scope. Innovationclusters are formed to conduct knowledge-intensiveactivities. They havethe capacityto innovate, to design new productsandprocesses, andto bringthem quickly to market. Source: Feser, 2002; Porter, 1998;and IADB, 2001a. 11.Makings of a Cluster Clustersin many ways are like beautyinthe eye of the beholder. Firmsfunction in a cluster ifthey cancreate economiesof scale and scope for commonbusiness gain through specializedtapping of cluster pertinent knowledge, andprovision of servicesandinputs. Clusters facilitate greaterflows of relevantinformation and non-markettransactions. Tacit knowledge i s moreeasily diffused, applicationsare shared more readily and learningby doing is encouraged. Access to skilled labor, the principle vector of tacit knowledge, is made easier. Clusters can rangefrom simple horizontal firmcollaboration andpooling of resourcesto sophisticated vertical integration in a spatialagglomeration. Important endowmentsfor clusters to develop and work would include: catalytic influence of local champions, entrepreneurialdrive andsoundbusinesspractices,facilitating technology andbusiness institutions, clear linkage andleverage strategies,full range of financing sources (seed, venture andinvestmentcapital); cohesiveformal andinformal information networks; services for metrology, standardsettingand certification. Source: For examples of clusters see UNIDO, 2002; Voyer, 1999;De Ferranti, Perry, et al, 2003. Box 9. A successfulcluster -The fruit industry inthe Central Valley The Central Valley, with its privileged agro ecologicalenvironment, has become a cluster of fruit- relatedactivities for growers, agronomists, researchinstitutes, service firms, fruit-trading companies, universities and specialized government agencies. The government, through CORFO, played a critical catalyzing role inthe incubation of the cluster. It championed initial surveys of existing orchards, analysis of potentialexternal demand, introduction and screening of new varieties, creation of nurseries to propagate disease free plants, requirement of phytosanitary inspectionof fruit exports, and opening of favorable credit lines for working capital andinvestment. A comprehensive R&D planintegratedspecialized initiatives inproductiontechniques, post-harvest technology and the adaptation of new species and varieties. Inthis context, C O W 0 signed contracts with the University of Chile, the Catholic University, the National Cooling PlantCompany and the National Institute for Agricultural Research(INIA). A ten year programof cooperation with the University of California andUniversity of Chile ensured access to advance technology and strengthened graduate training. This helped the University of Chile to develop a first rate faculty infruit relatedsciences andto begin modem fruit research. Inthe process Chile developed the scientific personnel andresearchcapabilities for initially effective technology transfer and subsequently original scientific advancements. Spill over effects strengthened government agencies and other universities. Basedon favorable naturalconditions, Chile buildcompetitive advantageessentially from scratch -- Chile has become the largest fruit exporter inthe world. Source: WorldBank, 200Ib. 47 Box 10. A cluster inwaiting -- The wood products industry inthe M a d e Region Chile's Maule Region' offers strong naturalcomparative advantagefor the wood products industry. However, the potential for dynamic growth has not been fully exploited. A survey and benchmarking study points out the main reasons: The industrydoes not operateas a cluster, clear opportunities for synergy notwithstanding. While 74% of firms were memberson the wood industry trade association, only 16%had undertaken innovationprojects inassociation with other companies. Entrepreneurs know each other well but have little trust. Opportunities for cooperation would exist indeveloping market information, notably for exports; procurement of equipment and machinery; supply and distribution chains; securing low cost quality financing sources; and filling common technology gaps. Diffusionof innovationamong firms is poor. Few innovations have benefited fromthe assistanceof other firms. Innovation predominantly i s driven by embodied technology innew machinery and associatedimprovements in processes. Second inimportance i s product diversification by emulating what i s being offered inthe market rather than new development. Innovation in coordinating suppliers and acquiring better inputscomes third. Innovation in marketing, distribution and client management i s absent, as i s a deliberate drive for product differentiation. Innovation, when it occurs, typically i s ad hoc rather than planned. Foreign suppliers of machinery are the most important source of innovation, usually incombination with tradeshows. Domestic universitiesand researchinstitutes virtually have no impact. Exportingcompanies generally make budget provisions for innovation, firms supplyingthe domestic market do not. There are significant differences between the Chilean and US wood producing companies. U S companies give greater weight to planning for innovation and to usingoutside consulting advice. Higher emphasis on product differentiation and quality i s reflected inthe importance given to production techniques anduse of numerically controlled machines. US companies focus more on customer satisfaction and feedback through sophisticated marketing, which ultimately leads to higher value-added. Incontrast to the downstream oriented of US companies, Chileancompanies are focusing on resource-basedvertical integrationwith lower value-added. Source: Koechlin, 2001. 48 Box 11. Mexico: Improvingthe viability of smallandmedium-sizeenterprisesthroughsupply chaininitiatives Supply chain initiatives involve small andmedium-sizeenterprise that are partof or could becomea partof a supply chain, often ledby a largercompany. Initiatives promoting vertical networks seek to strengthenlinkages betweenthese companies. Inrecent years there has beena significant growth of interestinthese networks, partly becauseof the extensive reorganizationoccurring inglobal supply chains. A rapid increasein outsourcinghas occurred, changinginter-firmdivisions of labor andresponsibility. New logistics systems aidedby information technology are also helping restructureglobal supply chains. Supply chain initiatives can help link small andmedium-sizefirms to customers andinternational markets. They can alsopromotethe growth and long-term sustainability of these firms by addressingtheir strategic position inthe chain. A company can move from beinga labor only supplier, or one that merely carries out simple assemblytasks, to being a manufacturer, brandowner, or seller. The Mexican DevelopmentBank (Nafinsa), the UnitedNations DevelopmentProgramme,andprivate companiesdevelopedapilot program involving5 large domesticfirms andtheir suppliers, 24 small and medium-sizeenterprises. Opportunities for low-cost improvementswere so abundantthat in slightly morethan ayear significant gains were achievedfor boththe small suppliers andthe large companies. The pilot group of smalland medium-size enterprises recordeda46 percentincreaseinlabor productivity, a 26 percentreduction ininventories,anda 10percentreduction incosts; the large buying companies reducedthe paymentperiodto small companiesby 75 percentandincreasedproductivity of their purchasingdepartments 30 percent. The thrust of the methodology is the coordinatedprivate sector-driven provision of technical assistance(rangingfrom simpleauto diagnosticsto ISO9OOO/ISO14000certification) andcapacity building for small suppliers. To achievethose gains, buyersand suppliersrelied on andstarted to adapt to their own needs the gamut of small and medium-sizeenterpriseassistanceprograms. Source: WorldBank staff Policy Recommendations 1.106. The private and public sector will need to work together more closely in order to overcome what may be low-level technological equilibrium traps in most sectors of the economy. Catalyzing interventions would be instrumental to overcome the reluctance o f entrepreneurs to access domestic research and development institutions because o f their apparent inadequacies, and of non-business institutions to develop capabilities for lack o f apparent demand. Strategically, the government will need to make public science and technology endowments more business relevant, and to shift from a predominant emphasis on domestic science and research to closer integration with international research institutions. Chile's innovation system has to be focus more directly on commercial competitiveness and geared to filling concrete gaps in technology and expertise. Making venture capital funding and expertise available and recruiting foreign experts directly would be important in this context. 1.107. Developing an overarching strategic framework and coordinating policy instruments. The government has created myriadpolicies and policy instruments for scientific research, technological development and innovation. Diffuse mandates, overlapping functions and bureaucratic considerations have complicated strategy formulation and policy coordination. As a first step in formulating a cohesive strategy, the government should make a thorough 49 evaluation, preferably using cluster analytical concepts, of its policies, programs and funding. This audit should be (i) encompassing to include the locus for effective overarching decision making, alignment of management responsibilities with accountability for results, and a budgeting process basedon clear criteria of priority; (ii) representative through collaboration of important Chilean stakeholders; (iii) of high technical caliber, comprising domestic as well as international experts: and(iv) independentinorder to avoid captureby administrative interests. 1.108. Increasing the effectiveness of public programs and resources. Further to shiftingto a more pronounced demand orientation and before expanding the resource envelope for science, technology and innovation, the government should use opportunities to obtain higher returns on its investments. This can be achieved generally by (i) coordinating innovation programs under an overarching cluster perspective to seize opportunities for synergy and critical mass, and (ii) giving preference to functional over administrative considerations in assigning management and oversight authority. Specific measures could include (i) shifting resources from unconstrained basic research to mission oriented research; (ii) emphasizing creation of scientific- technological capacity for clusters and value chains with comparative advantage; (iii) balancing the emphasis on domestic R&D with a more systematic effort at tapping international knowledge; (iv) linking the program of prospective technologies with technical and financial support mechanisms for coordinated strategy implementation; (v) expanding pre-competitive research; and (vi) leveraging funds through more aggressive use of non-profit organizations in identifying and harnessing opportunities for innovation and niche market development. 1.109. Fosteringthe role of the private sector. Chile's private sector role both on account of financing and execution of research and development is below standards in similar and high income country comparators. The private sector arguably takes a comparatively passive stance on usingproduct and process innovation as a strategic business development tool. The reasons seem to weaknesses both on the supply and demand side. The government could take on a catalytic function by (i)strengthening linkages between international and domestic technology companies by supporting research and training linked to joined ventures; (ii) prompting international technology companies to create research teams in Chile by making counterpart national experts available in matching grant schemes; (iii) science and technology moving researchers from government institutions to companies through specific public-private incentive programs; (iv) leveraging innovation spillovers from FDIthrough targeted investment promotion; (v) fostering an entrepreneurial innovation culture through a conducive enabling environment; and (vi) expanding association based SME promotion programs (PROFOs) for demand driven selective use of public innovationservices. 1.110. Transforming scientific capabilities into competitive innovation. The apparent progress in advancing Chile's science and technology infrastructure has not translated commensurately into commercial research andbusiness applications. Inadequaciesindomestic R&D to meetbusiness needs, lack of cutting edge expertise and skills have beenmentioned by entrepreneurs as key constraints to innovation. The constraints need to be overcome through concerted efforts of all parties concerned: (i)universities and public research institutes should try to overcome narrow academic interests and adopt a more prominent commercial orientation in developing cutting edge service capabilities and generating additional funding; (ii) firms need to seek a more proactive interface with the domestic research establishment to identify opportunities and develop long-term collaboration, to embrace knowledge as a strategy to 50 improve competitiveness and to access domestic R&D; (iii) government ought to promote the alliances and joint ventures among others by buying down initial launch costs, and to ensure that public funded research generates economic benefits; and (iv) all stakeholders should pursue possibilities to shortenthe maturation period of business ideas. 51 Q Y m I E w s8 sa C 0 Q $E 9 IC0 U 4E I I 11. CHILE'S INFORMATIONAND COMMUNICATIONTECHNOLOGY SECTOR' A. ExecutiveSummary Informationand CommunicationTechnology(ICT),incomegrowthandproductivity: lessonsfrominternationalexperiences 2.1. The last ten years have seen ICT investment play an ever increasing role inthe growth of OECD countries and beyond. Nonetheless, international experience suggests that supra-normal returns to ICT investment are rare at the macro level, limited largely to the US IT industry. One reason for this performance is that successfulexploitation of ICTsrequires complimentary assets -for example, education-and anenabling environment that supports innovation and institutional change at the micro level. These complimentary assets and enabling environment are frequently absent, especially in developing countries. This suggests that any attempt to maximize the returns to ICT investment should start with the cost and availability of informationinfrastructure, but needs to look far beyond that to issues such as skills, education and the general environment for business. 2.2. International experience suggests that Chile has already introduced many of the global best practice policies in the information infrastructure reform agenda. For the country, `new' issues such as convergence should be at the forefront, as well as continuing work on creating a level playing field for competitive provision. Continuing work on the legal environment for e- commerce i s also vital. 2.3. The role for government support of ICT production and use should be informed by international experience of the complexities of such programs, and their limited returns to date. Instead, the government should concentrate on the broader environment of the Knowledge Economy. Education, skills, business process reform are all vital to the successful implementation of ICT programs inbusiness and government. Access, applications, a broad and skilled user base with the institutional capacity to exploit the ICT-enhanced process are all required for success. Logistics systems and legal institutions are also required to exploit the potential of e-commerce. Telecomreformandinformationinfrastructure 2.4. Thanks to a reformprogram that startedin 1982, the Chilean telecom sector has achieved high overall levels of competition. The long-distance and cellular segments are particularly competitive, although the incumbent remains dominant in the local market. As a result of high competition, Chile had a well developed information infrastructure and one of the highest teledensities in Latin America by the end of 2000. Growth of cellular services and the Internet have been particularly impressive, placing Chile's penetration rates above those of both Latin American and income comparator countries. Penetration of fixed lines in Chile, on the other hand, is still slightly behind, and fixed line prices are above those of income comparator Thischapter was preparedby CharlesKenny andMarialisaMotta. 55 countries, as well as OECD countries. This suggests that regulatory fine tuningmay be required to allow prices to fall andfixed servicerollout to increasefurther. 2.5. Three critical policy objectives should be pursued to ensure that Chile's information infrastructure maintains its leading position vis-&vis other Latin American countries and that it reduces its gap with OECD countries. These are: (i) increase fair competition in the industry through improvements in the interconnection regime, (ii) facilitate introduction of new technologies through speeding the license process and reforming the spectrum management system, and (iii) increase autonomy and operational efficiency of the regulator (Subtel). (i) Toincreasefaircompetitionintheindustry,theregulatorshouldreviewinterconnection charges. In 1999, interconnection charges were set to the advantage of mobile and small companies, and to the disadvantage of the incumbent. This has produced distortion and controversy in the sector and is one of the reasons for highretail prices for fixed services. As a general rule, interconnection charges should be set so that the same services providedinthe same geographical areaby different operators are chargedthe same rate. (ii) Tofacilitateintroductionofnewtechnologies,theregulatorshouldsimplifythelicensing system and change the criteria for spectrum allocation. Licensingconstraints and current criteria for spectrum allocation have slowed the introduction of new technologies inthe past (e.g., for the wireless local loop - WLL - and PCS mobile phones). To avoid further delays in the future, the regulator should introduce a licensing system that does not impose technical or economic constraints on providing new services or new technologies, as well as a market for spectrum trading and a transparent mechanismfor awarding frequency rights. (iii)Underlyingtheproblemsindicated inpoints (i) (ii)s Subtel's weak regulatory and i capacity, which leads to delays and confrontation among various operators in the telecom industry. To guarantee that Subtel has the legitimacy, power and ability to independently regulate the industry, its institutional responsibilities should be broadened and clarified, its internalprocedures simplified, andits managerial systems improved. ICT for the poor: universalaccess andusesinChile 2.6. Telephones, computers and the Internet are means to improve quality of life among the poor, as well as effective tools for business. Econometric studies have found telephony to have a significant role in increasing income opportunities for the poor, while anecdotal evidence shows that those who do not have access to the Internet are marginalized because they lack information on health and public services, as well as jobs and educational and business opportunities. Becausethe poor are aware of the importance of telephone and Internet services, they are willing to pay up to 10percent (as a percentageof their income) more for themthan wealthy citizens are. 2.7. As in other countries, access to ICT (especially computers and the Internet) in Chile i s skewed toward the wealthy and people living in urban areas. Disparities in access to ICT are deeper in Chile than in comparator countries, driven mainly by high income inequalities (the Gini index is 0.56 in Chile, versus 0.32 in Poland, for example) and low population density in rural areas (Chile's rural population density averages 110people per square kilometer, compared to 268 people per square kilometer in income comparator countries). While the penetration of computers andthe Internet inthe tenthincome decile and inurban areas in Chile i s similar to that in OECD countries, the poor and people living in isolated areas are effectively excluded from 56 access to these technologies. This suggests that increasing overall Internet usage in Chile will require policies focusing on low-income people andpeople living inisolated areas. 2.8. The Chilean Government respondedto the issue of limited private access to telephony by launching the first Fondo de Desarrollo de Telecomunicaciones (FDTl) in 1995. FDTl i s a Universal Access Fundproviding public telephony to isolated rural areas through a "bidding for subsidies'' scheme. In seven years, the Fund, managed by a Council chaired by the Telecommunication Minister, has provided public telephones to approximately 6,000 rural localities hosting about 2.2 million inhabitants. The total investment committed has been US$161 million, of which 86 percent has been funded by private companies. While FDTl i s generally considered very successful, a thorough evaluation has not yet been conducted. The most important tasks for the coming years are to: (i) increase telephone density in rural areas while ensuring coverage of low-income urban areas, which FDTl left unattended and (ii) ensure a thorough evaluation of the results achieved to date, with particular emphasis on long run sustainability of the initiative. 2.9. To respond to the issue of limited private access to computers andthe Internet, the Chilean Government has recently launched a secondFondo de Desarrollo de Telecomunicaciones(FDT2). FDT2i s a UniversalAccess Fundproviding extension to public Telecenters inlow-income areas, also through abiddingfor subsidies scheme. FDT2 started operating inJanuary 2002. The amount assignedfor the first round of biddingi s US$4.5 million. The FDT2 law and subsidy scheme are basedon lessonslearned from international experiences and from the results of pilot experiencesconducted inChile. Important issuesthat Subtel should carefully consider duringthe first phase of the initiative andbefore proceeding with new bidding rounds are: (i) ensuring coordination of various ongoing Telecenter projects managedby different institutions, and (ii) sustainability of the Telecenter operations by: (a) clearly ensuring defining the partnershipsbetween the bidders for FDT2andother supporting organizations, (b) developing complementary assets that meet the needs of the users of the Centers, including appropriate online local content, adhoc trainingfor users andtrainers and appropriate software tools, and (c) designingsubsidies with specific criteriafor reduction and elimination as market development objectives are achieved. ICT applications:e-businessande-government 2.10. E-business has developed slowly and i s still nascent in Chile. In 2000, Chilean e- commerce generatedUS$54 million in sales, equivalent to only lpercent of total Latin America e-commerce sales, versus 69 percent from Brazil, 15 percent from Mexico and 9 percent from Argentina. Especially outside of Santiago, the use of the Internet for online transactions is very low (In2000, Santiago accounted for 80 percent of Business to Consumer--B2C--revenues.). This is due to low IT education levels among customers and entrepreneurs, and lack of confidence regarding online payment and delivery systems. Key changes needed to support e- business development are: (i) cultural and organizational changes in businesses (to exploit the potential of the Internet, firms have to modify their logistics, marketing and production functions); (ii) improving the efficiency of the postal system; (iii) ensuring development of online payment systems (e.g., credit, debit and pre-paid cards); and (iv) ensuring that the needed regulatory changes are put in place (e.g., including an e-commerce section in the consumer privacy law). 57 2.11. The Chilean Government has recently developed sites and applications providing information and facilitating interactions between government and businesses, between government and citizens, and among various public agencies. Significant progress has been made in the areas of online tax and customs payment. Initiatives have also been undertaken to simplify procedures for businessregistration and online procurement. 2.12. Comparatively limited take-up of e-commerce may be in part due to low IT education levels among customers and entrepreneurs. Whilst the country was early to introduce computers in schools, for example, it may be that the specific skills required to integrate computers into business processes are relatively scarce. Other barriers include late take-up of e-legislation, weak intellectual property laws, security, and concern over credit card protections. Remaining challenges include increasing access to computers and the Internet, which are key preconditions for successful implementation of e-government solutions; increasing online security; increasing coordination among various programs and between programs at the central and the municipal levels; and promoting the introduction of applications facilitating online interactions and transactions between government, businesses, and citizens (many existing government sites developed to date are only informational). ICT production: the high-technology industry 2.13. Chile's ICT production is very low. In 2001, total sales of electronic companies were US$50 million, one tenth of the level in Venezuela and significantly less than in other major Latin American countries. Both hardware and software are almost exclusively imported in Chile. The internal hardware industry focuses on PC assembly, while the local software industry produces mainly administrative and management software, which Chile exports to small Latin American countries that are usually neglectedby international companies. 2.14. FONTEC (Fondo Nacional de Desarrollo Tecnologico y Productivo), the high technology fund of CORFO, has promoted various initiatives supporting development of the high-tech industry. The Fund provides incentives to firms investing in the high-technology sector, including grants for pre-investment studies, acquisition of land and buildings, and staff training costs. Thanks to the program, various U S high technology companies have opened subsidiaries in Chile. While the C O W 0 initiative has met its original objectives, a number of questions arise concerning further expansion of such activities and the appropriate role for government. International experience suggests that widespread government intervention infavor of ICT industriescarries little benefit -both because the sector does not generate uniquely high development returns and becauseintervention does not generateespecially rapid sector growth in the absence of abroadly conducive macro environment. 2.15. The Chilean Government should limit its support of the high-technology industry to: (i)integrating the local industry with the global market by encouraging franchising, joint ventures, and exchanges among local and international companies; (ii) supporting research and development, shifting funds from basic to applied research; (iii) promoting property rights protection in the high-technology field; and (iv) supporting ICT use by government agencies. Based on lessons learned from international experiences, the Government should refrain from experimenting with sector-specific tax breaks, venture finance and attempting to pick winners in the high-technology field. 58 B. Introduction 2.16. The Government of Chile has shown continued commitment to the development of the ICT sector (see Box 1for a definition of ICT). Chile was one of the first countries inthe world to begin the process of liberalizing its information infrastructure sector, beginning in 1982. The privatization of telecommunications companies came in 1988. In July of 1998, President Frei created the Comisidn Presidencial de Nuevas Tecnologias de Informacidn y Comunicacidn to evaluate and improve access to and use of information andcommunication technologies (ICT) in the country. More recently, in June 2000, President Lagos gave the responsibility of promoting ICT to the Comite` de Ministros de Nuevas Tecnologias de la Informacidn y Comunicacidn (Comite`TIC),a multidisciplinary working group lead by the Minister of Economy and managed by the Secretariade Tecnologiade Informacidn (Secretaria TIC).2 2.17. This early and sustained commitment to ICTs as a force for development at the highest level has produced a number of initiatives and considerable success -not least a reformed telecommunication sector, an innovative universal access scheme and advanced Internet use by both government and citizens which includes mass payment of taxes online. There remain a number of challenges for ICT production and use, which spread beyond the boundaries of ICT policy itself. These remaining challenges andpolicy options are the focus of this chapter. 2.18. The first section of this chapter looks at the role of ICT in economic growth and productivity. It discusses the scale of the potential benefit from exploitation of ICTs and the Internet inparticular, and the factors that are likely to determine that benefit. It suggests lessons from international experience that might be of use in guiding policymakers in Chile towards investments in institutions, human capital and physical capital that might have the highest payoff interms of economic performance. 2.19. The next three sections discuss the challenges to policymakers in maximizing the development impact of ICTs, looking at the provision of high quality low cost information infrastructure services, access to those services by marginalized groups, the use of ICT by government and the private sector, and development of the IT industry. They will note progress to date anddiscuss future challenges. 2.20. The second section focuses on Chile's telecom services and policies. This section: (i) provides a brief overview of the telecom sector inChile and the key policies and regulations that have affected service roll out and tariffs in the last few years; (ii) compares Chile's basic ICT indicators with those of other countries (Regional, OECD and similar-income countries are The Comite`has four sub-groups, run by different ministries and secretariats, dealing with access to ICT (Subtel), ICT for business (Ministry of Economy), electronic government (Secretary of State Modernization) and ICT and human resources (SecretariaTIC, in collaboration with Ministers of Education and Labor). The Comitk is currently considering adding a fifth area, Information for Society, which would be managed by Subsecretaria General de Gobierno. (Interview with SecretarioTIC, Santiago, 2002). While the Comit6 TIC refers to the general objectives included in "Chile Hacia la Sociedad de la Informacibn", the areas of intervention and action proposals are now different from the ones included in the original paper. Although a new strategic document has not yet been prepared, the Secretariais moving ahead with the implementation of the programs defined with the working groups. Given the rapid pace at which the area changes, medium and long-term objectives are relevant only if defined in very general terms. In fact, the detailed proposals included in Chile Hacia la Sociedad de la Informacih became obsoletevery quickly. 59 chosen as comparators); and (iii) provides policy advice to improve market competition and facilitate development of new technologies. 2.21. The third section focuses on the Government's universal access initiatives, aimed at connecting isolated areas and low-income people to the telephone and the Internet. More specifically, this section provides an overview of current digital divides between high- and low- income households and between urban and rural areas in Chile. It then describes the initiatives that the Government has undertaken to extend access to telephony and to the Internet, as well as pending issues. 2.22. The fourth section focuses on ICT applications. It briefly describes the progress to date inthe useof ICTinthebusinessandgovernment fields anditunderlines remaining challenges. 2.23. Both the third and the fourth section emphasize the importance of developing ICT complementary assets, i.e., relevant online information, ICT skills, andpolicies supporting use of ICT for low-income population (section three) and for various sectors (section four). 2.24. Finally, in section five the paper turns to ICT production. It assesses whether Chile has specific competitive advantagesin this area, or is well positioned to develop them, and evaluates which policy options may be feasible to support development of this industry inthe future. Box 1. Defining ICT ICTconsists of hardware, software, networks, andmediafor collection, storage, processing, transmission, andpresentation of information. Itincludescomputers, underseacables, radio waves, spreadsheetsandweb sites as well as post offices andnewspapers. ICTcanbe sub- divided into two categories: (i) information infrastructure (ZZ), the physicalequipment through which informationtravels-wires, transmitters, host computers, postalnetworks-as well as the legalandregulatorycapacity that supports this physicalinfrastructure,and (ii) information infrastructureas well as the equipment that housesit -includingbudget management technology (IT)consistingof the applicationsandcontent that travelthrough information programsanddesktop computers. Source: WorldBank ICT Sector Strategy. C. ICT, Income Growth andProductivity LessonsfromInternational Experience - ICT Investment andEconomicPerformance 2.25. As our understanding of the `knowledge economy' grows, it has become increasingly clear that technology, broadly defined, i s perhaps the vital factor inpropellinglong-term g r ~ w t h . ~ `Technology' as defined in these discussions includes not only `invented gadgets', but new World DevelopmentReport, World Bank, 1998.The role and importanceof technology ineconomic growth has long beena matter of discussionand disagreement. Felipe (1999)concludesfrom the debate over the role of technology advance (as opposed to investmentand labor expansion) inEastAsia's period of `miracle' growth that "it seems that re-working the data, one can show almost anything." Nonetheless,the consensus positionseems to be strongly, and increasingly, infavor of a significant role for technology ineconomic growth and perhaps an even strongerrole indevelopment more broadly. 60 business processes, institutional forms, policy frameworks, social networks, the impact of increasing returns, complementarities and errors in measurement. Infact, it includes everything that is not a stock of physical capital, human capital or labor. 2.26. Given such a broad definition, it does not necessarily follow from the importance of technology in general that any particular group of technologies -such as ICTs-will be a significant source of growth and developmental progress. Having said that, there are practical reasons to think that ICT production may be a particularly dynamic sector in terms of productivity -not least the phenomenal technological advances seen in the sector over the past twenty years. Modern ICTs, in particular, are themselves high-technology goods, embodying significant intellectual property. In an international regime where such property i s protected by patent and copyright laws, it i s theoretically possible to make significant returns to investment in ICT development and production. Such manufacture also carries the potential to have `spillover benefits', producingskilled workers, managementexperience and institutional structures that can be utilized in other companies or other sectors, lifting the economy into a higher-productivity regime. 