1

COMPETITIVENESS, SCIENCE, TECHNOLOGY AND INNOVATION:

THE EXPERIENCE IN EL SALVADOR

Manuel HindsFebruary 2007

2

Agenda

1. The original conception 1995

a) The objectives

b) The economic framework c) The institutional reforms

1. The modernization of the state

2. Private sector competitiveness

2. The implementation

3. The outcomes

3

The original conception 1995

4

To compete…

• Not based on low wages

• But on true competitiveness, based on:

– Reducing all costs except wages

– Modernizing the state

– Modernizing the private sector

• Privatizing it • Turning El Salvador into an international services center

• The knowledge economy

• Pump priming the process

5

Reducing costs • Fiscal prudence: investment grade by 1997

• Macroeconomic stabilization: inflation at dollar levels by 1997

• Reduction of protection, including tariffs, from average 46% (80+ in the late 1980s) to 6% average

• Introducing full competition in strategic sectors where the government had monopoly

– Telecommunications: from 400,000 phones in 1998 to 4.5 million in 2006 (pop. 6 mill.)

– Electricity

• Privatizing telecom and electricity

• Reducing interest rates and increasing maturities to dollar levels

6

Modernizing the state

• Reducing the size of the state, in addition to privatizations

– First reduction of staff in the late 1990s, 16% of the staff

– Second stage in the early 2000s:

• Ministry of Public Works from 16,000 to 400

• Streamlining of strategic services

– Customs

– Investment procedures

7

Modernizing the private sector (1)

• Privatizing the private sector

– Fundamental and by far the most difficult

• Turning El Salvador into an international logistics center

– The only way to attain the volumes and quality of services needed to get

lower prices in many services

• Financial

• Transportation

• Distribution

8

Modernizing the private sector (2)

• The Knowledge economy

– Connectivity

• Aimed at improving the productivity of the economy • Three components

– Creation of a competitive telecom market before privatizing

– Telecenters (means)

– E-government (initial content)

– Technical schools (2004)

9

The implementation

10

Mixed implementation

Economic framework Largely successful

Modernization of the state

Streamlining of key institutions

Successful, sliding back

E-government Substantially planned till 2004, forgotten

Modernizing the private sector

Privatizing it Substantially, still 2 kinds of entrepreneurs

Logistics center Mixed implementation

Knowledge society Connectivity abandoned, technical centers

11

The outcomes

12

The Index of Economic Freedom

Wall Street Journal-Heritage Foundation Scores

ArgentinaBrazil

Chile

El Salvador

MexicoUruguay

Average LA

40

45

50

55

60

65

70

75

80

85

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

% o

f m

arke

t fr

eed

om

Closing gap with Chile, then sliding back

But still good at number 2 in Latin America

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In the Global Competitiveness Index, it was third in 2003, now it is fifth

Global Competitiveness Index 2006

3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0

Chile

Costa Rica

Panama

Mexico

El Salvador

Colombia

Brazil

Argentina

Uruguay

Peru

Guatemala

Republica Dominicana

Venezuela

Ecuador

Honduras

Nicaragua

Bolivia

Paraguay

14

The Salvadoran GCI, by activity

Score Place in Latin AmericaFirst Stage Overall competitiveness 3.51 5

Infrastructure 3.75 3Institutions 3.8 4Markets efficiency 4.32 4Macro 4.44 7

Second Stage Technical readiness 3.27 7Entrepreneurs sophistication 4.13 9Health and primary education 6.41 10Innovation 2.89 10Superior education and capacitation 3.51 11

15

Network readiness

Rank 2005

20 30 40 50 60 70 80 90 100 110 120

Chile

Brazil

Mexico

El Salvador

Colombia

Uruguay

Panama

Costa Rica

Argentina

Venezuela

Peru

Dominican Republic

Guatemala

Honduras

Ecuador

Bolivia

Nicaragua

Paraguay

SOURCE: World Economic Forum

16

The current problems

17

The political problem

• Who speaks passionately for STI among the political leaders of the developing countries?

• People talk about this in the leading developing regions

– East Asia, South Asia and Eastern Europe

• In the lagging countries, politics is moving against globalization, liberalization…

• And toward more state intervention

• These are the issues in:

– Latin America, with the resurgence of the radical left

– Middle East

– It has been the reality of Sub-Saharan Africa for most of the last forty or fifty years

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But the politicians…

• Are not the problem…

• They are the symptom

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The shape of society

• The new world that is emerging from Connectivity and STI is horizontal

• Developing societies are largely vertical

– For long their economies based on vertical structures:

• protection,

• cozy arrangements between the state and private persons,

• enormous powers vested on the bureaucracy

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A perplex and spoiled private sector

• Very common complaints in developing countries after liberalization:

– The government is not telling us what to do, what to plant, what to produce, at what prices

– The government is not giving us the incentives to invest

• Meaning that it is not offering subsidies and privileges, guaranteeing that they would never lose

• The skills of the old investors’ class are not adequate for the new world

– Their expertise was how to lobby the government to get privileges

• They are bound to disappear • But in the meantime they are still politically powerful

21

The natural allies of the old private investors in the lagging countries

• The politicians

– Who see a crucial source of patronage disappearing with liberalization

• The bureaucrats

– Who see their power diminishing radically as the government renounces to its ability to control the economy

• The general public

– In these countries, they have captured the support of the general public

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What should be done?