2.27. There are also theoretical reasonsto believe that ICT use might have a role. The flow of information i s vital to the functioning of markets, the efficiency of organizations and the spread of knowledge and ideas. And ICT use might have a significant impact on productivity through the externalities linked to its networkednaturea4 2.28. In order to fully understand the link between ICT and economic performance, it is important to distinguishbetween ICT production and use. On the use side, it is also necessary to distinguishevidence of `normal' returns to investment in ICTs (labor productivity increases that would be expectedfrom any growth incapital stock -1CT capital or other capital) and `excess' or `spillover' returns -measured by a growth in economy-wide total factor productivity (TFP -a measure of increased efficiency in the use of existing capital and labor). Finally, it i s important to distinguishbetween evidence regarding the US, andwhat appears to be happening ina broader sample of countries. This section will attempt to untangle these issues. 2.29. ZCT Production: Looking first at ICT production and its impact on TFP in the US and worldwide, there clearly has been an increasein TFP within the U S IT producing sector -adding the same amount of capital and labor produced more growth in output in IT production than in other sectors of the economy. TFP growth within the IT sector has added perhaps 0.3 percent per year to total US productivity growth. The evidence on capital deepening and IT sector TFP increasesi s acceptedeven by skeptics, such as Robert Gordon (2000). 2.30. Having said that, the evidence of dramatic TFP gains from lT production outside of the United States is more limited. Macro studies of the impact of IT production on developing countries focus on East Asia, the developing country region with by far the largest share in IT production. In that region, there i s no evidence that countries with a higher share of high Each new telephoneadded to the network, or host added to the world wide web, not only allows the new owner to communicatewith those already on the network, but allows those old users to communicate with the new owner. In joining the network, the new user makes that network more valuableto older users. Each investment ina connection therefore has a public (economic) rate of return far higher than the private (financial) rate of return that accrues to the new user. This network externality suggests the potential for a significant growth impact of investments in network infrastructure once a minimal stock of ICT investment is inplace. 61 Sample Group ICT Capital Contribution to Annual GDPGrowth U S 1990-9 0.95 Other 1990-9 0.39 All Countries 1990-5 0.31 All Countries 1995-9 0.62 APEC, 2001 'Heeks Dedrick and Kraemer, 2002. and Kenny, 2001. Labor productivity growth in the US since 1995 rose at a rate that Graham (2001) estimates at 0.85 percenthigher than the previous two decades (although more recent estimates cast some doubt on these figures (Cooper and Madigan, 2001). The consensus is that as much as half of this `additional' increase in labor productivity is due to investmentsin information technology. Businessinvestment incomputers accounted for 35 percent of total current investment in the US after 1994 (Gordon, 2000). Similarly, in other OECD countries, there has been capital deepening due to IT investment (capital per worker has increased). This has put upward pressure on labor productivity inother OECD countries as well. This is not to say that absent IT advances growth would have been 1percent lower in the US over the 1990s. Much of the investmentthat went to IT would have occurred in other sectors instead, if garnering a somewhat lower return. 62 the marginal return of other investments, or if IT investments cause 'free' efficiency gains in other cost centers, companies or sectors in the economy. These returns would appear in the data as a significant relationship between IT investment and TFP growth. If present, they would justify policy intervention to spur higher levels of ICT investment. 2.33. There is considerable (if sometimes disputed) micro evidence that may suggest the presence of TFP gains from IT investment. Researchers such as Brynjolfsson and Smith (2000) and Morton Zettelmeyer and Silva-Risso (2001) find that online customers pay less for goods ranging from cars (1.5-2 percent savings) to books and CDs (9-16 percent savings). Lehr and Litenber (1999) find excess returns to investment in computers in various industries in the US (although their results have been disputed by David, 2000). Governments have also estimated significant savings -Singapore claims that each dollar it spends on introducing ICTs into government services generates US$2.70 in savings due to enhanced productivity." Based on such micro evidence, some commentators are willing to suggest there will be a significant macroeconomic impact of ICT production anduse indeveloped anddeveloping economies alike. 2.34. However, the macro evidence for a widespread TFP (as opposed to labor productivity) impact of IT use to date is weak around the world. Inthe US, those sectors that were particularly reliant on IT actually under-performed in terms of productivity gains as compared to non-IT intensive industries-gross product originating per worker in IT intensive industries actually fell an average of 0.1 percent per year over the 1990-7 period." Inother OECD countries, there i s no evidence of an uptick inTFP in any sector" -the UK, with the second largest stock of IT capital inthe OECD behindthe US, actually saw TFP fall over the last years of the 199Os.l3 2.35. The scant macro evidence on excess returns to ICT investment to date does suggest that the successfulexploitation of ICTs i s complex, andthat growthbenefits, especially over the short term, might turn out to be elusive in LDCs. David (2000) points out that former 'great inventions' (such as the dynamo) only had a growth impact after the. complimentary development of processes and institutions that could exploit the initial invention. And as Brynjolfsson and Hitt (2000) find, "making computer investment without organizational change, or only partially implementing some organizational changes, can create significant losses." More broadly, the evidence suggests that the environment for the exploitation of ICTs has to be favorable before it should be expected that there would be a return in terms of company performance or economic growth. 2.36. To date, it appears that the people, companies and countries that have benefited from ICT -those that have the necessary environment for exploitation-have been those that were already performing better. In the US, those benefiting from the introduction of ICT in firms are the highly educated.14 Across firms, it appears that those that were already more efficient at loUNESCAP, 1999. UnitedStates Departmentof Commerce, 1999. l2Schreyer, 2000. l3Bank of England, 1999. More recentevidence on the US economy suggests a similar story -recent recalculations of TFP growth during the 1995-2001suggest that, outsidethe computer industry, TFP growth actually fell over that period comparedto the 1990-5period (Oliner and Satchel, 2002). l4Autor, Katz and Kreuger, 1998. 63 functions, such as supply-chain management, gain more from putting such functions on line,15 and early evidence from the US suggests Internet rollout i s concentrating supply chains.16 Within countries, knowledge good production remains concentrated in wealthier regions. And across countries, even those regression analyses which suggest a significant growth impact of IT investment in OECD countries tend not to find that link in developing c~untries.'~Again at the cross-country level, weak institutional capacity has been found to correlate in regression studies with lower network rollout and lower host site development." Because of this, in the future, most forecasters estimate a smaller impact of the Internet on developing countries than in developed ones. Mann, Eckert and Knight (2000) estimate that with 'effective' e-commerce policies, rich countries could see GDP increases of 5 percent and Latin America's by two percent-however they also provide estimates as low as 1.2 percent for LatinAmerica. 2.37. In conclusion, the international evidence suggests that investments in ICT played an important role in expanding output in OECD countries in the 1990s. There are also many examples at the micro level of ICT investments that garnered very high returns. Having said that, at the macro level, the evidence of excess returns to ICT production or investment are hard to find, especially in developing countries. This suggests that large-scale subsidy programs in support of ICT production and use would lack empirical justification based on an expected growth impact (although it might bejustified in terms of equity considerations, for example, and may have stronger empirical foundation in the case of telecommuni~ations).~~Instead, it appears that the most important factors for improving returns to ICT investment are (i) improving the policy environment in the sector itself (numerous studies link information infrastructure availability and cost with competition and strong regulation, for example"), (ii) ensuring the availability of complimentary assets -especially an educated workforce, and (iii) improving the enabling environment -such as the legal and institutional frameworks for commerce and innovation. Lessons for Chile 2.38. The lessonsfor Chile of this international experience are mixed. First, on the production side, there is little evidence of supra-normally high social or economic rates of return to ICT l5World Bank, 2000. l6Dell, acompany with much of its supply chain management online, has very few suppliers (30 companiesaccount for 78 percentof total purchasing(see TheEconomist, 11/11/00). l7Pohjola, 2001; Mayer, 2000. This evidenceis supportedat the micro levelby Lal's (1996) survey of Indian firm's ITusage, which found that those firms with agreater stock of ITcapital hiredmore highly skilled workers, but did not see higher productivity than firms with lower IT capital stocks. '*Kenny, 2001; Oxley and Yeung, 2000. There are significant conceptual and practical difficulties that dog all cross-country econometric work, including studies that use telephones per capita as a variable (Kenny and Williams, 2001). Nonetheless, the majority of studies suggest some link betweentelecommunications rollout and economic growth, if of an indeterminate size and dependent on factors inthe broader economic environment. A significant growth impact is found in studies such as Norton (1992) and Canning (1997), compared to little or no impact in studies such as Munell (1992) and Garcia- Mila and McGuire (1992). A larger growth impact is found in wealthy countries by Roller and Waverman (2001). Yet Maddenand Savage (1998) find a larger growth impact inpoor countries. 2oKenny, 2001. 64 production outside the United States. The sector can be a source of employment and capital returns, but there seems to be little reason to favor it over other industries on the basis of especially large spillover effects on the rest of the economy. 2.39. Second, looking at use, innovations in ICT provide new avenues for productive investment which can raise incomes. No one doubts that capital deepening through ICT investment increased labor productivityinthe OECD over the last ten years, for example. 2.40. Third, it does appear possible that with the correct `complimentary assets' (including a range of institutions and human capital) there i s the potential for new ICTs to contribute to increased total factor productivity as well. Using International Finance Corporation predictions of GDP growth rates over the next five years, we can obtain an upper-end estimate of the potential growth contribution of greater efficiency due to the use of new lT technologies to reduce transactions costs in commerce. According to this estimate, growth might be 0.3 percent per year higher if the correct policies are put in place to support the exploitation of e-commerce inChile over the five years 2000-2005 (see Table 2)." Table 2. The PotentialImpact of Exploiting E-Commerce on Chile Without Internet WithInternet GDP 1999 67,469 67,469 GDP 2005 87,862 89,544 Annualized Growth 4.5% 4.8% "AnevenmoreoptimisticfindingbyGallegoandLoayza(2001)suggeststhatmanageableimprovementsin `technological adoption' (as measuredby computersper capita) mightincreasegrowth rates by as much as 1 percent. 22 Assumption is basedon a 2 percentgrowth impact causedby the Internet in 2003. 23 Hilbert, 2001. 24 One reasonfor the concentration of economic activity apparently beingcaused by IT will be that incorporating IT into production processes is very expensive. To take the case of Chilean SMEs, according to SERCOTEC data, a large number of such enterpriseshaveacapital stock in the regionof two millionpesos, while the cost of a computer i s close to 400,000 pesos. This means that the addition of a computer (alone) to capital stocks implies a capital increase of almost 20 percent. But perhaps even more important in accounting for the apparent concentration of wealth being spurred by investmentsin IT are the significant skill and institutional requirementsfor exploitation of the new technologies. At the corporate level, David (2000) estimates that the cost of computer ownership to a US business is approximately ten times the cost of the computer itself, because of the high training and support requirements. Assuming that David's estimate applies to Chile, this suggests that total costs of computerizing an SME would average more than twice its capital stock. It may be that, absent effective public access to ICT services by SMEs that include support and training,they will be excluded from the opportunities offered by e-commerce. 65 2.42. A fifth lesson from international experience is worthy of note in Chile. Overall, it is the inability to exploit the new technologies because of non-capital factors, factors related to the enabling environment, that appears to be the more important barrier to exploitation of the Internet. The relative unimportance of capital i s suggested by the low take-up of technology functions even amongst those who have access to the basic capital required. For example, Internet connectivity and use is already common in Chilean firms, and even basic skills are spreading rapidly. Sixty percent of (non-micro) enterprises in Chile were connected to the Internet in March, 2001. As early as 1999, Chile was seeing 22 percent of taxpayers making payments online, suggesting widespread ability to use the Internet for simple transactions. Nonetheless, only 15percent of Chilean firms have their own web~ite.~~ 2.43. At this early stage of Internet development it is difficult to account for the exact cause of this low take-up between informed business decisions on the general low potential utility of e- commerce, informed business decisions based on a decision to wait until the environment for e- commerce has improved, and straightforward ignorance of the technology's potential. Evidence of a stagnation in e-commerce growth in the U S might suggest the first cause (an informed decision that e-commerce has low potential utility) is more important than generally assumed, however.26 2.44. Given a broad environment that i s likely to remain less favorable to e-commerce than in the US, even with an active government role, it i s quite possible that the low potential utility of the Internet i s even more significant as a barrier in Chile than in the US. The externalities that accrue to economic systems where networked technologies are widely used further the potential for a low-use low-utility trap. For example, in the tourism sector, e-commerce applications are far more common than in other sectors in Chile-reflecting the fact that a great number of that sector's potential worldwide clients are already online. Where few clients or suppliers are online inother sectorsthere is less benefit to acompany going online itself, 27creating a vicious cycle of low use. There is (disputed) evidence of such `scale effects' in the relationship between telecommunications and growth reported in Roller and Waverman (2001) -smaller communications networks have a very limited growth impact. 2.45. Overall, the evidence presentedsuggests that ICT i s an important tool for development - and that low levels of ICT use might create a poverty trap. However, to increase returns to ICT, it is probably more important to improve the general macro environment than to engage in activities designed to expand access to ICTs themselves. Further, the limitedempirical evidence on spillovers to modem ICT investment suggests that the role for large-scale government intervention in favor of ICTs is not yet firmly established. This suggests that general policies towards the Internet inparticular should bebasedon a `no regrets' strategy. Policies towards the Internet should be limited to those that are of limited cost (e-commerce laws, for example), those that would bejustified in the absence of the Internet (such as financial sector reform), and those 25Hilbert, 2001. 26BetweenAugust 2000 and August 2001US B2C online retail sales actually fell in value from US$4.2 to US$4.0 billion (www.forrester.com, 10/4/2001;e-Commerce Business, 12/4/2000). 27Again, this may be for the perfectly good reasonthat the utility of online servicesis lower inthat sector -perhaps becausethe Internetis apoor tool for transferring required information. This is likely to be the case inthe production of bulky, non-standardizeditems in manufacturing, for example. 66 where the return to ICT investments has been carefully evaluated at the micro level (such as computerization of tax and procurement systems or use in distance learning). Significant subsidies for ICT production or use in Chile would rest on weak empirical underpinnings, especially given that improving the broader environment for ICT use is likely to have far higher returns inthe ICT sector itself than would sector-specific interventions. D. TelecomPolicies andInformationInfrastructureServices inChile Chile Telecom Industryand Key Policies 2.46. The sectoral policy and regulatory environment for competitive provision of telecommunications in Chile are very favorable by world standards. The Chilean telecom sector overall has high levels of competition, both when compared to other Latin American countries (Le., Argentina, Brazil, Mexico and Uruguay) and when compared to income comparator countries (e.g., Poland, Hungary, South Africa andMalaysia).28 2.47. This strong performance is the result of a telecom reform program started in 1982, when the Government introduced the Ley General de Telecomunicaciones, which established the principles of independent regulation, free market entry, spectrum licensing and price liberali~ation.~'Additional telecom reforms, combined with Chile's rapid rate of economic growth and global technological advance, have led to an improvement in service rollout, a decrease intelecom tariffs and anerosion of profit marginsof the incumbent (CTC).30 2.48. As shown in Table 3, growth in penetration of fixed lines increased by more than 20 percent after the introduction of price regulation in 1987, which allowed Subtel to set prices every time the Regulatory Commission determined that the market was not sufficiently competitive. This put an end to price-setting consultations between the incumbents and the regulators, increased competition and reduced cross subsidization from the long distance market to the local market. The Multicarrier system reduced prices for long-distance calls by more than half as soon as it was introduced in 1994. The introductionof PCS31andprepayment services in 1997 and the "Calling Party Pays" (CPP) system in 1999 encouraged mobile rollout at an incredibly fast rate (71 percent CAGR between 1994 and 2000 - penetration increased three times between 1997 and 2000). Finally, network unbundlingand free Internet access increased Internet connections five fold intwo years.32 28Kenny, 2001. See detailed description of the comparisonmethodology in the next section. 29For acompleteoverview of the Chilean telecomreform since the introduction of the Ley General de Telecomunicacidn, see Bitrin, Serra, and Guasch, 2002. 30 Itshould be notedthat turning the principles contained in the original law into policy practice was a long process. Privatization of the two incumbents took place in 1988. The multicarrier system for long distance traffic (allowing long-distancecallers to choose their carriers for each phonecall by dialing a few digits on their phones) and opening to foreign operatorsonly occurred in 1994. Interconnection difficulties betweenoperatorscontinue to this day. 31PersonalCommunication Services are digital mobilenetworks using 1900Mhz frequencies. 32 With network unbundling, new entrants can obtain access to single unbundled components of the incumbent operator without having to buy other components as part of an "interconnection package". With the free Internet plan, users pay only per-minute rates, but do not pay connection charges. 67 i j j i/.i ii.i ii./ j j/ ii-/aim N N 3jp i3 1 nI I 5 N 2 .j.j.j..j I j Ij ! j. i j . I j i .. i .. j .. j ; .. 0 3 0 e4 8 0 e4 a a s 00 a 53 w e E 'd .I a W a '5 Y CI 3 00 e4 00 a 3 0 00 53 2.49. Whilst a significant degree of competition in the market has achieved much, it .is important to note that competition in the local segment i s still very limited (as in most other countries). Telefonica CTC remains the dominant player for fixed line `last mile' provision in most of the country, with its market share slightly over 80 percent. Similarly, Telefonica del Sur remains the dominant player in the southern regions where it used to be a monopoly. None of the new players has yet achieved a 5 percent market share, although they are creating competitive pressures on the former monopolies in the larger Chilean cities. (In Chile, as elsewhere, this i s the result of natural monopoly status based on network externalities, but also because of delayed and still incomplete reform.) Competition in the long distance, mobile and ISP sectors is significantly stronger than in the local segment (see Table 4). Internet users, in particular, have a choice among various providers, as both local and Regional players have a strong presence in Chile (e.g., Entel, the largest Chilean ISP, Terra Networks, Latin America's dominant ISP and other smalloperators). Table 4. Market structure of the Chilean telecom industry Market Segment Total number of Most important Market Market concessionaries concessionaries Shares (%) Structure ~ (May 2002) 14 1.Telefbnica CTC 80.8 Limited public access 2. Telefonica del Sur 4.4 competition 3. VTR Telefbnica 3.7 4. ENTEL 3.4 5. CMET 3.1 6. Other Companies 5.4 Total 100la Long-distance (national 33 1.Telefhica CTC 34 Competition and international) 2. ENTEL 36 3. Chilesat 15 4. Other companies 15 Total 100 1.Comunicaci6n y Telefonia N A Competition access (Fondo Desarrollo Rural S.A. (CTR) Telecomunicaciones)* 2. Gilat 3. Megacom 4. Natrans 1.Telefbnica CTC 40 Competition Cellular (800 Mhz) 2. ENTELPCS 36 Digital(1900 MHz) 3. Bellsouth Cellular 16 Satelital(l600 & 2400 4. Smartcom 8 Total 100IC 13 1.Telefhica CTC NA Competition 2. Chilesat 3. VTR BandaAncha 4. Telefhica del Sur I I 5. ENTEL 52 Internet Service 1.ENTEL NA Competition Internet Providers 2. Terra Networks la 'Refers Calculated on total number of clients: 3.3 Million May 2002). to international traffic. Sharesfor long-distance domestic traffic are similar. 69 Chile's InformationInfrastructure inComparative Perspective 2.50. To better assess Chile's progress in ICT development, we compared Chile's ICT indicators with those of other countries. The results of the comparison are reported in Table 5. The statistics we looked at evaluate four key aspects of ICT development: service rollout, quality, costs and efficiencies. We chose three categories of countries for comparison. First, four Latin American countries (Argentina, Brazil, Mexico and Uruguay) are shown under the `region' column inTable 5. Second, the ten closest countries to Chile in terms of PPP GNIper capita with GNIs of over US$1billion (Malaysia, Costa Rica, Mexico, Estonia, Poland, South Africa, Uruguay, Mauritius, Slovakia and Hungary) are shown in the `income' column. Finally, five high income countries (Australia, New Zealand, Ireland, the U S and Finland) are shown in the `OECD' column. `Average' scores are the unweighted average of available statistics in the comparator group. `BP' i s the `best practice' (highest or lowest, depending on variable) of available statistics in the comparator group. The next sections describe important findings from the international comparison. Table5. Chile's informationinfrastructureincomparativeperspective3' Chile Region Inc me OECD Average Average BP Average iervice Rollout MainLines/100 24 21 25 37 54 Mobile Subscribers/lOO 34 18 28 50 63 Mobile and Fixed Teledensity 58 39 53 87 117 PCs/100 8.4 7.4 11.6 17.5 46.8 Internet Users/10,000 2002 701 1356 3005 3632 BroadbandAccess (WEF grade 1-7) 4.5 3.8 3.8 5.0 5.2 iervice Quality FixedTelephony % Satisfied Demand 100 98 97 100 100 Digital Main Lines % Total 100 98 89 100 98 Faultsper 100MainLines/ Year 25 7 30 2 13 iervice Costs Business Basketof Services 177 201 175 97 81 International Calls % of Business Basket 66 63 71 54 39 BusinessCosts PercentageAbove Home Costs 0 85 64 0 44 ISP Cost % GDPICapita 4.5 4.1 4.7 2.6 0.8 lerviceEfficiency MainLinesEmployee 243 251 157 187 178 RevenueMainLine 754 998 722 1,368 1,482 RevenueEmployee 183,141 259,882 109,351 155,127 258,601 burces: ITU, 2002; World Bank, 2001; Kirkman et. 2002; Kenny, 2001. Notes: see textfor explanations. 32The numberof PCs per 100inhabitants is 8.4 in2001, accordingto ITU, CTC. However, for IDC-CNCthe amount shouldbe 10.7 70 Service rollout and quality 2.51. Table 5 shows that, compared to other Latin American countries, Chile has a high level of service roll out. B y the end of 2000, after a year of 40 percent growth, Chile had one of the highest teledensities in Latin America.33The most recent data indicate 5.27 million cellular subscribers (34 per 100 inhabitants) versus 3.7 million fixed main lines (23.9 per 100 inhabitant^).^^ Mobile growth over the last few years has been particularly impressive (due to PCS, CPP, as well as mobile low costs), especially on an internationalbasis as compared to fixed network services. Table 5 also shows connection rates to computers and the Internet. Chile's number of PCs per person was second only to Uruguay's in Latin America, and the country has the highest rate of Internet users inLatin America. Twenty percent of the Chilean populationuse the Internet, which compares very favorably with UnitedStates usage as recently as 1997, when only 15 percent of the U S population usedthe Internet.35 2.52. The number of Internet users appears particularly high inChile when considering the low penetrationrate of computers. This implies that while buying a PC is still outside the realm of possibility for most Chileans, they do have access to networked computers inpublic spaces or at work. According to a study conducted by the Facultad de Ciencia Econdmica y Administrativa de la Universidad de Chile in October 1999, about 40 percent of the people who surf the Internet in Chile access it from work, 33 percent access it from home, 20 percent from school and 8 percent from other locations (e.g., public libraries, Internet cafes or telecenters). Advanced phones with e-mail and Internet services are becoming available and quite affordable in Chile, offering a new method of Internet access with new concessions for third-generation (3G) and broadbandservicesunderway. 2.53. The picture regardingICT rollout i s less reassuring when Chile i s compared with OECD countries. Mobile and fixed teledensity are approximately one half the OECD group average, and the number of computers i s approximately one quarter. This i s not surprising, because ICT goods are consumption goods, and rollout i s highly dependent on income.36 A more reasonable comparator group is those countries with similar incomes. In fact, when comparing Chile's performance with that of Malaysia, Poland, Mexico, and other middle-income countries, we obtain a more nuanced picture. While Chile's fixed line provision appears to be behind income comparators, mobile services and Internet use are ahead (if not up to `best practice'). Perceptions of broadband a~ailability~~are positive compared to region and income comparator groups. Still, it is arguable that more progress could be made to increase the rate of broadband diffusion. (For example, broadband penetration at the beginning of 2002 was about 0.3 percent inChile, versus 15 percent inKorea, where broadbandwas significantlypushedby Government intervention.) 33Gartner, 2001. 34mu,2002. 35World Bank, 2001c. 36Even if there are concerns that network externalities create higher returns for larger networks, it is unreasonable to assumethat Chile (GNIper capita US$4,630) could ever have as many computers per head as the United States (GNIper capita US$31,910). 37Based on executives' responses to a cross-country World Economic Forum poll reported in Kirkmanet.al., 2002. 71 2.54. The key findings on ICT service quality are that Chile performs very well in terms of digitization (100 percent) and inmeeting demandfor services, while faults per 100mainlines are higher than regional comparators, suggesting (again) the potential for some improvement in the operation of the fixed network. Service costs and efficiency 2.55. Table 5 suggests that a business basket of monthly fixed line services3*costs US$177 a month in Chile, very close to the average cost for income comparators and below the regional average. Nonetheless, these costs are expensive as compared to `income best practice', which is only US$97, or the OECD average, which i s US$81. Cellular rates in Chile are significantly (25-50 percent) lower than in the U.S., and among the lowest inthe world. This i s due not only to strong competition, but possibly to distortions that have arisen from access charges paid by users of fixed lines to mobile phones beinghigher than (marginal) cost.39 ISP costs4' are higher than regional or income comparator best practice, although it should be noted that Internet use was boosted by the introduction of free Internet accounts by some ISPs in early 2000. Further, the unbundlingof the local loop meant that the incumbent operator hadto drop its access fees for Internet usage. 2.56. Generally high costs might be inpart due to the vicious circle of lower incomes per capita contributing to lower service usage, and the fixed costs of services being spread over a smaller quantity of those services -a problem especially acute in smaller markets (see the revenue per main line statistics in Table 5). The figures might also suggest lingering inefficiencies, However, further analysis i s necessary to prove this point, becauseChile scores highly on direct measures of fixed network efficiency-main lines per employee and revenue per employee - as demonstrated inTable 5. 2.57. The cost of international calls as a percentage of the fixed business basket (66 percent) is also similar to regional and income averages. This reflects in part an ongoing process of rebalancing tariffs towards costs. The cost of fixed business connection and subscription i s the same as the cost of residential connection and subscription, for example4*(ahead of the income average, where business connection and subscription remains 64 percent more expensive than residential connection). Nonetheless, there remains some way to go. The international telecommunications net settlement rate (the per minute charge paidby a network operator in the calling party's country to the network operator in the recipient country who completes the call) averages US$0.74/minute between the US and Chile, compared to US$0.38/minute between the U S and Brazil or US$O.l8/minute between the U S and Australia, for example.42 The international settlement rate with at least some Chilean operators appears to remain far above 38Made up of the fixed line connection charge divided by twenty, the cost of monthly subscription, 20 hours of local calling plus two hours of calls to the United States. 39This is discussed inmore detail inthe next section. 40Measuredas averageannual ISPcost for 20 hours of monthly Internet access as a percentage of GDPper capita PPPin2001 (Kirkman et. al., 2002). 41Cost of connection and subscription is calculated as cost for connectionplus two years service. The figure measuresthe percentage higher cost charged to business than home customers. 42Based on unweighted average 2002 country data from the FCC: http://www.fcc.gov/ib/pd/pf/artsweb.xls. 72 costs, then. The access toll for incoming international calls i s 14 times the local peak rate,43 suggesting that rebalancing i s not yet complete (international call costs are still too high). Looking at the other side of the equation, the `fixed' costs of services in Chile remain small - connection plus two years of subscription totals US$302, compared to a regional average of US$682, an income average of US$370 and an OECD average of US$639. This again suggests incomplete rebalancing, at least in the fixed segment, because it may indicate connection and subscription prices below cost.44 2.58. Overall, it appears that Chile might have lost some of its early price advantage from liberalization over the last few years and that there might well be fine tuning required in Chile's regulatory system to allow international prices to fall and service rollout to increasefurther. Policy ~ s s u e s ~ ~ 2.59. The discussion above suggests that, by and large, Chile is providing an efficient information infrastructure. It i s largely achieving the two central objectives of information infrastructure policy: providing widespread access to infrastructure at a low cost. Having said that, for a country that has movedas far as Chile has in introducing the superstructure of policies and regulations to support competitive provision of information infrastructure, and in an environment of macro-stability and broad investor-friendliness, it might be expected that Chile would have a more commanding position vis-&vis its income comparators, especially regarding fixed line services. There are a number of potential reasons why the country did not retain its early lead. For one thing, geographic complexities of service provisionin a country that i s long, thin and mountainous are potential limits on infrastructure expansion. Likewise, non-sector- specific policy barriers such as micro constraints to business development and lack of innovation (see Chapter 1) are also potential limits on infrastructure expansion. There are also some sector- specific issues that might reduce rollout growth inthe coming years, and which therefore deserve policy and regulatory responses.46Potential forimprovements exist inthree main areas: (1) Increasing competition betweendifferent segments of the market (Le., mobile and fixed telephony); (2) Increasing the pace of development of new technologies; and (3) Increasing the autonomy andoperational efficiency of the regulator. These issues are discussedinmore detailbelow. 43 Bitrin, Estache, Serra and Guasch, 2000. 44 The costs of abroadbandconnectionare inthe region of 25,000 to 33,000 Chilean pesos (38 to 50 US dollars) per month, while multi-useroptions cost in excess of 60,000 Chileanpesos (95 U S dollars) per month. Given that the tariffis set basedona `model operator,' itmay bethat the model is over-optimistic. 45 This sectionof thereport is basedon abackgroundpaperpreparedby Mr.Alejandro Jadresic (ENTEL)and on a brief note preparedby Mr.Oscar Cabello (Alfacentauro). 46 Subtelhas recently prepareda "Navigation Chart" proposing policy changes for the next few years. The proposalsincluded inthe NavigationChart are currently beingstudiedby representativesof the Chilean public and private sectors. 73 Increasingcompetition between different segments of the market 2.60. A key determinant of competition in the telecom sector is the criterion used to set interconnection charges among various operators. Interconnection gives an operator (the new entrant) the right to access the facilities of another operator (the incumbent) and vice-ver~a.~~ 2.61. Interconnection charges in Chile are regulated by the Ley General de Telecomunicacidn and the 1994 reform. Subtel sets these and other regulated charges every five years according to the Long Run Incremental Cost (LRIC) of an efficient company. In case the efficient company has economies of scale, rates obtained through LRIC must be marked up to cover for the corresponding Long Run Total Cost (LRTC). In such cases the regulator has to decide what regulated rates will be increased so as to "minimize inefficiencies" (as stated inthe law). 2.62. In 1999, Subtel set interconnection charges for each incumbent telephone company (Telefonica CTC and CNT) according to the marginal cost principle (and marked up rates of retail services). In 1998, on the other hand, Subtel hadset interconnection charges for all mobile operators at average cost. In 2001, Subtel for the first time defined interconnection charges for non-dominant telephone companies. For these operators, it followed a "case by case approach," with higher rates defined for smaller companies. As a result, interconnection charges for the incumbents are now significantly below those for mobile and non-dominant telephone companies. This has produceddistortions and controversy in the sector4*and, together with the highlevel of competition inthe cellular market,has contributed to the relativelylow penetration of fixed lines compared to mobiles. As a general rule, to ensure competition, interconnection rates should always be set so that the same services provided in the same geographical area shouldbe charged at the same rates. Increasing the pace of development of new technologies 2.63. In the past, introduction of new technologies such as mobile PCS and WLL (wireless local loop) have been slowed by the existing licensing and spectrum allocation management Efficient licensing and spectrum allocation facilitate rapid entry of potential 4'A lessimmediate but more complete definition of interconnectionis given by the European Commission Directive on access and interconnection: "Interconnection means the physical and logical linking of public electronic communications networks used by the same or a different undertaking in order to allow the users of one undertaking to communicate with the users of the same or another undertaking, or to access services provided by another undertaking. Services may be provided by the parties involved or other parties who have access to the network." (Article 2 - CEC (2000d)). For an easy-to-understand and complete discussion on interconnection, see the Telecommunication Regulation Handbook, edited by Hank, I., McCarthy, T., and published by Infodev in 2000. 48 Some arguments provided by the parties: (i) Telefonica CTC states that the 1999price review has cost it as much as US$200 million, due to mistakes and cost items that were not considered. It has gone to Court to ask for compensation. (ii) Competitors of Telefonica CTC state that the poor financial results of that company have not been causedby the tariff review, but due to gross inefficiency, as proven by recent measuresto cut costs. (iii)Local telephone companies argue that access charges to mobile phone companies were set too high (infact they were not set at marginal, but at average cost) and should be reduced in the 2003 review process. (iv) Although it did not raise this issue in its legal complaint, Telefonica CTC argues that it is unfair that its access charges have been set at marginal cost, whereas access charges for smaller telephone companies (such as VTR) that compete in some of the same cities have been set at higher levels. (v) Some smaller competitors argue that it is correct that access charges should be larger for them, due to the lack of scale economies. 49 Beyond ensuring an attractive market for new technologies, some countries have regulated or legislated to speed their rollout. The case for this needs to be carefully articulated and examined. For example, south Korea now has 74 competitors into traditional segments, increasingthe levelof market competition, lowering tariffs and increasing roll out of traditional as well as new services. Below i s a description of specific problems relatedto the current licensing regime and spectrum allocation management systems. 2.64. Licensing: Chilean legislation associates concessions, permits and licenses ("authorizations") with specific services and technologies. In order to provide new services or change the way services are provided, operators must obtain new authorizations or modify those they already have. Often, technical norms must be established before authorizations can be provided. This process was slow with WLL technology and helps to account for the low rollout of services to date. 2.65. Consistent with the principle of free competition and technology innovation, the Chilean Government should implement a licensing system that does not impose technical or economic constraints on providing new services or using new technologies. Special authorizations should be required only if there is a need for: (i) guaranteeing efficient use of scarce national resources (such as in the case of radio-electrical spectrum, which i s a public good), (ii) complying with international agreements, or (iii) preserving fair ~ompetition.~' 2.66. Spectrum management system: At present, the Telecommunications Law establishesthat radio-electric frequencies will be granted without limitation unless there i s a technical norm allowing only a limited number of them, in which case a public contest must be carried out. In such a case, a preferential right i s granted to those requesting frequencies before the norm i s enacted. Incase of equality between different participants in a public contest, the law allows for a public auction, whereby frequencies are grantedto the highestbidders. The current mechanism has three major problems that may hinder efficient spectrum allocation: 1. The regulator has the right to identify spectrum blocks that will be awarded without defining explicit objectives (e.g., facilitating competition or promoting technological innovation). This has caused conflicts between the regulator and the competition authority, resulting in delays, adjustments to technical norms, and the necessity for public contests (e.g., for PCS mobile phones andWLL). 2. When a public contest is required, the regulator has discretion over the evaluation criteria. This may cause inefficient investments or distortions in market competition by limiting the entry of operators, preventing reallocation of frequencies to more efficient uses, or imposing different obligations on players entering the market at different times. the highest broadband penetration in the World thanks in part to laws that required building owners to ensure broadband access to apartments. On the plus side, this policy obviously worked to expand broadband access. On the negative side, this was at the cost of billions, and home broadband access appears to be primarily used for gaming (Kenny, 2001). While broadband will be increasingly important to businesses in particular to deliver advanced e- commerce applications, it is not clear that there is a role for public subsidy or fiat to encourage broadband universal service. 50While a regulatory change may be required to eradicate the current problems with licensing, administrative simplifications can help address them in the short term. In recent years, the regulator has eased some licensing procedures (e.g., by reducing the amount o f information operators must provide to get new authorizations, simplifying standard forms to file requests, and introducing deadlines both for granting new licenses and for establishing technical norms for new services). Further progress could be made along these lines. 75 3. Because the current system grants preferential rights to parties that request a frequency before a technical norm has been enacted, it allows agents to acquire privilegedpositions in public contests simply by filing requests for frequencies, whether or not they are justified by technical or economic contributions to society. 2.67. To solve existing problems, the spectrum management system should be modified based on the following long term objectives: (i) standardization of frequency blocks in terms of bandwidth, geographical scope and duration of authorizations; (ii)definition of general obligations and rights of operators, without restricting services that can be provided or technologies that can used; (iii) simple and transparent mechanisms for spectrum trading; (iv) simple procedures for awarding new frequencies, including public auctions if the number of interested parties i s greater than the number of available blocks (Le., when frequencies are scarce); (v) allowances for constraints on allocation and operation of frequencies if necessaryto preservefair competition; (vii) elimination of preferential rights; (viii) reformof the levy system on frequencies in order to make it consistent with the scheme of awarding rights (i.e., do not double-tax the operator^).'^ Increasingautonomy and operational efficiency of the regulator 2.68. Underlying some of the weaknesses indicated in sections II.3.1 and 11.3.2 i s a weak regulatory capacity that leads to delays and confrontation. This suggests the need to ensure broader autonomy and improved operational efficiency of the regulators. The main institutional problems of the telecom industry are: (a) a lack of precise objectives and obligations for regulatory authorities - regulatory practice depends excessively on the person on command; (b) overlapping powers among different government agencies, causing dilution of responsibilities; (c) a mixture of policy-making, regulatory andcontrollingfunctions inthe same entity, hindering maximum performance in any single function; (d) a lack of autonomy for the regulatory body, such that processes are subject to influence from various quarters; (e) a lack of specialized mechanisms for conflict resolution, exacerbating "judicialization" of conflicts and lobbying; (0 slow, annoying and bureaucratic procedures that limit the effectiveness of regulation; (g) a lack of transparency and mechanisms for participation in the regulatory processes, facilitating discretion and capture of the regulator; and (h) deficiencies in terms of qualified human resources, budget and infrastructure that limit the quality of regulatory entities. Two particular sets of reforms worthy of consideration are: a. Modification of procedures and management systems. This could be achieved through: (i) defining specific guidelines for behavior (ethical codes) for officials of regulatory entities, 51I t is possible to implement many of these objectives through managerial and administrative changes, without modifying the law. For instance, i t i s possible to design public contests minimizing barriers for new entrants (e.g., by allowing many blocks), maximizing market flexibility (e.g., by reducing investment obligations), simplifying administrative procedures, allowing the reallocation of frequencies to new services (e.g., after a minimumnumber o f years) or increasing the probability that a bid will be called for due to equality among the proposals of the contestants. It is also possible to create a public record of frequencies, to dictate regulations restricting grants o f preferentialrightsand to modify the levy system on frequencies. Nonetheless, in the longer runit would be convenient to introduce more precise legal provisions to ensure efficient spectrum management, including a market for spectrum trading and a competitive, transparent and non discriminatory mechanism for awarding and renewing frequency rights. When doing so, the acquired rights of those currently operating frequencies must be kept inmind, so they are not unduly discriminated against. 76 (ii)publishing"procedures manuals" for the regulatory process, (iii) establishing the "positive administrative silence" criterion, such that requests are automatically accepted if deadlines pass with no answer, (iv) imposing an obligation that all regulatory decisions be duly and explicitly justified, (v) imposing an obligation for the regulator to preparean annual report of its administrative and financial performance, and (vi) creating mechanisms to facilitate participationof interested parties in the regulatory processes (e.g., public hearings). In general, these measures do not require legal reform and can be established by a simple decision of the authorities. b. Introductionof structural reforms inthe public structure. This couldbe achieved through the following changes: (i) Subtel from the Ministry of Transport to the Ministry of moving Economy; (ii) creating a highly autonomous, independent telecommunications regulator (the Superintendencia), in charge of proposing, applying and controlling regulations; (iii) establishing special requirements and procedures to appoint or discharge the regulator (Superintendente); (iv) establishing a small fee for regulated services to finance the budget of the sector regulator, wholly or in part; (v) creating a specialized economic court (the "National Economic Court") as a forum for appeals regarding regulatory processes in telecommunications, as well as inother economic sectors. E. ICTfor the Poor: Strivingfor UniversalAccess andUse 2.69. This section assesses digitaldivides between high- and low-income households in Chile, andreviews initiativesthat the Chilean Government has undertaken to extend access to ICT. 2.70. Telephones, computers and the Internet are means to improve quality of life among the poor as well as effective tools for business. Figure 1 shows the percentage of income that i s spent by the poorest, middleandrichest income quintiles on utilities inChile. It is clear from the graph that the poor view utilities as essential. Rather than forgo utilities, the poor are willing to pay more of their meager means (up to 10 percent) on them than are wealthy citizens. Telecommunications is no exception here, attracting about one third of the utilities expenditure of the poorest citizens. Figure1. ExpenditureonUtilitiesas aPercentageof Incomeby IncomeQuintileinChile i 1 0 2 4 6 8 10 12 Percentageof Income Source: Graphfrom Forestier,Graceand Kenny, 2002,based on datafrom deMelo,2000. 2.71. Among ICT, telephony, in particular, has been found to have a significant role in increasing earnings opportunities, improving the performance of low-income small businesses, and improving the quality of government services delivered to the poor across a range of countries over time. For example, econometric evidence suggests that access to telephony 77 improved the earnings and extent of off-farm activities in Ecuador.52 Access to telephone has also been linkedto improvements in the quality of public services such as health and Conversely, unequal access to telephony has been shown to lead to growing inequality within countries.54 2.72. Even if econometric evidence on the links between access to computers and the Internet (on the one hand) and poverty reduction (on the other) is still very limited, anecdotal evidence shows that those who lack access to these technologies are marginalized, especially in countries were the global economy and public services have become increasingly n e t ~ o r k e d .Computers ~ ~ and the Internet can reduce poverty by increasing the incomes of small entrepreneurs. They can also improve quality of life for the poor by giving them access to online information on health, public services,jobs and educational opportunities. 2.73. For this reason, there should be policy concern with the fact that the poor might be left behind in access to and use of ICT.56 Chile's innovative universal access scheme for telephony, discussedlater, suggests that unequal access to the telephone i s no longer likely to be a source of growing inequality in this country. However, the Internet may still be such a source, because access to this technology i s still highly skewed towards the wealthy and people living in urban areas.57 Remaining challenges to overcome this inequity are discussed in the rest of this section of the paper. Here, it should be noted that use of the Internet by poor people may not be primarily deterred by access barriers. Therefore, the correct response is not stand-alone investments in public access schemes. Instead, as with the economy at large, investment in complementary assets (human and institutional capital) may have higher returns than direct investment insupporting ICT rollout. Determinantsof DisparitiesinOwnershipof andAccessto ICT inChile 2.74. ITUfiguresreportedinTable 4 suggestthat the number of fixedphonesandcomputers in Chile i s lower than in comparator countries. There are 24 fixed lines and 8 computers per 100 people in Chile, versus 37 fixed lines and 17 computers in the best practice countries among income comparators. Given that the connection and subscription costs of fixed telephony are lower than the averages for the country's income comparators and that Figure 1 indicates a strong willingness to pay for ICT services in Chile, we can infer that lower connection rates in 52 Further cases include that access to telephony increased the number of small businesses in Botswana (Duncombe and Heeks, 1999), increased job opportunities through public call facilities in Bangladesh (Lawson and Meyenn, 2000), and reduced the costs of basic foodstuffs in villages in China by an average of 7.5 percent (calculated from Eggleston, Jensen and Zeckhauser, 2002). 53ITU, 1998. 54Forestier et. al., 2002. 55 Kenny, Sabater, and Qiang, 2002. 56Elbers and Lanjouw, 2001. For example, in countries some distance from universal access to telephony, rollout in telephone services appear to cause increases in national inequality. Results in Forestier, Grace and Kenny (2002) suggest that a country with a one standard deviation higher teledensity than average at decade start will see a 6.5 percent increase in inequality over the course o f the decade. 57Almost 55 percent of Internet users and 80 percent of e-commerce users are in Santiago, compared to 52 percent of the fixed telephone lines and under 40 percent o f the population (calculated from Hilbert, 2001 and World Bank, 2001c). 78 this country are due to factors other than relative cost and willingness to pay. Two key determinants of low connections rate are: Higher income inequality in Chile than in comparator countries, which puts private telephony beyondthe reach of more of the Chilean population than would be expected by lookingat average income figures alone; and 0 Higher geographic isolationand lower population density of some Chilean regions compared to the benchmark countries. 2.75. Income inequality because ICTs are consumption goods, ownership of ICTs closely correlates with income. Thus, Chile's income inequality drives a significant `digital divide' in terms of ownership of ICTs. Income distribution in Chile remains poor when compared with many other countries in the region and elsewhere -the country's Gini coefficient (-56) i s considerably higher than that of Poland(at 0.32) for example.58 2.76. As Figure 2 shows, household access to telephones, computers and the Internet i s proportional to household income. Only 22 percent of the households in the first income decile have a fixed phone, 2 percent computers and 1percent the Internet. At the opposite end of the spectrum, of the households in the tenth income decile, 53 percent have a fixed phone, 60 percent a computer and 38 percent the Internet. While the rate of increase inconnection to fixed phones rises proportionallybetween one decile and the next, the rate of increase inconnection to mobile phones, computers andthe Internet increasesmore rapidly as we move toward the highest income deciles. This translates to greater inequalities between high and low income populations in household access to these technologies. As the penetration of computers and the Internet in the tenth income decile in Chile i s similar to the penetration of these technologies in OECD c~untries,~'increasing Internet usage inChile will require policies that focus on increasing usage amongst the poorest. In turn, we will see that this requires a focus on sustainable access initiatives that involve a careful coordination of training, content and telecenter rollout. 2.77. While differences in household access to ICT between various income deciles are striking, it is important to note that only differences in access to the Internet and (to a lesser extent) computers are as great as income differences (see Figure 3), and significantly higher than differences in access to the Internet and computers inthe US. Differences in access to fixed and mobile telephones in Chile are not nearly as large as income differences. The income of the highest decile in Chile i s about 46 times higher than the income of the lowest decile, exactly equal to the difference in access to the Internet and slightly greater than the difference in access to computers. Conversely, the householdsbelonging to the highest income decile have only four times more fixed phones and six times more mobile phones than the households belonging to the lowest decile. This evidence emphasizes that the main challenge for the Chilean Government in the future i s to increase access to computers and the Internet - and to ensure that this i s done ina sustainable manner. World Bank, 2001c. 59See OECDdata in OECDICT Outlook, 2002. 79 Figure 2. Access to ICT by income decile (% values), year 2000 With fixed phone With mobiles 0 With PC 0 With Internetconnection 100 901 80 70 60 50 40 30 20 10 0 I 1 2 3 4 5 6 7 8 9 1 0 T o t a l / Source: Subtel2002, based on CASEN2000. Figure 3. Income disparities and disparities inaccess to ICT comparativeratios of the highest - andlowest deciles Chile USA 0Computer lntemet j 50 459 60 00 - 45 40 50 00 - 35 40 00 - 30 25 30.00 - 20 15 2000 - 10 5 1000- 396 4.06 0 000 / I I Source: Subtel2002, based on CASEN2000for Chile and Falling Through the Digital Netfor USA. 2.78. Geographic isolation: In Chile, as in other Latin American countries, access to telephones, computers and the Internet differs markedlybetween urban and rural areas. Figure 4 shows that private household access to mobile phones, computers and the Internet i s significantly higher inurban areas than inrural areas -compare this with the more balanceddistributioninthe US. The penetration of fixed phones in Chilean households i s about 60 percent in urban areas, versus only 8.5 percent inrural areas. The penetration of computers is 19percent inurban areas, versus 2 percent in rural areas. Finally, the proportion of households with connections to the Internet is 9 percent inurban settings versus only 1percent inrural zones.6o 6o Disparities between urban and rural areas are reflected in Regional disparities. While about 53 percent of Chilean households overall have access to fixed telephones, Regional access levels vary between 26 percent (for the poorest 80 2.79. While ICT disparities between urban and rural areas are common in many countries, these differences are more pronounced inChile, because of particularly low populationdensity in rural areas. Chile's ruralpopulation density averages 110people per square kilometer, compared to 268 people per square kilometer in the income comparator group (calculated from WDI). The teledensity inequality statistics quoted in Table 4 suggests that this translates into particularly unequal ownership in Chile. The largest city (Santiago in the case of Chile) sees 104 percent higher fixed teledensity than the rest of the country, or double the number of telephones per capita, versus an average of a 49 percent gap for income comparators. Figure4. Connectionto Computers andthe Internet urbanandruralareas (% values), year 2000 - Chileand USA Chile 1JSA Fixedphone Cellular 0 Computer lntemet 0 N3fixedandIKIcellular0Computer Internet 71 n AQ fi 51 60 50 40 30 20 10 0 Urban Rural Total Rural Total US Source: Subtel2002, based on CASEN2000for Chile and Falling Through the Netfor USA. 2.80. The importance of the geographic factor i s confirmed by the amount of subsidies for providing public telephone services in various Regions in Chile (the subsidy scheme will be discussedin details inthe next section). While the average subsidy to provide a public phone to a rural locality was 1,074,000 Pesos (equivalent to about US$3,700), this reached as high as 14,952,000 Pesos (about US$32,000) in the more difficult to reach communities. The five districts requiring significantly higher subsidies per locality (1 to 3, 11 and 12) were not, on average, particularly poor. They were, however, the five regions with the lowest population densities (see Table 6). Because population density varies across regions within a country more than income per capita, it tends to have a larger effect on income per unit area, perhaps the most important variable indetermining the feasibility of public network access. 2.81. Remote Regions (the north and the south), as well as scarcely populated areas within regions, are likely to continue to require larger subsidies to support the rollout of further telecommunications or advanced ICT services. It i s in these regions that the challenges of sustainability will also be at their greatest: before significant resources are usedto support rollout in such environments, it is important to evaluate whether the cost of the subsidy is likely to be justified by high-impact, sustainableuse of the resulting infrastructure. and most isolated Regions) and 69 percent (for the Metropolitana Region). And while 8 percent o f Chilean households overall have access to the Internet, Regional access levels vary between 3 percent and 15 percent. 81 Region ' Approx. , Approx. Subsidyper , Incomeper Households i Population , Approx. II No. 'I (Chilean Pesos, 000) I (000) i 1998 I 1998 I! Density p0p/km2) ........................................ j + i ............................................................................................................... ......................................................... + ..................;............................................................... 4 .......................................................................... ............................................. , locality localities I (Chileanpesos, 000) ..................................................... 1 72 I 13,280 4 386 7 i ....................................................... ....................................................................................... ......................................................... .................i................................................................ ~ i ................................................................. , "...... ' ........................................... 2 / ............................................... 27 ; i ..._............................................................................................................... 1..................................... 10,194 5 ,$ ............................................................... .!.......................................................................... 456 ' 4 3 1 i .......i.......................................... j 53 ....................., ................................................................................................ ......................................................... 8,130 358 I 264 4 i ...................... i ......................................................... ..,;.......................................................................... ....................................... ' ..I i................................................... 392 <............................................................................................................... ...................................................................................................................... , 2,027 j 3 562 14 1 .!.......................................................................... ............................................. 5 4]....................................................... I............................................................................................................... 438 751 i.... ........................................................................................................................................................................................................................ 445 j ............................................................... 1,525 93 R.M. 493 1 ..................................................................................... 362 612 I 5,923 1 : 385 741 i"""""""""'""""""""""~ ijI........................................................................................................................ 349 1I................................................................ .......................................................................... ............................................................... .j.......................................................................... 769 47 ............................................. 493 303 , + ..................................................... ............................................................................................................. + ........................................................................................................................ ............................................................... / ............................................................... 898 I.......................................................................... 30 i ............................................. 8 1074 1,564 377 1,895 i i 51 ~.................................................... ....................................................................................................................................... i i i .......................................................................... ........................................... 9 , 1040 1,779 349 856 ij 27 i j.............................................................................................................. ! ....................................................................................................................... ......................................................................................................................................... + .......................................... 10 iI....................................................... 1 .................................................................................................................................................................... 924 2,119 i........................................................................................................................ 320 i......................... 1039? .......................................................................................................... : 16 ' .................................... 11 .................................................... 50 12,994 ; 527 1 ~ i.......................................................................................................... ; ..................................................................................................................... + 92 .......................................... 12 .i j.................................................... 25 4............................................................................................................. i........................................................................................................................ 14,892 528 Ii............................................................... 1...................................................................... 155 1 i i Total 6,059 / 1,704 479 1 14,820 I.......................................................................... F. Government Initiativesto MoveTowards UniversalAccessandUseofICT Universal Fundfor access to telephony (FDT1) 2.82. In 1994, to respond to the limited private access to telephony in Chile, the Government promoted the first Fondo de Desarrollo de Telecomunicaciones (FDTl), a Universal Access Fundproviding extension to public telephony to isolated areas through a bidding for subsidies scheme6' (see Box 2). Box2. FDTl Background. To increase access to public telephones, in 1994 the Chilean Government set up FDT1, a fundfinanced by the nationalbudget and administered by a Councilchairedby the telecommunication minister. The Council was incharge of deciding which projects were eligible for subsidies and awarding subsidies through a competitive biddingprocess. Choosingthe eligible localities. Subtel chose localities eligible for subsidies by: (i) compiling a roster of rural localities needing public telephones, (ii) grouping these localities into "projects" according to geographical proximity and technical solutions likely to be cost effective, and (iii) carrying out a cost-benefit analysis to estimate the subsidy neededto install a public phone in eachlocality. Projects that looked commercially viable without subsidy were brought to the 61 The Chilean Fondo de Desarrollo de Telecomunicaciones(FDTl) was introducedwith an amendmentto the GLT in 1994to ensureprovisionof public telephony to rural andlow-incomeurbanareas with low telephone density (GLT, Titulo IV). 82 Box2 (cont.) attention of telecommunications companies, while projectsthat hadapositive net present social value but were not commercially viable were assigneda subsidy. The biddingprocess. Eachproject was awardedto the bidder askingfor the lowest subsidy. The winning bidderhadto provide at leastone public telephoneineachlocality. The choice of technology, network structureandlocation of the public phones was left to the licensee. The licenseewas alsofree to set the call charges subjectto a maximumequivalent to US$0.07per minutefor afive-minute call. Investments. Total investmentcommitted from 1995to 2000 was US$161million, of which 86% (US$109 million) was financedby private companies andonly 14% (US$21.8 million) was financed by the Fund. The total investment of the private companies covered both installation of payphones (US$52 million) andadditional services(US$109 million), mainly private phoneconnections andvalue-addedservices such as electronic mail and Internet, for which no subsidieswere received. The subsidies cost the Governmentless than 0.3% of total telecommunicationsector revenuesduring the funding period, andFund administration cost about 3% of the money granted. Results. Between 1995 and2000, with seven rounds of tenders, the Fundsupportedthe provision of payphoneservice to 6,059 rurallocalities with about 2.2 million inhabitants. Thanks to FDT1, inthe year 2000, the numberof householdswithout accessto telephony was only 3% (see Figure 5). Sources: Wellenius, 2002; Subtel, mimeo 2002. 2.83. The FDTl initiative i s generally considered very successful, although a thorough evaluation of the results has not yet been conducted. The most important tasks for the coming years are: (i) telephonedensityinruralareaswhileensuringcoverageoflow-income Increase urban areas, which FDTl left unattended, and (ii) athroughevaluationoftheresultsachievedtodate,withparticularemphasis Ensure on longrun sustainability of the initiative. 