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First and foremost…

• This is about convincing people

– Keep on doing it

– Show the evidence

– Remember that the single most important factor determining the success or failure of projects is the country’s ownership of the project

• Focus on the social side of it, building human capital

– Which is an equalizing activity

• Eventually, going back to the closed, paternalistic economies of the past will prove unsustainable

– The ideas to move into the future must be there,waiting

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Scale down operational objectives, though not long-term ambitions

• Emphasize the role of knowledge and innovation in creating value added…

– Not with rocket science but with simple cases that can be demonstrated in the reality of the country

• Rather than trying to transplant institutional settings from the developed to the developing countries

– Focus on the substance, not the form

– A project financing the use of universities to provide innovation to companies will soon fail if the university is incapable of producing any useful innovation

– Do not design projects that require a degree of institutional development that you don’t have

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Operationally, focus on pilot projects

• To generate an emulation effect

• Rather than on large projects, which can sink in bureaucratic incompetence

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El Salvador: data

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Exports performance: total exports growth

Exports of goods and services, 1992 = 1

0

1

2

3

4

5

6

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

19

92

= 1

Argentina

Bolivia

Brazil

Chile

Colombia

Costa Rica

Dominican Republic

Ecuador

El Salvador

Guatemala

Honduras

Latin America & Caribbean

Mexico

Nicaragua

Panama

Paraguay

Peru

Uruguay

Venezuela, RB

SOURCE: World Development Indicators, World Bank

28

Exports performance: Manufactures exports % of merchandise exports

Manufactures exports (% of merchandise exports)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

% o

f m

erc

han

dis

e e

xp

ort

s

Argentina

Bolivia

Brazil

Chile

Colombia

Costa Rica

Ecuador

El Salvador

Guatemala

Honduras

Latin America & Caribbean

Mexico

Nicaragua

Panama

Paraguay

Peru

Uruguay

Venezuela, RB

SOURCE: World Development Indicators, World Bank

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Exports performance: manufactured exports growth, 1992-2004

Manufactured exports

0

2

4

6

8

10

12

14

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

19

92

= 1

ARGENTINA

BOLIVIA

BRAZIL

CHILE

COLOMBIA

COSTA RICA

ECUADOR

EL SALVADOR

GUATEMALA

HONDURAS

MEXICO

NICARAGUA

PANAMA

PARAGUAY

PERU

URUGUAY

VENEZUELA, REP. BOL.

SOURCE: World Development Indicators, World Bank

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Growth performance: manufacturing value added, 1992-2004

Manufacturing, value added (current US$), 1992 = 1

0

0.5

1

1.5

2

2.5

3

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

19

92

= 1

Argentina

Bolivia

Brazil

Chile

Colombia

Costa Rica

Dominican Republic

Ecuador

El Salvador

Guatemala

Honduras

Latin America & Caribbean

Mexico

Nicaragua

Panama

Paraguay

Peru

Uruguay

Venezuela, RB

SOURCE: World Development Indicators, World Bank

31

Growth performance: GDP in real terms, 1992 = 1

Growth in real terms, 1992 = 1

1

1.1

1.2

1.3

1.4

1.5

1.6

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

GD

P a

t 2

00

0 D

oll

ars

(ch

an

ges e

qu

al

to t

ho

se o

f co

nsta

nt

do

mesti

c p

rices)

Brazil

El Salvador

Latin America & Caribbean

Mexico

Colombia

Argentina

SOURCE: World Development Indicators, World Bank

32

Growth performance: GDP in current PPP dollars, 1992 = 1

GDP Current PPP Dollars, 1992 = 1

0.9

1.1

1.3

1.5

1.7

1.9

2.1

2.3

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

19

92

= 1

Argentina

Brazil

Colombia

El Salvador

Latin America & Caribbean

Mexico

SOURCE: World Development Indicators, World Bank

33

Growth performance: GDP in current dollars, 1992 = 1

GDP Current Dollars, 1992 = 1

0

0.5

1

1.5

2

2.5

3

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

19

92

= 1

Argentina

Brazil

Colombia

El Salvador

Latin America & Caribbean

Mexico

SOURCE: World Development Indicators, World Bank

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The end of the interest rate discrimination

El Salvador: Interest rates in dollar equivalent

0%

5%

10%

15%

20%

25%

30%

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

DEPOSIT RATE COLONES

DEPOSIT RATE DOLLARS

LENDING RATE COLONES

LENDING RATE DOLLARS

El Salvador becomes investment grade

Dollarization

Source of basic data: International Financial Statistics of the IMF

35

The reduction of the spread between lending and deposit rates

ES & US: Spread lending / deposit rates

2.7%3.0%

0.3%0.7%

1.6%

8.4%

0%

2%

4%

6%

8%

10%

12%

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

US SPREAD LENDING / DEPOSIT

ES SPREAD LENDING / DEPOSITS

SPREAD ES / US

AVERAGE LATIN AMERICA WITHOUTBRAZIL

Dollarization El Salvador

Source of basic data: International Financial Statistics of the IMF