2.84. Increase telephone density in rural areas while ensuring coverage of low-income urban w.As a result o f FDT1, the number of households in Chile connected to public phones has increased significantly in the last few years. Nevertheless, there are three areas with room for improvement. First, rural access i s still significantly behind urban access (15 percent of houses inrural areas are disconnected, versus only 1percent inurban areas). Second, overall telephony density inChile is still low (especially inrural areas); public phones are often located some miles away from the households they serve (see Figure 5). This last finding is confirmed by cross- country comparative figures (In 2002, Chile had 13 public telephones per 10,000 people compared to an average among income comparators of 67 phones per 10,000). Third, while urban households have more access to public phones than ruralhouseholds, their access could be increased further. Urban sites have remained completely unserved by FDT1, because a first evaluation of the Net Present Value (NPV) of low-income urban areas was positive, excluding 83 them from the bidding scheme. A later review of the Fund suggested that the cost-benefit analysis underestimated costs of installing and operating public phones in low-income urban areas (especially due to vandalism), thus suggesting that further bidding rounds could be rolled out to increase penetration and density of public phones in low-income urban zones. Subtel plans to address these issuesby rolling out new Access Funds as soon as the evaluation of FDTl has been completed. When launching the new initiatives, the Council should: (a) Set up a roster of eligible localities. This should be done in the design phase - i.e., before rolling out the Fund - to avoid double-counting of localities or assignment of funds to scattered houses, single farms, or localities that already have telephone service. This happened on occasion with FDTl and should be avoided inthe future;62 (b) Ensure local participation in both design and implementation, especially when providing access not only to the telephone, but also to computers and the Internet (see next section); and (c) Have a monitoring system in place at the beginning of the Fund's roll out - Periodic evaluations of the results of the Fund should be conducted during the implementation phase, so that lessons can be incorporated in the ongoing bidding rounds. Figure5. Access to publicphones: urbanand ruralareas (% values), year 2000 Ei!Urban w Rural 0Total 250h1 23% % 20% 15% 15% 10% 5% 0% Less than 3 Between4 Between9 Between19 Morethan NOaccess Does not blocks and 8 blocks and 18 and27 28 blocks to public know where blocks blocks phone Source: Subtel based on CASEN2002. 2.85. Ensure evaluation of results achieved to date. During the roll out phase of FDT1, the Chilean Council did not introduce a monitoring system. This i s the most important task facing the Council next year, to shed light on whether and how to proceed with the next bidding 62Wellenius,2001. 84 Subtel has already decided that it will not conduct additional biddingrounds for public telephony until: (i) an evaluation of the FDTl has beencompleted, and (ii)has revised the list it of projects that were originally included in the bidding list but have not been awarded yet, to ensure that these localities have not beenreachedby private operators inthe meantime.64Table 7 proposescriteria and indicators that should be monitored when assessingthe results of FDT1. 2.86. The long-term sustainability of the initiative is a key criterion for evaluating the success of the Fund, one to which the Council should pay particular attention. Subtel already estimates that about 35 percent of the rural phones installed through the Fund have some operational problems. Inaddition, private non-rural companieshave recently begun to offer services inrural areas previously served only by companies funded with FDT1. Because private companies charge less than the rural companies that installed the public phones, a number of phones funded by FDTl are now unutilized. These and other problems that will arise during the evaluation of the Fundshould be carefully weighed andpromptly addre~sed.~~ Universal Fundfor Access to Computers and the Internet (FDT2) 2.87. The Government has turned its attention to the so-called `digital divide' through sponsorship of a number of Internet access schemes outlined in this section. Although similar methods can be used to expand access to the Internet as were used with telephony, it should be noted that the motivation, costs, benefits andlikely success of such schemes i s far more difficult to delineate. The utility of the Internet as a tool for direct poverty reduction is far less certain than is the case for telephony, in part because the importance of complimentary assets and a suitable enabling environment to ensure that utility i s far greater. This suggests the need for considerable caution and in-depth evaluation during the early stages of the program to ensure that lessons are learned before significant resources are committed to rollout schemes.@ Early evaluation i s essential especially considering the ambitious objectives of various institutions involved with universal access initiatives (although these initiatives are increasingly coordinated): in 2002, the Secretaria TIC planned to open 341 Multipurpose Telecenters in one year,67 the Ministry of Economy planned to open 100 Business Telecenters, DBAM and the Gates Foundation were considering providing computers to 368 public libraries, and the Enlaces project plannedto open 500 schools with PCs and Internet connections to the adult population.68 63To date, various countrieshave introduced Telecommunication Development Funds (in Latin America, Chile, Peru, Guatemala, and Colombia (Foster and Izaguirre, 2002). While the Fundsare generally consideredsuccessful, no governmenthas yet conductedathorough assessment of their design and implementation (Guasch, 2002). Subtel, mimeo 2002. 65 Interviews with the manager of the Departamentode Acceso Universal, Santiago, 2002. 66The evaluation process should be wide ranging --open to the possible conclusions that market mechanisms are already rolling out access at a rapid enough rate or that even well-designed telecenter schemes may have lower benefit-costratios than other pro-poor interventions as well as conclusions at the opposite extreme --that significant public investment is required to ensure a critical mass of users and applications that will generate very high returns to access by the poor, for example. 67Subtel, mimeo, 2002. 68Plans as of May, 2002. SecretariaTIC, 2002, Avances TIC: Minuta; Subtel, 2002. 85 Recently, the Secretaria has decided to reduce the number of Centers and to better coordinate various initiatives. As these experiences develop, monitoring their performance i s of paramount importance to selecting the most successful models and avoiding replication of ineffective pilots. Table 7. Proposed criteria to evaluate FDT1: The first Universal Access Fundto Public Telephony Areas of ~Reference criteria Specific aspects evaluation Designof the Correcttargeting Identification of clear ex-antecriteriafor selection of locations Fund Involvementof municipalitiesinchoosing localities Involvementof local populationby municipalities Consistencybetweenex-antecriteria and localitieschosen Crowding-outeffect: numberof locationstargetedby the Fundthat havebeenreached by unsubsidizedcompanieswithin ayear from assignment of subsidies Transparency Biddingprocess: Clear pre-qualificationcriteria Clear rules for subsidiesallocation Publicly advertisedbiddingprocess. Contracts: Clear maintenanceandquality requirements Specificationof numberof years for servicedelivery Competition Number of competitiveroundsandnumber of roundswhen subsidieswere assignedon the basisof the results of cost-benefit analysis Number of companiesparticipatingto eachbid Monitorinrr svstem IIMonitoringsvstem indace sincebepinningof the Fund I_ Evaluationconductedburingthe Fundexecution Implementation- demandside Increasedmarket contacts for SMEs (buyers andsuppliers) Improvedhealthdiagnosisandtreatment Implementation- supply side rules set inthe contract Pricesconsistent with rules set by the regulator added services(e.g., intemet). Sustainabilitv I Numberof uhonesthat are not utilized Numberof phonesthat are not working Types of problems Cost of repairingthe phones Implementation- Public Investment Amount of subsidiesper location Govemmentside Amount of subsidiesper biddinground Subsidiesover private investment (for public telephony) Subsidiesover private investment (for public telephony andadditionalservices) Intemal Costs Totalcosts for operatingthe Fund(fixed: labor andrent; andvariable: consultants, travel expenses, else) 86 2.88. Below i s a description o f the initiatives managed by Subtel and funded by the second Fondo de Desarrollo de Telecomunicaciones (FDT2), which will extend public Internet access to low-income areas using a 'bidding for subsidies' scheme. First, we describe the preliminary steps taken by the Chilean regulators before launching the Fund. Then, we describe the results of the first bidding round (which was concluded in M a y 2002). Finally, we outline key issues that should be addressed inthe coming years. 2.89. FDT2 was introduced inMay 2001 (Law 19/724) and started operating inJanuary 2002. The services covered by the FDT2 are: Public Phones, Community Telecenters, Radio and Television. The target groups are rural and low-income urban communities. The amount assigned by Subtel to FDT2for the first roundof biddingi s US$4.5 million (US$1.55 million for 2002 and US$3.03 million for 2003). This amount will be specifically dedicated to bids for Telecenters. Like FDT1, FDT2 i s managed by the Council for Telecom Development. Subtel plans to open 341 Telecenters by the end of 2002. 2.90. The Chilean Government moved carefully into the provision of access to computers and the Internet, conducting a number of studies before embarking on this new venture (see Box 3). Based on these lessons, the Council has defined the basic requirements that the Centers must meet (see Box 4). Box 3. Lessonslearnedfrom internationalexperiencesandnationalpilots before launchingFDT2 The FDT2 law and the subsidy scheme are basedon lessons learned from international experiences (Canada, UK,Denmark, Sweden, Finlandand Spain inNorth America and Europe; Brazil, Argentina andPeru inLatinAmerica), from the results of pilot experiences conducted in Chile (first Pilot Telecenters inCunco and Temuco, RedAraucania,' Red Enlaces) andfrom discussions with existing NGOS.' Based on lessons learned, the management of FDT2believes that the most important success factor for FDT2 i s establishing partnerships between the private andthe public sector for the financing, development and operation of the Centers. The Council believes that the following actors should be involved: Asociaci6n de Telecentristas de Chile (ATCH), telecom providers, municipalities, Regional authorities, private companies, universities and social organizations (e.g., social, cultural, sport associations). While only one institution will be awarded the bid and open the Center(s) ineach locality, agreementsshouldbe established with all other organizations, to ensure sustainability of the initiatives inthe longrun. Other, more specific lessons learned from international andlocal experiences are: (i) keep focus on users by identifying the needs of the community, creating online local content, easy- to-use interface, and updating online information; (ii) advertise the Centers before and after opening them; (iii) carefully select the operators, motivate and train them; (iv) involve municipalities and regional authorities; (v) ensure integration and update of information; (vi) ensure that the systems not only provide information, but also allow for interaction (e.& e- mail, chat rooms, online transactions); (vii) involve the local communities, and (viii) ensure that the available technology i s sufficiently sophisticated (low speedtechnologies may discourage the users).' Sources:Departamento de Ingenieria Industrial, Universidad de Chile; TelecentrosComunitarios, Factores de Exito, R. Hernandez, Subtel2000; and interviews with the manager of the Fund. 87 Box 4. Telecenters' basicrequirements to participateto FDT2bidding rounds Structure: space of at least 20 square meters. Hardware and software: at leastfour computerswith 128kbpsconnectionspeeds (higher speedi s required ifmorecomputersare connected), operating systems (Windows or Linux), Internet browsers, andMicrosoft Office for Windows or Star Office for Linux. At least one computermust havea CD-ROM. The computersmustbeconnectedto a local network. All Telecenters should also havea laser printer, aphotocopy machine, a fax, a scanner and security mechanisms. Tvues of services available: accessto computers, the Internet andthe other servicesavailable inthe Centers; training inthe use of computers', the Internet andother services; andtraining for trainers. Content: portal including information on the Telecenter, on the Telecenter network, andon the local community where the Center is located. To be consideredfor the bidding process, when submitting their businessplan, companies must include adiskette or aCD with the design of the Telecenterportal. Advertising: the bidder musthaveanadvertisingplan. Citizens' participation: the bidder must haveaplan to involve the localcommunity. Sources: Elementos a Considerarpara la Instalacidn de TelecentrosComunitarios, Subtel,January, 2002; Law 19124and Interviews with the manager of the Fund. 2.91. Table 8 shows the results of the first FDT2 biddinground, which was completed inMay 2002, and compares them with the results of the Telephony Funds. The total investment (and total subsidy) per locality i s much higher for Telecenters than for public phone provision; this i s as expected, given the infrastructure required to open a Telecenter. Weighting telephone bids by the location of the first round o f telecenter bids suggests that the average public telephone bid in those same regions was US$1,274. Compare this to the average subsidy bid for a Telecenter o f US$10,501.69 The percentage of subsidy over total initial investment appears low - only 25 percent, compared to 42 percent in the case o f telephony. However, most institutions participating in the Telecenter bid are NGOs, which are likely to receive subsidies from other sources.7o The bid for Region IX, for example, was awarded to Universidad de la Frontera, which contributed only 20 percent of the total investment; 55 percent was financed by Enlaces, and 25 percent was contributed by FDT2. Even if the University entered the biddinground in expectation of a profitable return, this suggests that direct or indirect subsidies will have to add 69 Subsidies per locality varied less for Telecenters than for telephony (range between 9,692,000 Pesos and 13,182,000 Pesos for Telecenters versus range between 740,000 Pesos and 14,892,000 Pesos for telephones). This reflects in part the limited number of regions who were part o f the original round, but also the smaller percentage o f total telecenter costs (compared to telephone costs) related to network costs that are higher in rural areas. It might also reflect less interest in profitability by NGOs that invested in telecenters than by private companies that invested intelephones. 70 It is worth noting that all winners had partners (local municipalities, Regional authorities,DIBAM,the Enlaces project, Universities, training institutes, telephone companies and local NGOs), although the nature of the partnershipsshould be examined more closely. 88 up to 80 percent of investment costsbefore telecenters become an attractive business proposition, even inrelatively attractive rural locations. Table 8. Results of first biddinground for Telecenters comparedto results for Telephony (Chilean Pesos) Telecenters Telephone (First biddinground 2002) - (Seven biddingrounds: 95-01) Localities Tot subsidies Subsidyper Localities Tot subsidies Subsidyper awarded(000) locality (000) awarded (000) locality(000) Region I 72 956,180 13,280 II 27 275,248 10,194 111 53 430,916 8,130 IV 16 163,321 10,208 392 794,701 2,027 V 7 74,000 10,571 438 328,744 751 VI 500 370,388 741 VII 19 205,885 10,836 971 478,862 493 Vlll 15 156,152 10,410 1,074 1,679,221 1,564 IX 12 116,300 9,692 1,040 1,849,822 1,779 X 5 65,928 13,186 924 1,958,132 2,119 XI 50 649,713 12,994 XI1 25 372,302 14,892 R.M. 9 90,000 10,000 493 178,531 362 Total 83 871,586 10,501 6,059 10,322,760 1,704 Telecenters Telephone (Firstbiddinground 2002) - (7bidding rounds) Subsidiesover total initial investment/a 25% 42% Subsidiesover total final investment/b NA 14% Localitiestenderedversus awarded 81O/O 77% Sources: Subtel, mimeo (2002); Subtel, Memoria Storica, 1999; Wellenius, 2002. /aInvestment for public telephony /bInvestment for additional services (not subsidized): e.g., private connections, Internet. 2.92. With such high `true subsidy' costs, one key question is raised: are telecenters, with far higher recurrent costs than public telephones (due to staffing, electricity and equipment replacement requirements), likely to be sustainable? Before the program i s dramatically expanded, further research into these questions i s justified. Key requirements to ensure sustainability of Telecenter operations are: 1. Clearly defining the partnerships between the bidders for FDT2 and other supporting organizations -private participation inthe Centers should be dominant. While the Council states that "private-public interaction" i s essential, it i s difficult to envision how these partnerships will work in practice and, most importantly, whether the partnerships will be fruitful and sustainable. For the Centers to be sustainable, contracts should be signed by the partners, ensuring that the responsibilities of each member are clear and binding. Participating universities and NGOs, for example, should dedicate resources to select, publish to the web, and update local content useful to low-income users. Municipalities should develop easy-to-use portals allowing people to request information and perform basic procedures (e.g., find information on primary health care, request certificates online). Participating software providers should be asked to adapt 89 their sophisticated tools to the basic needs of low-income users. Itis important to keep in mindthat in the past large IT companies have often supported Telecenter initiatives for charity reasons, rather than for making a profit. The ideal bidders, or key partners of bidders, are small-medium size private, for-profit local companies with previous experience in this field (e.g., phone and office service shops). These companies should be encouraged to develop an advanced ICT component in response to market opportunities, perhaps with the inducement of micro-loans for investment in PCs and Internet access.71 Their involvement is a sign of real growth potential of the project and, thus, of long-term sustainability. 12 ii. Designing subsidies with specific criteria for reduction and elimination as market development objectives are achieved. They should be mainly used for development of on-line local content, research and development (R&D) and for initial operating and investment costs such as facility development and staff training. The operational activities of the Centers should be completely self-sufficient, financed by the companies' operating income. iii. Developing complementary assets that meet the specific needs of the users of the Centers, including appropriate online local content, ad hoc training for users and trainers, and appropriate software tools. This could be achieved by ensuring that the Center developers: a. Involve citizens in the design and implementation phases of Telecenter development. Surveys should be conducted to assess whether establishing a Telecenter i s a priority for the local community and what barriers low-income populations face when accessing and using the Internet. The Box in Annex 1 reports the results of a survey conducted by the World Bank in two low-income areas in Chile: the Panaleon district at the periphery of Santiago (Region Metropolitana) and Temuco (Araucania Region).73 The results of the survey show the importance of complementary assets, which should be developed in collaboration with the local communities (e.g., citizens may contribute by posting and updating information on the web -the LINCOS Center model). b. Offer access to useful local online information. The Box in Annex 2 shows the results of surveys aimed at assessing the type of content useful for Chilean low-income users. While the results of ex-ante and ex-post surveys are somewhat different, it i s clear that poor Chilean adult users would like to use the web to find useful information, communicate, and save time and money. While the FDT2 Council requires that companies present a diskette with the design of 71Specific attention should be devoted to avoid oversizing the Centers for existing demand, especially inrural areas, Inthe past, donors have often driven creationof Telecenters that remainedlargely underutilized and closed after few years (sometimes months) of operation. For rural areas, low-cost Internet technologies (e.g. radio, V-Sat) should be considered first, as for the intervention of the private sector. 72For a detailed description of sustainable Telecenter models and relatedpolicy implications, see Navas-Sabater, Dymond, and Juntunen, 2002. 73This survey was financed by the World Bank under the current study. Interviews were conducted inthe Centers: ElEncuentro, Centro de Democratizacih de laInformatica and Trabajo paraunHermano. 90 the portal (including content that will be provided) when bidding for Centers, it does not specify what types of information should be included. To avoid false starts that might cause the program to fail, the Centers should not be allowed to start operating until sufficient online local information i s available. The portal of the Center should be connected with the online pages of the municipality and central administration, and the users should have the opportunity to conduct at least few basic transactions online - e.g., checking status of family certificates, licenses, business registrations - from the first day the Center i s in operation. Links to local banks, allowing users to expedite banking procedures online, are also crucial, especially for the higher-income segments of the market. Easy-to- use software targeted for local communities (e.g., tools to conduct financial analysis or accounting, or to develop business plans for micro and small entrepreneurs) should also be provided to users (see next chapter). c. Offer ad hoc training for both users and trainers. Basic literacy does not appear to be a barrier in the use of ICT in Chile (see Box 4). Thus, training can be specifically focused on the use of computers and the Internet, while demonstrating the immediate utility of these technologies to the customers. (Training on the use of PCs and the Internet per se is unappealing and often frustrating to users, and should be avoided at all costs.) Trainers should also receive special training on meeting the specific ICT needs of low-income populations. 2.93. While some of these principles are clearly reflected in the Council's criteria, applying them in practice i s a difficult matter. For example, while the Council specifies the structural characteristics of the Centers (square meters, number of computers, type of hardware) in a very detailed manner, it is much less specific on other aspects that are at least as important (e.g., the types of local content that should be included in the portal, or how to ensure that private-public partnershipsare fruitfuland sustainable). 2.94. On paper, and based on the results of the first round of bidding (see above), the Chilean plan seems far more advanced than those of other Latin American countries (e.g., Guatemala, Mexico, Peru), but a highrisk of unsustainability remains, and the Government should be careful in scaling up the initiative without having results from the first roll out of Centers (opening341 Telecenters in one year, for example, seems a very risky plan). As with the Telephony Fund, having a monitoring system in place at the beginningof the roll out i s critical, especially given the number of projects starting around the region. ICT Applications: E-businessesandE-government 2.95. The Ministry of Economy has recently made progress in the e-commerce field by approving digital signature online contract and an electronic invoicing laws, as well as by introducing protection of intellectual property over the Internet.74 In addition, the Ministry of 74As stated by Hilbert (CEPAL, 2001) on security: "In the long run, security is not a real obstacle (for development of e-commerce). Paradoxically, consumers are accustomed to give credit card information over the telephone or to a waiter in a restaurant. But many are reluctant to give it online for fear that it will be stolen or misused. Of course, the first alternative is a lot more susceptible for misuses. Furthermore, most e-commerce companies take full 91 Economy and C O W 0 have promoted initiatives supporting development of the Application Service Provider (ASP) industry to enhance the use of technology in traditional Chilean industries (mining, fishingandaquaculture). However, e-businesshas developed slowly inChile and i s still in a nascent phase. The Santiago Chamber of Commerce estimates that 523 Chilean companies had a web site in March 2002. Of these, 214 allowed their customers to place an order online, including 187 carrying out Business-to-Consumer transactions (B2C) and 27 carrying out Business-to-Business transactions (B2B electronic marketplaces). At the end of 2001, total online sales were US$54.4 million: US$53 million in the B2C segment (about 0.5 percent of the total retail sales) andUS$1.4 million inthe B2B segment (about 1percent of total transactions among businesses). 2.96. Table 9 shows that Chile's share of e-commerce in Latin America during the year 2000 was significantly below that of major countries. While hosting 3 percent of the Latin America population and producing 4 percent of the region's GNI, Chile generated only 1percent of the region's e-commerce sales at the end of 2000 (although these conclusions might changebasedon the source of the data and meaning of terms, see footnote 75). At the other end of the spectrum, Brazil, with 33 percent of the region's population and 32 percent of the region's GNI, generated 69 percent of the region's e-commerce sales. While Chile has made progress in the last two years, more recent figures indicate that it still lags behind its regional comparators. (According to Santiago Chamber of Commerce and e-Marketer estimates, e-commerce sales in Chile during 2002 totaled US$0.054 billion, versus US$12 billion inBrazil, US$4 billion inMexico andUS$2 billioninArgentina.75) 2.97. Reflectingthe capital city's dominant positioninChile, Santiago accountedfor more than 80 percent of B2C revenues. Outside the capital, neither telephone sales nor Internet sales are considered alternatives to the traditional commercial channels. According to a survey financed under this study, most of the population does not know whether it is possible to buy by telephone or through the Internet or, if aware of the possibility, does not consider it to be a practical alternative. Amongst one of the few exceptions to the rule of low use of e-commerce outside Santiago found in the survey i s that of tourism-related companies, some of which have moved online. This might suggest that where there i s consumer demand (many potential clients of tourism companies are likely to be online), suppliers are moving to provide online services. Where there is not, suppliers will not move to invest inwebsites untilthat positionchanges. responsibilities for financial transactions (e.g., Amazon). Finally, new technology devices that can be connected to computersare now able to read fingerprints of the user, transmitting and assuringhis identity inreal time." 75The low monthly volume of e-commerce sales also confirms that e-commerce is still in its infancy in Chile. Monthly e-commerce sales average less than US$lOO,OOO per month in the B2C segment in Chile, with only 2 percent of B2C companies selling more than US$500,000 per month (72 percent of B2B companies also sell less than US$lOO,OOO per month) (Cgmara de Comercio de Santiago, 2002). Having said that, using a different definition of e-commerce, Chile is performing far better. According to the Chamber of Commerceof Santiago USD 461.7 million worth of transactions were agreedupon electronically (while not completed over the web). 92 E-commerce Sales Population Gross National (US$ billion, 2000)la (million, 2000) I Income2000) (US$ billion,I Source: Santiago Chamber of Commerce,2002for Chile; E-Marketer, 2002for all other countries. /a: includes B2C and B2B, transactionscompletedover the web. Note that using a diSferentdefinition of e- commerce may lead to different estimates (seefootnote 75) 2.98. The Chilean Government has recently supported the use of ICT to improve interactions between government and businesses (G2B)76,government and citizens (G2C) and among various government agencies (G2G). However, more progress i s needed, especially inpromoting online transactions, supporting use of ICT at the municipal level, improving use of ICT in certain areas (e.g., health) and supporting coordination of various initiatives. 2.99. In terms of G2B, Chile has made some progress. For example, it has simplified procedures for business registration (sitioempresa.cl; zonaempresa.cl). It has also developed digital networks connecting private corporations (e.g., Transbank-Edibank for the financial and monetary sectors and Transaxion for the trade andretailindustries). Inaddition, it has supported access to and use of ICT by micro and small businesses (Telecenters sponsored by C O W 0 and the Ministry of Economy). Finally, it has promoted an online tax payment system (Servicio de Impuestos Internos - www.SII.cl). Thanks to Sewicio de Impuestos Internos, Chile's most renowned and successful e-government project, Chile i s a world-leader in online tax payments, with 42 percent of returns being delivered via the Internet in 2001 (up from 21 percent in 2000).77This demonstrates that the Government can effectively move from simple provision of information to support of online transactions and act as a catalyst inthe diffusion of ICT. 76 The impact on public sector management o f the Internet and of information and communications technology (ICT) in general is markedly felt in two processes. The first relates to the internal operations o f governments, and the second relates to the government's interface with the public. First, the Internet and ICT increase administrative efficiency by making the collection, maintenance, flow and management o f information faster and easier, reducing the unitcost of information. This affects areas such as tax administration, land registry, public finance management, and pensions and social security administration. Second, the Internet and ICT facilitate transactions between governments, businesses and citizens, and enable governmental transparency and accountability. More specifically, they allow governments to: (i) increase their revenues and their national economies by improving transactions with national and international businesses (B2G); (ii) improve the attractiveness of their countries, regions and cities as places to live and work, by improving their relationship with the citizens (B2C) - this can be done by increasing the amount and clarity of information available on the Internet and by reducing the time that citizens need to spend to receive government services; (iii) reduce the digital divide between higher and lower income people and between large, small and micro businesses, by encouraging access to the Internet for all citizens and for businesses o f different sizes, and by stimulating online education; (iv) create consultations and collaborations among government and businesses, government and citizens, and different governments worldwide. 77Economist Intelligence Unit,2002a. 93 2.100. Chile has also made progress in the G2C field. The Government has provided online information on government activities (www.presidencia.cl, www.nobiernodechile,cl) and other topics of interest. Finally, it has established online services. The tramitefacile portal (www.tramitefacil.cl), for example, provides the general public with step by step instructions on a wide array of procedures, including acquiring birth, death and civil marriage certificates, legal forms for consumers, motor vehicle certificates, export documents, and housing forms. 2.101. Finally, Chile has made some progress in the G2G area in terms of developing networks integrating various public agencies. This was accomplished through the introductionof a unified internal e-mail system and a government Intranet. Inthe next year, the Government plans to introduce a platform to promote a common accounting-administrative system for all public agencies. Inaddition, it has introduced specific training programs to improve the ICT skills of the labor force. 2.102. Despite all this progress, there are many remaining challenges for the Government. One of the most important i s further increasing access to computers and the Internet. Widespread access i s a key precondition for the successful implementation of e-government solutions, especially in the G2C field. Another important challenge is promoting e-government initiatives at the local level (only 33 percent of 256 Chilean municipalities had a web-site at the end of 2002) and in the healthfield (use of ICT to improve hospitals' and local health units' budgeting and reporting systems; increaseinstitutionalaccountability; improve internal monitoring of costs, outputs and outcomes). A third i s coordinating programs at the central and municipal levels. Finally, the Government must promote the introduction of applications facilitating online interactions and transactions between government and businesses and citizens. Most existing government sites are only informational (compraschile.cl, for example, provides information on procurement opportunities, but does not yet facilitate online tran~actions).~~ Key Constraints on Development of E-business andE-government 2.103. InChile, as inmost other countries, there are four mainconstraints to e-business and e- government development: (1) lack of access to and highcosts of ICT for the population; (2) lack of ICT skills; (3) needfor cultural, organizational and logisticalchanges, especially inbusinesses andgovernment agencies introducing ICT; and (4) legal constraint^.^^ This chapter has already discussedissues relatedto access to ICT (see the section on universal access and use), as well as issuesrelatedto costs reduction (see the section on service rollout and telecom policies). Inthe section below, we will focus on the other three constraints. ICT Skills 2.104. The only available data on the quality of Chilean ICT-workers has been providedby the World Economic Forum, which asked employers in a number of different countries to rate the quality of ICT-workers relative to other countries. Chilean employers rated the domestic supply of ICT-workers among the best in Latin America. Infact Chile was, together with Costa Rica 78Interviews with SecretariaTIC, Ministerio de Economia, Secretariade Modernizacihdel Estado. For a description of the initiative, see PREMViewpoint on compraschile) 79Santiago Chamber of Commerce, 2002; OECD, 2002a. 94 and Brazil, far above the mean value for Latin America and the East Asia and the Pacific.'' The survey also shows that Chilean highly skilled ICT workers are more likely to find good jobs in their native country, than are ICT-workers in other Latin American countries like Mexico, Argentina and Colombia.81 2.105. This relatively strong performance i s in part due to an already active program of extending access to ICTs and training in schools and universities. The Government of Chile early committed itself to expand the number of computer-literates." So far, one of the most significant policy initiatives is the Enlaces (Le,, Links) program, which has delivered computers andInternet connection to public schools. Inconsequence, almost 75 percentof primary schools and more than 90 percent of secondary schools have access to computer^.'^ Even though these numbers indicate a high penetration of ICT-technologies in a Latin American context, the ratio of students to computers i s at 57, which is significantly higher than most developed economies -- the Chilean Government aims to reducethe ratio to 30 by 2005.84 2.106. Realizing that hardware and software need to be coupled with skills to take advantage of it, the Enlaces programhas also providedfor trainingon how teachers can make the most of ICT technologies in their education. So far, close to 84,000 primary and secondary teachers have received basic ICT training and an additional 20,000 have received special programs focusing on how ICT can be applied to the learning process. These efforts are supported by the Chile Education Portal, which is delivering various services supporting the use of ICT in primary and secondary schools.85 A related project, Reuna2, has been launched to promote the use of ICT- technologies at the tertiary level. The project aims to integrate the use of ICT-technologies inthe tertiary education and research process and set up a network connecting tertiary education institutions.86 Subtel (in collaboration with Cisco) and Conycit have promoted development of schools providing advanced ICT training for software developers, web developers and other IT specialists. Specific courses have been introduced for people working in the public sector. INTEC opened a Center for Technology of Information providing advanced ICT training for private companies and courses on ITcertification. Arellano, 2002. On the other hand, accordingto the survey carried out for this study, the offering of training programson ICTs is very scarce or non-existentat the local level and the few training centers that currently exist are oriented towards teaching basic skills. SERCOTEC has found that the lack of skilled personnel is a significant obstaclefor the dissemination and use of ICTs inthe region. 81On a scale from 1-7, where 1indicateshighly skilled information technology workers must leave the country to find good jobs and 7 indicates that they have their pick of well-paid, desirablejobs in their native country, Chile scored 5.3 second only to Brazil at 5.4. By contrast, Mexico, Argentina and Colombia scored 4.2, 4.1 and 3.3, respectively (World Economic Forum, p.380). Having said that, the local universities of the IXth region do train a number of students, but most of them have difficulties finding employment in the region's small labor market and endby migrating to Santiago. 82Business LatinAmerica, 2001, p.6. 83Numbers accordingto Ministry of Education following Araneda andMarin,2002. 84Further, only asmall selection of schools has broadbandaccess, whereas the majority struggles with low-speed connections, which reducethe learning potentials of the Internet. 85This sectionbuilds on ArandedaandMarin,2002. The portalcanbe found at www.educarchile.cl. 86Comisi6n Presidencial, 1999. 95 2.107. Beyond these initiatives, there i s a significant number of institutions providing training on ICTs. They are mainly geared towards the most widely disseminated software packages (Windows, Office) and to the use of e-mail and the Internet; particularly with reference to the search for information and document downloading. There are independent schools as well as institutes attached to some of the universities that have a local presence. According to the survey in Temuco, the offering from IT training centers and institutions in the area is seen as adequate (however businessesshow little interest for attending courses). 2.108. Given this relatively strong performance, the role for further policy intervention to support traditional ICT education and training appears limited. Training, in particular, carries privatebenefits that suggest, as a rule, private initiatives should be sufficient to meet much of the demand. On the education side, exposure to ICT appears to be large enough to have created a significant level of computer literacy nationwide. It is, however, worth noting that the role of ICT as a pedagogical tool in its own right i s a contentious one, suggesting the need for careful evaluation of programs to further expand computer use in Introducing ICT tests to assess use of computers and the Internet among both students and the general population would be very useful. It i s important that these tests measure the impact ICT has on the quality of education (e.g., the number of students able to use various programs and increasedunderstanding of class materials thanks to the use of computers). Merely measuring inputs (e.g., number of computers per school or number of teachers trained) i s not sufficient. For the adult population, evaluations could be centeredon assessingthe current costs of accessing and using computers as compared with the benefits of using these technologies. The benefits would preferably be measured in terms of time and costs saved, increased profits (for entrepreneurs), and increased job opportunities. 2.109. Further, whilst Chile appears to have done well in providing the basic skills of computer literacy, it may well be that a gap remains in supporting the development of the skills required to incorporate ICT into business practices. RegardingSMEs in particular, for example, the lack of ICT skills does appear to be a barrier to further uptake of e-commerce. It would be worth undertaking a survey of needs in the area of developing capacity to undertake business process reform that incorporates ICTs. Depending on the results of such an exercise, some support for the development of skills inthis area may bejustified. 2.110. Turning to other pre-requisites for successful utilization of ICTs, it i s important to emphasize that, while addressing these issues and creating an enabling regulatory environment are essential pre-conditions for the development of e-commerce and e-government, cultural and organizational changes are also necessary to ensure that businesses and government exploit the opportunities offered by ICT. The necessary changes include adjustments to the governments' and businesses' logistical, production and marketing functions. These cannot be achieved through regulatory interventions. Thus, the effectiveness of regulatory measures will depend strongly on the concrete initiatives taken by businesses and governments, and on their willingness to invest in and take advantage of the opportunities offered by ICT. 87 See Ruth and Shi (2001) and Johnson (2000) for recent evaluations of the impact of computers on educational performance in the US which may suggest that the cost-benefit ratio o f investments incomputers is lower than that of a number of viable alternatives. 96 2.111. More broadly, the fact that so many of the country's economically active population have the capacity and willingness to use the Internet to make tax payments suggests that low general e-commerce usage is not necessarily related to barriers specific to the Internet. Instead it might well be more general barriers that account for low take-up of the Internet. Survey respondents outside Santiago suggestedthat local micro and small businesses (MSBs) could not benefit from more complex Internet-based application because the general educational level of entrepreneurs would not allow them to make use of such complex applications, for example. ImplementationConstraintP 2.112. Turning to other pre-requisites for successful utilization of ICTs, it i s important to emphasize that, while addressing these issues and creating an enabling regulatory environment are essential pre-conditions for the development of e-commerce and e-government, cultural, organizational and infrastructure changes are also necessary to ensure that businesses and government exploit the opportunities offered by ICT. The effectiveness of regulatory measures will depend strongly on the concrete initiatives taken by businesses and governments to implement the changes needed to make effective use of ICT (see Chapter 3, the Internet chain adoption). 2.113. Survey respondents outside Santiago suggested that local MSBs could not benefit from complex Internet-based applications because the general educational level of entrepreneurs would not allow them to use these applications. This suggests the need for improvement of the population's higher order skills (math, science skills). Even when sufficiently educated to use computers and the Internet, local entrepreneurs are often unaware of the changes required to ensure that their organizations effectively adopt ICT. These changes include adjustments to the businesses' logistical, productionand marketingfunctions (see Chapter 3 - the Internet adoption chain). 2.114. Local survey evidence also suggests that lack of confidence regarding on-line payments, the use of credit cards and the delivery of goods are some reasons why even those with basic knowledge of the Internet do not purchase online. Even if Chile has the highest credit card penetration rate in the region, its use of Internet-based payment systems i s still behind the best practice income comparator country (see Table 10). Support development of medios de micropagos (pre-paid cards, debit cards, payment systems with direct charges to fixed or mobile phones) would increase e-commerce penetration, especially by giving the opportunity to buy online to lower-income population. 2.115. Chile's logistic infrastructure i s also not as advanced as its telecom infrastructure. The country's centralization (about one third of Chile's 16 million people live in Santiago) assists relativelyefficient distribution of mail inthe major urban centers, but not inruralareas. Overall, the need for an efficient and reliable distribution of goods brought over the Internet has seen e- businessesturn to courier services. However, foreign logistics firms have not yet expanded their presence in Chile in the way that they have in other Latin American countries (e.g., Argentina and Brazil). In recent years, Chilean Governments have also worked hard to improve the 88See Chapter 3 for a more detailed description of implementation constraints for micro, small, and medium businesses (MSMBs). 97 country's road and rail networks. The road network is improving, but long-distance rail services have yet to attract private operatorscrucial for their effective m~dernization.~~ 2.116. A further issue, reflected in local polls, is that the Internet might not be a good tool for the sale of many goods produced by Chilean businesses. Although e-commerce should (and will) grow if it i s to have an economic impact, it i s important to note that it i s unlikely to dominate purchases. Legal issues 2.117. Despite the fact that the broad barriers mentioned above are likely to be the largest constraint on Internet use, a number of low-cost sector specific legal issues could be addressedto improve Internet use inChile. These include electronic data interchange, consumer privacy, and online security. 2.118. Chile was late in introducing its law on electronic data interchange. The law was approved only in March 2002, well after similar laws had been enacted by most other Latin American countries. As inother countries, the law is basedon a (very broad) model proposed by the United Nations Conference on International Trade Law (UNCITRAL). The Chilean Government applied the UNCITRALmodel by approving a law that: (i) gives digital signatures the same legal status as hand-written ones, (ii) recognizes electronic documents and contracts as having the same legal value as contracts executed on paper and (iii) defines the obligations of institutions providing electronic certificati~n.~~Although lack of interest and initiative from businesses in the e-commerce field has likely been the main reason for the slow take off of online sales in Chile (see progress to date in the previous section), the slow approval process of the electronic data interchange law may have also played a role. 2.119. Although a law governing electronic contracts i s necessary, there i s more that a country can and must do to facilitate e-commerce. Electronic contracts can be effective only if they are complemented by protections for privacy (of consumers), property rights (of suppliers) and system security. Chile has been ahead of other Latin American countries in enhancing online privacy protection, through a data protection law enacted in 1999. The act includes rules governing the processing and use of personal data, the rights of individuals, the use of information by government agencies, and the use of financial, commercial or banking data. A recent plan would also amend the law to include a bill containing a special section relating to e- c~mmerce.~' 2.120. Security i s a complex topic that encompasses several areas, including authenticity (evidence that a communication actually comes from the purported sender), integrity (proof that the content of a communication has not been altered during transmission), non-repudiation (prevention of later denial of the transmission of the message) and confidentiality (evidence that the contents of a transmission have not been disclosed to third par tie^).^' For example, ad hoc *'Economist Intelligence Unit, 2002b. httr,://www.ebusinessforum.com. 90Economist Intelligence Unit, 2002a; CEPAL, 2002; SantiagoChamber of Commerce, 2002. 91Economist Intelligence Unit,2002a. httu://www.ebusinessforum.com. 92Van Dam, 1999;Feldmanand Meranus, 2000. 98 certification technologies are typically used to ensure the confidentiality of transmissions to and from a website. 2.121. Chile lags behind other Latin American countries in this area. Only 17 percent of Chilean web sites were "secure" in 2002, versus 20 percent in Brazil and 25 percent in Argentina, according to a recent survey by the Santiago Chamber of Commerce. Although Brazil was only slightly ahead Chile in terms of secured websites, it i s much more advanced in terms of e-commerce in general (see Table 9). This confirms that security issues alone do not determine a country's progress in this field.93Thus, although Chile seems to be slightly behind other countries in this measure, this may not be a serious constraint on its development of e- commerce in general. Nevertheless, the Government shouldnot ignore this area altogether. 2.122. Overall, it i s importantto underline that while the Government can take certain regulatory steps to improve Chile's policy environment for doing business online, the focus must ultimately be on implementation. The Government should improve protection of property rights on the Internet, ensure that the privacy law i s amended to include a special section on e-commerce, support development of a secure infrastructure (especially by ensuring that its own sites are secure) and promoting an electronic invoice law. Beyond that, however, the initiative must be taken by the private sector - the Government's role should be to encourage and enable the private sector to take this initiative. G. ICT Production: (Not Much) Potentialfor the HighTechnology Industry inChile ICT andSoftware Production: Starting from the Bottom 2.123. World wide production of ICT goods, which totaled US$1.07 billion at the end of 1999, i s concentrated in the USA (29 percent), OECD countries (27 percent), Asian economies (20 percent), and Japan (18 percent). The Latin America region lags behind all other Regions (excluding Africa) inthis field, with its most dynamic countries (Brazil, Mexico, Venezuela and Puerto Rico) contributing only 5 percent to the world production of ICT goods. Latin American production focuses mainly on consumer products (e.g., television, radios, VCRs, tape recorder^)'^ and electronic data processing (e.g., computers and computer accessories). Production of more advanced technologies, such as ICT components (e.g., television tubes, diodes, audio devices) and radio communication devices (e.g., mobiles, pagers, radars) is particularlylow inthe region. 2.124. Chile's ICT production is very low, even when compared with other Latin American countries. In 2001, total sales of the electronics companies associated with the Asociacidn Electrdnica de Chile (AIE) were US$50 million,95one tenth of Venezuela's and significantly less 93 As statedby Hilbert (CEPAL, 2001) on security: "In the long run, security is not a real obstacle (for development of e-commerce). Paradoxically, consumersare accustomedto give credit card informationover the telephoneor to a waiter in a restaurant. But many are reluctant to give it online for fear that it will be stolen or misused. Of course, the first alternative is a lot more susceptible for misuses. Furthermore, most e-commerce companies take full responsibilities for financial transactions (e.g., Amazon). Finally, new technology devices that can be connectedto computers are now able to readfingerprints of the user, transmitting and assuringhis identity inreal time." 94 Mexico is the second largestproducer of ICT consumer goods inthe world (after China). 95 AIE, 2002. 99 thanall other "dynamic LatinAmerican economies" -total ICTproductionwas US$19billionin Brazil andUS$24billioninMe~ico.'~ 2.125. The high-technology industry's share in the total value added manufacturing sector (MVA) is only 26 percent, and the share of high-technology products inmanufacturedexports is 6 percent. Both indicators are lower than in all other Latin American countries. They are also lower than those of similar income countries (in Poland, for example, the share of the high- technology industry in the total manufacturing sector is 45 percent and the share of high- technology products inmanufactured exports is 36 percent, see Table 2.126. Chile's hardware, software and high-technology industry consists of an estimated 8,000 companies, most of which are small and medium enterprises. Hardware is almost exclusively imported, and the Chilean market is dominated by leading international brands, while the internal industry focuses on PC assembly: about half of the country's PCs are assembled locally, mainly by small and mediumenterprises.'* Table 10. Relevance of high-technology inthe country's manufacturing sector (2001) MVA/capita Exports/capita High-Technology Share in High-Technology share Total Value Added (%) la in manufactured exports (%> Chile 749 443 26 6.3 Argentina 1,475 391 37 23.3 MBxico 855 1,082 36 65.5 Brazil 912 234 58 34.3 Venezuela 607 337 32 10.3 Costa Rica 557 971 30 32.6 Guatemala 237 129 35 15 Ireland 7,043 15,659 65 51.2 Finland 5,557 7,918 53 58.4 New Zealand 2,611 1,626 40 14.5 Australia 2,488 1,151 51 14.6 Israel 2,599 3,702 54 46.1 Malaysia 937 2,937 60 65.1 Poland 779 629 45 35.7 South Africa 557 322 44 25.9 laHigh-technology includes electronic and electrical manufactures. 2.127. In2000, the production of software in Chile was about US$20 million, compared to sales of US$114 million." Both production and sales of software are below those of similar-income '`Reed Electronics, 2000. 97 Despite very low ICT production, Chile is second only to Brazil in terms of ICT spending -1.7 percent of GDP in ''Oxford 2000, versus 2.3 percent inBrazil (IDC, 2002). Analytica, 2002. "Ofwhich55percent(US$63million) wasfor softwareapplications(tools suchasERP,CAD/CAM/CAE! and consumer and home applications for personal finance, education and creativity); 24 percent (US$27 million) for application development tools (database management systems, components and Internet tools supporting e- commerce solutions), and 21 percent (US$24 million) for systems infrastructure software (computer programs that 100 countries. Poland, for example, had software sales of US$511 million in 2001. Export i s also limited (estimated US$8 million in2000), and mainly directed to less-developed Latin American countries, such as Peru, Ecuador, and Central America, which are usually neglected by international companies. As for hardware, the vast majority of software i s also imported, with local software productionconfined to few traditional niches: administrative (mainly accounting) and management software, software for planning manufacturing and supply management, and few innovative fields, such as software for private pension funds, health insurance and utility billing. Both CRM (Customer Relationship Management) and ERP (Enterprise Resource Planning), the most requested applications world wide, are almost exclusively imported in Chile." 2.128. Application Service Providers (ASPs) representan interesting untapped market, given the importance of SMEs in the Chilean economy. ASPs provide companies with information warehousing and management administration systems (e.g., ERP and CRM, Groupware, sector- specific applications and standard applications for office management). SMEs are likely to benefit significantly from the use of ASPs, which would alleviate them from the burden of information systems' administration, improve their internal organization and reduce costs. However, SMEs are often not aware of the potential of these solutions, or unwilling to externalize warehousing and management of their information. Specific initiatives should be undertaken to overcome SMEs' culturalbarriers inthis field (see Chapter three)."' Supporting ICT and Software Production: A Role for the Government? 2.129. FONTEC (Fondo Nacionul de Desarrollo Tecnolo'gico y Productivo), as the High- technology Fund of CORFO, the Government's development agency, has taken the lead in investment support for the high-technology and software industries. In the last ten years, the program has financed 177 projects inthe high-technology sector, for a total investment of US$24 million, of which US$16 million was invested by the private sector and US$8.6 million was providedby the Fund(8 percent of its total portfolio of US$156 mi1lion).lo2 2.130. A more recent FONTEC program to attract FDIin the high-tech sector (with computers, multimedia, software and information processing as four of six focus areas) provides incentives including: (i) a grant to cover up to 60 percent of the cost of pre-investment studies, with an upper limit of US$30,000; (ii)grant covering 40 percent of investment costs, to a maximum of a US$520,000, directed towards the acquisition of land, buildings, basic services and equipment for new installations in industrialor technological parks; (iii) for R&D projects with high funds commercial impact; and (iv) a grant of up to US$3,600 per employee for staff trainingcosts. 2.131. The program's successes to date include: establishing a Chilean office in Silicon Valley, which serves as a magnet for foreign investment in Chile and provides support for local deal with the internal operations of a computer such as operating systems, middleware, and systems management and security). These figures indicate that the market for faster growing software tools, such as development applications (e.g., Internet tools) and systeminfrastructure (e.g., middleware and security), are still limited inChile. looOxford Analytica, 2002; OECD, 2002a. lo'ACTI, 2002; C6marade Comercio de Santiago, 2002. Other areas in which FONTEC invests are agro, biotechnology, services, construction, electricity, gas and water, manufacturing, forestry, fishery and aquaculture and minery. 101 companies that want to expand into the US market; Ericsson's initiative to establish call centers in Chile for the whole Latin American region; Delta Airlines' development of a reservation center in Chile serving the entire Latin American region; Banco Santander's installation of its world-wide support software center in Chile; and Motorola's creation of a center for development of wireless software solutions in Va1parai~o.l~~FONTEC has also contributed to financing four Business Parks: the Valparaiso high-technology park, Enea, Ciudad Empresarial and Curauma. 2.132. Whilst there i s undoubtedly a role for the government in supporting training and R&D for high technology, a range of studies suggest that sector-specific incentives are not terribly effective in attracting high technology businesses that provide significant economic returns. Malaysia's Multimedia Super Corridor (MSC) is a case in point. The MSC began in the mid- 1990s with a US$10 billion commitment of public funds for infrastructure, a US$31.6 million government-backed venture capital fund and incentives including freedom from taxation for ten years. It has attracted investments worth US$475 million and employing 7,300 people (as of 2001). These figures are far below target. Reasons that companies cited for not moving to the corridor included concerns about government monitoring of Internet traffic, capital control, red tape, slow visa approval, weak intellectual property protection, weak infrastructure and absence of an appropriate skillbase." 2.133. These lessons are echoed ina recent survey of managersworking inU S electronic companies which reports that the most important factors inlocation decisions are (inorder of importance): infrastructure, political stability, skilled labor cost and availability, proximity to customers and suppliers, and (last) tax incentives.lo5 2.134. Emerging countries that are leaders in ICT production generally have either: (i) a large, secure market driving industry growth (e.g., Israel's defense market, Mexico's closeness to the USA); or (ii) capacity to attract FDI (e.g., Ireland, with 97 percent of its electronics industry controlled by foreign multinationals).'06 Lacking a market driving industry growth, Chile is pursuing the second strategy. The role of the government in supporting this strategy should be limited to broad interventions aimed at: (1) integrating the local hightechnology industryinto the global economy, (2) supporting R&D, (3) promoting property rights protection, and (4) supporting use of ICT in government agencies. Based on lessons learned from international experiences (see above), the government should refrain from experimenting with sector-specific tax breaks, venture finance, andpicking winners inthis field. 2.135. First, given the rapid peace of change of the high technology industry, the Government should encourage franchising, joint ventures, and exchanges among local and international companies (Recent initiatives of the Chilean Government along these lines have included visits to international high-technology leader countries such as Israel, Finland, and the USA, as well as opening of the Chilean Center in Silicon Valley, California). Innovative local high-technology companies could also be assisted in efforts to find sound international partners to expand to lo3Centrode Produccidn,FONTEC, Comitkde Ministros de TIC,2002. IO4Dedrick and Kraemer, 2000; Far Eastern Economic Review, 2000. Ibid. lo6Reed Electronic Research, 2000. 102 larger markets. Inaddition, the government could provide funds for dissemination activities and exchanges, bothwithin Chile and with other countries. 2.136. Second, research and development in the high-technology field has been limited to date and should be encouraged as part of the Government's broader innovation policy. A concern is Chile's Enterprise R&D per capita of US$5.3 compared to that of Brazil (US$13.7), South Korea (US$211) or Finland (US$413).lo7 Moving funds from basic to applied research and linking private and public initiatives inthis field i s particularly important (see Chapter 3). 2.137. Third, the Government should improve protection of intellectual property rights. The Economy Ministry's Industrial Property Department currently takes an average of five years to award an industrial patent. Addressing industry-specific issues on intellectual property protection i s also needed, because enforcement of traditional protection rights in the technology area (andon the Internet) i s more difficult than intraditional sectors. 2.138. Finally, perhaps the most important sector-specific policy that the Government can undertake to support sector development i s strengthening use of ICT in government agencies. In a recent survey of OECD countries, government procurement of ICT goods was cited as a key factor in developing the high-technology industry's capabilities and reducing prices. The development of electronic tax filing systems, especially for value-added tax, as well as better on- line technologies to serve citizens were also mentioned.lo8 While Chile has made progress in introducing e-government solutions in some areas (the online tax system has been very successful), the public sector i s generally perceived as being slow to adopt technology (see section on government applications). Further improvement in this area would help develop the high-technology industry. 2.139. Although Chile's Government has progress to make inthe broad areas mentioned above, its current strategy of encouraging foreign investment without granting any sector-specific tax breaks fits with international best practice. On the other hand, CORFO's US$520,000 grants to attract high technology companies might be an excessive incentive in support of the industry. While public support for venture capital i s widespread around the world, these funds tend only to work in an environment more broadly conducive to high-risk. In Hong Kong, for example, a US$lOO million public venture fund for IT was unable to find suitable investments and was forced to return assets to the G0~ernment.l'~Government subsidies are not the best way to encouragehightechnology start ups if the businessenvironment i s not sufficiently conducive. 2.140. Whether or not the high-technology industry will develop in Chile i s hard to say, especially given the country's absence of initial competitive advantages in this area and the country's distance from world markets, which increases the relative cost of transport of both finished goods and imported raw materials. New Zealand's slow growth in the electronic industry, notwithstanding its high per capita income and the Government's efforts in this field, should serve as a warning for Chile. lo'Lall, 2001. lo8OECD, 2002a. logThe Economist,Feb.3, 2000. 103 2.141. In any case, as mentioned above, pursuing a policy of improving the business environment in general is likely to have a higher return than any sector-specific policy. The issues that impact the development of any businessescan have a particularly significant effect on the rollout of ICT industries. Chile's low scores internationally on the costs of starting a company (12 percent of GNPkapita compared to 0.4 percent in New Zealand) and low labor flexibility (29 out of 36 countries, compared to Brazil at 13) may explain Chile's difficulties in attracting FDIin the high technology, as well as in other sectors - see recent decisions of Intel and Microsoft to open new branchesinCostaRica and Argentina rather than Chile."' H. Conclusion 2.142. International experience suggests that ICT production anduse can be an important source of employment and gains in labor productivity. At the same time, however, that experience suggests that the sector is not so different from others as to justify the need for widespread government intervention to ensure optimal economic outcomes. There i s a role for governments to ensure a policy and regulatory environment to allow private competition to flourish and to promote access to ICTs in order to meet equity goals, but perhaps the most important method to increase the development returns of ICTs i s to improve the enabling environment of the broader knowledge economy. 2.143. This may be especially the case in Chile, where the narrow policy environment covering ICT i s already used as a model case. There remains only some tweaking to be done of the policy and regulatory environment covering issues such as regulatory independence and the interconnection regime. The universal access model applied by the country i s widely considered as global best practice, although, again, there may be some issues to confront as the program extends into the more complex area of multipurpose community telecenters, and the costs and benefits of this program extension need to be carefully evaluated on an ongoing basis. Regarding ICT production and applications, a regime of limited, targeted intervention appears well suited to a sector that may not be one where Chile has a strong regional or global comparative advantage. 2.144. On the other hand, there do appear to be a number of areas covering the broader enabling environment -logistics, labor flexibility, research and dissemination, for example, where policy reform i s a more pressing issue. It may be through the indirect impact of policy interventions in these areas that the greatest difference is made to the performance of the ICT sector inChile. 'loEdwards, 2002. 104 Annex 1 Key barriers on access to and use of computers andthe Internet for low-income populations in Chile: the importance of complementary assets (results of survey conductedinPanaleonand Temuco) Access to and cost of ICT: low-income users do not have access to PCs and the Internet from home (the cost of a PC i s prohibitive). Inboth Temuco andSantiago, about half of the low-income employed population access these technologies from work. Use of ICT: limiteduse of PCs and the Interneti s mainly due to lack of awarenessof their potential benefits, lack of ad hoc training, lack of adequate software tools and lack and cost of technical assistance. The cost of the Internet andits low speedinvarious areas (due to dial-up connections) are not perceived as major barriers -thanks to "Internet free", the cost of the Interneti s now equivalent to the cost of a phone call, and low speed i s not a problem given that the use made of the Internetby low-income people i s mostly exploratory. Barriers to more advanced use (e.g., online transactions) are due to perceivedlack of online security andprivacy. (Consumers often reject the idea of entering their credit card data on the web.) For low-income people, lack of payment systems (e&, credit anddebit cards, smart card) i s also a key barrier. Basic andICT Skills: the basic literacy level of the low-income population i s not a barrier to ICTuse. However, the ICT training offered inthe surveyed areas i s not considered attractive by low-income customers -training offered inTelecenters focuses only on the basics, while training offered at Universities i s too advanced for this target market. Online local content: low-incomeusers believe that they can access a large amount of information of general nature through the Internet. However, the available content does not provide answers to specific problems, especially for people living in small communities. Information i s also considered hardto reach; trial and error methods of finding information are time consuming and often frustrating. While search engines andbrowsers help, they do not provide a complete answer. Language i s not considered a barrier by basic users, but lack of Spanish online content i s mentioned as a constraint by more advanced users (e.g., low-income people living inthe city lookingfor newjob opportunities). Source: World Bank consultants' report, 2002d. 105 Annex 2 Content that low-income userswould like to find on the web: resultsof various Chilean surveys An ex-ante interview conducted inTemuco"' shows that the localpopulation would like to find information on the following subjects on the web: (i) sector: documents required to expedite family public and businessprocedures (e.g., birthcertificates, deathcertificates, businessregistrationforms) and the cost of the procedures; (ii) social benefits: social programs, benefits and subsidies relatedto food, education, health, culture, housing, social security and legal assistance; (iii) business: lists of suppliers, potential buyers, fairs and online prices -this informationwas considered particularly important because it would allow entrepreneurs consultingthe web to avoid atrip to Santiago, thus savingtime andmoney; and (iv) labor market: training andjob opportunities. An ex-Dost survey of the users of the Temuco Telecenter'" showed that the informationmost requested by the users of the Centers included: (i) social benefits: information on protection from family violence, social programs for youth and adults, government credit programs to support development of enterprises and labor laws; (ii) local information: lists of services available inthe municipalities or the Region, information on local healthunitsandhospitals, culture and tourism, censusdata and agro-veterinary information. Finally,the results of a survey of ruralpeopletravelingto the regional cauitalto get information and expedite procedures revealed that most of the travelers would like to find information on health on the web (23% of those interviewed), while 13% would like to find information for their studies and 9% would like to find information onjob opportunities. Source: Departamentode Ingenieria Industrial, 1999. "'The ex-ante survey was conducted on 1010people inrural and interurban bus terminals; Temuco square (where most of the private and public local organizations were located); localprimary care health centers; and the Civil Register. The objective of the survey was to assessthe potential utility that an I C T Center would have for the local people (Departamento de Ingenieria Industrial for Subtel, 1999). ''*The ex-post survey was conducted through individual interviews and focus groups o f Telecenter users. 106 111. ACCELERATINGE-BUSINESSFORSMALL BUSINESSINNOVATIONAND GROWTH^ A. Introduction ChapterObjectivesandScope 3.1. The aim of this chapter i s to investigate how e-business may help increaseinnovation and growth among Chile's smallbusinesscommunity, upon which the majority of those employed in the nation's private sector depend, and explore how this process may be accelerated in light of experience to date in Chile and elsewhere. This chapter focuses on a strategy of promotion of adoption of digital applications and technologies, in conjunction with a sound business environment and other programs to promote business innovation, rather than the development of digital industries themselves. It is intended primarily as a contribution to the already very active efforts among public and private stakeholders to further engage small business in the digital economy and reduce income inequality inChile. 3.2. The chapter first briefly reviews the current profile of Chile's small business sector. It then examines the basic process of business transformation which is often observed to take place with e-business development and provides some indications of development impact. It goes on to benchmark e-business progress in Chile in relation to member countries of the Organization for Economic Cooperation and Development (OECD) and looks at observed constraints to this process experienced by small business in Chile. This is followed by a review of the public policies andprograms emerging inChile and OECD countries over the past few years to promote e-business among small firms and some lessons from initial experiences. Finally, it suggests measuresthat might accelerate the pace anddeepene-business adoption inChile. 3.3. Although there are a variety of dissimilarities between Chile and OECD countries, Chile's frontrunner status in Latin America in many aspects of digital development and the somewhat longer experience of OECD countries in conducting e-business adoption support programs make them useful benchmarks. This report does not describe Chile's overall ICT sector, which i s discussedinChapter 2. Key Definitions 3.4. "Small business" is used in this report as a generic description of the aggregation of micro, small and medium sized firms (MSMBs). Specific reference to any one or more of these three segments is identified as such. Comparisons between Chile and OECD countries are based upon numbers of employees. In Chile, this classification by the Government's National Statistics Institute (INE) applies to the industrial sector, in which microbusinesses are those which are "own account'' (self-employed) or employ up to 10employees; small businesses, 10to 49 employees; medium businesses, 50-200 employees; and large businesses, over 200 employees. This classification is similar to those in many OECD member countries, which This chapter was prepared by James Hannaand RobertVickers. 107 generally refer to this group under the heading of "SMEs". However, caution i s needed in making strict comparisons by size category. Firmclassifications across sectors are also defined in Chile by INE and COW0 by level of sales, inwhich microbusinesses are those with annual sales below 2,400 UF (unidud defomento, or about US$55,200); smallbusinesses are those with annual sales between 2,400 and 25,000 UF (US$55,200 - US$575,000); and medium business have annual sales between 25,000 and 100,000 UF(US$575,000 - US$2.3 million). 3.5. "E-business development" refers to the broadprocesso f 1. investment by a business in information and communications technologies (ICT), including personal computers (PCs), other hardware equipment, software, Internet connectivity, and its localand wide area networking; 2. their application to and re-engineering of business organization and specific business processes, such as market research, product design, staff skills training, production, quality assurance, finance, advertising and promotion, facilitation of business contacts, supply-chain management, customer relationship management, administration and general management; and 3. the sale or purchase of goods and services between a business and other businesses, households, individuals, governments and other organizations over computerized networks (including Web-enabled applications, ED1or interactive telephone systems). Such transactions may involve orders over such networks, but payment and delivery may be conducted on or off line. 3.6. The emphasis of this report is not on the ICT industry or ICT equipment, but on this three-step process, and its impact on productivity, competitiveness, growth- and profits. It i s important to underline that success for small business development depends on the adoption of technology and of ICT, as well on other factors, such as improvements inmanagement skills and access to credit. Together, these elements can help to stimulate and enable increased rates of product andprocess innovation, increasedinvestments inintangibles such as "up-skilling" of the labor force, and the transformation of economic activity into more productive uses of scarce resources. B. Chile's Small BusinessSector Profile 3.7. Small business is a very important segment of the Chilean economy, as it i s elsewhere in the world.2 In 2000, small business accounted for 640,500 firms, or 99 percent of the total number of firms in Chile.3 This included 533,500 microbusinesses alone (83 percent of the total), which have been growing rapidly in number --nearly 100,000 more such businesses than in 1994. About three-quarters (73 percent) of small business is concentrated in the country's For example, inthe European Free Trade Areas, small business accounts for 213 of total employment and has generated 80 percent ofjob creation over the past five years. InAustralia, the average firm size is 5-7 employees and small business generates about 40 percent o f GDP and accounts for more than 56 percent o f private sector employment. Almeyda and De L aBarra, 2002. 108 Statistically significant variables affecting revenue Effect on small business revenue growth rate o f surveyed small business growth rates Impact of doubling investment intechnology Increase 1% Impact o f doubling product imitation Increase 4% Impact of training Increase 5% Innovationand Growth 3.9. Product and business process innovation and technology acquisition among small business have been shown to play an important role both in building the knowledge economy and promoting growth: for example, by introducing new products, creating business start-ups, and in regional development within the country. A recent study5on factors affecting the rate of growth of Chilean small business has similarly shown that businesses across a variety of sectors that invest in new production technology per worker grow more rapidly than those that do not make such investments (Table 1). More importantly, the study also shows that the acquisition of new technology combined with product or process innovation (for example, by investing in the imitation of cutting edge products developed by larger firms) results inhigher growth rates than simply expanding production capacity. Exporting businesses have a larger probability of technology innovation, as do businesses that have used support instruments. Investments in employee trainingare also closely linkedto innovation and are correlated to growth regardlessof size of the business. C. E-businessfor Innovationand Growth 3.10. Convincing evidence has yet to emerge at the macro level in most countries about the aggregate impact of digital development and e-business on growth. However, empirical evidence at other levels shows reasonably clearly that it can serve at least to increase the flow of information, thereby improving the functioning of markets, reduce the transaction costs associatedwith the management of substantial amounts of information, and provide externalities OECD, 2000a. Bravo, Crespi, and Gutitrrez, 2002. 109 through network connectivity and spillovers, such as worker up-skilling, that contribute at large to an economy. 3.11. More particularly, businesses capable of acquiring and integrating digital applications and engaging in "e-business" have been able to use them effectively to address, for example, a number of the key issuesjust recently identifiedby many Chilean small business entrepreneurs as significant barriers to growth;6 namely (i) human resources - the quality of human resources and a lack of information, high cost and absence of time to access training services; (ii) market links - concentration in client markets and sources of supplies (apparently, some 55 percent of small businesses rely on only two suppliers and about half of their sales (49 percent) depend on only two clients); (iii) -businessdevelopmentsewices -lackofknowledge anduseofbusiness development services networks; and (iv) regulations - lost sales as a result of bureaucratic government processes relatedto businessoperations, particularly at the municipallevel. TheE-businessLadder 3.12. "E-business" i s a process which includes to a lesser or greater extent (i) investment the (or sharing through fee payments) in ICT equipment, such as telephones, PCs, software, peripheralsand Internet connectivity; and (ii) application to and transformation of business their organization and specific processes, including market research, business contacts, product design, production, quality control, skills training and upgrading, advertising and promotion, finance, supply chain management, customer relations management, and the sale or purchase of goods and services between businessesor individuals (such transactions may involve orders over such networks, but payment and delivery may be conducted on or off line). The adoption of this process depends both on internal firm factors, particularly management skills, as well as on the quality of the basic business environment for private sector development, access to ICT infrastructure at a reasonable cost, the availability of appropriate applications and content, and basic market incentives for business innovation. Experience shows that, while climbing this ladder can have substantial payoffs, it tends to lend itself to some sectors more than others (see section II13.3). 3.13. Surveys in many countries suggest that small business typically adopts digital solutions in stages (Figure l).' first stage usually involves introducinge-mail as a basic communications The tool to increase internal and external efficiency. The second step i s to obtain inbound and generate outbound information-sharing through the use of websites for marketing through "brochureware" and exchanges of somewhat more complex information, such as product design and specifications. According to European Commission findings on business usage of websites in the European Union (EU), Canada and United States in 1999,* more strategic uses of electronic applications and re-engineering of business processes among small firms tend to Bravo, Crespi, and Gutitrrez, 2002. The survey included 622 businesses, of which 163 were microbusinessesand 433 were small and medium businesses, in the regions V (196 businesses), VI11 (196 businesses) and the Metropolitan Region (208 businesses). Businesses representedcommerce (206), manufacturing industry (197) and 'services(197). OECD, 2002a. OECD, 2001a. Survey included anautomatedinformationcollected on 200,000 businesswebsitesanda questionnairesurveyrecording 2,129 responsesof web businesssite ownerstwebmasters. 110 develop from this stage once a business has a website. The third step involves sales promotion andreceiving sales orders, often from the consumer sector, and receiving payment on or off line trading activities ("e-commerce"). The fourth stage incorporates the use of digital applications for ordering of production inputs from other businesses as well as sales to businesses or consumers, order fulfillment, for internal management processes, and to handle in-bound and out-bound logistics ("e-business"). The final stage is to transition to network the company's systems with those of its customers, suppliers and partnersinto a fully integrated business model (e-business as "transformed organizations"). Inthese upper rungs of the ladder are found the use of tools for e-customer relationship management (e-CRM) to achievebetter customer service and more efficient marketing campaigns through the use of electronic customer databases, data analysis, personalization and online customer services. Similarly, collaborative e-supply chain management (e-SCM) i s used to reduce costs following automation of business processes, to minimize inventory with just-in-time delivery and upgrade customer service by, for example, enabling access to online prices, product availability andorder status. Figure1. Modelof E-adoptionLadder Model of E-adoption ladder transformed e-business organizations e-commerce -ordering of -open systemsof information for website production inputs from other customers, suppliers email -sales promotion businesses,sales to and partners -new businessmodels -place in and receiving sales businessesand based on inter- -efficient internal orders using ICT, consumers,order working between and external market often from the fulfillment, organizations and communications -window an consumer sector, internal individuals worldwide and receiving management suppliers payment for on or processes,and off-line trading management of activities inbound and out- bound logistics KxIenr of orgontiarronol chonge & sophismalion Partnership siudy on e-commerceID smallbusiness Adapred from Cisco led InformationAge Motivation and Impact 3.14. The driving force behind a firm's interest to climb this ladder is of key importance for innovation and competitiveness. A recent assessmentgof the motivations and expected benefits in firms located in OECD countries to engage in e-business shows that reaching new or more customers and geographical market expansion-generally regarded as the leading motivational factor-in fact tends to account for only about 30 percent of motivational factors. Rather, efficiency measures, including speed of processing, improvement in service quality, simplification of tasks, cost reductions and simpler business processes, account for about 50 percent of motivation factors and probably reflect the predominance of business-to-business OECD, 2002d. 111 (B2B) relationships over business-to-consumer (B2C) activity." Fear of losing market share accountedfor at most 20 percent. 3.15. Another key lessonfrom the OECD for innovation and competitiveness and for programs that support e-business development i s that it i s essential for firms to reach these higher rungs of the ladder (in which digital applications are more diffused and tend to drive, or at least facilitate, the reorganization of work within firms), in order to fully achieve the benefits of e-business (Figure 2). "There is a marked association between ICT use and new work practices, such as teamwork, employee involvement and flatter management structures. Moreover, during the 1990s, labor productivity in U S firms which implemented ICT and reorganized work grew very rapidly, while it practically stagnated in firms which implemented the new technology but did not reorganize work. Likewise, inDenmark, productivity gains infirms that introduce new work practices together with ICT are 4-5 times larger than in firms that introduce ICT and do not reorganize work."" Figure 2. New work practices and ICT investment I $ 9 A \ UI *. ' ~ ~ ~ ~ ~ a ' l ' a ~9w a $ ~ ~ ? . : ~ %Mymj?*:rr%, 13:"; "E Note: ICT penetrationand work-reorganization go hand-in-hand. Inthe Figure, work re-organization is measured as the incidenceof new work practices(teamwork,job rotation schemes, employee involvement, flatter management, etc.). Sweden and the UnitedKingdom, which have high ICT penetration,also have a high incidence of new work practices. Source: OECD,2001. 3.16. Signs of a positive impact of e-business that involves substantial business process transformation and drive gains in firm-level innovation, competitive advantage and growth are emerging in various analyses.l2 Preliminary results from OECD cross-country analysis also loMost data on e-business activity in OECD countries and Chile show B2B activity ahead of B2C by about4:1. l1OECD, 2001d. See also researchby APEC, 2001, which found that the combination of ICT investmentand behavioralchanges yield a more durable increaseintrendlabor and multi-factor productivity growth and that diffused uses of ICTs are key for productivity and growth. l2Guaschand Subramanian, 2002. OECD, 2000c. 112 show that e-business reduces the costs of transactions linked to production and distribution, and enables firms to manage their supply chains more effe~tively,'~not only for new companies and new product innovation, but for companies in traditional sectors. The OECD Electronic Commerce Business Impacts Project (EBIP), undertaken in 2000-2001 with a focus on e- business and Internet applications by proactive firms in established industries, found that most firms consider that e-business facilitates the management of business relationships and that e- business tools lower the costs of reaching new customers and suppliers, It found considerable differences, however, by sector and firm size. Product innovations are more common among firms with intangible products and assets (mainly services firms); process innovations are more frequently implemented by large firms. Market expansion and segmentation are more common for firms with intangible products and assets, and small firms benefit from Internet-based expansion strategies, as they use e-commerce to make themselves known and explore new markets to a greater extent than large firms.I4 Other evaluations have also been undertaken, notable by Canada" and by Australia's National Office for the Information Economy (NOIE), which examined small businesses that had introduced e-business into their operations (see Box 2),16 and substantial efforts made to generate descriptions of models and success cases of e- Box l OECDSector Review of the Textile Industry in Spain.'' The textile sector is graduallyadoptingsome strategies orientedto improvequality controlat all stages of production, face the challenge of remote controlandtransmission of designs (modeling, sample, andimage), increaseB2Brelationshipswith suppliers, develop electronic control of stocks (B2Brelationshipswith shops) andcreate virtual areas of business (B2B markets), where companiescan look for andfindnew partners. These strategies endup with the production, on the side of largetextile manufacturers, of some projectsthat are basedon e- procurement, online sales, andplanningthe capacity of production. E-procurementprojects are the first step towards the creationof largeExtranets, which will endup connecting different participantsof the same supplyingchain. Currently,the most successfule-business projectsonline are those dealingwith managementbetweenmanufacturersand shops, mainly inthe onlinecontrolof stocks andinthe supply of detailedandupdatedinformation. Projectsconcerningthe capacity of productionare all relatedto the sending of orders andto the creationandinterchangeof informationabout stock management, inwarehouses andwith suppliers/subcontractors. business adoption by small business. l3OECD, 2001b. l4OECD, 2002c. l5There is evidencethat small firms usinge-business are far more likely to be selling to marketsoutside their local areas. According to CFIB data inCanada, 52 percentof e-businesses sell to marketsoutsidetheir local geographic locations, comparedto only 31 percentnot connectedto the Internet. l6Australia, NOIE, 2001. 113 Box 1(cont.) The impact of e-commerce on the structure of this sector can be summarized inthe following trends: (i) an increaseincompetition because of the emergenceof new agents that have modern systems at their disposal, which can be obtained at a lower cost for productionand distribution; (ii) contacting opportunities, since relationships between intermediaries are new closer and it i s easier for commercial partnersto share information: (iii) increasingimportance inthe role of retailers and suppliers (thisis becausethey have a largernumber of offers); and (iv) reorganizationof the stages of the production inthe countries with the lowest salaries. UKStudy of E-commerceImpact Study of the TechnicalTextilesSector in the UK2' This study utilizedin-depthinterviews with nine sector companies andatelephone survey of 110manufacturers, customers andsuppliers inthe sector, of which about three-quarters is export-oriented. The main issues facing firms inthe sector are competition from emerging countries, the cost and availability of personnel, and customer buying power and changing needs, which were identified as reasonsfor the uptake of e-commerce. E-commerce technologies have beenused in the sector typically for messagingand marketing, online ordering, intranets and electronic data interchange (EDI) with customers andsuppliers. Better customer service, improvements in knowledge managementandcommunication, and reducing costs/improvingprofitability were the major motivators for adoption. The overall picture of impacts has been reported as almost unanimously positive (only 8% of firms had seen any negative impacts). Interms of firms' key performance indicators, two-thirds of technical textile manufacturers have seen an improvementintheir service provision as a result of e- commerce, over a quarter have seen productivity improvements, and 17% have experienced an increase inprofitability. At the same time, costs have increased for nearly one-third of firms. At the sector level, these impacts are reflected particularly in new or enhanced channels to market, andre-engineering and better integration of processesacross the value chain. ''Excerptedfrom OECD, 2001a. httu://www.oecd.org/EN/document/O..EN-document- 1 10- 'nodirectorate-no-20-20570-13,OO.html. Preparedby PricewaterhouseCoopersfor the Departmentof Trade and Industry, May 2002. 114 Box 2. Australia: Earlyresults of smallbusinessdigitaldevelopment The following summarizes the results of 34 case studiesundertaken by Ernstand Young in 2001 for the National Office for the InformationEconomy (NOIE) on small businessesfrom a wide range of industries around Australia, experienceswith e-commerce. Motivation. For the majority of participants inthe case studies (62 percent) e-commerce was viewed primarily as an opportunity to improvethe efficiency of their business operations. For the remaining businesses(38 percent) the primary opportunity was potentially higher sales to new andexisting markets. Financial investment. (i) majority of companies (65 percent) invested less than The US$l5,000 ine-commerce which includes the value of their time (46 percent of these companies spending less than US$5,000). Thirty five percent of businessesspent more than US$15,000. (ii) all businessesthe biggest cost of establishing e-commerce was that of For developing a website (59 percent of total). Most businessesoutsourced this task to a professional web developer but some constructed their own websites. (iii) The most significant hurdle for businesseswas finding the rightwebsite developer. Ina number of cases businesseswere dissatisfied with the work of their first web developer andneededto use a seconddeveloper to get the right result. (iv) On average, 55 percent of the gross benefit of e- commerce came from efficiency savings and the remaining 45 percent from additional revenue. (v) On average, the largest ongoing cost as a proportion of total ongoing costs was website maintenance (54 percent) although this applied much more to businessesthat made a medium or large e-commerce investment than those that made a small investment. (vi) The highest cost for small investors was the value of time spent responding to e-mail correspondence generatedby the website. BeneJits.(i) Businessesthat made small and medium-sized investments ine-commerce saw a higher proportion of their return come from additional revenue while those makinga large investment reaped the most benefit from businessefficiencies. (ii) Efficiency savings generally came from leveragingelectronic communications, usingthe website as a marketing tool, and usingthe Internetto conduct financial transactions online. A combination of these efficiencies allowed some businessesto grow without havingto employ more staff or to otherwise engage staff inmore satisfying andprofitable activities. (iii)The key non-financial benefits were improved customer service andimproved relationships with other businesses such as suppliers. Likelyfuture outcomes. (i) Businessesthat established an Internet presenceas a way of marketing their products and/or services are typically now lookingto introduce electronic ordering to their websites to capture more orders from customers that are lookingfor the convenience of Internet shopping. Some are capturing customer details to improve marketing efforts. (ii) As a logical next step those businessesthat have introducede-commerce may also seek to capture further efficiencies by usinge-commerce to better integrate their business processes, particularly those processesinvolvingthe management of their supply chain. Source: "Advancing with E-commerce-a summary of 34 case studies of small business e-commerce ventures", National Officefor the Information Economy, Commonwealth of Australia, 2001a. 115 Benchmarking Chile's E-business Progress 3.17. A survey carried out by the Ministry of Economy inMarch-May 2002 of 3,134 firms by the Ministry of Economy (ICT Division of the Sub-secretary of Economy)16shows that, overall, 64% of Chilean firms had one or more computers, 44% had an Internet connection, 14% had a web page and 20% had a dedicated connection. By firm size, the study shows that nearly universal Internet access has been achieved by medium and large firms (85% and 93%, respectively). Connectivity among micro and small firms i s substantially lower (37% and 68%, respectively). Looking beyond connectivity, the gap by firm size in web sites development and use for e-business i s greater. Most of the small business sector remains on the lower rungs of the e-business ladder: only 10% of microbusinesseshave web sites, compared with 28% for small business; 36% for mediumand 53% for large businesseswhich forge aheadwith sophisticated e- strategies. The shallow digital integration of small business through web sites i s also reflected in software according to recent ana lyse^,'^ and indicates that the main use of software was for generic applications (51% used Microsoft Office) and that there i s a low utilizationof specialized software for businessmanagement(16%) or databaseadministration (10%). Table 2. Chilean businesswith Internet connections and Web sites (2002) (%) Micro Small 68 28 Medium II 85 11 38 II Large Total ~~ Source:Mhtk.try ofEconomy 2002Survey of ChZemFirm ZCTAccemandUxe 3.18. Among all firms with Internet connections, it i s used by 70% of firms for banking services (mainly reviewing accounts and transferring funds) and by 67% for public services (mainly declaration or payment of taxes and obtaining permits). It is used by 35% of firms with their suppliers (mainly for checking prices and supply, ordering and purchasing inputs and services) and by 30% with their clients (mainly exchanging information, ordering products and services and exhibitingcatalogues). Variations by firm size for these uses i s not substantial. l6"Acceso y Us0 de las TIC en las EmpresasChilenas", Ministry of Economy, August 2002. Survey is basedon interviews with arepresentativesample of 3,134 firms. l7 Impact0 de las Technolgiasde Informacion en las Pymes Chilenas(borrador), CEPAL, Octubre 2001. 116 3.19. The Ministry's survey also shows that, rather uniformly across firmsize, small businesses perceive the strongest contribution of the Internet to their businesses to increasing competitiveness, followed by improving information on clients and reducing costs (Figure 3). About three-quarters across size categories exchange information; around one-half provide quotations for products and/or services, one-third to one-half exhibit in catalogs, but only 18-20 percent actually sell online. Figure 3. Chilean MSMB perceptions of contributions of the Internet to businessdevelopment I Source: Chile, Subsecretariade Economia, 2002. 3.20. Among those not connected, over one-half would connect to better their businesses, defined as increasing the exchange of business information, making contacts with potential clients, keeping up with competitive conditions, selling goods and services, and understanding business abroad. Lack of connectivity, according to the Ministry of Economy Survey, i s due to the high cost for PCs and monthly connection charges, as well as to a lack of entrepreneurs' understanding of the benefits of connectivity and relevance to their businesses. 3.21. Chile's Internet access rates and access growth trends among various business size categories, with the exception of microbusinesses, are quite comparable to average OECD country averages (Figure 4 and Box 3). Internet access i s highest in larger enterprises, while smallbusiness access to the Internet also increased significantly over 1999-2001, particularlyfor microbusinesses, for which access rose from a total of 41 to 71 percent of firms, while small and mediumscale firms have addedto already highconnectivity rates (67 to 81percent and 86 to 92 percent, respectively).l8 Variations both between countries and industries diminished substantially over these two years. l8Observatory of European SMEs 2001 Survey o f more than 7,600 small firms with less than 250 employees in 19 countries producedby the EuropeanNetwork for SME Research (ENSR). 117 Figure 4. OECD countries' small business Internet accessby firm size, 1999-2001 80 70 60 50 0 1999 40 2001 30 20 10 I o 0to 9 10to 49 50 to 249 Source:Weighted data 2001 ENSR Surveyon SMEs 3.22. A review of European SMEs ICT and e-business adoption rates show that some sectors are faster than others. Internet connections are highest in business services with an 80 percent penetration among SMEs, while the retail sector shows lower Internet access with 62 percent. More networked PCs are used in business services, wholesale and manufacturing, while around half of firms in retail or construction do not use internally or externally connected computers. Around 45 percent of firms in manufacturing and business services have a web site, while the rate falls inwholesale (3 percent), construction (34 percent) andretail (30 percent). Reception of orders over the Internet is similar across all these sectors at 33-38 percent, excepting for construction (26 per~ent).'~ 3.23. However, in contrast to Chile, web site development and operation by small businesses themselves in more digitally advanced OECD countries, such as Germany, Denmark, Finland, Sweden, and the United Kingdom i s increasing extremely rapidly and exceeds 50-60 percent of such firms in these countries. To these figures, however, needs to be added the outsourcing of website services that are maintained by third parties. Such providers range from 8 percent of small businesses in Greece to 28 percent in Spain, and are very useful to help alleviate time pressures faced by small business owners and managers. OECD, 2002b. 118 Box 3. Country Profiies of E-Business Progress 3.1. InCanada,78%ofCanada'sonemillionsmallbusinessesemploy fewer than5 people and97% employ lessthan50 (CFIB, 2000). According to the Survey of Electronic Commerce andTechnology (coveringthe entire economy and a sample of 21,000 businesses), small business use of the Internetgrew over 2000-2001 from 63% to 71%, up from 38% in 1997. Applications beyonde-mail were rapidly gaining acceptance, usingit to market their services or make transactions online. Firmsoperating a website range from 18% among micros to 49% among firms over 100employees. Firms selling online are carried out by 8% of micros to 19% inthe over 100-employee group. Business services, manufacturers, wholesalers and franchises ledine-business use. Firmsusingthe Internet tend to be transacting with other businesses, which tend to be longer lasting andcontractually based supplier-customer relationships, thereby reducingthe concerns associatedwith privacy and security. Businessesselling to consumers tend to have the lowest rate of Internet activity (about 60% for retailers, hotels, restaurantsandpersonal services firms). Enterprises with over 500 employees accounted for only 40% of Internet sales, down from 43% in2000, and e- business inCanadai s heavily export-oriented, with about 54% of online sales destined for export. Regional trends show small business adoption of the Interneti s growing strongly across regions of Canada. Also, inthe latest CFIB survey, 52% sell to markets outside their local geographic areas, compared to only 31% of businessesnot connected to the Internet., InAustralia, averagefirmsizeis5-7 employeesandsmallbusinessgeneratesabout40%of GDP. Australia ranks 2nd out of 60 countries ine-readiness. At June 2001,69% of Australian businesseswere actively usingthe Internet, up from 56% inJune 2000 and about 30% inJune 1998. Growth in online presencehas been strong across firm size range: micro (less than 5 employees) increasedto 50% from 24%; small (5-19 employees) to 65% from 32%; medium (20-199 employees) to 83% from 56%; and large to 95% from 87%. The small business segment has, infact, achievedthe highest online growth rate, which had risen further to 75% inMay 2001. The share of firms with websites are 10% micro, 25% small, 50% medium, 68% large; online bankinginvolves 53% of medium, 33% small. E-business i s becomingpervasive among Australian businesses, as 95% of firms online use the Internet to communicate, 67% use it to research, 59% use it to receive orders and 55% to purchase. Smallbusinessuse of online procurement increased from 17% in2000 to 26% in2001, while 20% of firms took orders over the Internet. Around 55% of Australian companies were participatingine-marketplaces in 2001, first in this respect among a group of leading countries which includedthe US (participation rate of 39 %), Canada (39 %), France (34 %), Japan (22 %) and Germany (21 9%). InDenmark, the Government's "IT for All-Denmark'sFuture" (June2002) statesthat 95% of all Danishbusinesseswith more than 5 employees use information technology and 89% have Internet access; such access i s substantially uniformacross firm size, with 85% of firms with 5-9 employees havingit, as well as across different sectors. About 62% of all firms have their own website, rangingfrom 52% of 5-9 employee firms to 89% for firms over 100 employees. Internet applications are advanced, with nearly 7 of each 10businessesuse it for financial transactions, 52% to conduct contacts with public authorities, and 24% recruiting personnel via the Internet. About 40% make online orders and 19% online payments to suppliers, while 23% sell online. 119 3.24. The percentage of small businesses using e-business to make purchases also varies substantially across OECD countries, from 5 percent inGreece to over 30 percent inSweden, the United Kingdom, Finland, Germany and Denmark, and up to 43 percent in Norway. There i s a similar gap with the use of e-business solutions to make sales, which are observed to be a generally lower share than for purchases, reflecting the greater complexity given the need to match online offering with supporting logistics, need for scalability of response to demand, and need to avoid channel conflict, etc. However, in countries such as Greece, Spain and Austria, small businesses are using e-commerce for purchases and sales purposes at almost equal levels, which may reflect a tendency to adopt complete e-commerce solutions rather than starting only with simple applications. Smaller businesses that use the Internet appear to have roughly the same propensity to sell over the Internet as larger ones in Australia, Denmark, Finland and the Netherlands. Constraints 3.25. From assessments by the Government entities involved in promoting digital development, like Chile's Ministry of Economy, technical assistance agency (SERCOTEC) and development bank (CORFO),20and small business associations and independent analysts," there are similar views on the main constraints to e-business development by small business. These views are also consistent with most findings in more digitally advancedcountries, the OECD and other organizations,22which have themselves shown relative consistency (see Box 4). In the business environment, pro-innovation and growth policies and the availability of complementary digital development (particularly online content, e-government, and large firm-small firm e- linkages) are essential ingredients for e-business development. The predominant factors at the firm levelspecific to e-businessdevelopment mainly involve: (a) Lack of awareness of the potential range of benefits of e-business and/or an inability to correctly assess their impact. For example, a 1999 survey of Canadian small businesses found that almost 40 percent of non-users could not identify a key benefit to usingthe Internet, compared to less than 5 percent of Internet users.23 It also found that only 19 percent of non-users believed that the Internet would have a major impact on their businesses, in contrast to over half of Internet user firms. Lack of awareness i s reinforced often by an absence of well-articulated business models and success cases that show how small business can use e-business profitably and justify investments in ICT equipment, technical support and business transformation advice. This leaves a wide range of entrepreneurs unconvinced about the appropriateness of e-business for their particular business and very cautious about makinge-businessinvestments; 2o Corporucio'n de Foment0 de la Produccidn (CORFO) is the state organismchargedwith supporting national productive activity. Key areas of support include innovation and technological development, modernization of businessesassociations, improvement of business management, financing, and regional productive development in emerging sectors. 21Lhpez, 2001. 22OECD, 2000d; OECD, 2002c; and APEC, 2001. Researchwork by APEC reviewingthe past ten years work amongits own 21 member states, the OECD, ITUand others shows substantialconstancy across various sources probing the reasonsfor and barriers to ICT adoption by SMEs. 23SES CanadaResearchInc., 1999. 120 (b) Lack of ICT and e-business know-how, technical support and time to redesign business profitably develop e-business activities, and deal with rules applicable to e-business. Small business' ability to reap the benefits of e-business i s linked strongly to the managerial and technical capabilities of entrepreneurs and their workforce, time to carve out a new role, and to the firm's ability to accumulate knowledge. These factors tend to be weaker in smaller firms than in large ones given their lower levels of skills differentiation. These constraints are compounded frequently by inadequate numbers of outside technical people to help maintain e-business systems, as well as the high degree of systems complexity; 25 (c) Luck of network access from the physical absence, poor reliability and slow speeds (e.g., less than 256 kbps) of Internet networks, or from the initial cost of designing and installing new hardware and software technology in order to incorporate digital applications into business processes; (d) Lack of trust and confidence inthe security of electronic transactions and payment systems, mostly related to clarification, enforcement and cross-border interoperability of existing legal frameworks rather thanthe needfor new ones; and (e) Lack of finance to meet initial investment in ICT hardware and software equipment, website development and technical support, and the initial cash deficits from maintainingweb sites in the absence of a ready market of customers and suppliers. In many cases, maintenance by smaller companies of a dedicated e-commerce system also entails significant costs of entrepreneurial time, website maintenance cost, telephone lines, ISPand web hosting charges. Box 4. Country profiles of e-business inhibitors InCanada,the CanadianE-Business Opportunities RoundtableReport of October 2000 lists the top two challenges that small business faces when attempting to implement e-commerce strategies as lack of education and informationdissemination, particularly regarding the understanding of e-business andits potential impact; and lack of strategic resources-namely, qualified talent to help adapt business strategy to the Web, e-business suppliers, managersto operate an e-business web site, and access to funding. It also found that cost was cited as a major barrier in only 17% of responses. Plus, of smallbusinesses with a web site, 77% outsource the hosting and only 22% hosted it internally. The mainbarriers to accepting orders online were security, privacy, appropriateness of the product for sale online, and whether the benefits of doing so outweigh the cost and time invested. The increasing effectiveness 24 InNew Zealand, ane-business survey of 1565 firms in2000-2001 (of which 67 percenthad 10-49 employees) showedthat companieswith an explicit e-business strategy investedsignificantly more intheir e-businessinitiatives than did other respondents. University of Waikato, 2001. 25 EuropeanUnion, 1998. Resultsfromthe Frabirt-led project on Managing Change inInformation Delivery Mechanismsfor SMEs found that neutral technical support and shortageof time for training was a consistent feature limiting ICT adoption throughout Europe. 121 Box 4 (cont.) of security measures such as encryptionand secure electronic systems should help boost business and consumer confidence inthis area. Also, an entire industry i s evolving to offer inexpensive online credit card processing services to merchants and some now offer it to small business to avoid the needto buildsuch capabilities on their own. InDenmark,theGovernment's Denmark'ITStatus2002reportsthatthebiggestobstaclesto usingIT are alack of personnel with ITskills inthe business (16%) or difficulty inrecruiting personnelwith IT skills (9%), too rapid changes in software (17%), and inflexibility inIT suppliers (13%). The biggest obstacle to the use of the Interneti s considered to be risks from hacking, viruses, etc. (29%), the cost of developing and maintaining websites (17%), and hardware and software costs (14%). The main obstacles to e-business reported among all businesses surveyed were a sense that a business' goods and services are not suited to Internet sales (29%), there i s a lack of client base available (17%), a lack of security of payment transmissions (15%) or lack of certainty over contractual agreements (15%). However, among those with Internet sales in 2001, concerns expressedinthese areas was only about one-half as high. InIreland,intheCCI'ssecondNationalSurveyexaminingsmallbusinessattitudes toe- business, 70% of those interviewedbelieve that the cost of acquiring specialist e-business technical skills i s the biggest obstacle facing SMEs; 62% see the cost of accessingthe Internet as a problem, while 71% see the cost of hardware as a problem. Other major obstacles were customers without e-business capabilities and lack of technical skills within the companies. Yet, overall, there was agreement among 75% that e-business will massively change the way companies do business over the next 5 years and most (67%) felt it would offer new business opportunities, or that competitive forces would pushcompanies to get involved (69%). InNewZealand,anOctober 2000surveybytheGovernment indicatedthat, among22 possible inhibitingfactors of e-business development, eight of the top ten factors were shared by companies with and without web sites (though they were rankedina different order). Those with web sites considered low customer use of e-commerce, the highcost of computing and network technology, and limitedknowledge of technologies as most difficult. Non-web site companies considered financial viability issues, market size andlack of time as the most difficult factors. The role of partners, customers and suppliers in e-business implementation was recognized and the lack of readinessof these groups was perceived as a major source of difficulty by non-web site firms. 3.26. InChile, network access, security of electronic transactions and financing continue to be essential issues to be addressed. However, with substantial coverage and growth inconnectivity, the highest priority constraints for small business to climb the e-business ladder to higher levels of utilization of websites and integration of digital applications in management, marketing and logistics systems involve awareness-building, technical and management skills development, and e-business systems simplificationladaptation. 3.27. Surprisingly, this is substantially also the case inmany OECDcountries. The importance of the first two factors inthe listing above is reflected in a 2001 survey of small business across OECD countries showing that the most important reasons among non-users for not using the Internet to sell products or services were a sense that that the Internet i s not suited to the nature 122 of the enterprise/product (43 percent), that it would not pay off (18 percent), or that no skilled personnel were available (17 percent).26 Other reasons listed in the survey - inadequate trust in the technology or security, inadequate confidence in the regulatory environment, consumer protection or insufficient customer access to the internet-accounted together for only 11percent of non-user respondents. 3.28. While incremental growth prospects for electronic transactions in Chile appear to be relatively good, in particular being backstopped by recent digital signature legislation, falling Internet connection charges and the highest penetration of credit cards in the Latin America region, stronger income distributional differences also place constraints on the market which differ from many OECD country settings. For example, only 8 percent of the population had a computer in 2000 (about one-fourth the rate of Ireland and one-sixth that of Australia), which i s partially explained by strong differentials in income and education levels in Chile. Also, the business practices and skills of microbusiness in Chile, much of which remains in the informal sector, are also generally distinct from the smallest businesses in OECD countries. Consequently, Chile needs to make special efforts to change business culture in favor of digital development and to devise more innovative strategies for digital applications to more broadly penetratelow-income small business. 3.29. SMEs remain very concerned about the security aspects of Internet access, and in particular of hacking and viruses. SMEs are faced with either investing the time to protect themselves against these risks, or, if they use a thirdparty to manage their web access, satisfying themselves that these risks are being sufficiently addressedby their application service provider. For example, 48 percent of SMEs in Germany say that concerns about security are a very important barrier to their use of the Internet. This i s also very important to a significant percentageof SMEs in Austria (40 percent), Finland (38 percent), Italy and the United Kingdom (37 percent), Spain (34 percent), Sweden (29 percent), andDenmark(26 percent). 3.30. Legal uncertainty and uncertainty about makingpayments are the most important barriers to SMEs to use e-business for purchases.27The legal framework associated with e-commerce for domestic and, in particular, cross-border transactions, such as that relating to distance contracts and the acceptability of electronic signatures, is a particular issue for small business. This is because they often lack access to the internal legal resources or the financial resources to purchase those services. Concerns of customers about security and confidentiality of payments reduce the incentive for businesses to invest in the adoption of e-business, because of the risk that, even if the product or service offering i s competitive, consumers may not be comfortable about makingon-line payments. The costs associatedwith establishing trust and reducing risks weigh more heavily on SMEs than on larger enterprises. 26OECD, 2002. 27The Eurostat "E-commerce and ICT usage by European enterprise" survey of 2001 covering small businesses with 10-249 employees in 13 EU member states plus Norway with a gross sample of 100,000 enterprises and an overall response rate of 40 percent focused on e-business integration and associated skills.It provides the most comprehensive picture of the main inhibitors to e-business in Europe and is broken down into barriers to Internet use, e-business for purchase, and use of e-businessfor sales. Responsesvary greatly betweencountries and topics. 123 D. AcceleratingE-businessDevelopment 3.31. Chile and OECD countries have expressed substantial concern about the lags in small business uptake of e-business, which are viewed as prolonging disadvantages in access to global markets, public procurement, competitiveness and employment promotion, as well as riskingthe accentuation of income inequalitye2*While recognizing that firms themselves have the primary responsibility to overcome e-business inhibitors, governments have been creating an increasing number of policies andinstrumentsto promote digitalbusinessinnovationande-businessuptake, particularly focused on market imperfections experienced by small business in acquiring technology and training. For example, the European Union has adopted the "Go Digital" initiative as the first policy response EU-wide to help accelerate the use and take-up of e- business among the small business community. This initiative was launched by the European Commission in April 2001 within the context of the e-Europe Action Plan 2002. It has a target to support and improve ICT uptake by 1.5 million small businesses by 2003, and to continue to help drive them up the value chain to e-business and transformed organizations between 2003 and 2005. Similar concerns and initiatives are found at other international levels, such as the G- 8." This section examines Chile's own programs inlight of such initiatives. Agenda 3.32. Inhis Inaugurationspeech in2000, PresidentRicardo Lagos considered the incorporation of Chile to the global and digital economy a top priority: "What we are discovering i s that technology will enable us to surmount the geographical disadvantages of our nation.. ..It i s our obligation to take advantage of it to the fullest."30 Under the nation's overall strategy "Chile: Toward the Information Society", the President has laid out five key areas to focus digital development: technology infrastructure, community and business access, the legal framework for electronic transactions, education, and government services. Advances in many of these areas have important positive effects on e-business development among small firms. In particular, Chile has engendered an advanced telecommunications infrastructure, put in place basic legislation to support electronic transactions, and demonstrated the value of digital development through its e-government programs for online income tax, customs andpublic procurement. 3.33. While these steps are necessary, they are not sufficient to ensure wide access andincrease the adoption rate of ICT by small business. The Government has established a specific agendato promote digital development among small business under the Ministerial Committee on New 28Also, the EUhas expressedthe concern that the gap in e-business capabilities between larger and smaller firms may put a brake on the integration process and considers the climb up the e-business ladder by small business a central challenge. 29At the G8 Summit in Kananaskis, Canada inJune 2002, the G8's Digital Opportunity Task Force announced the creation of the DOT Force EntrepreneurialNetwork (DEN), an organization to help SMEs and microentrepreneurs to overcome the Digital Divide and stimulate economic growth. Other international initiatives focused on small business digital development include the Enterprise Steering Committee o f the World Economic Forum; the Business Enterprise and Entrepreneurship Working Group of the UN ICT Task Force; and the Global Digital Opportunity Initiative (GDOI) being driven by the Markle Foundation, UNDPand its steering group. 30Santiago Times, November 24,2000. 124 Information and Communications Technologie~.~'The agenda for 2002-200532has four broad objectives: legal framework - to strengthen the legal framework to provide confidence and security for the development of e-business; e-business support - to strengthen and broaden support for access, training and innovation to facilitate more complex uses of digital applications, especially by micro andsmallfirms; e-governmentfor business - to extend electronic applications to government services utilizedby business; and ZCT industry development-to stimulate the development of a competitive ICT sector via the promotionof venture capital and incubation of new ICT firms andproducts. Some Emerging Lessons 3.34. Programs targeted to support e-business adoption by small business are relatively new and experience has yet to be synthesized in many countries. However, the European Commission recently completed (May 2002) a benchmarking exercise that covered a wide range of policies andinstruments of its membersto help small businesses to "Go Digital." The process identified more than 150 regional and national initiatives, many of which facilitate a process of fundamental change inthe way these entrepreneurs do business. 3.35. It reached a number of interesting conclusions about program design that may well be relevant for other countries (see Box 5). First, there remains a need, even among more advanced ICT-adopter countries, to expand the awareness of the benefits and business models for ICT adoption. General awarenessinitiatives have been found to be weak. Instead, such programs, as we11as those to extend training and access, will be more effective when they are basedupon case studies rather than general materials,. Materials also need to be as sector-, location- and individual-business specific as possible. Programdelivery should also engage intermediaries and advisors closely associated with the sectors and locations involved (see Box 6 - a summary of recent initiativesby Australia's Government along these lines). 3.36. Closely related to this is the need for strategic emphasis on intermediary development, given the large number of MSMBs and the needto leverage limited resources (business advisors, chambers of commerce, banks and sector-specific networks) to work directly with entrepreneurs. It found that the involvement of local or regional "catalysts" that work with small business to facilitate the change process i s akey to success. 3.37. It also considered that adoption rates may be boosted with a stronger effort in (i) e-skills to reduce the e-business skills gap between major companies and small firms, (ii) e-government for small business: e-procedures, on-line submission of official documents requiring digital 31 This Committee is anchored by the Ministry of Economy and includes the participation of organizations responsiblefor telecommunications (SUBTEL), export promotion(PROCHILE and ASEXMA), technical assistance (SERCOTEC and FOSIS), vocational training (SENCE), development banking (the Banco del Estado and CORFO), and the NationalCouncilof Small and Medium Businesses (CONAPYME). 32 Chile, Comitd de Ministros de Tecnologias de Informaci6ny ComunicacZm, 2001. 125 signature, on-line VAT returns and tax payments, as well as access to public e-procurement; and (iii) lowering the complexity barrier of ICT applications to increase smaller business adoption rates Box 5. Lessonsfrom EUdigitaldevelopment programs A number of lessonswere derivedfrom a recent benchmarking exercise across many programs aimed to acceleratedigital adoption by small businessand were articulated at a recent Go Digital Conference inMay 2002, convened by the EC Commissioner for Enterprise andInformation Society: Awareness raising among SMEseven inthe EUcontinues to be important, despite positive momentum, as many which are connected do not yet understand how to move toward an integrated e-business strategy. Inpart, this means changing from the narrow past focus on e-commerce (selling and purchasing online) to e-business. SMEs, given limited time to devote to training and adopting e-business, will be more receptive to successfulcase study examples relevant to their business rather than lengthy seminars on e-business. General awarenessinitiatives are likely to produce weak outcomes. Programs that are very sector- and firm-specific are more effective inhelpingbusinessesto raise their awareness of e-businessbenefits, as well as planning and implementing e-business adoption. There is, for example, frequently a need to fully understand the local or regional context for suchbusiness. Thus, intermediarieshusiness advisors and partnerships at this level are better positionedto tailor solutions to their particular markets and business needs than approachesthat are too general. Knowledge sharingcan be improved also by providing opportunities for small business to exchange experience and learn from one another. Given the number of smallbusinesses,focus on developing solid intermediaries, namely those with highcredibility among SMEs, includingbusinessadvisors, chambers of commerce, banks, and sector-specific networks. Itis difficult for an SMEto develop e-business on its own and success is likely to be higher with a hands-on approach; this can be enhancedby stressing networking and clusters to assist inICT adoption. Most SMEs are looking fundamentally to save time and money, and this i s more important than trading over the Internet. Clarifyingthe business case for adopting new technologies and ensuring ICT solutions will reduce costs and improve networks. To help deependigital development, develop new support programs to encourage business restructuringand sharingmarkets, purchasing and distribution. Use, infrastructure and access are equally important for uptake development. SMEs often invest insystems that are too complex for their needs. 126 Box 6. Australia's 2002 strategy to promotee-businessuptakeby small business InAustralia, there arealmost one million smallbusinessesengaging about 5 millionworkers. The Strategy to promote e-business uptake by small businesswas developed after extensive consultation with stakeholder groups, industry associationsand State andTerritory governments, andi s supported by funding of US$6.5 million over two-years. It comprises four initiatives which emphasize e-business awareness-building,security concerns, the business casefor e-businessadoption and online access to governmentpurchasing. E-businessuathwavsguide -The guide is the overarching element of the strategy. Research shows that the majority of small businessesare inthe early stages of e-commerce adoption and there i s confusion on how to apply it to their business. This guide outlines how to get online, the typical pathway a firm mightfollow to integrate e-commerce into its business, and the sort of e-commerce options available depending on businesssize and sector. It provides practical assistance such as checklists, questions to ask when seeking solutions andindicative expenditure guidelines. Case studies: tranche 2 -This secondset of case studies, demonstrating the business case for deeper integration of e-business, would complement the NOIEpublication `Advancing with E-commerce' (September 2001), which profiles 34 firms that adopted early stage e-business tools. Understanding the businesscase for e-business i s still one of the fundamental issues for small businesses-case studies examining small firms that have more deeply integratede- business processesintheir businesseswill further increaseunderstanding. These case studies will also support other elements of the strategy through examples involvingbroadband applications ande-security solutions. This is complemented by the Australian Electronic Business Network, AUSeNet, which provides a set of training modules to SMEs to help develop e-business awareness linkedto business expansion strategies, provide an individualIT audit which can be usedas technical options inputsto a company's businessplan, andhands-on support and mentoring. E-security: trusting the Internet -A simple guide to improve smallbusiness confidence ine- security businessapplications. Security concerns remain one of the top impedimentsto small business adoption of e-business, inparticular they remainconfused about what security controls they need to protect their business once it i s online. Broadbandfor small business -This project will identify and profile early small business broadband adopters, emergingapplications and the businesscase for its wider use. Although there i s anecdotal evidence that a small proportion of this sector i s embracingbroadband, in general it has a poor understanding of broadband and the business case for its adoption. This project will complement and support the broadband work of the Skills andAccess Branch of NOIE. Programs and InstitutionalDevelopment 3.38. "Plug the average owner of a small enterprise into the Internet and nothing much happens. To make effective use of ICT's, he or she needs an infusion of far more than just data.. .money, knowledge, skills, power and advice."33 Under its 2002-2005 Agenda, the Chilean 33Heeks, 2002. 127 Government has adopted specific targets for e-business support programs to help accelerate e- business adoptionby small business: . ... E-business training Train 80,000 small businessesinthe PYME Infocenters over 2002-2004; and . . 20,000 over four years via C O W 0 and SENCE's Fondo de Capacitacih. ICT access increase the number of small business Infocenters from 70 to 200; . .... increase the PC +Internet Program sponsoredby C O W 0 and Banco del Estado from 2,500 (October 2001) to 10,000 users; test the feasibility of recycling PCs for small business. Innovationindigital applications convert 15-20 more business proceduresto online access and encourage the same at the municipal level; promote the ASP model via CORFO's www.RedNegocios.cl and facilitate development of local content andfunctionality; and develop an E-businessUse Program with Banco Santander andGlobalNet to incorporate a platform for payments via credit cards for smallbusiness. 3.39. Awareness and Training. At the end of 1999, the University of Chile did a study of those businesses that were not using the Internet. While one-third responded that it was because of cost, 23 percent did not perceive its utility, 16 percent said they had no interest, 16 percent said that they were not knowledgeable about the subject, and 6 percent said they had no particular reason to do so. A full 61percent could not identify the businessbenefits of digital te~hnology.~~ 3.40. The owners of most small businesses must cover a range of management, productionand technical disciplines in the absence of human capital to specialize in them. Therefore, awareness-building on e-business benefits and training are crucial to help establish an understanding of how new technologies work and provide practical benefits, how to apply them to business processes, and how to find appropriate and independent sources of business advice and information. While Chile is makingsignificant efforts downstream to buildaccess to digital tools through facilities and portals, and notwithstanding ambitious targets under its 2002-2005 agenda, its current efforts upstream to generate basic e-business awareness in these respects among the very large number of small businesses in Chile is relatively weak and needs to be substantially reinforced in order to help motivate a basic "cultural change" toward digital solutions. 3.41. In OECD countries, awareness-building is the most common form of e-business promotion activity; even incountries like Finland and Ireland, which has achieved a high degree of digital penetration yet are focusing on very small firms. There are a wide range of awareness- raising programs, from simple workshops and demonstrations to cluster- or trade association- 34Saenz, 2000a. 128 based initiatives, facilitation of exchange of experience among small business entrepreneurs themselves ("peer to peer"), and growing efforts to articulate and disseminate widely success cases showing best practices of front runners in e-business. Some countries also utilize prizes and awards to give high visibility and publicity to e-business adoption by small business, as well as in some cases to promote further e-business ladder climbing (e.g., the UK, France and Italy, which provide "e-business tuition"). 3.42. The importance of supporting digital skills development as an integral part of buildinge- business adoption among small business entrepreneurs is well illustrated in an evaluation of an early experience of CORFO's "FAT-h~ternet".~~ In 1997-98, with the aimof helping to increase competitiveness, some 425 small firms were provided with Internet connections and web pages for communication, product promotion and information search. All firms began with low levels of ICT use, technical skills, and product and process innovation. The evaluation showed that, after 12-18 months, the intensity of ICT use was relatively low (or nilin some cases) and firms generally did not use it for much beyond e-mail. The average perceived impact on sales, costs andproduct or processinnovation was similarly low. 3.43. However, ex-post interviews recordedthat firms generally expected that the impact of the technology would be positive in the future and 66 percent said that they would join in a similar experience again, even without additional outside financial help (ex-post monitoring, in fact, revealed that 75 percent of participating firms did renew their Internet connection contract). More importantly, the interviews revealed that participants considered that main impediments to expected success were the absence of readily available technical support and lack of staff training; 79 percent considered that training was inadequate to integrate the ICT tools into their businesses. 3.44. Currently in Chile, digital training in the private market i s largely focused on the use of the Internet to deliver courses within universities and large-scale worker e-learning systems. Over 1998-2001, the e-learning mode of training grew rapidly36and is currently provided by roughly 200 institutions, of which about 110 are firms providing training for their own workers and 17 are universities. Still, the use of e-learning is incipient and accounted for only about 2 percent of total training in 2001. Within the Government's Ministry of Labor, SENCE (Servicio Nacional de Capacitacio'n y Empleo) is responsible for corporate and employment training (www.SENCE.cl). SENCE provides a Web-based list of approved training programs. SENCE i s interested in developing e-learning programs and has collaborated, for example, with Nucleo- Educativo, an e-learning company that i s registered with SENCE. The most popular courses offered by Nucleo-Educativo are on business skills for managing conflict, leadership, delegating and basic IT skills (MS Office). However, the current enrollment for most ICT courses are primarilymiddle-school students. 3.45. Training is clearly a powerful means to ensure technological absorption and generate impact. However, the most important initiatives neededto promote e-business absorption are to (i) moredeliberatelyonspecificsmallbusinessrequirementsoffirmsratherthansimplyon focus technology use, (ii) emphasizebusiness value addedinstead of simply "information search", and 35 Saenz, 2000b. 36 Chile, Cimarade Comercio de Santiago, 2002. 129 (iii) entrepreneurstopracticallyintegratedigitaltoolsintotheirbusinessprocesses. Todo help this, SENCE and other local organizations involved in e-learning programs (e.g., PBM, Se Aprende), should form working alliances to benchmark experience elsewhere (e.g., Mexico) and builde-learning systemsthat that are refocusedalongtheselines. 3.46. Access and networking. Given the breadth of the small business sector and cost and technical requirements of doing e-business, effective and sustainable intermediaries are critical to accelerate e-business development. They are also a critical part of helping small business to build business networks and relationships. Telecenter models, particularly in Latin America, which emphasize "connectivity" have been a favored approach, yet most have offered minimal value added and support to entrepreneurs, and have poor records of financial sustainability. To be successful, they require: (i) programs carefully targeted to take into account specific beneficiary needs; (ii) industry-specific content and tailored software applications readily useful to a heterogeneous businesspopulation; (iii) lower levels of complexity of front-end ICT systems to reduce the formal educational level, time and cost for productive use; 37and (iv) establishment as commercial market ventures with adequateuser fees and management. 3.47. The Chilean Government's main initiative to build small business access to digital applications i s the National Network of Infocenters, sponsored by the Ministry of Economy, SERCOTEC (Programa de Foment0 Productivo del Sewicio de Cooperacidn Tkcnica) and FOSIS (Fondo de Solidaridad e Inversidn Social). The mission of SERCOTEC is to promote and support initiatives for growth and competitiveness of micro and small enterprises and to strengthen and develop the skills of managers. The Infocenter project i s designed to greatly increase small business access to the Internet and to provide information and training for small business entrepreneurs. Centers offer Internet access, relevant software, training, and access to pertinent information through portals such as RedSercotec, an Internet portal with information relevant to small business. 3.48. Infocenters have been organized via a competitive bidding process for funding and include a series of sustainability conditions to be met. Infocenter operators can be public or private entities equipped to support increased productivity and development among small businesses. The project has raised US$1.7 million, of which US$0.5 million has come from an IDB loan and US$1.2 million from local projects. Municipalities make up the vast majority of co-participation in Infocenter projects (82 percent), followed by trade associations (13 percent), governments (9 percent), NGOs (7 percent) and private entities (2 percent). The project began in 2001, and 61 business Infocenters have already been established as a result of the program.38 FOSIS has installed an additional 55 Infocenters, bringing the total to 116 Infocenters. Another 110are plannedinthe comingtwo years. 3.49. While these are important steps in the buildout of infrastructure to support e-businessby small business, there generally remains much to do; particularly to provide adequate in-center business learning and coaching support to entrepreneurs, boost business-useable local content, refine performance indicators, and develop appropriate service pricing and cost-recovery policies for financial sustainability. Accordingly, SERCOTEC's goals for the Infocenters are to continue 37These are other lessons fromthe C O W 0 FAT-Internet evaluation. Saenz, 2000b. 38Meza, 2002. 130 with a model focused on sustainability and a participatory process of development, stimulate development of local and regional content, and notjust infrastructure, and increase the supply of training inthe Infocenters. It also aims to design a monitoring and evaluation system that allows measurement in real-time, design a ranking system for the competency of operators and managers of Infocenters, complete the 2nd National Infocenter Survey for Micro and Small Businesses to share experiences and best practices, develop regional Infocenter networks to promote collaboration and cooperation, expand and implement e-government initiatives for small businesses, andintegrate and connect the Infocenters with private enterprises. 3.50. The need for such improvements were reflected in interviews carried out as part of preparation of this report in Temuco with three telecenters and with three other centers in Santiago operated by NGOS,~'in order to shed light on how such intermediaries do or do not assist small business. Other analyses have been done explicitly on the Infocenters initiati~e.~' Chile's Region IX, whose capital is Temuco, and in Penalolen on the periphery of the capital of Santiago, which are among the lowest income areas of the country. InRegion IX,production i s carried out almost exclusively by micro and small businesses, which concentrate on agriculture, forestry and furniture production. 3.5 1. These reports reflect a considerable physical advancement in increasing digital access to small business, combined with a number of constraints which are common to telecenters inLatin America and el~ewhere.~~ A major lesson so far, consistent with conclusions elsewhere in this report, i s that resources have not been adequately devoted to building awareness about the services offered and the basic benefits of e-business. While small businesses have readily accepted cellular phones and e-mail as business instruments, neither in Region IX nor around Santiago have they perceived the benefits of digital applications as business tools. This issue is so important that surveys found that, even with decreases in user charges, usage habits would probably not increase significantly without a cultural change in business people and a clearer perception of economic benefit. 3.52. To be most effective, awareness-building andbusiness skills training need to be designed in a sector- and location-specific manner. This is challenging, given heterogeneity of small business and the frequently limited formal educational attainment of entrepreneurs. Centers also needto be equipped with digital applications that respondto specific small business client needs, as centers are now limited by relatively complex off-the-shelf software programs and content which are mostly applicable to large businesses rather than the small business sector. This work also has to be backed by a strong technical ICT capacity and networking with business intermediaries at local levels, particularly between small and large firms. 3.53. The Government has taken a step in this direction by promoting development of e- marketplaces as gateways to e-business for small businesses. Chile's www.Zonaempresas.cl, a web-based marketing tool, i s supported by FOSIS and GlobalNet and provides opportunities for microbusinesses to have storefronts at no cost, to develop business networks with other small businesses, and to undertake e-business. Incentives are also offered to help small businesses to 39ElEncuentro, the Center for Democratization ofInformation, andWork for a Brother. 40Bellavista Net Group, 2001. 41Proenza, Bastidas-Buch, and Montero, 2001. 131 join in the site. While this i s a sound initiative, the Government could better leverage this by helping to enable private sector service providers to design and organize e-marketplaces focused on specific small businesssectors and their buyer-seller links with larger firms. Emphasis should be given to increasing the functionality of such sites, and to enable common business functions such as purchasing and invoicing. For example, Marketboomer (http://www.marketboomer.com.au) inAustralia operates a successfule-marketplace which links small companies that previously did not have trading relationships with each other and larger firms. The attractions are faster ordering and processing of orders, reduced error rates, reduced transaction costs, andthe opportunity to expand sources of supply or customers. 3.54. Government collaboration with trade associations andclusters is critical to accelerating e- business adoption by small business and there appears to be considerable scope to expand their role as services This is also a means to encourage small businesses themselves to form networks and, through buildingB2B transactions, to reduceinput costs and increasemarket The European Commission has specifically identifiedtrade associations as appropriate networks to provide online business information links needed by small business. Many chambers across Europe have adopted such a promotional role by acting as information brokers, selecting valuable business information for members, providing training and raising awareness, andmakingon-line memberdatabases and websites available. 3.55. For example, many Italian small businesses belonging to industrial districts ("clusters") pursue electronic partnerships, including by the creation of local or industry-wide portals such as Prato Porta; the glass industry portal of Veneto Regions; the leather portal for the clusters of Solofra, Santacroce, Arzignano; the Sassuolo portal for tiles run by the Italian Association of tiles producers; the jewel portal created by the industrial association of Arezzo. The creation of such portals i s in many cases related to an active role by local authorities. Prato Portal i s a good example of effective public-private partnerships and how firms operating in traditional industries can benefit from information exchange, links outside the area and the network effect for e- procurement, markets for raw materials, on-line advice, home and corporate banking, and jobs supply anddemand (www.portaleprato.it).44 3.56. Regarding ICT infrastructure, these centers do reduce the cost barriers to e-business through the sharing of digital equipment and applications. Small businesses in the areas of inquiry have generally not incorporated the PC or Internet intheir operations at their workplaces, as PCs are excessively costly. On average, the cost of a PC is equivalent to about 20 percent of small business' capital, excluding software, operation and maintenance costs. Monthly costs would range from 25,000-33,000 Pesos (US$38-50) for a broadband single-user connection; multiple user costs are in excess of 60,000 Pesos (US$95), which are major expenses compared to turnover of small companies. 42 Small businessi s representedinChile by a number of business associations and their federations: The Confederacidnde Gremiosde las PequeiiasEmpresas (CONAPYME); the Confederacidnde las Pequeiias Industrias (CONUPIA), which has 15,000 member firms, the Confederaci6ndel Comercio Detallista y Turismo, the Confederacidnde Camioneros de Chile y la Federaci6nde Autobuses. 43FerraraUniversity and ConsultoraNomisma, 2002. 44 OECD, 2002e. 132 3.57. Still, proper managementand location of Infocentros are criticalto their success. Centers have faced the problems of supply of technical assistance and trained personnel to operate them and to assist clients (for example, to help develop web sites). Some centers require better location to make them more accessible to entrepreneurs. There is also an overarching issue about the coordinated management and financial sustainability of the network of centers. Underlying governance and localownership of the centers also needto be strengthened. 3.58. Financing e-business innovation. Chile has a significant number of programs to support business innovation in general and digital development in particular. In a recent inventory of public sector development programs for directly productive purposes, a total of 90 instruments were identified for all types of purposes, of which 66 were grant-based (12,704,802 UF were spent in2001), and 24 were reimbursable (26,305,981 UFwas disbursed inthe form of credits or guarantee^).^^ Of these, there are four principal programs to encourage technological inn~vation:~~ FONTEC (Fondo Nacional de Desarrollo Tecnoldgico y Productivo) supports technological innovation of businesses of all sizes. Specifically, it finances set up of R&D facilities, and undertaking pre-investment studies, prototypes and pilot projects to incorporate new production processes. It covers up to 50 percent of technological innovation project costs and provides financing for projects related to technology transfer, technology innovation, technology infrastructure and management traininghechnology transfer centers. In 2001, it executed 398,386 UF for its 1041 beneficiaries, covering an average of 59 percent of total project costs; a(Fondo de Desarrollo e Znnovacidn) is administered by C O W 0 and uses two tools: the co-financing of pre-competitive projects, and support for the creation of new businesses. Co-financing i s provided for the development and adoption of new technologies, technology diffusion and market perfection. Support for new business creation consists of promotion of national and international business alliances, as well as support for incubation programs and venture capital. In 2001, it supported 297 beneficiaries with 392,7 18 UF; 0 FONDEF is administered by CONICYT and is similar to the FDI. It aims to help create innovation by promoting links between research centers and firms. In2001, it executed 502,860 UF for its 44 beneficiaries, providing subsidies for capital goods, working capital and fees of technical consultants for selectedprojects; and 0 FAT(FondodeAsistencia Tkcnica)administered by CORFO, which aims to increasethe competitiveness of small business by co-financing consultants to help across a broad range of disciplines to integrate modern business management and new technologies in their productive processes. In2001, its 2761 beneficiaries received an averageof 110UF covering 36 percent of total costs. 45AlmeydaandDeL aBarra, 2002. 46There are others, suchas SENCE, PROCHILEandPROFO, which alsoprovidesupportas part of their support for training, exportsandbusinessdevelopment. 133 3.59. Detailed evaluation of the effectiveness of these programs was not within the terms of reference for this paper. However, recent work by Almeyda and De La Ba~-ra,~~shows that they generally receive a favorable rating among users (especially FAT). Yet, it also shows that many small firms are unaware of them, includinginthe context of e-businessadoption. Consequently, a much stronger effort may be merited to promote the use of these funds in connection with technology institutions and private business for building e-business capacity and for R&D to help lower the ICT complexity barrier to promote small business use.48 3.60. In addition, consideration should be given to indirect ways for the Government to help enable firms to engage in e-business adoption, such as use of fiscal incentives to help stimulate private venture capital. The Government of Australia, for example, has introduced venture capital-related initiatives aimed to improve SME access to equity. The COMET (Commercialising Emerging Technologies) program i s a competitive grant program, for individuals, early-stage growth firms and spin-off companies to improve their potential for successful commercialization. Also, the Government's PDF (Pooled Development Funds) program i s designed to increase the supply of equity capital by encouraging private companies (PDFs) to raise capital from investors to be invested as equity in Australian SMEs in exchange for shareholdersbeing taxed at lower rates on income generatedthrough PDF activities. 3.61. On another level, more effort should be expended to help the banking community to better assess and facilitate e-business development. In Canada, for example, the Business Development Bankof Canadafeatures on line e-businessdiagnostic tools to help firms assess the potential benefits of e-business and determine a firm's e-readiness. It also offers one-to-one consultation to develop and implement a customized e-business strategy, which also helps to improve financing decisions. Legal Framework 3.62. Although policies governing electronic transactions apply to firms of all sizes, certain areas are more vital than others to help extend e-business across the small business sector. These include strong efforts to reduce network infrastructure access costs; user-friendly regulations and wide dissemination of information on electronic transactions legislation; emphasis on measures to build trust and confidence in online transactions since small firms often lack strong brand name identificationamong consumers. 3.63. Chile's basic telecommunications infrastructure has improved network access a lot since privatization of the industry and the sector i s quite ~ompetitive.~'The fixed telephone network has been fully digitalized since 1993 and Chile was the first Latin American country to privatize its telecommunication sector. Chile's ICT trade policy i s the best in the Region, with free market access to ICT goods and services thanks to zero tariffs on PC and peripherals, and application of a uniform tariff of 7 percent on telecommunications equipment. Still, while telecom prices are cheaper than in most other countries in the region, small firms would be important beneficiaries 47Almeyda and De LaBarra, 2002. 48Agapitova and Holms-Nielsen, 2002; Mullen, 1999. 49See Chapter 2 of this report, "Chile's ICT Sector". 134 of additional steps to introduce flat-fee pricing, which encourages "always-on" use of the Internet, further telecom liberalization andprice reductions. 3.64. In January 2002, the Chilean Congress approved the bill establishing a framework for electronic transactions. This legislation (i) recognizes digital signatures, giving them the same legal status as hand-written ones, (ii) recognizes e-documents and e-contracts as legal, and (iii) defines the obligations of institutions providing electronic certification. With the emphasis now on implementation, consideration needs to be given to how to best simplify regulations to make them readily comprehensible to small business, the preparation of a simple guide to build small business confidence in this new framework, and to the design of a very broad dissemination strategy to promote maximumunderstanding and uptake by small business. 3.65. Reliable and low-cost authentication and certification mechanisms are especially important to small business to establish their online identity and confidentiality. At present, only about 12 percent of the web sites in Chile have privacy policies and 17 percent are secure sites (as compared with 51 percent and 39 percent, respectively in the United States and 31 percent and 16 percent inthe UnitedKingdom). Further, only 2 percent of sites inChile have electronic certification (versus 34 percent in the U S and 11percent in the UK),though this i s much higher inrelationto those sites doing electronic transactions (about 60 per~ent).~'InChile, e-certchile (Empresa Nacional de Certificacidn Electro'nica) was created by the Santiago Chamber of Commerce with the support of ACT1 (Asociacio'n Chilena de Empresas de Tecnologi'as de la Infomacidn) and C O W 0 and began in 2002 to offer certifications of identity and confidentiality based on international standards. It certifies web servers, email, and digital signatures of documents, andi s mutually recognizedby Cambersign, certifying entity inBrussels of the Chambers of Commerce of the European Union, and by the International Chambers of Commerce. Market deepening of trust seals, quality labels and the like will help to expand certification of compliance with a number of pre-established rules on honest business conduct and a good past record. In addition, Chile's 1999 privacy act, which includes coverage of the processing and use of personal data by government agencies and others, i s expected to be amended to provide a special section relating to e-commerce. Action on this initiative should receive a high priority and broad dissemination among the small business community to bolster confidence ine-businesstransactions. R&Dto Lower the ICT ComplexityBarrier 3.66. Innovative initiatives inChile to adapt digital applications (software, PDA, etc.) for low- income users are not readily apparent. Mainstream ICT systems have been designed almost wholly in the OECD markets, which are marked on average by better endowed physical capital andeducatedhuman capital than in economically developing markets. These designs generally do not reflect the capital mix of lower-income groups in such markets, including Chile, and so present major barriers to e-business adoption by small business. Even in OECD countries, such as Ireland, there are currently calls for technology providers to develop products and services that recognize the limited financial and ICT resources of small businesses where technology i s not a core business function. Although Chile does not represent a large mass market, it does provide a very good environment to develop and test new devices, such as applications drivenby 50Chile, CAmarade Comercio de Santiago, 2002. 135 voice and touch-screen recognition, simplified software to prepare business planning, market research marketing, and financial analyses, that can be readily learned and used by microbusiness inChile. 3.67. Additional research and development work should be undertaken to assess, for example, use of wireless technology to increase Internet access in rural areas; adaptation of training and software programs to the needs, budgets and skill levels of low-income communities; special interventions target youth for ICT training, who are quick learners with the longest productivity horizon; digital literacy and related training for under- or uneducated adult users and indigenous groups; and complementary investments in content in sectors relevant to the poor, such as agriculture, transport and small business. The Government should spearhead an e-business research and development program through incentives which engage Chile's local ICT industry and small business groups in the development and testing of innovations in ICT software, hardware andnetworking to produce affordable and applicable functionality and local content for smallbusiness. E-government for SmallBusiness 3.68. Business-related activities supportedby government electronic services have been shown inmany countries to have a strong positive effect on e-businessadoption by firms. They canbe grouped into 4 major types: (i) transactions, such as business registration and other interactive electronic forms, taxation and social security-related transactions; (ii) information provision, such as business and corporate legislation, local government information, building zoning, and information collection; (iii)government procurement; and (iv) government consultation activities, such as calling for inputs into new planning or zoning initiatives. The Chilean Government has been a strong promoter-through-demonstration of digital development in this area. The 2002 survey of ICT access and use of the Ministry of Economy shows that Internet use across firm size is heavily focused on accessing public services - particularly tax declarations and payments and obtaining business certificates (accessing account information with firms' banks i s the other prominent use).'' 3.69. Initiatives have involved www.compraschile.cl, the system of information on public purchases and contracting which operate with more than 100 public services in Chile.52 Companies that wish to do business with the public sector need only to register a single time in the areas in which they do business (e.g., office furniture, construction services, IT consulting, etc.). Whenever a public agency needs to purchase goods or contract a service, it will fill out a request in the electronic system, specifying the kind of operation and including all the documentation and information associated with the request. Automatically, the system sends an e-mail to all the private companies registered inthat selectedarea, minimizing responsetime and providing an equal opportunity for all firms. 3.70. The tax collection agency (Sewicio de Zmpuestos Znternos) has also been leading the public sector Internet-based services solutions. In 2000, it distributed free software through its www.sii.cl web site to facilitate preparation of annual income tax returns for 1999. As a result, Chile, Subsecretariade Economia, 2002. 52Orrego, Osorio, andMardones, 2000. 136 26 percent of all returns were delivered via the Internet; payment of income tax to the national Treasury via Internet has beenusedby nearly 50 percent of taxpayers. The customs services also operates wholly in electronic format. The Government has also been active in developing electronic services of more direct interest to small business. It has launched its businessone-stop window via its portal www.sitioemuresa.cl, which has information for business on more than 1,200 items and available at 130 state offices. It enables single-window access to 59 state procedures concerning business, employment and trade. 3.71. SERCOTEC also is developing content via www.redsercotec.com, which aims to support small business management, facilitate new business opportunities and encourage business networks by providing access to training courses, consulting services, management support, business publication, auto-diagnosis, publication of experiences, opinions in on-line forums, event marketing, interviews, etc.). Services provided by RedSercotec at no cost to the user include identification of business opportunities, training courses, self-diagnostic support and direct consulting. RedSercotec has so far served 3,342 businesses with training and Internet assistance. The site registered 70,35 1 visitors during 2000. It integrates services SENCE, MINECON, C O W 0 and other public and private institutions. Continued development of the portal i s planned, for example, to incorporate new services andpartnersthrough expansion of the network to universities, banks and other portals, increased marketing through newsletters and other forms. 3.72. In export development, ProChile's programs are oriented towards providing a better understanding of markets and management support and training, and include information services, export support services, and specific instruments. Applications-oriented services include "VideoNegocios" and "Inter-PYME'. VideoNegocios i s a tool that allows business transactions to be completed between two or more people over large distances. The technology allows for the exchange of documents, digital images and videos. Clients can be searched for through ProChile's commercial offices, and information on the exporter's product can be providedto foreign markets. The advantages of usingVideoNegocios include reduction of travel expenses, increased transaction and resolution speed, improved business image and improved relationships with clients, extend national and international coverage of the business. The service costs US$l50 per hour, and i s provided through ProChile offices in Santiago, Concepcibn, Talca, Rancagua y Antofagasta, and allows for contact with potential clients in major cities worldwide. Inter-PYME was developed by ProChile with the support of COW0 and through strategic alliances with management associations. The mission of InterPYME i s to provide small and medium businesses with the support necessary to begin exporting with minimumrisk and inan innovative manner, with the support of an expert providedby ProChile. The program has two phases: "pre-internationalization" and "internationalization". The first phase lasts two months, including 25 hours of tutoring, and results intwo products: (i) Diagnosis of business (2 weeks), and (ii) competitive analysis with technical assistance from CORFO. In 2001, it spent an average of 156UFper its 116beneficiaries. 3.73. Though the Chilean Government i s advanced in this field, benchmarking of experiences of countries that have emphasized the e-facilitation for small business operation could still be a useful step to enhance Chile's government electronic services in this area. A good example of this using a single access point to all government information and services i s Ireland's BASIS Project (Business Access to State Information and Services), operated by the Department of Enterprise Trade and Employment. The site explains a wide range of business life cycle 137 operational issues covering regulation in regard to importing and exporting, marketing and distribution support, online trading, licensing and permits for production, and trading laws and regulations; starting a business - techniques, sources of advice and funding; registration and startup, employment; and premises and the environment, planning and building permission, utilities and services, health and safety and environmental licenses. Similarly, in Scotland, Scottish Enterprise supports online services that have provided comprehensive information, advice, guidance and e-business support since 1997. E. Conclusions andRecommendations 3.74. E-business Progress. Overall e-business adoption in Chile is improving at a fairly rapid pace. Internet connectivity in Chile i s growing quickly. In 2001, it reached near universality among medium and large firms (93 percent and 97 percent of the total, respectively). Connectivity of micro and small firm, while showing marked lags (58 percent and 77 percent), has grown rapidly over the past two years. Chile has reached substantial parity with average OECD connectivity rates in all firm size categoriesexcept among microbusiness inwhich it lags. More pronounced gaps are found in web site development, in which the incidence of use by micro, small and mediumbusinesses in Chile (9-36 percent of all firms) i s markedly lower than the ranges for digitally advanced countries like Denmark, Germany and the United Kingdom (50-60 percent). Shallow digital integration inbusinessprocessesi s also reflected in the low use of specialized software applications for data and business management, as well as the low incidence of online transactions: 10-20 percent of small firms make online purchases (OECD comparators 20-60 percent) and 4-20 percent make online sales (OECD comparators 5-45 percent). 3.75. Constraints. Constraints to e-business development by small business are generally consistent with those observed in many OECD countries. Fundamentally, they depend upon the basic business environment affecting the propensity for innovation and investment. Other external factors are significant, such as network infrastructure services, the security of electronic transactions and local online content applicable to small business development. The most predominant constraints at the firm level to move small business along the e-business ladder involve awareness-building, skills development, access to ICT-based business services, and the financing of e-businessinnovation. The complexity of mainstream ICT systems also represents a substantial barrier to e-business adoption in Chile, as in many other countries, given the large low-income microbusiness sector. 3.76. Accelerating E-businessAdoption by Small Business. Chile's commitment to e-business adoption by the small business community i s evident. Its 2002-05 Agenda to advance this i s thematically comprehensive and consistent with those found in more digitally advanced countries. It rightly places basic responsibility for small business going digital with firms themselves, and reflects an effort to complement and not compete with the private sector. However, the focus, approach and dimensions of existing programs can be much improved in a number of instances to help accelerate the pace and coverage of e-business adoption in Chile. Fundamentally, this requires: Refining end-userfocus. A more targeted focus on the largest market that is least advancedine-businessadoption--micro and small businesses programs expanded and 138 adaptedto fit the profiles of MSBentrepreneurs, their businesstypes andpredominant sectors of activity; 4 Building BDS intermediary capacity. More emphasis should be given to building and networking the business development services capacity of intermediaries between Government and the enterprise levels to deliver e-business support services, focusing on trade associations, NGOs, universities and the ICT industry. This effort needs to be trained particularly on (i)awareness-building and training, particularly for management skills, (ii) and networking, particularly between small and large firms, (iii) access financing of e-business innovation, and (iv) adaptation of software functionality to lower the complexity barrier. Specific actions are discussedbelow; and 4 Improving regular monitoring and evaluation. More emphasis on mechanisms to ensure adequate data collection, monitoring and review at least annually by the Public-Private Committee on SmallBusiness of (i) progress inachieving the Government's Agenda, and (ii) effectivenessofpublicassistanceprogramstopromotee-business. the Awarenessand Training 3.77. Awareness-building on e-business benefits and training are crucial to help establish an understandingof how new technologies work and provide practical benefits, how to apply them to business processes, and how to find appropriate and independent sources of help to do so. A study by the University of Chile of businesses that were not using the Internet found that a full 61 percent of respondents could not identify the business benefits of digital technology. In OECD countries, this i s the most common form of e-businesspromotion activity. While Chile i s making significant efforts downstream to build access to digital tools through facilities and portals, its current efforts upstream to generate basic e-business awareness in these respects among the very large number of small businesses need to be strengthened through SENCE, C O W 0 and other local organizations. Closer working alliances should be formed on the following: 4 Success cases - better illustrate success cases of e-business adoption by Chilean small business. Initial CSS work is illuminatingand its value canbe increasedby looking more at how the interactivity of various e-business processes influence productivity and competitiveness andthe firmlevel and for specific sectors. Many sector analysesby now have been done by the OECD, the UK and Canada among others and can serve, among others, emerging good practices. 4 Information campaigns - expand information campaigns and workshops partnered with clusters and trade associations, and facilitate the exchange of experience peer-to-peer among small business entrepreneurs. Benchmarking awareness and training program designs with those of OECD leaders in this field, such as UK, Scotland, Sweden and Irelandwould be very useful for this purpose. 4 Training - focus training content on specific business requirements and management skills rather than simply on technology use; concentrate on business value added instead of simply "information search", and help entrepreneurs to integrate digital tools into their businesses. 139 Access andNetworking 3.78. The Government has undertaken several initiatives to build small business direct access to and use of ICT systems, notably the National Network of Infocenters and the www.Zonaemr>resas.cl marketing portal. However, much more deliberate effort is needed to make these Infocenters strong instruments to accelerate the rate of e-business adoption by small business, to extend their use to a larger segment of the sector, to adapt applications to individual client needs, to utilize e-business adoption to strengthen business networks, and to improve financial sustainability of services provision. For this purpose, the Government should help Infocenters to do the following: Content - develop more local and regional content relevant to small business and according to local demand, and training programs that promote good microbusiness practices. This can be facilitated by partnering with local trade associationsthat can help buildonline information exchange, e-procurement, on-line advice andthe like; Functionality - in partnership with private applications providers, develop specialized software and e-marketplaces that simplify computer functionality, help entrepreneurs enhance competitiveness of business processes and cut transaction costs, and focus on specific small businesssectors; Operating pe$omance -better measurethe performance of client services impact, client satisfaction and the operators and managers of Infocenters; Financial sustainability -develop service pricing and cost recovery policies which promote financial sustainability. FinancingE-businessInnovation 3.79. The primary public vehicles to encourage the financing of e-business innovation at the firm level are: FONTEC, FDI, FONDEF and FAT. A number of these programs receive a favorable rating among users (especially FAT), though many small firms seem to be unaware of them according to a recent survey. Stronger and more diversified efforts are needed to generate financing for e-business adoption by small businesses. These might include: Existing programs - better dissemination in awareness-raising and training programs on the availability of the Government's technology innovation funds for buildinge-business capacity and for R&D to help lower the ICT complexity barrier to use by small businesses; Venturecapital - Incentives for the mobilizationof private venture capital for individuals, early-stage growth firms and spin-off companies to improve their potential for successful commercialization; and Evaluation - Promotion among the banking community of online diagnostic and advisory tools to help firms assess the potential benefits of e-business, determine a firm's e- readiness, develop and implement customized e-business strategies; and help financial institutions to assess financing requests. 140 The LegalFramework 3.80. While policies and the legal framework governing network access and electronic transactions in Chile are quite well advanced, accelerating the e-business adoption rate by small business requires continued attention to: . Simplified regulations - Chile's legal framework for electronic transactions, approved in 2002, needs wherever possible to have simplified implementing regulations, to be explained in a simple guide and broadly disseminated to promote maximum understanding and uptake by small business; Certification - the Government's recent launch of "e-certchile" to certify the identification and confidentiality of a variety of electronic communications and . transactions should be followed by efforts to help deepen the market of trust seals, quality labels andthe like; and Privacy Act - expedite amendments to Chile's 1999 privacy act covering the use of personal data to make specific reference to e-business and make it a part of the communications campaign on the legal framework. R&Dto Lower the ICT Complexity Barrier 3.81. ICT devices have been designed almost wholly in and for OECD country markets; their complexity, in particular, often represents an important barrier to e-business adoption by low- income microbusinesses. Attempts to reduce this complexity have been limited to date. However, Chile offers a very good environment to develop and test new devices which can be readily reduce this barrier. The Government should take advantage of this opportunity for its own market as well as potentially export markets and undertake in cooperation with the local ICT industry and smallbusiness groups: . Benchmarking - such a program would benefit first by benchmarking innovative ICT . applications and delivery systems being piloted in other countries to increase low- income-business adoption. Local R&D - a research and development program to develop commercially viable applications and delivery systems, using, for example, voice and touch-screen recognition, hand-held devices, simplified business process software, for low-income microbusiness. E-government for Small Business 3.82. The Government already offers a number of electronic services which small business can use once it begins to climb the e-business ladder. These include a one-stop window on state procedures involving business employment and trade, online tax payments, and e-procurement. 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